U.S.
SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form
10-Q





(Mark
One)





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







For the
quarterly period ended: August 31, 2008







|__|
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934








Commission
file number: 000-27225







DigitalTown, Inc.


(Name of
small business issuer in its charter)





Minnesota
            41-1427445(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification No.)11974 Portland Avenue,
      Burnsville, Minnesota
            55337(Address
      of principal executive offices)
            (Zip
      Code)Registrant's
      telephone number: (952)
      890-2362





Securities
registered under Section 12(g) of the Exchange Act:





Title of Each
Class


Common
Stock


Par Value
$0.01 per share














Check
whether the issuer (1) has filed all reports required to be filed by Section 13
or 15(d) of the Exchange Act during the past 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





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





Large
Accelerated Filer
[  ]                                                                           Accelerated
Filer
[  ]                                                      Non-Accelerated
Filer [  ]


Smaller
reporting company [X]





There
were 27,153,487 shares of the registrant’s common stock outstanding as of
September 30, 2008





ii















TABLE OF CONTENTS







PART
      IItem
      1.
            Financial Statements
            1-12Item
      2.
            Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
            13-17Item
      3.
            Quantitative and Qualitative Disclosures About Market
      Risk
            17Item4.
            Controls and Procedures
            17PART
      IIItem
      1.
            Legal Proceedings
            18Item
      1A.
            Risk Factors
            18Item
      2.
            Unregistered sales of Equity Securities and Use of
      Proceeds
            18Item
      3.
            Defaults Upon Senior Securities
            18Item
      4.
            Submission of Matters to a Vote of Security
      Holders
            18Item
      5.
            Other Information
            19Item
      6.
            Exhibits
            19










iii














PART
I





ITEM 1.  FINANCIAL STATEMENTS





PageFinancial
      Statements:Consolidated Balance Sheets
            1Consolidated Statements of Operations
            2Consolidated Statements of Cash Flows
            3Notes to Financial Statements
            4-12








Return
to Table of Contents





DigitalTown, Inc.


CONSOLIDATED
BALANCE SHEETS





ASSETSAugust
      31,
              2008
            
            
            February
      29,
              2008(unaudited)
            
            
            (audited)Current
      assets:Cash
            
            $
            221,043
            
            
            $
            67,161Other
      receivables
            
            
            -
            
            
            
            70,528Total
      current assets
            
            
            221,043
            
            
            
            137,689Property
      and equipment, net
            
            
            5,054
            
            
            
            6,737Intangible
      assets, net
            
            
            751,375
            
            
            
            602,194Total
      assets
            
            $
            977,472
            
            
            $
            746,620


LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            91,839
            
            
            $
            100,683Loan
      from director/stockholder
            
            
            145,000
            
            
            
            -Accrued
      expenses:Accrued
      payroll
            
            
            9,382
            
            
            
            14,301Accrued
      interest
            
            
            -
            
            
            
            11,156Total
      current liabilities
            
            
            246,221
            
            
            
            126,140Commitments
      and contingenciesStockholders’
      equity:Common
      stock, $.01 par value, 2,000,000,000 shares authorized, 27,153,487 and
      27,081,750 shares issued and outstanding at August 31, 2008
      and  February 29, 2008, respectively
            
            
            271,564
            
            
            
            270,812Additional
      paid-in-capital
            
            
            21,096,010
            
            
            
            19,737,494Subscription
      receivable
            
            
            (4,752,163
            )
            
            
            (5,030,795
            )Accumulated
      deficit
            
            
            (15,884,160
            )
            
            
            (14,357,031
            )Total
      stockholders’ equity
            
            
            731,251
            
            
            
            620,480Total
      liabilities and stockholders’ equity
            
            $
            977,472
            
            
            $
            746,620






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








Return
to Table of Contents
 1





DigitalTown, Inc


CONSOLIDATED
STATEMENTS OF OPERATIONS


For
      the Three Months Ended
            
            
            For
      the Six Months EndedAugust
      31,
            
            
            August
      31,2008
            
            
            2007
            
            
            2008
            
            
            2007(unaudited)
            
            
            (unaudited)
            
            
            (unaudited)
            
            
            (unaudited)Operating
      expenses:Selling,
      general and administrative expenses
            
            $
            619,085
            
            
            $
            1,236,532
            
            
            $
            1,522,396
            
            
            $
            1,777,465Loss
      from operations
            
            
            (619,085
            )
            
            
            (1,236,532
            )
            
            
            (1,522,396
            )
            
            
            (1,777,465
            )Other
      income (expense)Interest
      expense
            
            
            (3,326
            )
            
            
            (280
            )
            
            
            (5,082
            )
            
            
            (1,680
            )Other
      income
            
            
            285
            
            
            
            1,219
            
            
            
            349
            
            
            
            4,193Total
      other income (expense)
            
            
            (3,041
            )
            
            
            939
            
            
            
            (4,733
            )
            
            
            2,513Net
      loss before income taxes
            
            
            (622,126
            )
            
            
            (1,235,593
            )
            
            
            (1,527,129
            )
            
            
            (1,774,952
            )Income
      tax provision
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      loss
            
            $
            (622,125
            )
            
            $
            (1,235,593
            )
            
            $
            (1,527,129
            )
            
            $
            (1,774,952
            )Loss
      per common share – basic and diluted
            
            $
            (0.02
            )
            
            $
            (0.05
            )
            
            $
            (0.06
            )
            
            $
            (0.07
            )Weighted
      average common shares outstanding – basic and diluted
            
            
            27,104,077
            
            
            
            25,723,750
            
            
            
            27,093,684
            
            
            
            25,717,704







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








Return
to Table of Contents
 2





DigitalTown, Inc.


