Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

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**FORM 10-Q**

 
| **x**                                                  | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                   |       |                                                                                                     |
| **For the quarterly period  ended June 30, 2010** |
|                                                   |
| **OR**                                                 |
|                                                   |       |                                                                                                     |
| **o**                                                  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition period from          to         **

 

**Commission file number 1-32600**

 

**TUCOWS INC.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Pennsylvania**                | ** ** | **23-2707366**      |
|---------------------------------|------------|---------------------|
| (State or Other Jurisdiction of |       | (I.R.S. Employer    |
| Incorporation or Organization)  |       | Identification No.) |

 

**96 Mowat Avenue,**

**Toronto, Ontario M6K 3M1, Canada**

(Address of Principal Executive Offices) (Zip Code)

 

**(416) 535-0123**

(Registrant’s Telephone Number, Including Area Code)

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days:  Yes x  No o

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T §232.405 of this chapter during the preceding 12 months (or forsuch shorter period that the registrant was required to submit and post suchfiles).   Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer o                |   | Accelerated filer o         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer o                  |   | Smaller reporting company x |
| (Do not check if a smaller reporting company) |   |                             |

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act):  Yes o  No x

 

Asof August 13, 2010, there were 57,362,611 outstanding shares ofcommon stock, no par value, of the registrant.

 

 

 

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Table ofContents

 

**TUCOWS INC.**

**Form 10-Q Quarterly Report**

**INDEX**

 
| **PART I  FINANCIAL INFORMATION** |
|----------------------------------------|
|                                   |   |   |
| Item  1.                               | Consolidated Financial  Statements | 3 |
|                                   |   |   |
|                                   | Consolidated  Balance Sheets as of June 30, 2010 (unaudited) and December 31,  2009 | 3 |
|                                   | Consolidated  Statements of Operations (unaudited) for the three and six months ended  June 30, 2010 and 2009 | 4 |
|                                   | Consolidated  Statements of Cash Flows (unaudited) for the three and six months ended  June 30, 2010 and 2009 | 5 |
|                                   |   |   |
|                                   | Notes to Consolidated Financial Statements (unaudited) | 6 |
|                                   |   |   |
| Item 2.                                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 16 |
|                                   |   |   |
| Item 3.                                | Quantitative  and Qualitative Disclosures About Market Risk | 32 |
|                                   |   |   |
| Item 4.                                | Controls and  Procedures | 33 |
|                                   |   |   |
| **PART II  OTHER INFORMATION**    |
|                                   |   |   |
| Item 1.                                | Legal Proceedings | 33 |
|                                   |   |   |
| Item 1A.                               | Risk Factors | 33 |
|                                   |   |   |
| Item 2                                 | Unregistered  Sales of Equity Securities and Use of Proceeds | 34 |
|                                   |   |   |
| Item  6.                               | Exhibits | 35 |
|                                   |   |   |
| Signatures                             |   | 36 |

 

**TRADEMARKS,TRADE NAMES AND SERVICE MARKS**

 

Tucows®, Butterscotch® and OpenSRS® areregistered trademarks of Tucows, Inc. or its subsidiaries. Other servicemarks, trademarks and trade names of Tucows, Inc. or its subsidiaries maybe used in this Quarterly Report on Form 10-Q (this “Quarterly Report”). Allother service marks, trademarks and trade names referred to in this QuarterlyReport are the property of their respective owners. Solely for convenience, anytrademarks referred to in this Quarterly Report may appear without the ® or TM symbol, but such references are notintended to indicate, in any way, that we or the owner of such trademark, asapplicable, will not assert, to the fullest extent under applicable law, our orits rights, or the right of the applicable licensor, to these trademarks.

 

2

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Tableof Contents

 

**PART I.**

**FINANCIAL INFORMATION**

 

**Item 1. Consolidated Financial Statements**

 

**Tucows Inc.**

**Consolidated Balance Sheets**

**(Dollar amounts in U.S. dollars)**

** **
| ** **                                                                                                                                                                                                | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                                                                | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                |       |              |       |                  |       |
|                                                                                                                                                                                                      |       |              |       |                  |       |
| Current assets:                                                                                                                                                                                           |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                 |       | $                 | 4,067,668  |                  | $          | 9,632,394 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $110,000 as of June 30, 2010 and December 31, 2009                                                                              |       | 3,385,650         |       | 2,822,045             |       |
| Prepaid expenses and deposits                                                                                                                                                                             |       | 2,927,409         |       | 2,498,922             |       |
| Derivative instrument asset, current portion (note  6)                                                                                                                                                    |       | 664,765           |       | 2,107,825             |       |
| Prepaid domain name registry and ancillary  services fees, current portion                                                                                                                                |       | 34,476,972        |       | 31,596,236            |       |
| Income taxes recoverable                                                                                                                                                                                  |       | 382,000           |       | 674,000               |       |
| Total current assets                                                                                                                                                                                      |       | 45,904,464        |       | 49,331,422            |       |
|                                                                                                                                                                                                      |       |              |       |                  |       |
| Derivative instrument asset, long-term portion  (note 6)                                                                                                                                                  |       | —            |       | 112,553               |       |
| Prepaid domain name registry and ancillary  services fees, long-term portion                                                                                                                              |       | 12,676,451        |       | 12,126,515            |       |
| Property and equipment                                                                                                                                                                                    |       | 1,509,105         |       | 1,986,768             |       |
| Deferred financing charges                                                                                                                                                                                |       | 26,900            |       | 41,000                |       |
| Deferred tax asset, long-term portion (note 7)                                                                                                                                                            |       | 3,664,728         |       | 3,907,476             |       |
| Intangible assets (note 4)                                                                                                                                                                                |       | 17,773,663        |       | 18,656,353            |       |
| Goodwill                                                                                                                                                                                                  |       | 17,990,807        |       | 17,990,807            |       |
| Total assets                                                                                                                                                                                              |       | $                 | 99,546,118 |                  | $          | 104,152,894 |   |
|                                                                                                                                                                                                      |       |              |       |                  |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                            |       |              |       |                  |       |
|                                                                                                                                                                                                      |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                                      |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                                          |       | $                 | 1,261,526  |                  | $          | 1,547,863 |   |
| Accrued liabilities                                                                                                                                                                                       |       | 1,857,296         |       | 1,889,980             |       |
| Customer deposits                                                                                                                                                                                         |       | 3,461,557         |       | 3,624,317             |       |
| Derivative instrument liability, current portion  (note 6)                                                                                                                                                |       | 111,875           |       | —                |       |
| Loan payable, current portion (note 5)                                                                                                                                                                    |       | 2,263,004         |       | 3,220,125             |       |
| Deferred revenue, current portion                                                                                                                                                                         |       | 43,330,579        |       | 40,211,766            |       |
| Accreditation fees payable, current portion                                                                                                                                                               |       | 560,369           |       | 530,656               |       |
| Deferred tax liability, current portion (note 7)                                                                                                                                                          |       | 664,728           |       | 907,476               |       |
| Total current liabilities                                                                                                                                                                                 |       | 53,510,934        |       | 51,932,183            |       |
|                                                                                                                                                                                                      |       |              |       |                  |       |
| Derivative instrument liability, long-term portion  (note 6)                                                                                                                                              |       | 159,232           |       | 15,708                |       |
| Deferred revenue, long-term portion                                                                                                                                                                       |       | 16,716,150        |       | 16,098,812            |       |
| Accreditation fees payable, long-term portion                                                                                                                                                             |       | 168,224           |       | 169,620               |       |
| Deferred tax liability, long-term portion (note 7)                                                                                                                                                        |       | 4,840,000         |       | 4,840,000             |       |
|                                                                                                                                                                                                      |       |              |       |                  |       |
| Stockholders’ equity (note 11)                                                                                                                                                                       |       |              |       |                  |       |
| Preferred stock - no par value, 1,250,000 shares  authorized; none issued and outstanding                                                                                                                 |       | —            |       | —                |       |
| Common stock - no par value, 250,000,000 shares  authorized; 57,362,611 shares issued and outstanding as of June 30, 2010  and 67,080,353 shares issued and outstanding as of December 31, 2009 |       | 12,107,580        |       | 14,030,384            |       |
| Additional paid-in capital                                                                                                                                                                                |       | 42,468,074        |       | 47,287,351            |       |
| Deficit                                                                                                                                                                                                   |       | (30,424,076       | )          | (30,221,164           | )          |
| Total stockholders’ equity                                                                                                                                                                           |       | 24,151,578        |       | 31,096,571            |       |
| Total liabilities and stockholders’ equity                                                                                                                                                           |       | $                 | 99,546,118 |                  | $          | 104,152,894 |   |

