Rightside Group, Ltd.
RIGHTSIDE GROUP, LTD. (Form: 10-Q, Received: 08/09/2016 16:17:03)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

OR

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to              

Commission File: Number 001‑36262

 

RIGHTSIDE GROUP, LTD.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

32‑0415537

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

5808 Lake Washington Blvd. NE, Suite 300

Kirkland, WA 98033

(Address of principal executive offices)

(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   x     No   o

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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   o

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):

 

Large accelerated filer

 

o

  

Accelerated filer

 

x

 

 

 

 

Non-accelerated filer

 

o (Do not check if a smaller reporting company)

  

Smaller reporting company

 

o

 

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

As of August 4, 2016, there were approximately 19,305,711 shares of the registrant’s common stock outstanding.

 

 

 

 

 


 

RIGHTSIDE GROUP, LTD.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

 

PAGE

Part I. Financial Information

1

Item 1.

Financial Statements (Unaudited)

1

 

Balance Sheets

1

 

Statements of Operations and Comprehensive Loss

2

 

Statements of Cash Flows

3

 

Notes to Financial Statements

4

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

12

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

25

Item 4.

Controls and Procedures

26

Part II. Other Information 

27

Item 1.

Legal Proceedings

27

Item 1A.

Risk Factors

27

Item 6.

Exhibits and Financial Statement Schedules

54

SIGNATURES

55

EXHIBIT INDEX

56

 

 

 

 


 

PART I.  FINANCI AL INFORMATION

Item 1. Financial Statements (Unaudited)

Rightside Group, Ltd.

Balance Sheets

(In thousands, except per share amounts)

(Unaudited)

 

 

 

June 30,

 

 

December 31,

 

 

 

2016

 

 

2015

 

Assets

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

47,809

 

 

$

45,095

 

Accounts receivable, net

 

 

12,669

 

 

 

11,306

 

Prepaid expenses and other current assets

 

 

5,214

 

 

 

7,233

 

Deferred registration costs

 

 

77,915

 

 

 

75,435

 

Total current assets

 

 

143,607

 

 

 

139,069

 

Deferred registration costs, less current portion

 

 

16,298

 

 

 

15,700

 

Property and equipment, net

 

 

11,818

 

 

 

13,298

 

Intangible assets, net

 

 

52,371

 

 

 

54,328

 

Goodwill

 

 

103,042

 

 

 

103,042

 

gTLD deposits

 

 

2,540

 

 

 

8,139

 

Other assets

 

 

1,072

 

 

 

1,451

 

Total assets

 

$

330,748

 

 

$

335,027

 

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

Accounts payable

 

$

8,300

 

 

$

7,262

 

Accrued expenses and other current liabilities

 

 

20,262

 

 

 

24,591

 

Debt

 

 

1,500

 

 

 

1,500

 

Capital lease obligation

 

 

1,101

 

 

 

1,193

 

Deferred revenue

 

 

102,326

 

 

 

97,593

 

Total current liabilities

 

 

133,489

 

 

 

132,139

 

Deferred revenue, less current portion

 

 

21,158

 

 

 

20,487

 

Debt, less current portion

 

 

21,751

 

 

 

21,701

 

Capital lease obligation, less current portion

 

 

399

 

 

 

811

 

Deferred tax liabilities, net

 

 

15,003

 

 

 

15,477

 

Other liabilities

 

 

842

 

 

 

1,125

 

Total liabilities

 

 

192,642

 

 

 

191,740

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

 

Preferred stock, $0.0001 par value per share; 20,000 shares authorized

   Shares issued and outstanding: 0 and 0

 

 

 

 

 

 

Common stock, $0.0001 par value per share; 100,000 shares authorized

   Shares issued and outstanding: 19,300 and 19,099

 

 

2

 

 

 

2

 

Additional paid-in capital

 

 

149,873

 

 

 

147,475

 

Accumulated deficit

 

 

(11,769

)

 

 

(4,190

)

Total stockholders’ equity

 

 

138,106

 

 

 

143,287

 

Total liabilities and stockholders’ equity

 

$

330,748

 

 

$

335,027

 

 

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

 

 

-1-


 

Rightside Group, Ltd.