CONSOLIDATED
STATEMENT OF CASH FLOWS





Six
      months ended
              August
      31, 2008
            
            
            Six
      months ended
              August
      31, 2007(unaudited)
            
            
            (unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (1,527,129
            )
            
            $
            (1,774,952
            )Adjustments
      to reconcile net loss to net cash flows used in operating
      activities:Depreciation
            
            
            1,338
            
            
            
            788Stock
      based compensation expense
            
            
            1,171,740
            
            
            
            1,308,727Non-cash
      stock issued for services
            
            
            10,000
            
            
            
            50,063Gain
      on sale of asset
            
            
            (55
            )
            
            
            -Changes
      in operating assets and liabilities:Other
      receivables
            
            
            70,528
            
            
            
            971Accounts
      payable
            
            
            (39,844
            )
            
            
            43,677Accrued
      expenses:Accrued
      payroll
            
            
            (4,919
            )
            
            
            (7,373
            )Accrued
      interest
            
            
            (11,156
            )
            
            
            1,680Deferred
      officer compensation
            
            
            -
            
            
            
            6,885Net
      cash used in operating activities
            
            
            (329,497
            )
            
            
            (369,534
            )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of fixed assets
            
            
            -
            
            
            
            (3,956
            )Proceeds
      from sale of asset
            
            
            400
            
            
            
            -Purchase
      of intangible asset-website development
            
            
            -
            
            
            
            (25,000
            )Purchases
      and  renewal of  intangible assets – domain
      names
            
            
            (149,181
            )
            
            
            (72,884
            )Net
      cash used in investing activities
            
            
            (148,781
            )
            
            
            (101,840
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Advances
      from officer/stockholder
            
            
            -
            
            
            
            (16,354
            )Proceeds
      from loan – director/stockholder
            
            
            145,000
            
            
            
            -Note
      payable-shareholder
            
            
            -
            
            
            
            (70,000
            )Payments
      received on stockholder subscription receivables
            
            
            322,233
            
            
            
            568,000Proceeds
      from issuance of stock
            
            
            63,540
            
            
            
            -Proceeds
      from exercise of stock options
            
            
            101,387
            
            
            
            -Net
      cash provided by financing activities
            
            
            632,160
            
            
            
            481,646Net
      change in cash and cash equivalents
            
            
            153,882
            
            
            
            10,272Cash
      and cash equivalents, beginning of period
            
            
            67,161
            
            
            
            8,933Cash
      and cash equivalents, end of period
            
            $
            221,043
            
            
            $
            19,205SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Non-cash
      flow information:Cash
      payments for interest
            
            $
            16,238
            
            
            $
            -Intangible
      assets-domain name renewals incurred with accounts payable
            
            $
            -
            
            
            $
            142,720Accounts
      payable added back that were previously paid with stock and
              subsequently
      cancelled
            
            $
            31,000
            
            
            $
            -






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






Return
to Table of Contents
 3





DigitalTown, Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





Note 1. Nature of Business and
Summary of Significant Accounting Policies:





Nature of
Business





DigitalTown,
Inc (the “Company”) formed an advisory board to lead the next stages of
development for the Company as it constructs and integrates approximately 27,000
online communities into a social “civic and school spirit” network serving
students, alumni, schools, local towns and their citizens.  The
advisory board is made up of innovative leaders in the technology,
entertainment, sports and content fields who are affiliated with companies
deeply rooted in interactive media.  The advisory board members are
based in the greater Los Angeles area where the strategic planning and creative
development will generally take place.  This network, when complete,
will connect approximately 27,000 local online spirit sites formed around a town
and its high school and will include easy-to-use and free features such as
email, alumni communication and reunion tools, calendar and organizing tools for
boosters, personal profiles, photo, video and music sharing and timely community
news.  The Company owns the Internet domain names associated with all
of these high school communities.





The
Company has sustained losses and negative cash flows from operations and expects
these conditions to continue into the foreseeable future.  At August
31, 2008, the Company had an accumulated deficit of
$15,884,160.  Subsequent to August 31, 2008, the Company has received
cash proceeds totaling approximately $45,800 from its stock subscription
receivable.  The Company anticipates that existing cash, stock
subscription proceeds received to date, expected future proceeds from its stock
subscription receivables and any additional financing needed through the sale of
its common stock or other equity-based securities will be sufficient to meet its
working capital and capital expenditures needs through at least August 31,
2009.  In the event the Company is unable to obtain additional capital
in the future, we would be forced to reduce operating expenses and/or cease
operations altogether.





Basis of
Presentation





The accompanying unaudited consolidated
financial information has been prepared by the Company in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and the instructions to Form 10-Q and
Article 10 of Regulation S-X of the Securities and Exchange Commission
(SEC). Accordingly, it does not include all of the information and notes
required by accounting principles generally accepted in the United States of
America for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring adjustments) considered necessary
for a fair statement of this financial information have been included. Financial
results for the interim six-month period ended August 31, 2008 are not
necessarily indicative of the results that may be expected for the year
ending February 28, 2009. The February 29, 2008 consolidated balance
sheet was derived from audited financial statements, but does not include all
disclosures required by accounting principles generally accepted in the United
States of America. This financial information should be read in conjunction with
the consolidated financial statements and notes included in the company’s Annual
Report on Form 10-K for the year ended February 29, 2008.