 

See accompanying notes to unaudited consolidated financial statements

 

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**Tucows Inc.**

**Consolidated Statements ofOperations**

**(Dollar amounts in U.S. dollars)**

**(unaudited)**

 
| ** **                                                                  | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                  | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                  | ** ** | **(unaudited)**                      | ** ** | **(unaudited)**                    | ** ** |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Net revenues (note 9)                                                       |       | $                                    | 20,846,598 |                               | $          | 20,022,119 |   | $ | 41,291,751 |   | $ | 40,113,543 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Cost of revenues:                                                           |       |                                 |       |                               |       |   |   |   |   |
| Cost of revenues (*)                                                        |       | 15,455,986                           |       | 14,386,048                         |       | 30,380,860 |   | 28,171,446 |   |
| Depreciation of property and equipment                                      |       | 253,057                              |       | 576,419                            |       | 563,115 |   | 969,367 |   |
| Amortization of intangible assets (note 4)                                  |       | 74,802                               |       | 29,199                             |       | 149,604 |   | 58,398 |   |
| Total cost of revenues (note 9)                                             |       | 15,783,845                           |       | 14,991,666                         |       | 31,093,579 |   | 29,199,211 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Gross profit                                                                |       | 5,062,753                            |       | 5,030,453                          |       | 10,198,172 |   | 10,914,332 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Operating expenses:                                                         |       |                                 |       |                               |       |   |   |   |   |
| Sales and marketing (*)                                                     |       | 1,786,893                            |       | 1,339,167                          |       | 3,649,229 |   | 2,692,343 |   |
| Technical operations and development (*)                                    |       | 1,189,937                            |       | 1,175,355                          |       | 2,432,950 |   | 2,279,494 |   |
| General and administrative (*)                                              |       | 600,776                              |       | 1,592,325                          |       | 1,416,356 |   | 3,462,221 |   |
| Depreciation of property and equipment                                      |       | 43,431                               |       | 92,363                             |       | 87,320 |   | 174,816 |   |
| Amortization of intangible assets (note 4)                                  |       | 360,540                              |       | 360,540                            |       | 721,080 |   | 721,080 |   |
| Loss (gain) on change in fair value of forward  exchange contracts          |       | 1,924,985                            |       | (1,938,821                         | )          | 1,811,012 |   | (2,024,164 | ) |
| Total expenses                                                              |       | 5,906,562                            |       | 2,620,929                          |       | 10,117,947 |   | 7,305,790 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| (Loss) Income from operations                                               |       | (843,809                             | )          | 2,409,524                          |       | 80,225 |   | 3,608,542 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Other (expenses) income :                                                   |       |                                 |       |                               |       |   |   |   |   |
| Interest (expense) income, net                                              |       | (33,727                              | )          | 2,550,870                          |       | (72,895 | ) | 2,487,408 |   |
| Total other (expenses) income                                               |       | (33,727                              | )          | 2,550,870                          |       | (72,895 | ) | 2,487,408 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| (Loss) income before provision for income taxes                             |       | (877,536                             | )          | 4,960,394                          |       | 7,330 |   | 6,095,950 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| (Recovery of) provision for income taxes (note 7)                           |       | (105,758                             | )          | 581,651                            |       | 210,242 |   | 689,076 |   |
| Net (loss) income for the period                                            |       | $                                    | (771,778   | )                                  | $          | 4,378,743 |   | $ | (202,912 | ) | $ | 5,406,874 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Basic (loss) earnings per common share (note 8)                             |       | $                                    | (0.01      | )                                  | $          | 0.06 |   | $ | — |   | $ | 0.08 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Shares used in computing basic (loss) earnings per  common share (note 8)   |       | 59,193,180                           |       | 68,923,313                         |       | 60,223,815 |   | 70,778,950 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Diluted (loss) earnings per common share (note 8)                           |       | $                                    | (0.01      | )                                  | $          | 0.06 |   | $ | — |   | $ | 0.08 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Shares used in computing diluted (loss) earnings  per common share (note 8) |       | 59,193,180                           |       | 69,092,946                         |       | 60,223,815 |   | 70,785,712 |   |

 

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(*) Stock-based compensation has beenincluded in expenses as follows:

 
| Cost of revenues                     |   | $      | 5,574  |   | $      | 3,367  |   | $      | 9,202  |   | $ | 8,367 |   |
|--------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---|-------|--------|
| Sales and marketing                  |   | 25,545 |   | 15,057 |   | 41,231 |   | 29,957 |   |
| Technical operations and development |   | 18,264 |   | 11,121 |   | 32,845 |   | 21,721 |   |
| General and administrative           |   | 51,890 |   | 53,193 |   | 74,624 |   | 71,893 |   |

 

See accompanying notes to unaudited consolidated financial statements

 