Statements of Operations and Comprehensive Loss

(In thousands, except per share amounts)

(Unaudited)

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Revenue

 

$

54,037

 

 

$

52,171

 

 

$

109,161

 

 

$

102,702

 

Cost of revenue (excluding depreciation and amortization)

 

 

40,695

 

 

 

40,330

 

 

 

82,615

 

 

 

79,287

 

Sales and marketing

 

 

2,706

 

 

 

2,533

 

 

 

5,344

 

 

 

5,027

 

Technology and development

 

 

4,741

 

 

 

5,267

 

 

 

10,625

 

 

 

10,382

 

General and administrative

 

 

5,280

 

 

 

4,904

 

 

 

10,204

 

 

 

9,887

 

Depreciation and amortization

 

 

4,203

 

 

 

4,094

 

 

 

8,249

 

 

 

8,080

 

(Gain) loss on other assets, net

 

 

(2,219

)

 

 

262

 

 

 

(2,218

)

 

 

(6,961

)

Interest expense

 

 

1,218

 

 

 

1,226

 

 

 

2,453

 

 

 

2,470

 

Other income, net

 

 

(41

)

 

 

(44

)

 

 

(90

)

 

 

(2

)

Loss before income tax

 

 

(2,546

)

 

 

(6,401

)

 

 

(8,021

)

 

 

(5,468

)

Income tax benefit

 

 

(75

)

 

 

(728

)

 

 

(443

)

 

 

(1,671

)

Net and comprehensive loss

 

$

(2,471

)

 

$

(5,673

)

 

$

(7,578

)

 

$

(3,797

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss per share attributable to common stockholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.13

)

 

$

(0.30

)

 

$

(0.39

)

 

$

(0.20

)

Diluted

 

 

(0.13

)

 

 

(0.30

)

 

 

(0.39

)

 

 

(0.20

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

19,247

 

 

 

18,805

 

 

 

19,197

 

 

 

18,755

 

Diluted

 

 

19,247

 

 

 

18,805

 

 

 

19,197

 

 

 

18,755

 

 

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

 

 

-2-


 

Rightside Group, Ltd.

Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2016

 

 

2015

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(7,578

)

 

$

(3,797

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

8,249

 

 

 

8,080

 

Amortization of discount and issuance costs on debt

 

 

899

 

 

 

937

 

Deferred income taxes

 

 

(443

)

 

 

(1,671

)

Stock-based compensation expense

 

 

3,096

 

 

 

3,137

 

Gain on gTLD application withdrawals, net

 

 

(1,113

)

 

 

(6,961

)

Gain on sale of assets

 

 

(1,105

)

 

 

 

Other

 

 

13

 

 

 

(140

)

Change in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(1,382

)

 

 

(858

)

Prepaid expenses and other current assets

 

 

1,269

 

 

 

(690

)

Deferred registration costs

 

 

(3,079

)

 

 

(4,953

)

Other long-term assets

 

 

49

 

 

 

(470

)

Accounts payable

 

 

1,038

 

 

 

672

 

Accrued expenses and other liabilities

 

 

(4,899

)

 

 

1,343

 

Deferred revenue

 

 

5,405

 

 

 

8,211

 

Net cash provided by operating activities

 

 

419

 

 

 

2,840

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(1,758

)

 

 

(2,761

)

Purchases of intangible assets

 

 

(406

)

 

 

(972

)

Payments, deposits and returns of deposits for gTLD applications

 

 

3,119

 

 

 

(10,018

)

Proceeds from gTLD withdrawals

 

 

1,250

 

 

 

7,160

 

Proceeds from repayment of note receivable

 

 

750

 

 

 

1,500

 

Proceeds from sales of assets

 

 

1,105

 

 

 

 

Other

 

 

187

 

 

 

194

 

Net cash provided by (used in) investing activities

 

 

4,247

 

 

 

(4,897

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Principal payments on capital lease obligations

 

 

(503

)

 

 

 

Principal payments on debt

 

 

(750

)

 

 

(750

)

Proceeds from stock option exercises

 

 

4

 

 

 

46

 

Minimum tax withholding on restricted stock awards

 

 

(703

)

 

 

(572

)

Net cash used in financing activities

 

 

(1,952

)

 

 

(1,276

)

Change in cash and cash equivalents

 

 

2,714

 

 

 

(3,333

)

Cash and cash equivalents, beginning of period

 

 

45,095

 

 

 

49,743

 

Cash and cash equivalents, end of period

 

$

47,809

 

 

$

46,410

 

 

 

 

 

 

 

 

 

 

Supplemental disclosure of cash flows

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

1,484

 

 

$

1,519

 

Cash paid for income taxes

 

 

78

 

 

 

41

 

 

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

 

 

-3-


 

Rightside Group, Ltd.