Return
to Table of Contents
 4





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





Principles of
Consolidation





The
Company files consolidated financial statements that include its controlled
Subsidiaries. All material intercompany accounts and transactions have been
eliminated in consolidation.





Use of
Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and revenues and expenses during the reporting
period.  Actual results could differ from those
estimates.





Revenue
Recognition





The
Company does not currently generate revenue from its operations.





Intangible Assets – Domain
Names





The
Company is in the development stage of its social-networking portal, and
accordingly, all costs including license renewals, associated with domain names
expected to be utilized in its portal have been capitalized and any future costs
to get the portal operational will be capitalized or expensed.  Since
the ownership of these domain names can be renewed at a nominal fee each year
prior to their expiration date, the useful lives of the domain names are deemed
to be indefinite and no amortization of the capitalized costs for the domain
names will be recorded.  Amortization for any capitalized portal costs
will start once a revenue generating site is in service.





Property
and Equipment





Property
and equipment are stated at cost and depreciated on a straight-line basis over
their estimated useful lives, ranging from two to five years. Leasehold
improvements are amortized over the shorter of the useful life or the term of
the related lease. Repairs and maintenance costs are expensed as incurred; major
renewals and improvements are capitalized.  As items of property or
equipment are sold or retired, the related cost and accumulated depreciation are
removed from the accounts and any gain or loss is included in operating
income.





Impairment of Long-Lived
Assets





Long-lived
assets, such as property and equipment and intangible assets – domain names
costs are reviewed for impairment whenever changes in circumstances indicate
that the carrying amount of an asset may not be
recoverable.  Recoverability of assets to be held and used is measured
by comparison of the carrying amount of an asset to estimated undiscounted
future cash flows expected to be generated by the asset. If the carrying amount
of an asset exceeds its estimated future cash flows, an impairment charge is
recognized in the amount by which the carrying amount of the asset exceeds the
fair value of the asset.







Return
to Table of Contents
 5





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





Income
Taxes





Deferred
taxes are provided on a liability method whereby deferred tax assets are
recognized for deductible temporary differences and operating losses and tax
credit carryforwards and deferred tax liabilities are recognized for taxable
temporary differences. Temporary differences are the differences between the
reported amounts of assets and liabilities and their tax basis. Deferred tax
assets are reduced by a valuation allowance when, in the opinion of management,
it is more likely than not that some portion


or all of
the deferred tax assets will not be realized. Deferred tax assets and
liabilities are adjusted for the effects of changes in tax laws and rates on the
date of the enactment.




FIN
No. 48 requires the recognition of a financial statement benefit of a tax
position only after determining that the relevant tax authority would more
likely than not sustain the position following an audit. For tax positions
meeting the more-likely-than-not threshold, the amount recognized in the
financial statements is the largest benefit that has a greater than fifty
percent likelihood of being realized upon ultimate settlement with the relevant
tax authority.





Stock-Based
Compensation





Effective
March 1, 2006, the Company adopted Financial Accounting Standards Board (“FASB”)
Statement No. 123(R), “Share-Based Payment,” applying the modified prospective
method.  This standard requires the fair value of share-based
payments, including grants of employee stock options and employee stock purchase
plan shares, to be recognized in the income statement based on their grant date
fair values. The fair value of the Company’s stock options issued under the
requirements of SFAS No. 123(R) have been estimated using a Black-Scholes
pricing model, which assumes no expected dividends and estimates the option
expected life, volatility and risk-free interest rate at the time of the
grant.





Net Loss Per Common
Share





Basic
loss per share is computed using the weighted average number of shares
outstanding for the period. Diluted loss per share is computed using the
weighted average number of shares outstanding adjusted for the incremental
shares attributed to outstanding stock options. Incremental shares attributable
to the assumed exercise of stock options for the three and six months ended
August 31, 2008 and 2007 were excluded from the computation of diluted loss per
share as their effect would be anti-dilutive.





As of
August 31, 2008 and 2007, the Company had stock options outstanding of 4,118,000
and 3,297,000 respectively.







Return
to Table of Contents
 6





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





Recently Issued Accounting
Pronouncements





In
February 2008, the FASB issued FASB Staff Position FAS 157-2 (“FSP FAS 157-2”) “
Effective Date of FASB Statement No. 157” which delays the effective date
of SFAS No. 157 for non-financial assets and non-financial liabilities that
are recognized or disclosed in the financial statements on a nonrecurring basis
to fiscal years beginning after November 15, 2008.  These
non-financial items include assets and liabilities such as reporting units
measured at fair value in a goodwill impairment test and non-financial assets
acquired and non-financial liabilities assumed in a business combination. The
Company has not applied the provisions of SFAS No. 157 to its non-financial
assets and non-financial liabilities in accordance with FSP FAS
157-2.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) retains the fundamental
requirements in Statement 141 that the acquisition method of accounting (which
Statement 141 called the purchase method) be used for all business combinations
and for an acquirer to be identified for each business combination. In general,
the statement 1) broadens the guidance of SFAS No. 141, extending its
applicability to all events where one entity obtains control over one or more
other businesses, 2) broadens the use of fair value measurements used to
recognize the assets acquired and liabilities assumed, 3) changes the accounting
for acquisition related fees and restructuring costs incurred in connection with
an acquisition, and 4) increases required disclosures. We are required to apply
SFAS No. 141(R) prospectively to business combinations for which the acquisition
date is on or after January 1, 2009. Earlier application is not
permitted.