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**Tucows Inc.**

**Consolidated Statements of CashFlows**

**(Dollar amounts in U.S. dollars)**

**(unaudited)**

** **
| ** **                                                              | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                              | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                    |       | **(unaudited)**                      |       | **(unaudited)**                    |       |
| Cash provided by (used in):                                             |       |                                 |       |                               |       |   |   |   |   |
| Operating activities:                                                   |       |                                 |       |                               |       |   |   |   |   |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Net (loss) income for the period                                        |       | $                                    | (771,778   | )                                  | $          | 4,378,743 |   | $ | (202,912 | ) | $ | 5,406,874 |   |
| Items not involving cash:                                               |       |                                 |       |                               |       |   |   |   |   |
| Depreciation of property and equipment                                  |       | 296,488                              |       | 668,782                            |       | 650,435 |   | 1,144,183 |   |
| Amortization of deferred financing charges                              |       | 6,700                                |       | 9,700                              |       | 14,100 |   | 20,100 |   |
| Amortization of intangible assets                                       |       | 435,342                              |       | 389,739                            |       | 870,684 |   | 779,478 |   |
| Gain on disposal of investment in Afilias                               |       | —                               |       | (2,010,395                         | )          | — |   | (2,010,395 | ) |
| Disposal of domain names                                                |       | 4,434                                |       | 974                                |       | 12,006 |   | 1,947 |   |
| Unrealized loss (gain) in the fair value of  forward exchange contracts |       | 1,924,985                            |       | (1,938,821                         | )          | 1,811,012 |   | (2,024,164 | ) |
| Stock-based compensation                                                |       | 101,273                              |       | 82,738                             |       | 157,902 |   | 131,938 |   |
| Changes in non-cash operating working capital:                          |       |                                 |       |                               |       |   |   |   |   |
| Accounts receivable                                                     |       | 311,895                              |       | 252,927                            |       | (563,605 | ) | (264,066 | ) |
| Prepaid expenses and deposits                                           |       | (66,785                              | )          | (310,655                           | )          | (428,487 | ) | (889,223 | ) |
| Prepaid fees for domain name registry and  ancillary services fees      |       | (815,103                             | )          | (496,502                           | )          | (3,430,672 | ) | (2,621,901 | ) |
| Income tax recoverable                                                  |       | (24,000                              | )          | 750,216                            |       | 292,000 |   | 835,398 |   |
| Accounts payable                                                        |       | (385,999                             | )          | 561,228                            |       | (199,430 | ) | 380,407 |   |
| Accrued liabilities                                                     |       | 94,120                               |       | (125,130                           | )          | (32,684 | ) | 3,643 |   |
| Customer deposits                                                       |       | (433,559                             | )          | 161,969                            |       | (162,760 | ) | (147,533 | ) |
| Deferred revenue                                                        |       | 531,558                              |       | 249,615                            |       | 3,736,151 |   | 2,712,991 |   |
| Accreditation fees payable                                              |       | (36,080                              | )          | (34,302                            | )          | 28,317 |   | 44,305 |   |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Net cash provided by operating activities                               |       | 1,173,491                            |       | 2,590,826                          |       | 2,552,057 |   | 3,503,982 |   |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Financing activities:                                                   |       |                                 |       |                               |       |   |   |   |   |
| Proceeds received on exercise of stock options                          |       | 10,308                               |       | 25,422                             |       | 14,809 |   | 25,422 |   |
| Repurchase of common stock                                              |       | (1,702,520                           | )          | —                             |       | (6,914,792 | ) | (1,811,179 | ) |
| Repayment of loan payable                                               |       | (478,560                             | )          | (1,203,560                         | )          | (957,121 | ) | (1,682,121 | ) |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Net cash used in financing activities                                   |       | (2,170,772                           | )          | (1,178,138                         | )          | (7,857,104 | ) | (3,467,878 | ) |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Investing activities:                                                   |       |                                 |       |                               |       |   |   |   |   |
| Cost of domain names acquired                                           |       | —                               |       | —                             |       | — |   | (5,900 | ) |
| Additions to property and equipment                                     |       | (116,947                             | )          | (102,770                           | )          | (259,679 | ) | (145,010 | ) |
| Proceeds on disposal of investment in Afilias                           |       | —                               |       | 2,110,395                          |       | — |   | 2,110,395 |   |
| Net cash (used in) provided by investing  activities                    |       | (116,947                             | )          | 2,007,625                          |       | (259,679 | ) | 1,959,485 |   |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| (Decrease) increase in cash and cash equivalents                        |       | (1,114,228                           | )          | 3,420,313                          |       | (5,564,726 | ) | 1,995,589 |   |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Cash and cash equivalents, beginning of period                          |       | 5,181,896                            |       | 4,002,743                          |       | 9,632,394 |   | 5,427,467 |   |
| Cash and cash equivalents, end of period                                |       | $                                    | 4,067,668  |                               | $          | 7,423,056 |   | $ | 4,067,668 |   | $ | 7,423,056 |   |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Supplemental cash flow information:                                     |       |                                 |       |                               |       |   |   |   |   |
| Interest paid                                                           |       | $                                    | 33,521     |                               | $          | 62,508 |   | $ | 72,797 |   | $ | 128,029 |   |
|                                                                    |       |                                 |       |                               |       |   |   |   |   |
| Supplementary disclosure of non-cash investing  activity:               |       |                                 |       |                               |       |   |   |   |   |
| Property and equipment acquired during the period  not yet paid for     |       | $                                    | 6,687      |                               | $          | 250,734 |   | $ | 6,687 |   | $ | 250,734 |   |

 

See accompanying notes to unaudited consolidated financial statements

 

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**NOTES TO UNAUDITED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**1. ORGANIZATION OF THE COMPANY:**

 

Tucows Inc., a Pennsylvania corporation (referred to throughoutthis report as the “Company”, “Tucows”, “we”, “us” or through similarexpressions), together with our consolidated subsidiaries, is a globaldistributor of Internet services, including domain name registration, securityand identity products through digital certificates and email through itsdistribution network of Internet Service Providers, web hosting companies andother providers of Internet services to end-users.

 

Wewere incorporated under the laws of the Commonwealth of Pennsylvania inNovember 1992 under the name Infonautics, Inc. In August 2001,we completed our acquisition of Tucows Inc., a Delaware corporation, and wechanged our name from Infonautics, Inc. to Tucows Inc. Our principalexecutive office is located in Toronto, Ontario and we have other offices inthe United Kingdom and the United States.

 

**2.BASIS OF PRESENTATION:**

 

Theaccompanying unaudited interim consolidated balance sheets, and the relatedconsolidated statements of operations and cash flows reflect all adjustments,consisting of normal recurring adjustments, that are, in the opinion ofmanagement, necessary for a fair presentation of the financial position ofTucows and its subsidiaries as at June 30, 2010 and the results ofoperations and cash flows for the interim periods ended June 30, 2010and 2009. The results of operations presented in this Quarterly Report onForm 10-Q are not necessarily indicative of the results of operations thatmay be expected for future periods.

 

Theaccompanying unaudited interim consolidated financial statements have beenprepared by Tucows in accordance with the rules and regulations of theSecurities and Exchange Commission (the “SEC”). Certain information andfootnote disclosure normally included in the Company’s annual auditedconsolidated financial statements and accompanying notes have been condensed oromitted. These interim consolidated financial statements and accompanying notesfollow the same accounting policies and methods of application used in theannual financial statements and should be read in conjunction with the Company’saudited consolidated financial statements and notes thereto for the year endedDecember 31, 2009 included in Tucows’ 2009 Annual Report onForm 10-K filed with the SEC on March 22, 2010.