Notes to Financial Statements

(Unaudited)

 

1.  Company Background and Basis of Presentation

Description of Business

Rightside Group, Ltd. (together with its subsidiaries, “Rightside,” the “Company,” “our,” “we,” or “us”) provides domain name registration and related value‑added service subscriptions to third parties. We are also an accredited registry for new generic Top Level Domains (“gTLDs”) made available by the expansion of new gTLDs (the “New gTLD Program”) by the Internet Corporation for Assigned Names and Numbers (“ICANN”).

Basis of Presentation

Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). All significant intercompany accounts and transactions have been eliminated in consolidation. We will refer to our consolidated financial statements as “financial statements,” “balance sheets,” “statements of operations and comprehensive loss,” and “statements of cash flows” herein.

We had no significant components of other comprehensive income (loss) during any of the periods presented, as such, a separate consolidated statement of comprehensive income (loss) is not presented. In addition, we had no significant changes in equity, as such, a consolidated statement of stockholders’ equity is not presented.

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, consisting of normal recurring adjustments and accruals, necessary for the fair presentation of our financial statements. The results for the three and six months ended June 30, 2016 are not necessarily indicative of the results expected for the full year.

The unaudited interim 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 11, 2016.

Reclassifications

Certain amounts previously presented for prior periods have been reclassified to conform to current presentation. These reclassifications did not affect consolidated net income, cash flows, or equity for the years presented.

We reclassified $1.6 million of other assets, representing debt issue costs, to noncurrent debt on our balance sheets as of December 31, 2015, in accordance with our retrospective adoption of the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Update (“ASU”) 2015-03. We also reclassified $0.7 million of prepaid expenses and other current assets to the current portion of deferred revenue on our balance sheets as of December 31, 2015.

 

 

2.  Summary of Significant Accounting Policies and Accounting Pronouncements

Refer to our audited financial statements included in our Form 10-K as filed with the SEC on March 11, 2016, for a complete discussion of all significant accounting policies.

-4-


 

Adoption of New Accounting Pronouncements

In April 2015, the FASB issued ASU No. 2015-05,  “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.”  The new standard provided guidance to customers about whether a cloud computing arrangement included 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 did not change a customer’s accounting for service contracts. We adopted ASU 2015-05 prospectively on January 1, 2016 with no material impact on our financial statements. 

In April 2015, the FASB issued ASU 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The new standard required 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 as an asset, consistent with debt discounts. Debt disclosures include the face amount of the debt liability and the effective interest rate. We adopted this standard retrospectively on January 1, 2016. As of December 31, 2015, we reclassified $1.6 million of debt issuance costs from an other asset to a direct reduction of the carrying amount of debt liability on our balance sheets.  In August 2015, the FASB issued ASU 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements.” The new standard clarified the SEC staff’s position on debt issuance costs in connection with line of credit arrangements from ASU 2015-03. The SEC staff would not object to presenting debt issuance costs as an asset if they were incurred before a debt liability is recognized or if they were associated with revolving debt arrangements. We adopted this standard on January 1, 2016. As of December 31, 2015, we ha d $0.3 million of debt issuance costs that remained classified as an other asset on our balance sheets because it is related to our line of credit agreement .

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 GAAP concept of extraordinary items. It instead requires transactions that are unusual, infrequent or both to be presented as a separate component of income from continuing operations or, alternatively, disclosed in the notes to the financial statements. We adopted ASU 2015-01 prospectively on January 1, 2016.  See Note 4 – gTLD Deposits for further information.

Accounting Pronouncements Not Yet Adopted

In June 2016, the FASB issued ASU 2016-13, “ Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments .” The new standard replaces the current incurred loss impairment methodology with one that reflects expected credit losses and utilizes a broader range of information to make credit loss estimates. The new standard is effective for interim and annual reporting periods beginning after December 15, 2019 with early adoption permitted. We do not expect the adoption of ASU 2016-13 to have a significant impact on our financial statements.

In March 2016, the FASB issued ASU 2016-09, “Compensation Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” which is intended to simplify several aspects of share-based payment accounting. The new standard requires entities to recognize income tax effects of share-based payments at settlement through the income statement. The new standard allows entities to withhold up to the employee’s maximum individual statutory tax rate without classifying the awards as a liability, and allows entities to make a policy election to recognize forfeitures when they occur. It also affects the classification in the statements of cash flows. The new standard is effective for interim and annual reporting periods beginning after December 15, 2016 with early adoption permitted. We are assessing the impact of ASU 2016-09 on our financial statements, and have not determined the timing or impact of the adoption.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which increases transparency and comparability for lease transactions. The new standard brings substantially all leases on the balance sheets for operating lease arrangements with lease terms greater than 12 months for lessees. This standard will require a modified retrospective application, which includes a number of optional practical expedients related to the

-5-


 

identif ication and classification of leases commenced before the effective date. The new standard is effective for interim and annual reporting periods beginning after December 15, 2018 with early adoption permitted. We are assessing the impact of ASU 2016-02 on our financial statements, and have not determined the timing or impact of the adoption.