In
December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51” (“SFAS No. 160”).  SFAS No. 160 will change the accounting and
reporting for minority interests, which will be re-characterized as
non-controlling interests and classified as a component of equity. This new
consolidation method will significantly change the accounting for transactions
with minority interest holders. SFAS No. 160 is effective for fiscal years
beginning after December 15, 2008, and will be adopted by us in the first
quarter 2009.  SFAS No. 160 is currently not expected to have a
material effect on the Company’s results of operations, cash flows or financial
position.





In
June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether
Instruments Granted in Share-Based Payment Transactions Are Participating
Securities. This guidance states that unvested share-based payment awards that
contain nonforfeitable rights to dividends or dividend equivalents are
participating securities and should be included in the computation of earnings
per share using the two-class method outlined in SFAS No. 128, Earnings per
Share. The two-class method is an earnings allocation formula that determines
earnings per share for each class of common stock and participating security
according to dividends declared and participation rights in undistributed
earnings. The adoption of this new guidance on January 1, 2009 should not
have an effect on our reported earnings per share.







Return
to Table of Contents
 7





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





In
April 2008, the FASB issued FASB Staff Position (FSP) No. FAS
142-3, Determination of the Useful Life of Intangible Assets. This guidance
addresses the determination of the useful life of intangible assets which have
legal, regulatory or contractual provisions that potentially limit a company’s
use of an asset. Under the new guidance, a company should consider its own
historical experience in renewing or extending similar arrangements. We are
required to apply the new guidance to intangible assets acquired after
December 31, 2008.





Note
2. Intangible Assets





Intangible
assets are as follows:





August
      31,
              2008
            
            
            February
      28,
              2008Domain
      names
            
            $
            751,375
            
            
            $
            654,333Website
      development and portal costs
            
            
            -
            
            
            
            72,540Less
      accumulated amortization
            
            
            -
            
            
            
            -Less
      impairment of domain names
            
            
            -
            
            
            
            (52,139
            )Less
      impairment of website development costs
            
            
            -
            
            
            
            (72,540
            )$
            751,375
            
            
            $
            602,194





Since the
useful life of the domain names are deemed to be indefinite, no amortization has
been recorded.





During
the six months ended August 31, 2008, the Company incurred $147,544 for license
renewals and $1,637 in additional domain purchases.





At
February 29, 2008, due to legal constraints on the use of our college domain
names, the Company concluded that the carrying amount of their college domain
names would not be recoverable and the Company recorded an impairment loss of
$52,139.





During
the year ended February 29, 2008, the Company capitalized $72,540 of website
development costs.  As of February 29, 2008, due to changes in the
Company’s website development plan, the Company concluded that the carrying
amount of their website development costs would not be recoverable and the
Company recorded an impairment loss of $72,540 for the entire website
development costs incurred during the year.





Note
3. Stockholders Equity





Stock
Transactions





During
the quarter ended August 31, 2008, the Company entered into stock purchase
agreements and issued 29,285 restricted common shares at a price of $2.60 per
share, valued at $76,141.  The Company has received proceeds of
$32,540 and the remaining balance of $43,601 has been recorded as subscription
receivable at August 31, 2008.  The Company has collected $42,600 of
the subscription receivable for the period from September 1, 2008 to October 14,
2008.





Return
to Table of Contents
 8





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





During
the quarter ended August 31, 2008, the Company issued 39,500 common shares at an
average price of $2.57 per share for the exercise of stock options and received
cash proceeds of $101,387.





On
August 28, 2008, the Company cancelled 10,690 common shares because that were
previously issued for payment of accounts payable for services.  The
agreement with the vendor was cancelled and the shares were put back
into treasury stock.  The accounts payable to this vendor was recorded back
into the accounts payable aging.  The Company re-issued and sold the
10,690 common shares at $2.90 per share, valued at $31,000 to a current
shareholder and received cash proceeds of $31,000.





On August
15, 2008, the Company issued 1,412 restricted common shares at $4.25 per share,
valued at $6,000, to four directors of the Company for payment of director
fees.





On May
16, 2008, the Company issued 1,540 restricted common shares at $2.60 per share,
valued at $4,000, to four directors of the Company for payment of director
fees.





Other





During
the period from May 2007 to September 2007, holders of previously subscribed
shares sold a portion of their shares to other subscription holders of the
Company in order to pay the Company the remaining balance due on their
subscription agreements.  As of August 31, 2008, a total of 827,092
shares had been sold and transferred to the new purchaser for a total purchase
price of $1,842,108 which is due to the original subscription holder. The
underlying original subscription receivable due the Company for these
transferred shares totaled $620,319.  As of August 31, 2008, the
entire $620,319 has been paid to the Company and has reduced the original
investor’s stock subscription receivable accordingly.  Additionally,
due to these shares being re-sold at prices in excess of the original face
amount of the shares purchased, a portion of the proceeds is due back to the
Company.  Per the 2006 stock subscription agreements, the seller of
the subscribed shares is entitled to up to 200% of the face amount of each share
sold and the Company is entitled to 50% of any additional proceeds of the stock
in excess of that 200%.  Therefore, the Company is owed $300,735 for
their share of the additional proceeds for sales that occurred through August
31, 2008.  As of October 2, 2008, no payments have been received and
the Company has not recorded the $300,735 in the stock subscription receivable
balance at August 31, 2008.  The Company will record those future cash
receipts to Additional Paid in Capital when received.





