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: November 30, 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 27,163,862 shares of the registrant’s common stock outstanding as of
January 13, 2009.








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
            17Item
              4.
            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
            19-24









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








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to Table of Contents





DigitalTown, Inc.


CONSOLIDATED
BALANCE SHEETS





ASSETSNovember
      30,
              2008
            
            
            February
      29,
              2008(unaudited)
            
            
            (audited)Current
      assets:Cash
            
            $
            75,580
            
            
            $
            67,161Other
      receivables
            
            
            -
            
            
            
            70,528Total
      current assets
            
            
            75,580
            
            
            
            137,689Property
      and equipment, net
            
            
            4,599
            
            
            
            6,737Intangible
      assets, net
            
            
            809,316
            
            
            
            602,194Total
      assets
            
            $
            889,495
            
            
            $
            746,620LIABILITIES
      AND STOCKHOLDERS' EQUITY


Current
      liabilities:Accounts
      payable
            
            $
            78,434
            
            
            $
            100,683Loan
      from director/stockholder
            
            
            105,463
            
            
            
            -Accrued
      expenses:Accrued
      payroll
            
            
            4,698
            
            
            
            14,301Accrued
      interest
            
            
            -
            
            
            
            11,156Total
      current liabilities
            
            
            188,595
            
            
            
            126,140Commitments
      and contingenciesStockholders’
      equity:Common
      stock, $.01 par value, 2,000,000,000 shares authorized, 27,163,862 and
      27,081,750 shares issued and outstanding at November 30, 2008
      and  February 29, 2008, respectively
            
            
            271,668
            
            
            
            270,812Additional
      paid-in-capital
            
            
            21,621,917
            
            
            
            19,737,494Subscription
      receivable
            
            
            (4,616,963
            )
            
            
            (5,030,795
            )Accumulated
      deficit
            
            
            (16,575,722
            )
            
            
            (14,357,031
            )Total
      stockholders’ equity
            
            
            700,900
            
            
            
            620,480Total
      liabilities and stockholders’ equity
            
            $
            889,495
            
            
            $
            746,620




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




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 1




DigitalTown, Inc


CONSOLIDATED
STATEMENTS OF OPERATIONS


For
      the Three Months Ended
            
            
            For
      the Nine Months EndedNovember
      30,
            
            
            November
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007(unaudited)
            
            
            (unaudited)
            
            
            (unaudited)
            
            
            (unaudited)Operating
      expenses:Selling,
      general and administrative expenses
            
            $
            688,833
            
            
            $
            598,182
            
            
            $
            2,211,229
            
            
            $
            2,375,648Loss
      from operations
            
            
            (688,833
            )
            
            
            (598,182
            )
            
            
            (2,211,229
            )
            
            
            (2,375,648
            )Other
      income (expense):Interest
      expense
            
            
            (2,783
            )
            
            
            0
            
            
            
            (7,865
            )
            
            
            (1,680
            )Other
      income
            
            
            54
            
            
            
            1,014
            
            
            
            403
            
            
            
            5,208Total
      other income (expense)
            
            
            (2,729
            )
            
            
            1,014
            
            
            
            (7,462
            )
            
            
            3,528Net
      loss before income taxes
            
            
            (691,562
            )
            
            
            (597,168
            )
            
            
            (2,218,691
            )
            
            
            (2,372,120
            )Income
      tax provision
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      loss
            
            $
            (691,562
            )
            
            $
            (597,168
            )
            
            $
            (2,218,691
            )
            
            $
            (2,372,120
            )Loss
      per common share – basic and diluted
            
            $
            (0.03
            )
            
            $
            (0.02
            )
            
            $
            (0.08
            )
            
            $
            (0.09
            )Weighted
      average common shares outstanding – basic and diluted
            
            
            27,158,196
            
            
            
            26,546,335
            
            
            
            27,114,973
            
            
            
            25,992,965




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




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 2





DigitalTown, Inc.