In May 2014, the FASB issued ASU 2014‑09, “ Revenue from Contracts with Customers (Topic 606 ).” ASU 2014-09 provides new criteria for recognizing revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which an entity expects to be entitled in exchange for those goods or services. It also 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. ASU 2014-09 was set to be effective for interim and annual periods beginning after December 15, 2016. In August 2015, the FASB issued ASU 2015-14, “ Deferral of the Effective Date,” which changed the effective date to interim and annual periods beginning after December 15, 2017, with early adoption permitted as of the original effective date. In March 2016, the FASB issued ASU 2016-08, “ Principal versus Agent Considerations (Reporting Revenue Gross versus Net) ,” which clarifies the implementation guidance on determining the proper unit of account and applying the control principle. In April 2016, the FASB issued ASU 2016-10, “ Identifying Performance Obligations and Licensing ,” which clarifies the implementation guidance on identifying when a performance obligation has been satisfied and determining how to recognize revenue when an entity grants a license to use or access its intellectual property. In May 2016, the FASB issued ASU 2016-12, “ Narrow-Scope Improvements and Practical Expedients,” which aims to reduce the risk of diversity in practice for certain aspects of Topic 606, including collectibility, noncash consideration, presentation of sales tax, and transition. The new standard may be applied retrospectively to each prior period presented or as a cumulative-effect adjustment recognized as of the date of adoption. We do not intend to adopt the standard early and are currently assessing the provisions of the new standard. We have not determined the transition method or impact of the adoption on our financial statements.

 

 

3.  Intangible Assets

Intangible assets consisted of the following (in thousands):

 

 

 

June 30, 2016

 

 

December 31, 2015

 

 

 

Gross

 

 

 

 

 

 

 

 

 

 

Gross

 

 

 

 

 

 

 

 

 

 

 

carrying

 

 

Accumulated

 

 

 

 

 

 

carrying

 

 

Accumulated

 

 

 

 

 

 

 

amount

 

 

amortization

 

 

Net

 

 

amount

 

 

amortization

 

 

Net

 

Owned website names

 

$

14,273

 

 

$

(11,473

)

 

$

2,800

 

 

$

14,977

 

 

$

(11,628

)

 

$

3,349

 

Customer relationships

 

 

20,842

 

 

 

(20,152

)

 

 

690

 

 

 

20,842

 

 

 

(19,515

)

 

 

1,327

 

Technology

 

 

7,953

 

 

 

(7,943

)

 

 

10

 

 

 

7,953

 

 

 

(7,934

)

 

 

19

 

Non-compete agreements

 

 

207

 

 

 

(143

)

 

 

64

 

 

 

207

 

 

 

(122

)

 

 

85

 

Trade names

 

 

5,466

 

 

 

(2,624

)

 

 

2,842

 

 

 

5,466

 

 

 

(2,465

)

 

 

3,001

 

gTLDs

 

 

54,348

 

 

 

(8,383

)

 

 

45,965

 

 

 

51,988

 

 

 

(5,441

)

 

 

46,547

 

Total

 

$

103,089

 

 

$

(50,718

)

 

$

52,371

 

 

$

101,433

 

 

$

(47,105

)

 

$

54,328

 

 

Amortization expense of intangible assets was $2.5 million for both of the three months ended June 30, 2016 and 2015, respectively, and $4.8 million for both of the six months ended June 30, 2016 and 2015, respectively.

 

-6-


 

Estimated future amortization expense related to intangible assets held as of June 30, 2016 (in thousands) :

 

Years Ending December 31,

 

Amount

 

2016 (July 1, 2016 to December 31, 2016)

 

$

4,240

 

2017

 

 

6,808

 

2018

 

 

6,630

 

2019

 

 

6,321

 

2020

 

 

6,078

 

Thereafter

 

 

22,294

 

Total

 

$

52,371

 

 

 

4.  gTLD Deposits

As of June 30, 2016 and December 31, 2015, our gTLD deposits were $2.5 million and $8.1 million, respectively.  During the six months ended June 30, 2016, we received $3.1 million related to the settlement of certain gTLD applications under the New gTLD Program. Payments and deposits 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 withdrawal of our interest in certain gTLD applications resulted in a net gain of $1.1 million for the three months ended June 30, 2016, and the settlement of our interest in certain gTLD applications resulted in a net loss of $0.3 million for the three months ended June 30, 2015. The withdrawal of our interest in certain gTLD applications resulted in a net gain of $1.1 million and a net gain of $7.0 million for the six months ended June 30, 2016 and 2015, respectively. We recorded these gains and losses in (gain) loss on other assets, net, on the statements of operations and comprehensive loss.