Note
4. Stock Options





The
Company has one stock option plan called The 2006 Employee Stock and Option
Plan. As of August 31, 2008, an aggregate of 5,000,000 shares of common stock
may be granted under this plan determined by the Board of Directors. The stock
options may be granted to directors, officers, employees, consultants and
advisors of the Company.  Options granted under this plan are
non-qualified stock options and have exercise prices and vesting terms
established by the Board of Directors at the time of each
grant.  Vesting terms of
outstanding options range from immediate to two years from the grant date
anniversary.  All options expire five years from the date of
grant.








Return
to Table of Contents
 9





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





The
Company’s consolidated financial statements as of and for the three and six
months ended August 31, 2008 and 2007, reflect the impact of SFAS
123(R).  For the three months ended August 31, 2008, the Company
granted stock options to three consultants allowing for the purchase of up to an
aggregate of 175,000 shares of common stock, with a weighted-average-grant-date
fair value of $2.92. Total stock compensation expense for all option grants was
$449,927 and $993,107 for the three months ended August 31, 2008 and 2007,
respectively.  For the six months ended August 31, 2008 and 2007, the
Company has recorded $1,171,740 and $1,308,727 in stock compensation expense,
respectively.  This expense is included in selling, general and
administrative expense. As of August 31, 2008, there was no tax benefit from
recording this non-cash expense due to the Company having a full valuation
allowance against its deferred tax assets. The compensation expense impacted the
three and six months ended August 31, 2008 basic loss per common share by $0.02
and  $0.04,  respectively. There remains $679,346 of total
unrecognized compensation expense, which is expected to be recognized over
future periods through August 31, 2011.





The
following table summarizes information about the Company’s stock
options:





Number
      of Options
            
            
            
            Weighted
      Average Exercise Price
            
            
            
            Weighted
      Average Remaining Contract Life
            
            
            
            Aggregate
      Intrinsic Value (1)Options
      outstanding - February 28,
      2007
            
            3,125,000
            
            
            $
            1.725
            
            
            
            -
            
            
            
            -Granted
            
            622,000
            
            
            
            3.019
            
            
            
            -
            
            
            
            -Canceled
      or expired
            
            (299,500
            )
            
            
            (1.936
            )
            
            
            -
            
            
            
            -Exercised
            
            (25,000
            )
            
            
            (1.725
            )
            
            
            -
            
            
            
            -Options
      outstanding - February 29,
      2008
            
            3,422,500
            
            
            $
            1.942
            
            
            
            
            
            
            
            -Granted
            
            765,000
            
            
            
            4.237Canceled
      or expired
            
            (30,000
            )
            
            
            3.107Exercised
            
            (39,500
            )
            
            
            2.567Options
      outstanding – August 31,
      2008
            
            4,118,000
            
            
            $
            2.354
            
            
            
            3.35
            
            
            $
            7,812,625Exercisable
      at August 31,
      2008
            
            3,784,833
            
            
            $
            2.286
            
            
            
            3.27
            
            
            $
            7,434,231





(1)
            The
      intrinsic value of an option is the amount by which the fair value of the
      underlying stock exceeds its exercise
price.





Note
5. Related Party Transactions





The
Company entered into a five year lease with a director of the Company for
approximately 2,650 square feet of space used for offices and operations
equipment storage at 11974 Portland Avenue, Burnsville,
Minnesota.  The lease commenced on December 16, 2006 at a monthly rent
of $2,650 for the five year term of the lease and contains an option to renew
for an additional term of one year at a monthly rent of $3,650.  The
Company’s lease payments made to the director for the three months ended August
31, 2008 and 2007 totaled $7,950 and $7,950, respectively.





Return
to Table of Contents
 10





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





Minimum
      lease payments at August 31, 2008 are as follows:2009
            
            $
            15,9002010
            
            
            31,8002011
            
            
            31,8002012
            
            
            25,175$
            112,625





Loan from
Director/Stockholder





As of
August 31, 2008, the Company had an outstanding working capital loan of $145,000
from a director/stockholder.  The loan is due on demand and bears
annual interest at 6.5%.  Interest expense incurred on this loan for
the three and six months ended August 31, 2008 was $1,756 and $3,326,
respectively.





Note
6. Commitments and Contingencies





The
Company is exposed to asserted and unasserted claims encountered in the normal
course of business. In the opinion of management, the resolution of these
matters will not have a material adverse effect on the Company's financial
position or results of operations.





Note
7. Common Stock Subscriptions Receivable





During
the year ended February 28, 2006, the Company received subscriptions for
4,811,709 restricted common shares at $0.75 per share.  Significant
terms of the subscription agreement are as follows:


·
            Payment
      is due in full in 60 months


·
            At
      24 months, the Company can demand at its option, monthly 1/36 payments on
      the subscription agreement.


·
            The
      Company has the option to charge simple annual interest of up to
      4%.


·
            The
      Company will provide downside protection of up to 30% of the stock price
      upon conversion.


·
            If
      the purchaser sells these common shares, the purchaser shall be entitled
      to an amount equal to 200% of the original purchase price of each share
      and the Company shall be entitled to 50% of any additional net sales
      proceeds from the stock sale.





On
October 5, 2007, the Company received subscriptions for 1,300,000 restricted
common shares at $2.50 per share.  Significant terms of the
subscription agreement are as follows:


·
            The
      price per share of $2.50 was based on the closing price on October 4,
      2007.


·
            At
      24 months, 1/36 payments are due
monthly.


·
            The
      Company, at its option, may call up to 1/12 of the gross receivable per
      month if the preceding 30 day average trading price is at or above $7.00 a
      share with minimum trading volume of 5,000 shares per
  day.