CONSOLIDATED
STATEMENTS OF CASH FLOWS





Nine
      months ended November 30,
              2008
            
            
            Nine
      months ended November 30,
              2007(unaudited)
            
            
            (unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (2,218,691
            )
            
            $
            (2,372,120
            )Adjustments
      to reconcile net loss to net cash flows used in operating
      activities:Depreciation
            
            
            1,916
            
            
            
            1,195Stock
      based compensation expense
            
            
            1,679,066
            
            
            
            1,645,040Non-cash
      stock issued for services
            
            
            16,000
            
            
            
            50,063Gain
      on sale of asset
            
            
            (55
            )
            
            
            -Changes
      in operating assets and liabilities:Other
      receivables
            
            
            70,528
            
            
            
            971Accounts
      payable
            
            
            (53,249
            )
            
            
            90,895Accrued
      expenses:Accrued payroll
            
            
            (9,603
            )
            
            
            (13,438
            )Accrued interest
            
            
            (11,156
            )
            
            
            1,680Deferred
      officer compensation
            
            
            -
            
            
            
            (18,865
            )Net
      cash used in operating activities
            
            
            (525,244
            )
            
            
            (614,579
            )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of fixed assets
            
            
            (123
            )
            
            
            (3,956
            )Proceeds
      from sale of asset
            
            
            400
            
            
            
            -Purchase
      of intangible asset-website development
            
            
            -
            
            
            
            (72,540
            )Purchases
      and  renewal of  intangible assets – domain
      names
            
            
            (207,122
            )
            
            
            (145,298
            )Net
      cash used in investing activities
            
            
            (206,845
            )
            
            
            (221,794
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Advances
      from officer/stockholder
            
            
            -
            
            
            
            (16,354
            )Proceeds
      from loan – director/stockholder
            
            
            145,000
            
            
            
            -Payments
      on loan – director/stockholder
            
            
            (39,537
            )
            
            
            -Note
      payable-shareholder
            
            
            -
            
            
            
            (70,000
            )Payments
      received on stockholder subscription receivables
            
            
            413,832
            
            
            
            1,067,250Proceeds
      from issuance of stock
            
            
            107,141
            
            
            
            -Proceeds
      from exercise of stock options
            
            
            114,072
            
            
            
            -Net
      cash provided by financing activities
            
            
            740,508
            
            
            
            980,896Net
      change in cash and cash equivalents
            
            
            8,419
            
            
            
            144,523Cash
      and cash equivalents, beginning of period
            
            
            67,161
            
            
            
            8,933Cash
      and cash equivalents, end of period
            
            $
            75,580
            
            
            $
            153,456SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Non-cash
      flow information:Cash
      payments for interest
            
            $
            19,021
            
            
            $
            -Intangible
      assets-domain name renewals incurred with accounts payable
            
            $
            -
            
            
            $
            71,360Common
      stock issued in lieu of rent payments owed a director of the
      Company
              included
      in Accounts Payable
            
            $
            -
            
            
            $
            (33,125
            )Accounts
      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.




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 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 in August 2008 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 November
30, 2008, the Company had an accumulated deficit of
$16,575,722.  Subsequent to November 30, 2008, the Company has
received no additional proceeds 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 November 30,
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 nine-month period ended November 30, 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.





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.





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 4





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





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.




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.







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 5





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





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





The
Company follows the Financial Accounting Standards Board (“FASB”) Statement No.
123(R), “Share-Based Payment,” in accounting for its stock-based
compensation.  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 nine months ended
November 30, 2008 and 2007 were excluded from the computation of diluted loss
per share as their effect would be anti-dilutive.





As of
November 30, 2008 and 2007, the Company had stock options outstanding of
4,088,000 and 3,427,000 respectively.





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.





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 6





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





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.