 

In April 2016, we sold the majority of our non-core registrar credentials. Registrars are required to be accredited by ICANN in order to register domain names. The registrar credentials that were sold were mainly used to increase our ability to register newly deleted domain names the instant they became available. They were part of a business on which we are no longer focusing. Instead, we continue to focus on utilizing alternative channels to obtain domain names for our Aftermarket business. The sale of these credentials resulted in a net gain of $1.1 million for the three and six months ended June 30, 2016. We recorded this gain in (gain) loss on other assets, net, on the statements of operations and comprehensive loss.

 

 

5.  Other Balance Sheet Items

 

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

 

 

 

June 30,

 

 

December 31,

 

 

 

2016

 

 

2015

 

Prepaid expenses

 

$

3,204

 

 

$

3,167

 

Prepaid registry fees

 

 

2,000

 

 

 

3,306

 

Note receivable

 

 

10

 

 

 

760

 

Prepaid expenses and other current assets

 

$

5,214

 

 

$

7,233

 

 

Namecheap Senior Unsecured Promissory Note Receivable

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. In January 2016, we entered into Amendment No. 4 of Senior Unsecured Promissory Note, which extended the maturity date of the Note receivable to June 30, 2016. As of December 31, 2015, the outstanding balance on the Note receivable was

-7-


 

$750,000. During the six months ended June 30, 2016, Namecheap made four principal payments totaling $750,000. There was no ba lance that remained outstanding on the Note receivable as of June 30, 2016.

 

 

6.  Debt

Silicon Valley Bank Credit Facility

In March 2016, we entered into Amendment No. 3 to Credit Agreement (“Amendment”) with Silicon Valley Bank. The Amendment revises the terms of our existing Credit Agreement (“SVB Credit Facility”). The Amendment revises the financial condition covenants, including the consolidated net leverage ratio, minimum liquidity ratio, and minimum consolidated EBITDA. The Amendment removes the consolidated fixed charge coverage ratio, consolidated senior leverage ratio and minimum liquidity. Additionally, the Amendment approves a one-time distribution of $10.0 million for the partial prepayment of our term loan with Tennenbaum Capital Partners LLC. As of June 30, 2016, we were in compliance with all covenants.

 

 

7.  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 proceeding to which we are a party that, in our belief, could have a material adverse effect on our future financial results.

 

 

8.  Income Taxes

Our effective tax rate differs from the U.S. Federal statutory rate primarily as a result of state taxes, non-deductible stock option expenses and implementing a domestic valuation allowance. The effective tax rate was 2.9% and 11.4% for the three months ended June 30, 2016 and 2015, respectively, and was 5.5% and 30.6% for the six months ended June 30, 2016 and 2015, respectively.

We recorded an income tax benefit of $0.1 million during three months ended June 30, 2016, compared to $0.7 million during the same period in 2015. The decreased benefit was primarily due to an increase in stock-based compensation shortfall and the impact of implementing a valuation allowance on projected excess deferred tax assets in the current period.

We recorded an income tax benefit of $0.4 million during the six months ended June 30, 2016, compared to $1.7 million during the same period in 2015. The decreased benefit was primarily due to an increase in stock-based compensation shortfall and the impact of implementing a valuation allowance on projected excess deferred tax assets in the current period.

We currently have a net deferred tax liability related to our U.S. activities. However, projected future growth in our deferred tax assets indicates that we will have net deferred tax assets in the U.S. by the end of the current year, which will require a valuation allowance as it is more likely than not that those net deferred tax assets will not be realized. When calculating the annual effective income tax rate for the three and six months ended June 30, 2016, we have included the anticipated valuation allowance in the effective tax rate to ensure that the tax benefit recorded on the year-to-date losses would not exceed the amount expected to be generated during the current year.

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 flows.

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, 2016 or 2015, and we do not expect our uncertain tax position to change materially during the next 12 months. We file a U.S. federal tax

-8-


 

return as well as tax returns in many states and multiple foreign jurisdictions. All tax years since our incorporation remain subject to examination by the Internal Revenue Service and various state authorities.