·
            If
      the purchaser sells these common shares, the purchaser shall be entitled
      to an amount equal to 200% of the original purchase price of each share
      and the Company shall be entitled to 50% of any additional net sales
      proceeds from the stock sale.








Return
to Table of Contents
 11





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





The
following tables summarize information about the stock subscription
receivable:





Receivable
      balance at February 28, 2007
            
            $
            2,947,470Cash
      collected
            
            
            (1,166,675
            )New
      subscriptions received October 5, 2007
            
            
            3,250,000Receivable
      balance at February 29, 2008
            
            
            5,030,795Cash
      collected
            
            
            (322,233
            )Additional
      stock sold on subscription basis (Note 3)
            
            
            43,601Receivable
      balance at August 31, 2008
            
            $
            4,752,163Summary
      of outstanding subscriptions:2006
      subscriptions
            
            $
            1,458,562October
      5, 2007 subscriptions
            
            
            3,250,0002008
      stock issuances
            
            
            43,601$
            4,752,163





No
interest has been charged on these subscription agreements.  The
Company has collected approximately $45,800 of additional outstanding
subscription receivables for the period from September 1, 2008 to October 14,
2008.







Return
to Table of Contents
 12





ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS





The
following is a discussion of the financial condition of the Company as of August
31, 2008 and its results of operations for the three and six months ended August
31, 2008 and 2007, which should be read in conjunction with, and is qualified in
its entirety by, the financial statements and notes thereto included elsewhere
in this report.





CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING INFORMATION





This Form
10-Q for the quarter ended August 31, 2008, contains forward-looking statements
within the meaning of Section 27A of Section 21E of the Securities Exchange Act
of 1934, as amended (“Exchange Act”).  Forward-looking statements may
be identified by the use of forward-looking terminology, such as “may,” “shall,”
“could,” “expect,” “estimate,” “anticipate,” “predict,” “probable,” “should,”
“continue,” or similar terms, variations of those terms or the negative of those
terms.  The forward-looking statements specified in the following
information have been compiled by our management and are considered by
management to be reasonable.  Our future operating results, however,
are impossible to predict and no representation, guaranty, or warranty is to be
inferred from those forward-looking statements.





Company
Overview





DigitalTown,
Inc (the “Company”) formed an advisory board to lead the next stages of
development for the Company as it constructs and integrates approximately 27,000
online communities into a social “civic and school spirit” network serving
students, alumni, schools, local towns and their citizens.  The
advisory board is made up of innovative leaders in the technology,
entertainment, sports and content fields who are affiliated with companies
deeply rooted in interactive media.  The advisory board members are
based in the greater Los Angeles area where the strategic planning and creative
development will generally take place.  This network, when complete,
will connect approximately 27,000 local online spirit sites formed around a town
and its high school and will include easy-to-use and free features such as
email, alumni communication and reunion tools, calendar and organizing tools for
boosters, personal profiles, photo, video and music sharing and timely community
news.  The Company owns the Internet domain names associated with all
of these high school communities.





It is the
Company’s intent to have its stock listed on a major stock exchange at a future
date when the Company’s financial condition and demand for its stock warrants
such a change.





In
September 2008, the Company named John A. Witham to the new position of
Executive Vice President and Chief Financial Officer.  Mr. Witham has
over 20 years of experience in effective corporate financial leadership and
raising capital.







Return
to Table of Contents
 13





RESULTS
OF OPERATIONS





THREE
MONTHS ENDED AUGUST 31, 2008 and 2007





Selling,
general and administrative expenses for the current three months decreased by
$617,447 to $619,085 compared to a year ago primarily due to a $543,181 decrease
in stock option expense.  Excluding stock compensation expense for the
two comparable quarters, selling, general, and administrative expenses were
$169,158 for the three months ended August 31, 2008 compared to $243,425 for the
three months ended August 31, 2007.  The decrease in selling, general,
and administrative expenses of $74,266 for the two comparable quarters was
primarily due to a decrease in compensation expense of $24,059 due to lower
headcount, investor relations expense of $15,811, professional fees of $12,154,
automobile expense of $9,213, employee benefit costs of $6,501 and a reclass of
property tax of $6,196.  The Company’s overall net loss for the
current three months decreased by $613,467 to $622,126.





SIX
MONTHS ENDED AUGUST 31, 2008 and 2007





Selling,
general and administrative expenses for the current six months decreased by
$255,069 to $1,522,396 compared to a year ago primarily due to a $136,987
decrease in stock option expense.  Excluding stock compensation
expense for the two comparable quarters, selling, general, and administrative
expenses were $350,656 for the six months ended August 31, 2008 compared to
$468,738 for the six months ended August 31, 2007.  The decrease in
selling, general, and administrative expenses of $118,082 for the two comparable
quarters was primarily due to a decrease in professional fees of $62,496,
compensation expense of $36,722 due to lower headcount and investor relations
expense of $15,948 offset by an increase of $10,908 in travel and entertainment
expense.  The Company’s overall net loss for the current six months
decreased by $247,823 to $1,527,129.





LIQUIDITY
AND CAPITAL RESOURCES





SIX
MONTHS ENDED AUGUST 31, 2008





The
Company’s cash position at August 31, 2008 was $221,043, an increase of $153,882
from $67,161 at February 29, 2008.  During the six months ended August
31, 2008, net cash used in operating activities was $329,497 which was primarily
due to losses from operations, and decreases in accounts payable, accrued
payroll and accrued interest offset by stock based compensation expense, a
non-cash stock payment and a decrease in other receivables.  Net cash
used in investing activities for the six months ended August 31, 2008 was
$148,781, of which, $147,544 was used for the renewal of existing domain names
and $1,637 was used for the purchase of additional domain names offset by $400
received from the sale of an asset.  Net cash provided by financing
activities for the six months ended August 31, 2008 was $632,160 which consisted
of a $145,000 working capital loan from a director/stockholder of the Company
and payments received on stockholder subscription receivables of $322,233,
exercise of stock options of $101,387 and stock purchase agreements of
$63,540.