 

Therehave been no material changes to our significant accounting policies during thesix months ended June 30, 2010 as compared to the significantaccounting policies described in our Annual Report on Form 10-K for thefiscal year ended December 31, 2009.

 

Duringthe first quarter of fiscal 2010, the Company recorded out-of-periodadjustments relating to rent expense and the amortization of intangible assets.These immaterial corrections of errors reduced net income after taxes by$35,000 for the three months ended June 30, 2010, and by $0.1 million forthe six months ended June 30, 2010.

 

TheCompany recognizes the effects of events or transactions that occur after thebalance sheet date but before financial statements are issued (“subsequentevents”) if there is evidence that conditions related to the subsequent eventexisted at the date of the balance sheet date, including the impact of suchevents on management’s estimates and assumptions used in preparing thefinancial statements. Other significant subsequent events that are notrecognized in the financial statements, if any, are disclosed to the notes tothe unaudited interim consolidated financial statements. Material subsequentevents are evaluated and disclosed thorough the report issuance date,August 13, 2010.

 

**3. NEWACCOUNTING POLICIES:**

 

*Recent Accounting Pronouncements Adopted*

 

Nonew accounting pronouncements have been adopted during the three months endedJune 30, 2010.

 

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*Recent Accounting Pronouncements Not Yet Adopted*

 

InOctober 2009, the FASB issued Accounting Standards Update 2009-13, “RevenueRecognition (Topic 605): Multiple-Deliverable Revenue Arrangements” (“Update2009-13”). Update 2009-13 applies to multiple-deliverable revenue arrangementsthat are currently within the scope of FASB ASC Subtopic 605-25 (previouslyincluded in Emerging Issues Task Force Issue no. 00-21, “Revenue Arrangementswith Multiple Deliverables”). Update 2009-13 provides principles andapplication guidance on whether multiple deliverables exist, how thearrangement should be separated, and the consideration allocated. It alsorequires an entity to allocate revenue in an arrangement using estimatedselling prices of deliverables if a vendor does not have vendor-specificobjective evidence or third-party evidence of selling price. The guidanceeliminates the use of the residual method, requires entities to allocaterevenue using the relative-selling-price method, and significantly expands thedisclosure requirements for multiple-deliverable revenue arrangements. Update2009-13 is effective on a prospective basis for revenue arrangements enteredinto or materially modified in fiscal years beginning on or after June 15,2010. We are currently assessing the impact of Update 2009-13 on our futureconsolidated financial statements.

 

*Regulatory Update*

 

InOctober 2009, the SEC issued Press Release 2009-213, “Small PublicCompanies to Begin Providing Audited Assessment of Internal Controls OverFinancial Reporting in Nine Months”. Press Release 2009-213 requires publiccompanies with a public float below $75 million begin to comply with Section 404(b) ofthe Sarbanes-Oxley Act of 2002 for annual reports with fiscal years ending onor after June 15, 2010. Section 404(b) requires that companiesreport on the effectiveness of their internal control over financial reporting.

 

OnJuly 21, 2010, President Obama signed into law the Dodd-Frank Wall StreetReform and Consumer Protection Act (the “Financial Reform Act”). Section 989Gof the Financial Reform Act exempts companies with a public float below $75million from compliance with Section 404(b) of the Sarbanes-Oxley Actof 2002. Accordingly, Tucows will only be required to provide auditorattestation of the effectiveness of its internal control over financialreporting for fiscal years in which its public float exceeds $75 millionon June 30th of such fiscal year.

 

**4****.****INTANGIBLEASSETS****:**

 

Intangibleassets consist of acquired technology, brand, customer relationships, surnamedomain names and our portfolio of domain names. As reflected in the tablebelow, these balances are being amortized on a straight-line basis over thelife of the intangible assets, except for the surname domain names andportfolio domain names; which have been determined to have an indefinite lifeand which are tested annually for impairment.

 

Asummary of acquired intangible assets for the three months endedJune 30, 2010 is as follows:

** **
| ** **                              | ** ** | **Technology**                 | ** ** | **Brand**        | ** ** | **Customer  relationships**    | ** ** | **Surname domain  names** | ** ** | **Direct navigation  domain names** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|--------------------------------|------------|------------------|------------|--------------------------------|------------|--------------------------------|------------|-----------------------------------------------|------------|------------|------------|
| **Amortization period**            | ** ** | **2 - 7 years** | ** ** | **7 years** | ** ** | **4 - 7 years** | ** ** | **indefinite life**       | ** ** | **indefinite life**                      | ** ** | **Total**  | ** ** |
|                                    |       |                           |       |             |       |                           |       |                           |       |                                          |       |       |       |
| Net book value, March 30, 2010     |       | $                              | 250,126    |             | $          | 645,060                        |       | $                              | 3,089,600  |                                          | $          | 12,131,759 |       | $ | 2,096,894 |   | $ | 18,213,439 |   |
| Sale of domain names                    |       | —                         |       | —           |       | —                         |       | (1,298                         | )          | (3,136                                        | )          | (4,434     | )          |
| Amortization expense                    |       | (74,802                        | )          | (41,760          | )          | (318,780                       | )          | —                         |       | —                                        |       | (435,342   | )          |
| Net book value, June 30, 2010 |       | $                              | 175,324    |             | $          | 603,300                        |       | $                              | 2,770,820  |                                          | $          | 12,130,461 |       | $ | 2,093,758 |   | $ | 17,773,663 |   |

 

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Asummary of acquired intangible assets for the six months endedJune 30, 2010 is as follows:

** **
| ** **                              | ** ** | **Technology**                 | ** ** | **Brand**        | ** ** | **Customer  relationships**    | ** ** | **Surname domain  names** | ** ** | **Direct navigation  domain names** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|--------------------------------|------------|------------------|------------|--------------------------------|------------|--------------------------------|------------|-----------------------------------------------|------------|------------|------------|
| **Amortization period**            | ** ** | **2 - 7 years** | ** ** | **7 years** | ** ** | **4 - 7 years** | ** ** | **indefinite life**       | ** ** | **indefinite life**                      | ** ** | **Total**  | ** ** |
|                                    |       |                           |       |             |       |                           |       |                           |       |                                          |       |       |       |
| Net book value, December 31, 2009  |       | $                              | 324,928    |             | $          | 686,820                        |       | $                              | 3,408,380  |                                          | $          | 12,132,408 |       | $ | 2,103,817 |   | $ | 18,656,353 |   |
| Sale of domain names                    |       | —                         |       | —           |       | —                         |       | (1,947                         | )          | (10,059                                       | )          | (12,006    | )          |
| Amortization expense                    |       | (149,604                       | )          | (83,520          | )          | (637,560                       | )          | —                         |       | —                                        |       | (870,684   | )          |
| Net book value, June 30, 2010 |       | $                              | 175,324    |             | $          | 603,300                        |       | $                              | 2,770,820  |                                          | $          | 12,130,461 |       | $ | 2,093,758 |   | $ | 17,773,663 |   |