 

 

9.  Fair Value of Financial Instruments

We measure our financial assets and liabilities in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

 

·

Level 1—valuations for assets and liabilities traded in active exchange markets, or interest in open‑end mutual funds that allow a company to sell its ownership interest back at net asset value on a daily basis. Valuations are obtained from readily available pricing sources for market transactions involving identical assets, liabilities or funds.

 

·

Level 2—valuations for assets and liabilities traded in less active dealer, or broker markets, such as quoted prices for similar assets or liabilities or quoted prices in markets that are not active. Level 2 includes U.S. Treasury, U.S. government and agency debt securities, and certain corporate obligations. Valuations are usually obtained from third-party pricing services for identical or comparable assets or liabilities.

 

·

Level 3—valuations for assets and liabilities that are derived from other valuation methodologies, such as option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

Financial assets and financial liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and consider counterparty credit risk in our assessment of fair value. Our assessment of the significance of a particular input to the fair value measurements requires judgment, and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy.

Assets and liabilities not carried at fair value in our financial statements, but for which the fair value is disclosed, are summarized below (in thousands):

 

 

 

Carrying

 

 

Fair Value Measurement Using

 

 

Total

 

As of June 30, 2016

 

Value

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Fair Value

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note receivable

 

$

10

 

 

$

 

 

$

 

 

$

10

 

 

$

10

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt

 

$

23,251

 

 

$

 

 

$

 

 

$

30,324

 

 

$

30,324

 

 

 

 

Carrying

 

 

Fair Value Measurement Using

 

 

Total

 

As of December 31, 2015

 

Value

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Fair Value

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note receivable

 

$

760

 

 

$

 

 

$

 

 

$

760

 

 

$

760

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt

 

$

23,201

 

 

$

 

 

$

 

 

$

31,489

 

 

$

31,489

 

Our note receivable is short-term in nature and its carrying value approximates fair value. This is classified as a Level 3 measurement.

The fair value of our debt is estimated based on the discounted cash flow approach, using the current cost of debt available to us with similar loan terms and remaining maturities. As of June 30, 2016, the current cost of debt available to us was 6%. Because these estimates utilize significant unobservable inputs, we classify our debt as a Level 3 measurement.

-9-


 

The current cost of debt is considered a significant unobservable input used in the fair value measurement of our debt. This significant unobservable input would have a direct imp act on the fair value of our debt if it were adjusted. Consequently, significant increases or decreases in the cost of debt would result in a significantly higher or lower fair value. At June 30, 2016 and December 31, 2015, a hypothetical 10% increase or d ecrease in the cost of debt would change the fair value of our debt, classified as Level 3 within the fair value hierarchy, by $0.4 million and $0.5 million, respectively.  

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

 

 

 

Amount

 

Balance as of December 31, 2015

 

$

31,489

 

Principal and interest payments on debt

 

 

(2,036

)

Change in fair value of future payments on debt

 

 

871

 

Balance as of June 30, 2016

 

$

30,324

 

The following table presents a reconciliation of our note receivable measured at fair value using unobservable inputs (Level 3) (in thousands):

 

 

 

Amount

 

Balance as of December 31, 2015

 

$

760

 

Repayments on note receivable

 

 

(750

)

Balance as of June 30, 2016

 

$

10

 

 

 

10.  Business Segments

We follow the authoritative literature that established annual and interim reporting standards for an entity’s operating segments and related disclosures about its products and services, geographic regions and major customers. We operate in one operating segment. Our chief operating decision maker (“CODM”) manages our operations on a global 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 global 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):

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Registrar services

 

$

44,157

 

 

$

43,281

 

 

$

88,175

 

 

$

85,280

 

Registry services

 

 

2,932

 

 

 

1,925

 

 

 

5,571

 

 

 

3,530

 

Aftermarket and other

 

 

7,839

 

 

 

7,544

 

 

 

17,108

 

 

 

14,876

 

Eliminations

 

 

(891

)

 

 

(579

)

 

 

(1,693

)

 

 

(984

)

Total revenue

 

$

54,037

 

 

$

52,171

 

 

$

109,161

 

 

$

102,702

 

 

Amounts in the eliminations line reflect the elimination of intercompany charges between our Registrar and Registry services businesses.