Return
to Table of Contents
 14





Our current monthly operating expenses
for the six months ended August 31, 2008, adjusted for non-cash stock based
compensation of $1,171,740 and non-cash stock issued for director fees of
$10,000, was approximately $58,000 per month. We believe our current cash reservesand amounts we expect to collect on our outstanding stock subscription
receivables should be sufficient to enable us to operate for the next 12
months. We anticipate that
any additional financing could be through the sale of our common stock, other
equity-based securities or issuance of debt instruments.  In the event
that we are unable to obtain additional capital in the future, we would be
forced to reduce operating expenses and/or cease operations
altogether.





Critical
Accounting Policies





The discussion and analysis of
DigitalTown, Inc.’s financial condition and results of operations are based on
our financial statements, which have been prepared in accordance with accounting
principles generally accepted in the U.S. The preparation of these financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities and expenses and related disclosure of
contingent assets and liabilities. Management reviews its estimates on an
ongoing basis. Management bases its estimates on historical experience and on
various other assumptions that it believes to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities. Actual results may differ from
these estimates under different assumptions or conditions. While DigitalTown
Inc.’s significant accounting policies are described in more detail in Note 1 to
its financial statements and year-end 10-K filed for February 29, 2008,
management believes the following accounting policies to be critical to the
judgments and estimates used in the preparation of its financial
statements:





Intangible
Assets- Domain Names





The
Company is in the development stage of its social-networking portal, and
accordingly, all costs including license renewals, associated with domain names
expected to be utilized in its portal have been capitalized and any future costs
to get the portal operational will be capitalized or expensed.  Since
the ownership of these domain names can be renewed at a nominal fee each year
prior to their expiration date, the useful lives of the domain names are deemed
to be indefinite and no amortization of the capitalized costs for the domain
names will be recorded.  Amortization for any capitalized portal costs
will start once a revenue generating site is in service.





Impairment
of Long-Lived Assets





Long-lived
assets, such as property and equipment and intangible assets – domain names are
reviewed for impairment whenever changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.  Recoverability of
assets to be held and used is measured by comparison of the carrying amount of
an asset to estimated undiscounted future cash flows expected to be generated by
the asset. If the carrying amount of an asset exceeds its estimated future cash
flows, an impairment charge is recognized in the amount by which the carrying
amount of the asset exceeds the fair value of the asset.





Return
to Table of Contents
 15





Recently
issued accounting pronouncements:





In
February 2008, the FASB issued FASB Staff Position FAS 157-2 (“FSP FAS 157-2”) “
Effective Date of FASB Statement No. 157” which delays the effective date
of SFAS No. 157 for non-financial assets and non-financial liabilities that
are recognized or disclosed in the financial statements on a nonrecurring basis
to fiscal years beginning after November 15, 2008.  These
non-financial items include assets and liabilities such as reporting units
measured at fair value in a goodwill impairment test and non-financial assets
acquired and non-financial liabilities assumed in a business combination. The
Company has not applied the provisions of SFAS No. 157 to its non-financial
assets and non-financial liabilities in accordance with FSP FAS
157-2.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) retains the fundamental
requirements in Statement 141 that the acquisition method of accounting (which
Statement 141 called the purchase method) be used for all business combinations
and for an acquirer to be identified for each business combination. In general,
the statement 1) broadens the guidance of SFAS No. 141, extending its
applicability to all events where one entity obtains control over one or more
other businesses, 2) broadens the use of fair value measurements used to
recognize the assets acquired and liabilities assumed, 3) changes the accounting
for acquisition related fees and restructuring costs incurred in connection with
an acquisition, and 4) increases required disclosures. We are required to apply
SFAS No. 141(R) prospectively to business combinations for which the acquisition
date is on or after January 1, 2009. Earlier application is not
permitted.





In
December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51” (“SFAS No. 160”).  SFAS No. 160 will change the accounting and
reporting for minority interests, which will be re-characterized as
non-controlling interests and classified as a component of equity. This new
consolidation method will


significantly
change the accounting for transactions with minority interest holders. SFAS No.
160 is effective for fiscal years beginning after December 15, 2008, and will be
adopted by us in the first quarter 2009.  SFAS No. 160 is currently
not expected to have a material effect on the Company’s results of operations,
cash flows or financial position.





In
June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether
Instruments Granted in Share-Based Payment Transactions Are Participating
Securities. This guidance states that unvested share-based payment awards that
contain nonforfeitable rights to dividends or dividend equivalents are
participating securities and should be included in the computation of earnings
per share using the two-class method outlined in SFAS No. 128, Earnings per
Share. The two-class method is an earnings allocation formula that determines
earnings per share for each class of common stock and participating security
according to dividends declared and participation rights in undistributed
earnings. The adoption of this new guidance on January 1, 2009 should not
have an effect on our reported earnings per share.