 

**5. LOANPAYABLE:**

 

The Company entered into a non-revolving, reducing credit facility (the“credit facility”) in the amount of $9.6 million with the Bank of Montrealto finance the purchase of Innerwise, Inc. in July 2007. EffectiveFebruary 23, 2009, the Company agreed to amend the interest rate payablefrom the bank’s US Base rate plus 0.50% per annum to the bank’s US Base rateplus 1.50% per annum. The principal and accrued interest on the loan is payablemonthly over the five year term of the loan, which is five years. Tucowsmay prepay the credit facility in full or in part without any premium orpenalty. The credit facility provides that we maintain certain financial andoperating covenants which include, among other provisions, maintaining specificleverage and coverage ratios during the term of the loan. Certain covenantsunder the credit facility may limit the amount of our capital expenditures. Thecredit facility is collateralized by a first lien on, and pledge of, themajority of the Company’s and our subsidiaries present and future property andassets (subject to certain exclusions). As of June 30, 2010, the Companycontinued to comply with all covenants under the credit facility, and theinterest rate at June 30, 2010 was 3.75%.

 

Pursuant to the terms of the credit facility, the Company is requiredto make an annual cash sweep payment based on excess cash flow as defined inthe credit facility agreement, as well as monthly principal repayments ofapproximately $160,000. Based on the assessment of the audited results for our2008 fiscal year, the Company made a cash sweep payment for its 2008 fiscalyear of $0.7 million, which was paid on May 1, 2009. As of June 30, 2010,the estimated cash sweep payment for the year endedDecember 31, 2009, which was payable during the three months endedJune 30, 2010, would have been sufficient to fully repay all amountsoutstanding under the credit facility. However, since the Company would havethen repaid the facility two years earlier than originally contemplated priorto June 30, 2010, it began exploring with the Bank of Montreal if analternative facility should be put in place. As part of the discussions withthe Bank of Montreal, they have deferred the payment of the fiscal 2010 cashsweep payment pending the outcome of these negotiations.

 

To estimate the fair value of the Company’s loan payable under thecredit facility, the Company uses interest rates that are currently availableto the Company for issuance of loans on similar terms and remaining maturities.The estimated fair value of the Company’s loan payable atJune 30, 2010 was $2,254,514, compared to a carrying amount of$2,263,004 at June 30, 2010.

 

**6.********DERIVATIVEINSTRUMENT ASSETS AND LIABILITIES****:**

 

The Company enters into foreign currency contracts to hedge a portionof the Company’s expected Canadian dollar requirements. All derivativefinancial instruments are recorded at fair value on our consolidated balancesheet. The fair value of our foreign currency contracts at June 30, 2010was a net unrealized gain of $0.4 million as compared to a net unrealizedgain of $2.2 million at December 31, 2009. The net unrealized gain isa result of fluctuations in foreign exchange rates between the date thecurrency forward contracts were entered into and the valuation date at periodend.

 

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At June 30, 2010, the Company had the following outstandingforward exchange contracts to trade U.S. dollars in exchange for Canadiandollars:

 
| ** **                        | ** ** | **Notional**     | ** ** | **Weighted  average** | ** ** | ** **     | ** ** |
|-----------------------------------|------------|------------------|------------|-----------------------|------------|----------------|------------|
| ** **                        | ** ** | **amount of**    | ** ** | **exchange rate of**  | ** ** | ** **     | ** ** |
| **Maturity  date**                | ** ** | **U.S. dollars** | ** ** | **U.S. dollars**      | ** ** | **Fair value** | ** ** |
|                              |       |             |       |                  |       |           |       |
| July - September 2010   |       | 5,400,000        |       | 0.8596                |       | 510,554        |       |
| October - December 2010 |       | 5,400,000        |       | 0.9236                |       | 97,388         |       |
| 2010                              |       | 10,800,000       |       | 0.8904                |       | 607,942        |       |
|                              |       |             |       |                  |       |           |       |
| January - March 2011    |       | 5,400,000        |       | 0.9307                |       | 49,286         |       |
| April - June 2011       |       | 3,900,000        |       | 0.9635                |       | (104,338       | )          |
| June - September 2011   |       | 3,900,000,       |       | 0.9604                |       | (98,981        | )          |
| October - December 2011 |       | 1,950,000        |       | 0.9644                |       | (60,251        | )          |
| 2011                              |       | 15,150,000       |       | 0.9508                |       | (214,284       | )          |
|                              |       |             |       |                  |       |           |       |
| Total                             |       | $                | 25,950,000 |                  | 0.9247     |           | $          | 393,658 |   |
|                                   |            |                  |            |                       |            |                |            |  |  |

 

During the six months ended June 30, 2010, the Company enteredinto a series of foreign exchange forward contracts to hedge a portion of our2011 fiscal year expected Canadian dollar requirements. These contracts,collectively, have a notional value of US$10.0 million, whereby amounts ofUS$250,000, US$400,000 or US$650,000 are converted into Canadian dollars on asemi-monthly basis from January 2011 to November 2011 at an averageforeign exchange rate of US$1.00:Cdn$1.0437.

 

The Company does not apply hedge accounting and, therefore, for thethree and six months ended June 30, 2010, the Company recorded a lossof $1.9 million and $1.8 million, respectively, in the fair value offorward contracts in its consolidated statements of operations. For the threeand six months ended June 30, 2009, the Company recorded a gain onforward contracts of $1.9 million and $2.0 million respectively.

 

**7.INCOME TAXES**

 

For the six months ended June 30, 2010, the Company recorded aprovision for income taxes of $210,242 on income before income taxes of $7,330,using an estimated effective tax rate for its 2010 fiscal year adjusted forcertain foreign exchange losses for which the Company does not anticipateobtaining a current tax benefit. Included in the provision for income taxes isa recovery of $95,721 in respect of refundable Ontario research tax credits.Comparatively, for the six months ended June 30, 2009, the Companyrecorded a current tax expense of $689,000 on income before income taxes of$6.1 million, using an estimated effective tax rate for its 2009 fiscal yearthat accounts for the utilization of remaining net operating loss carryforwards and alternative minimum tax credits available to the Company.

 

As of December 31, 2009, the Company recorded a valuationallowance of $4.3 million and a net deferred tax asset of $3.0 million. As of June 30,2010 the Company has recorded a non-current deferred tax asset of $3.6 millionand current deferred tax liabilities of $0.6 million. As of June 30, 2010and December 31, 2009, the Company has also recorded a non currentdeferred tax liability related to the temporary difference arising onindefinite life intangibles of $4.8 million.