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 7





DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





Note
2. Intangible Assets





Intangible
assets are as follows:




November
      30,
            
            
            February
      28,2008
            
            
            2008Domain
      names
            
            $
            809,316
            
            
            $
            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
            )$
            809,316
            
            
            $
            602,194





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





During
the nine months ended November 30, 2008, the Company incurred $203,344 for
license renewals and $3,778 in additional domain name 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 November 30, 2008, the Company issued 7,375 common shares at
an average price of $1.72 per share for the exercise of stock options and
received cash proceeds of $12,685.





On
November 15, 2008, the Company issued 3,000 restricted common shares at $2.00
per share, valued at $6,000, to four directors of the Company for payment of
director fees.





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, for total cash proceeds of $76,141.





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 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 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.  That same day, 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.  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 November 30, 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 those sales. As of January 14, 2009, no payments have
been received and the Company has not recorded the $300,735 in the stock
subscription receivable balance at November 30, 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 November 30, 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.  The terms of the options
vary from one year to five years from the date of grant.





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DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





The
Company’s consolidated financial statements as of and for the three and nine
months ended November 30, 2008 and 2007, reflect the impact of SFAS
123(R).  For the three months ended November 30, 2008, the Company
granted stock options to three consultants allowing for the purchase of up to an
aggregate of 210,000 shares of common stock, with a weighted-average-grant-date
fair value of $2.67. Total stock compensation expense for all option grants was
$507,326 and $336,314 for the three months ended November 30, 2008 and 2007,
respectively.  For the nine months ended November 30, 2008 and 2007,
the Company has recorded $1,679,066 and $1,645,040 in stock compensation
expense, respectively.  This expense is included in selling, general
and administrative expense. As of November 30, 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 nine months ended November 30, 2008 basic loss per common share by
$0.02 and  $0.06,  respectively. There remains $733,377 of
total unrecognized compensation expense, which is expected to be recognized over
future periods through August 31, 2010.





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
            
            
            975,000
            
            
            
            4.919Canceled
      or expired
            
            
            (262,625
            )
            
            
            2.083Exercised
            
            
            (46,875
            )
            
            
            2.163Options
      outstanding – November 30,
      2008
            
            
            4,088,000
            
            
            $
            2.640
            
            
            
            3.28
            
            
            $
            -Exercisable
      at November 30,
      2008
            
            
            3,801,250
            
            
            $
            2.593
            
            
            
            3.22
            
            
            $
            -





(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
November 30, 2008 and 2007 totaled $7,950 and $7,950,
respectively.  The Company’s total lease payments made to the director
for the nine months ended November 30, 2008 and 2007 was $23,850 and $23,850,
respectively.





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DigitalTown,
Inc.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)




Minimum
lease payments at November 30, 2008 are as follows:


FY
      2009-remainder
            
            $
            7,950FY
      2010
            
            
            31,800FY
      2011
            
            
            31,800FY
      2012
            
            
            25,175$
            96,725





Loan from
Director/Stockholder





As of
November 30, 2008, the Company had an outstanding working capital loan of
$105,463 from a director/stockholder.  The loan is due on demand and
bears annual interest at 6.5%.  The Company made principal payments of
$39,537 during the three months ended November 30, 2008.  Interest
expense incurred on this loan for the three and nine months ended November 30,
2008 was $2,783 and $7,865, 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.





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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
            
            
            (413,832
            )Receivable
      balance at November 30, 2008
            
            $
            4,616,963Summary
      of outstanding subscriptions:2006
      subscriptions
            
            $
            1,366,963October
      5, 2007 subscriptions
            
            
            3,250,000$
            4,616,963





No
interest has been charged on these subscription agreements.  The
Company has collected no additional outstanding subscription receivables for the
period from December 1, 2008 to January 14, 2009.
















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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
November 30, 2008 and its results of operations for the three and nine months
ended November 30, 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 November 30, 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 in August 2008 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.