In
April 2008, the FASB issued FASB Staff Position (FSP) No. FAS
142-3, Determination of the Useful Life of Intangible Assets. This guidance
addresses the determination of the useful life of intangible assets which have
legal, regulatory or contractual provisions that potentially limit a company’s
use of an asset. Under the new guidance, a company should consider its own
historical experience in renewing or extending similar arrangements. We are
required to apply the new guidance to intangible assets acquired after
December 31, 2008.







Return
to Table of Contents
 16





FORWARD-LOOKING
INFORMATION





Any
statements contained herein related to future events are forward-looking
statements and are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Readers are cautioned not to place
undue reliance on forward-looking statements. DigitalTown, Inc. undertakes no
obligation to update any such statements to reflect actual events.








ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





We are
exposed to market risk for the effect of interest rate
changes.  Information relating to quantitative and qualitative
disclosure about market risk is set forth below and in Management’s Discussion
and Analysis of Financial Condition and Results of Operations – Liquidity and
Capital Resources.


As of
August 31, 2008, the Company did not have any off-balance sheet investments or
hedging investments.








ITEM 4. CONTROLS AND PROCEDURES





(a)
Evaluation of Disclosure Controls and Procedures.





An
evaluation made at the end of the period covered by this report was performed
under the supervision and with the participation of the Company's president,
chief executive officer ("CEO") and the chief financial officer ("CFO") of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934 (“the Exchange Act”) to insure that the Company records, processes,
summarizes and reports in a timely and effective manner the information required
to be disclosed in reports filed with or submitted to the Securities and
Exchange Commission. Based on that evaluation and in taking into account the
limited number of employees noted in the following paragraph, the Company's
management, including the CEO and CFO, concluded that the Company's disclosure
controls and procedures were effective in timely bringing to their attention
material information related to the Company required to be included in the
Company's periodic Securities and Exchange Commission filings. Since the date of
this evaluation, there have been no significant changes in the Company's
internal controls or in other factors that could significantly affect those
controls.





Due to
the limited number of Company employees engaged in the authorization, recording,
processing and reporting of transactions, there is inherently a lack of
segregation of duties. The Company periodically assesses the cost versus benefit
of adding the resources that would remedy or mitigate this situation, and
currently does not consider the benefits to outweigh the costs of adding
additional staff in light of the limited number of transactions related to the
Company's operations.





(b)
Changes in Internal Controls over Financial Reporting.





There
have been no significant changes in internal control over financial reporting
that occurred during the fiscal period covered by this report that have
materially affected or are reasonably likely to materially affect the Company’s
internal control over financial reporting.







Return
to Table of Contents
 17




PART
II





ITEM 1.  LEGAL PROCEEDINGS





DigitalTown,
Inc. is, from time to time, a party to litigation arising in the normal course
of its business.  The Company believes that none of these actions will
have a material adverse effect on its financial condition or results of
operations.





ITEM 1A.  RISK FACTORS





We are
subject to various risks that may materially harm our business, financial
condition and results of operations.  You should carefully consider
the risks and uncertainties described below and the other information in this
filing before deciding to purchase our common stock.  If any of these
risks or uncertainties actually occurs, our business, financial condition or
operating results could be materially harmed.  In that case, the
trading price of our common stock could decline and you could lose all or part
of your investment.





ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS





During
the quarter ended August 31, 2008, the Company entered into stock purchase
agreements and issued 29,285 restricted common shares at a price of $2.60 per
share, valued at $76,141.  The Company has received proceeds of
$32,540 and the remaining balance of $43,601 has been recorded as subscription
receivable at August 31, 2008.  The Company has collected $42,600 of
the subscription receivable for the period from September 1, 2008 to October 15,
2008.





During
the quarter ended August 31, 2008, the Company issued 39,500 common shares at an
average price of $2.57 per share for the exercise of stock options and received
cash proceeds of $101,387.





On August
28, 2008, the Company cancelled 10,690 common shares because that were
previously issued for payment of accounts payable for services.  The
agreement with the vendor was cancelled and the shares were put back
into treasury stock.  The accounts payable to this vendor was recorded back
into the accounts payable aging.  The Company re-issued and sold the
10,690 common shares at $2.90 per share, valued at $31,000 to a current
shareholder and received cash proceeds of $31,000.





On August
15, 2008, the Company issued 1,412 restricted common shares at $4.25 per share,
valued at $6,000, to four directors of the Company for payment of director
fees.





On May
16, 2008, the Company issued 1,540 restricted common shares at $2.60 per share,
valued at $4,000, to four directors of the Company for payment of director
fees.








ITEM 3.  DEFAULTS UPON SENIOR SECURITIES





None.




ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS





None.







Return
to Table of Contents
 18





ITEM 5.  OTHER INFORMATION





(a)
            All
      information required to be disclosed on a report on Form 8-K during the
      period ended August 31, 2008 has previously been
  reported.


(b)
            There
      have been no material changes to the procedures by which security holders
      may recommend nominees to the registrant’s board of
    directors.








ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K




3.1
            Articles
      of Incorporation, as amended (1)
            Previously
      Filed3.2
            Bylaws
      (1)
            Previously
      Filed31
            Certifications
      of Chief Executive Officer and Chief Financial Officer under Rule
      13a-14(a)/15d-14(a)
            Included32
            Certifications
      under Section 1350
            Included





(1)
Incorporated by reference to exhibit filed as a part of Registration Statement
on Form 10-SB (Commission File No. 000-27225).





Return
to Table of Contents
 19


SIGNATURES





In
accordance with the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.





DigitalTown,
      Inc.Dated:
      October 14, 2008Richard
      A. Pomije, CEOJohn
      A. Witham, CFO


Return
to Table of Contents


20