 

The Company analyzes the carrying value of its deferred tax asset on aregular basis. In determining future taxable income, assumptions are made toforecast federal, state and international operating income, the reversal oftemporary timing differences, and the implementation of any feasible andprudent tax planning strategies. The assumptions require significant judgmentregarding the forecasts of future taxable income, and are consistent with otherforecasts used to manage the business. During the six months ended June 30,2010, there was no reversal of the valuation allowance. The valuation allowancewill be maintained until sufficient evidence exists to support a reversal of,or decrease in, the valuation allowance.

 

The Company follows the provisions of FASB ASC Topic 740, IncomeTaxes to account for income tax exposures. The application of thisinterpretation requires a two-step process that separates recognition ofuncertain tax benefits from measurement thereof.

 

The Company had approximately $107,000 of total gross unrecognized taxbenefit as of June 30, 2010 and $124,000 of total gross unrecognized taxbenefit as of December 31, 2009, which if recognized would favorablyaffect our income tax rate in future periods. The unrecognized tax benefitrelates primarily to prior year Pennsylvania state franchise taxes and otherinsignificant US state taxes. The unrecognized tax benefit has decreased by $17,000as of June 30, 2010 when compared to the gross unrecognized tax benefits as of

 

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December 31,2009 as we have now settled the claim for the Pennsylvania franchise taxes forthe years December 31, 1996 to December 31, 2000. The Company doesnot expect the unrecognized tax benefit for its 2010 research and developmentclaim to be significant. The Company recognizes accrued interest and penaltiesrelated to taxes in tax expense. The Company did not have significant interestand penalties accrued as of June 30, 2010 and June 30, 2009,respectively. The Company believes it is reasonably possible that $107,000 ofthe unrecognized tax benefit will decrease in the next twelve months as it isanticipated that the U.S. tax authorities will finalize their review of priortaxes owing in Pennsylvania within the period and certain other prior yearstate tax returns will be filed.

 

**8.BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE:**

 

Basic earnings per common share has been calculated by dividing netincome for the period by the weighted average number of common sharesoutstanding during each period. Diluted earnings per share has been calculatedby dividing net income for the period by the weighted average number of commonshares and potentially dilutive common shares outstanding during the period. Incomputing diluted earnings per share, the treasury stock method is used to determinethe number of shares assumed to be purchased from the conversion of commonshares equivalents or the proceeds of option exercises.

 

The following table is a summary of the basic and diluted earnings percommon share:

 
| ** **                                                    | ** ** | **Three months  ended  June 30,  2010** | ** ** | **Three months  ended  June 30,  2009** | ** ** | **Six months  ended  June 30,  2010** | ** ** | **Six months  ended  June 30,  2009** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| Numerator for basic and diluted earnings per  common share:   |       |                                         |       |                                         |       |                                       |       |                                       |       |
| Net (loss) income for the period                              |       | $                                            | (771,778   | )                                            | $          | 4,378,743                                  |       | $                                          | (202,912   | ) | $ | 5,406,874 |   |
| Denominator for basic and diluted earnings per  common share: |       |                                         |       |                                         |       |                                       |       |                                       |       |
| Basic weighted average number of common shares  outstanding   |       | 59,193,180                                   |       | 68,923,313                                   |       | 60,223,815                                 |       | 70,778,950                                 |       |
| Effect of outstanding stock options                           |       | —                                       |       | 169,633                                      |       | —                                     |       | 6,762                                      |       |
| Diluted weighted average number of shares  outstanding        |       | 59,193,180                                   |       | 69,092,946                                   |       | 60,223,815                                 |       | 70,785,712                                 |       |
| Basic earnings per common share                               |       | $                                            | (0.01      | )                                            | $          | 0.06                                       |       | $                                          | 0.00       |   | $ | 0.08 |   |
| Diluted earnings per common share                             |       | $                                            | (0.01      | )                                            | $          | 0.06                                       |       | $                                          | 0.00       |   | $ | 0.08 |   |

 

Forthe three months ended June 30, 2010, outstanding options to purchase2,837,750 common shares were not included in the computation of diluted incomeper common share because all such options had exercise prices greater than theaverage market price of the common shares. During the three months endedJune 30, 2009, outstanding options to purchase 3,851,243 common shareswere not included in the computation of diluted income per common share becauseall such options had exercise prices greater than the average market price ofthe common shares. For the three months ended June 30, 2010, the effect ofpotentially dilutive securities of 2,028,478 was excluded from the computationof diluted weighted average number of shares outstanding as they areanti-dilutive to the basic loss per share.

 

Forthe six months ended June 30, 2010, outstanding options to purchase2,837,750 common shares were not included in the computation of diluted incomeper common share because all such options had exercise prices greater than theaverage market price of the common shares. During the six months endedJune 30, 2009, outstanding options to purchase 6,661,992 common shares,were not included in the computation of diluted income per common share becauseall such options had exercise prices greater than the average market price ofthe common shares. For the six months ended June 30, 2010, the effect ofpotentially dilutive securities of 2,054,771 was excluded from the computationof diluted weighted average number of shares outstanding as they are anti-dilutiveto the basic loss per share.

 

OnJanuary 13, 2010, 6,341,470 common shares were repurchased andcancelled under the terms of a modified Dutch auction tender offer.

 

Duringthe three and six months ended June 30, 2010, 2,453,300 and 3,409,300common shares were repurchased and cancelled, respectively, under the terms ofour stock repurchase program announced in February 2010.

 

Thecomputation of earnings per share and diluted earnings per share for the threeand six months ended June 30, 2010 include reductions in the numberof shares outstanding due to these purchases (see note 11).

 

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**9.SUPPLEMENTAL INFORMATION:**

 

Thefollowing is a summary of the Company’s revenue earned from each significantrevenue stream:

 
| ** **             | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **             | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| OpenSRS :              | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Domain Services        |       | $                                    | 15,748,912 |                               | $          | 14,737,932 |   | $ | 31,151,922 |   | $ | 28,939,954 |   |
| Email Services         |       | 580,658                              |       | 873,855                            |       | 1,218,846 |   | 1,995,790 |   |
| Other Services         |       | 1,084,943                            |       | 1,091,988                          |       | 2,178,654 |   | 2,186,448 |   |
| Total OpenSRS Services |       | 17,414,513                           |       | 16,703,775                         |       | 34,549,422 |   | 33,122,192 |   |
|                   |       |                                 |       |                               |       |   |   |   |   |
| YummyNames             |       | 1,631,848                            |       | 1,455,557                          |       | 3,343,169 |   | 3,320,590 |   |
| Hover                  |       | 1,110,962                            |       | 1,258,828                          |       | 2,240,459 |   | 2,559,413 |   |
| Butterscotch           |       | 689,275                              |       | 603,959                            |       | 1,158,701 |   | 1,111,348 |   |
|                   |       | $                                    | 20,846,598 |                               | $          | 20,022,119 |   | $ | 41,291,751 |   | $ | 40,113,543 |   |

 

Nocustomer accounted for more than 10% of revenue for the three and six monthsended June 30, 2010 or the three and six months endedJune 30, 2009. Significant management judgment is required at thetime of recording of revenue to assess whether the collection of the resultingreceivables is reasonably assured. On an ongoing basis, we assess the abilityof our customers to make required payments. Based on this assessment, we expectthe carrying amount of our outstanding receivables, net of allowance fordoubtful accounts, to be fully collected.