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RESULTS
OF OPERATIONS





THREE
MONTHS ENDED NOVEMBER 30, 2008 and 2007





Selling,
general and administrative expenses for the most current three months increased
by $90,651 to $688,833 compared to a year ago due to an increase in stock option
expense of $171,012 for the most current three months.  Excluding
stock compensation expense, selling, general, and administrative expenses were
$181,506 for the three months ended November 30, 2008 compared to $261,868 for
the three months ended November 30, 2007.  The decrease in selling,
general, and administrative expenses of $80,362 for the two comparable quarters
was primarily due to a decrease in filing fees of $70,549, compensation expense
of $26,680 due to lower headcount, and investor relations expense of
$26,114.  The decreases were offset by an increase in professional
fees of $46,958.  The Company’s overall net loss for the current three
months increased by $94,394 to $691,562.





NINE
MONTHS ENDED NOVEMBER 30, 2008 and 2007





Selling,
general and administrative expenses for the current nine months decreased by
$164,419 to $2,211,229 compared to a year ago.  Excluding stock
compensation expense, selling, general, and administrative expenses were
$532,163 for the nine months ended November 30, 2008 compared to $730,607 for
the nine months ended November 30, 2007.  The decrease in selling,
general, and administrative expenses of $198,444 for the two comparable periods
was primarily due to a decrease in filing fees of $71,473, compensation expense
of $55,828 due to lower headcount, investor relations of $42,062, professional
fees of $14,685 and automobile expense of $13,489.  The Company’s
overall net loss for the current nine months decreased by $153,429 to
$2,218,691.





LIQUIDITY
AND CAPITAL RESOURCES





NINE
MONTHS ENDED NOVEMBER 30, 2008





The
Company’s cash position at November 30, 2008 was $75,580, an increase of $8,419
from $67,161 at February 29, 2008.  During the nine months ended
November 30, 2008, net cash used in operating activities was $525,244 compared
to cash used of $614,579 for the comparable period.  The current cash
used in operations 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 offset by a decrease in other
receivables.  Net cash used in investing activities for the nine
months ended November 30, 2008 was $206,845 compared to cash used of $221,794
for the comparable period.  For the nine months ended November 30,
2008, $203,344 was used for the renewal of existing domain names and $3,778 was
used for the purchase of additional domain names and $123 for purchase of fixed
assets offset by $400 received from the sale of an asset.  Net cash
provided by financing activities for the nine months ended November 30, 2008 was
$740,508 compared to cash provided of $980,896 for the comparable
period.  The 2008 activity consisted of a $105,463
net  working capital loan from a director/stockholder of the Company
and payments received on stockholder subscription receivables of $413,832,
exercise of stock options of $114,072 and proceeds from issuance of stock
pertaining to stock purchase agreements of $107,141.





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Our current average monthly operating
expenses for the nine months ended November 30, 2008, adjusted for non-cash
stock based compensation of $1,679,066 and non-cash stock issued for director
fees of $16,000, 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.





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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.





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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 November 30, 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.





Under the
supervision and with the participation of our management, including our
Company's chief executive officer ("CEO") and the chief financial officer
("CFO") we evaluated 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.





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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





The most
significant risk factors applicable to the Company are described in Part I, Item
1A “Risk Factors” of our Annual Report on Form 10-K for the year ended February
29, 2008.  There have been no material changes from the risk factors
previously disclosed in our Annual Report on Form 10-K.





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





During
the quarter ended November 30, 2008, the Company issued 7,375 common shares at
an average price of $1.72 per share for the exercise of stock options and
received cash proceeds of $12,685.





On
November 15, 2008, the Company issued 3,000 restricted common shares at $2.00
per share, valued at $6,000, to four directors of the Company for payment of
director fees.





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.





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 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.





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ITEM 5. OTHER INFORMATION





(a)
            All
      information required to be disclosed on a report on Form 8-K during the
      period ended November 30, 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).






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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:
      January 14, 2009Richard
      A. Pomije, CEOJohn
      A. Witham, CFO








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