-10-


 

Revenue by geographic lo cation is as follows (in thousands):

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

United States

 

$

39,294

 

 

$

37,828

 

 

$

79,723

 

 

$

74,440

 

International

 

 

14,743

 

 

 

14,343

 

 

 

29,438

 

 

 

28,262

 

Total

 

$

54,037

 

 

$

52,171

 

 

$

109,161

 

 

$

102,702

 

 

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

 

 

11.  Loss Per Share

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

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30,

 

 

June 30,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Net loss

 

$

(2,471

)

 

$

(5,673

)

 

$

(7,578

)

 

$

(3,797

)

Weighted average number of shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

19,247

 

 

 

18,805

 

 

 

19,197

 

 

 

18,755

 

Diluted

 

 

19,247

 

 

 

18,805

 

 

 

19,197

 

 

 

18,755

 

Net loss per share attributable to common stockholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.13

)

 

$

(0.30

)

 

$

(0.39

)

 

$

(0.20

)

Diluted

 

 

(0.13

)

 

 

(0.30

)

 

 

(0.39

)

 

 

(0.20

)

 

For the three months ended June 30, 2016 and 2015, we excluded approximately 224 thousand and 79 thousand shares, respectively, of restricted stock units and stock options from the calculation of diluted weighted average shares outstanding as their inclusion would have been antidilutive. For the six months ended June 30, 2016 and 2015, we excluded approximately 169 thousand and 36 thousand shares, respectively, 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. 

 

 

-11-


 

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:

 

·

our future operating results, including our expectations regarding total revenue, operating margins and net loss;

 

·

trends in sales, marketing, technology, development and general and administrative expenses as a percentage of our revenue;

 

·

our ability to develop, maintain and grow significant market share for our gTLDs in a competitive environment;

 

·

our ability to attract new wholesale and retail customers and to retain existing customers;

 

·

the implementation of our business model and strategic plans for our business, including our ability to improve margin structure through pricing optimization and cost reduction initiatives ;

 

·

our expectations regarding the level of consumer demand for new generic Top Level Domains (“gTLDs”) and our ability to capitalize on this demand;

 

·

legal, regulatory, accounting and tax developments, including additional requirements imposed by changes in federal, state or foreign laws and regulations;

 

·

our strategic relationships, including with the Internet Corporation for Assigned Names and Numbers (“ICANN”);

 

·

our ability to enter into and maintain agreements on favorable terms with commercial partners, including with registry operators, service providers and distributors;

 

·

our ability to effectively manage our growth;

 

·

our ability to enhance our existing products and services and introduce new products and services;

 

·

our ability to evaluate and respond to unsolicited proposals to acquire certain of our assets;

 

·

our ability to adequately protect our intellectual property rights;

 

·

our ability to timely and effectively maintain, scale and adapt our existing technology and network infrastructure and security ;

 

·

our ability to retain key personnel, attract qualified officers and directors and hire key personnel ; and

 

·

the impact of actions by stockholder activists .

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

-12-


 

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. 

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited interim consolidated 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, 2016, compared to the same periods in 2015, we refer to the prior periods as “2015.”

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 approximately 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 335,000 customers. As of June 30, 2016, we had approximately 16.6 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 40 gTLDs acquired from ICANN’s New gTLD Program. To date, we have launched 39 of our gTLDs into the market, including .NEWS, .ROCKS and .LIVE. In May 2016, we acquired the exclusive registry operator rights to .GAMES, which we plan to launch in the third quarter of 2016. Our registry services business continues to build a diverse distribution network of over 125 ICANN accredited registrars, including eNom, Name.com and GoDaddy, as well as other complementary distribution partners such as website builders and email service providers, that offer our gTLD domain names to businesses and consumers. Furthermore, our distribution network includes registrars and other partners in international markets, positioning our company to capture additional sales on a global scale. In addition to operating our own registry, we provide technical back-end infrastructure services to Donuts Inc. (“Donuts”), a third-party operator of new gTLDs (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.

-13-


 

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 re curring revenue and positive operating cash flows.   

Second Quarter Highlights

Below are our key highlights as of and for the three months ended June 30, 2016. All comparisons are relative to the fiscal second quarter 2015.

 

·

Total revenue increased to $54.0 million from $52.2 million.

 

·

Registry services revenue increased 52% to $2.9 million from $1.9 million.

 

·

Net loss was $2.5 million compared to net loss of $5.7 million.

 

·

Adjusted earnings before interest, income taxes, depreciation and amortization (“Adjusted EBITDA”), a non-GAAP financial measure, was $2.3 million compared to $0.8 million.

 

·

Cash and cash equivalents were $47.8 million.

 

·

Gain (loss) on other assets, net was $2.2 million representing the gain on withdrawals of our interest in gTLD applications and the sale of our non-core registrar credentials.

Opportunities, Challenges and Risks

The majority 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 strong growth in Name.com, our 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 accounted for 27% and 29% of our consolidated revenue for the three months ended June 30, 2016 and 2015, respectively, and 28% and 27% of our consolidated revenue for the six months ended June 30, 2016 and 2015, respectively. We also generate advertising revenue through our monetization platform for websites or domain names that we or our customers own. Going forward, we expect the revenue associated with these websites to remain relatively flat with low traffic and advertising yields in the marketplace.

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 services revenue since launch. For the three months ended June 30, 2016 and 2015, our revenue from our Registry services was $2.9 million and $1.9 million, respectively, and $5.6 million and $3.5 million for the six months ended June 30, 2016 and 2015, respectively.

We received returns of deposits of $3.1 million and we made payments and deposits of $10.0 million for the six months ended June 30, 2016 and 2015, respectively, for gTLD applications under the New gTLD Program. These payments and deposits 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 on the balance sheets. 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 withdraw 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

-14-


 

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 for the three and six months ended June 30, 2016 compared to the same period in 2015.

Our marketing expense has grown in recent years as we have promoted 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.

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. In addition, we are driving initiatives in the area of price optimization and other operating cost reduction programs that we believe will further expand our direct profit in the registrar services business.

Registrar Services Operating Metrics

We review a number of business metrics, including the following key metrics, to evaluate our Registrar services 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:

 

·

Registrar services domain: We define a registrar services domain as an individual domain name registered by a third-party customer on Rightside’s registrar platforms for which Rightside has begun to recognize revenue.

 

·

Average revenue per domain (“ARPD”): We calculate ARPD by dividing registrar services revenue for a period by the average number of domains registered on Rightside’s registrar platforms in that period.  ARPD for partial year periods is annualized.

 

·

Renewal rate:   We define the renewal rate as the percentage of domain names on our registrar platform that are renewed after their original term expires.

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):

 

 

 

Three Months Ended

 

 

 

 

 

 

 

Six Months Ended

 

 

 

 

 

 

 

 

June 30,

 

 

 

 

 

 

 

June 30,

 

 

 

 

 

 

 

 

2016

 

 

2015

 

 

Change

 

 

 

2016

 

 

2015

 

 

Change

 

 

End of period registrar services domains

 

 

16.3

 

 

 

 

16.3

 

 

 

0.0

 

%

 

16.3

 

 

 

 

16.3

 

 

 

0.0

 

%

Average revenue per domain

 

 

$

10.82

 

 

 

$

10.66

 

 

 

1.5

 

%

 

$

10.84

 

 

 

$

10.58

 

 

 

2.5

 

%

Renewal rate

 

 

 

73.3

 

%

 

74.1

 

%

 

 

 

 

 

 

75.3

 

%

 

 

75.8

 

%

 

 

 

 

 

Average Revenue per Domain

The average revenue per domain for the three months ended June 30, 2016 increased 1.5% to $10.82 from $10.66 in 2015. The average revenue per domain for the six months ended June 30, 2016 increased 2.5% to $10.84 from $10.58 in 2015. The increase was due to an increasing mix of higher margin new gTLDs, which have an average selling price approximately three times that of legacy gTLDs.

-15-


 

Renewal Rate

The renewal rate for the three months ended June 30, 2016 was 73.3% compared to 74.1% in 2015. The decrease was primarily due to consolidation in the industry which drove transfers out of a few large portfolios with historically high renewal rates. The renewal rate for the six months ended June 30, 2016 has remained relatively flat compared to 2015.

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.

Our revenue also includes registration fees from our portfolio of 39 gTLDs in general availability for which we are the exclusive registry operator, as part of the gTLD Initiative. The amount as well as the timing of revenue is uncertain and is dependent upon the demand and level of user adoption of new gTLDs, the timing and number of our back‑end registry customers’ launches of 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-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 registrar 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.

-16-


 

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 technology and development expense will increase slightly in the near term as a percentage of revenue as we continue to invest in certain areas of our business.

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, but in the long term, we anticipate our general and administrative expenses will decline as a percentage of revenue.

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. We expect the depreciation of property and equipment to remain relatively flat in the near term.

Amortization expense consists of charges relating to the amortization of capitalized identifiable intangible assets from the acquisition of domain names, including initial registration costs, as well as costs to acquire gTLDs, and intangible assets acquired in connection with business combinations. 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 remain relatively flat in the near term.

(Gain) Loss on Other Assets, Net

(Gain) loss on other assets, net consists of gains and losses on withdrawals or settlement of costs related to our interest in certain gTLD applications, as well as other sales of assets. 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 transaction gains and losses on foreign currency‑denominated assets and liabilities, and interest income.

-17-


 

Income Tax Benefit

W