 

Asof June 30, 2010, two customers accounted for 25% of accountsreceivable, all of which has been paid subsequent to June 30, 2010.As of June 30, 2009, no customer accounted for more than 10% of accountsreceivable.

 

The following is a summary of the Company’scost of revenues from each significant revenue stream:

** **
| ** **                                   | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                   | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| OpenSRS :                                    | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Domain Services                              |       | $                                    | 13,089,345 |                               | $          | 11,943,842 |   | $ | 25,705,576 |   | $ | 23,298,602 |   |
| Email Services                               |       | 117,319                              |       | 153,228                            |       | 224,457 |   | 333,146 |   |
| Other Services                               |       | 400,342                              |       | 411,287                            |       | 787,465 |   | 800,139 |   |
| Total OpenSRS Services                       |       | 13,607,006                           |       | 12,508,357                         |       | 26,717,498 |   | 24,431,887 |   |
|                                         |       |                                 |       |                               |       |   |   |   |   |
| YummyNames                                   |       | 253,740                              |       | 250,529                            |       | 456,495 |   | 436,084 |   |
| Hover                                        |       | 350,288                              |       | 475,369                            |       | 749,733 |   | 988,579 |   |
| Butterscotch                                 |       | 25,380                               |       | 1,110                              |       | 44,238 |   | 7,850 |   |
| Network, other costs                         |       | 1,219,572                            |       | 1,150,683                          |       | 2,412,896 |   | 2,307,046 |   |
| Network, depreciation and amortization costs |       | 327,859                              |       | 605,618                            |       | 712,719 |   | 1,027,765 |   |
|                                         |       | $                                    | 15,783,845 |                               | $          | 14,991,666 |   | $ | 31,093,579 |   | $ | 29,199,211 |   |

 

Thefollowing is a summary of the Company’s property and equipment by geographicregion:

 
| ** **     | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------|------------|-----------------------------|------------|---------------------------------|------------|
|           |       |                        |       |                            |       |
| Canada         |       | $                           | 1,153,011  |                            | $          | 1,475,056 |   |
| United States  |       | 354,368                     |       | 506,533                         |       |
| United Kingdom |       | 1,726                       |       | 5,179                           |       |
|           |       | $                           | 1,509,105  |                            | $          | 1,986,768 |   |

 

**10.COMMITMENTS AND CONTINGENCIES:**

 

The Company is involved in various legal claims and lawsuits inconnection with its ordinary business operations. The Company intends tovigorously defend these claims. While the final outcome with respect to any actionsor claims outstanding or pending as of June 30, 2010 cannot be predictedwith certainty, management believes that their resolution will not have amaterial adverse effect on the Company’s financial position.

 

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**11.STOCKHOLDERS’ EQUITY:**

 

Thefollowing unaudited table summarizes stockholders’ equity transactions for theperiod ended June 30, 2010:

 
| ** **                                                           | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | ** **             | ** ** | **Total**  | ** **  |
|----------------------------------------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|------------------------|------------|------------|-------------|
| ** **                                                           | ** ** | **Common stock** | ** ** | **paid in** | ** ** | ** **     | ** ** | **stockholders’** | ** ** |
| ** **                                                           | ** ** | **Shares**            | ** ** | **Amount**       | ** ** | **capital**    | ** ** | **Deficit**            | ** ** | **equity** | ** **  |
|                                                                 |       |                  |       |             |       |           |       |                   |       |       |        |
| Balances, December 31, 2009                                     |       | 67,080,353            |       | $                | 14,030,384 |           | $          | 47,287,351             |       | $          | (30,221,164 | ) | $ | 31,096,571 |   |
| Exercise of stock options                                            |       | 10,433                |       | 8,320            |       | (3,819         | )          | —                 |       | 4,501      |        |
| Repurchase and retirement of shares — Dutch  Auction            |       | (6,341,470            | )          | (1,268,294       | )          | (3,222,692     | )          | —                 |       | (4,490,986 | )           |
| Repurchase and retirement of shares — Normal  course issuer bid |       | (956,000              | )          | (191,200         | )          | (530,086       | )          | —                 |       | (721,286   | )           |
| Stock-based compensation                                             |       | —                |       | —           |       | 56,629         |       | —                 |       | 56,629     |        |
| Cancellation of restricted stock                                     |       | (500                  | )          | —           |       | —         |       | —                 |       | —     |        |
| Net income for the period                                            |       | —                |       | —           |       | —         |       | 568,866                |       | 568,866    |        |
| Balances, March 31, 2010                                        |       | 59,792,816            |       | 12,579,210       |       | 43,587,383     |       | (29,652,298            | )          | 26,514,295 |        |
|                                                                 |       |                  |       |             |       |           |       |                   |       |       |        |
| Exercise of stock options                                            |       | 23,245                |       | 19,030           |       | (8,721         | )          | —                 |       | 10,309     |        |
| Repurchase and retirement of shares — Normal  course issuer bid |       | (2,453,300            | )          | (490,660         | )          | (1,211,861     | )          | —                 |       | (1,702,521 | )           |
| Stock-based compensation                                             |       | —                |       | —           |       | 101,273        |       | —                 |       | 101,273    |        |
| Cancellation of restricted stock                                     |       | (150                  | )          | —           |       | —         |       | —                 |       | —     |        |
| Net income for the period                                            |       | —                |       | —           |       | —         |       | (771,778               | )          | (771,778   | )           |
| Balances, June 30, 2010                                         |       | 57,362,611            |       | $                | 12,107,580 |           | $          | 42,468,074             |       | $          | (30,424,076 | ) | $ | 24,151,578 |   |

 

Thefollowing unaudited table summarizes stockholders’ equity transactions for theperiod ended June 30, 2009:

 
| ** **                                                | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | ** **             | ** ** | **Total**  | ** **  |
|-----------------------------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|------------------------|------------|------------|-------------|
| ** **                                                | ** ** | **Common stock** | ** ** | **paid in** | ** ** | ** **     | ** ** | **stockholders’** | ** ** |
| ** **                                                | ** ** | **Shares**            | ** ** | **Amount**       | ** ** | **capital**    | ** ** | **Deficit**            | ** ** | **equity** | ** **  |
|                                                      |       |                  |       |             |       |           |       |                   |       |       |        |
| Balances, December 31, 2008                          |       | 73,073,782            |       | $                | 15,198,358 |           | $          | 48,714,676             |       | $          | (42,462,370 | ) | $ | 21,450,664 |   |
| Repurchase and retirement of shares — Dutch  Auction |       | (4,185,769            | )          | (837,138         | )          | (974,041       | )          | —                 |       | (1,811,179 | )           |
| Stock-based compensation                                  |       | —                |       | —           |       | 49,200         |       | —                 |       | 49,200     |        |
| Net income for the period                                 |       | —                |       | —           |       | —         |       | 1,028,132              |       | 1,028,132  |        |
| Balances, March 31, 2009                             |       | 68,888,013            |       | 14,361,220       |       | 47,789,835     |       | (41,434,238            | )          | 20,716,817 |        |
|                                                      |       |                  |       |             |       |           |       |                   |       |       |        |
| Stock-based compensation                                  |       | —                |       | —           |       | 82,508         |       | —                 |       | 82,508     |        |
| Exercise of stock options                                 |       | 68,707                |       | 46,858           |       | (21,436        | )          | —                 |       | 25,422     |        |
| Issuance of restricted stock                              |       | 12,600                |       | —           |       | 230            |       | —                 |       | 230        |        |
| Net income for the period                                 |       | —                |       | —           |       | —         |       | 4,378,743              |       | 4,378,743  |        |
| Balances, June 30, 2009                              |       | 68,969,320            |       | $                | 14,408,078 |           | $          | 47,851,137             |       | $          | (37,055,495 | ) | $ | 25,203,720 |   |

 

OnJanuary 13, 2010, the Company announced that it successfully concluded amodified “Dutch auction tender offer” that was previously announced onDecember 14, 2009. Under the terms of the offer, the Company repurchasedan aggregate of 6,341,470 shares of its common stock at a purchase price of$0.70 per share, for a total of $4,439,029, excluding transaction costs of$51,957. The purchase price was funded from available cash. Of the 6,341,470shares purchased, 5,000,000 were shares the Company offered to purchase in theoffer and 1,341,470 where shares purchased pursuant to the Company’s right topurchase up to an additional 2% of the shares outstanding immediately prior tothe commencement of the tender offer. Due to over-subscription, the finalproration factor for shares tendered at or below $0.70 per share wasapproximately 99.9%. For this purpose, shares tendered at $0.70 per shareincluded shares tendered by those persons who indicated, in their letter oftransmittal, that they were willing to accept the price determined in theoffer. All shares purchased in the tender offer received the same price.

 

OnFebruary 16, 2010, the Company’s Board of Directors authorized therepurchase of up to $10 million of the Company’s common stock at the Company’sdiscretion. The Company has repurchased 2,453,300 shares under this repurchaseprogram during the

 

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threemonths ended June 30, 2010. The Company has repurchased 3,409,300shares under this repurchase program during the six months endedJune 30, 2010.

 

**12.SHARE-BASED PAYMENTS**

 

(a)                                  Stock options

 

The Company’s 1996 Stock Option Plan (the “1996 Plan”) was establishedfor the benefit of the employees, officers, directors and certain consultantsof the Company. The maximum number of common shares which may be set aside forissuance under the 1996 Plan was 11,150,000 shares, provided that the Board ofDirectors of the Company has the right, from time to time, to increase suchnumber subject to the approval of the stockholders of the Company when requiredby law or regulatory authority. Generally, options issued under the 1996 Planvest over a four-year period. The 1996 Plan expired on February 25, 2006and no options have been issued from the 1996 Plan after that date.

 

The Company’s 2006 Equity Compensation Plan (the “2006 Plan”), servesas a successor to the 1996 Plan. The 2006 Plan was established for the benefitof the employees, officers, directors and certain consultants of the Company.The 5,000,000 common shares that have been set aside for issuance under the 2006Plan are to provide eligible persons with the opportunity to acquire aproprietary interest, or otherwise increase their proprietary interest, inTucows. Generally, options issued under the 2006 Plan vest over a four-yearperiod and have a term not exceeding seven years.

 

The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option-pricing model, consistent with the guidance onstock compensation. Because option-pricing models require the use of subjectiveassumptions, changes in these assumptions can materially affect the fair valueof the options. The assumptions presented in the table below represent theweighted average of the applicable assumption used to value stock options attheir grant date. The Company calculates expected volatility based onhistorical volatility of the Company’s common shares. The expected term, whichrepresents the period of time that options granted are expected to beoutstanding, is estimated based on historical exercise experience. The Companyevaluated historical exercise behavior when determining the expected termassumptions. The risk-free rate assumed in valuing the options is based on theU.S. Treasury yield curve in effect at the time of grant for the expected termof the option. The Company determines the expected dividend yield percentage bydividing the expected annual dividend by the market price of our common sharesat the date of grant.

 

During the three and six months ended June 30, 2010, stockoptions to purchase 1,574,000 common shares were granted, as compared to stockoptions to purchase 25,000 common shares granted during the three and sixmonths ended June 30, 2009. The stock options granted during thethree and six months ended June 30, 2010 expire on various dates through2017.

 

Details of stock option transactions for the three months endedJune 30, 2010 and June 30, 2009 are as follows:

 
| ** **                         | ** ** | **Three months ended  June 30, 2010** | ** ** | **Three months ended  June 30, 2009**       | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                         | ** ** | **Number of  shares**                      | ** ** | **Weighted  average  exercise price  per share** | ** ** | **Number of  shares** | ** ** | **Weighted  average  exercise price  per share** | ** ** |
| Outstanding, beginning of period   |       | 6,795,170                                  |       | $                                                | 0.53       |   | 7,125,559 |   | $ | 0.56 |   |
| Granted                            |       | 1,574,000                                  |       | 0.70                                             |       | 25,000 |   | 0.38 |   |
| Exercised                          |       | (23,245                                    | )          | 0.44                                             |       | (68,707 | ) | 0.37 |   |
| Forfeited                          |       | (23,125                                    | )          | 0.70                                             |       | (12,594 | ) | 0.82 |   |
| Expired                            |       | (98,717                                    | )          | 1.17                                             |       | (40,000 | ) | 0.69 |   |
| Outstanding, end of period         |       | 8,224,083                                  |       | $                                                | 0.56       |   | 7,029,258 |   | $ | 0.56 |   |
| Options exercisable, end of period |       | 6,069,833                                  |       | $                                                | 0.51       |   | 5,875,789 |   | $ | 0.53 |   |

 

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Details of stock option transactions for the six months endedJune 30, 2010 and June 30, 2009 are as follows:

 
| ** **                         | ** ** | **Six months ended  June 30, 2010** | ** ** | **Six months ended  June 30, 2009**         | ** ** |
|------------------------------------|------------|------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                         | ** ** | **Number of  shares**                    | ** ** | **Weighted  average  exercise price  per share** | ** ** | **Number of  shares** | ** ** | **Weighted  average  exercise price  per share** | ** ** |
| Outstanding, beginning of period   |       | 7,203,977                                |       | $                                                | 0.56       |   | 7,282,777 |   | $ | 0.56 |   |
| Granted                            |       | 1,574,000                                |       | 0.70                                             |       | 25,000 |   | 0.38 |   |
| Exercised                          |       | (33,678                                  | )          | 0.44                                             |       | (68,707 | ) | 0.37 |   |
| Forfeited                          |       | (38,125                                  | )          | 0.67                                             |       | (168,312 | ) | 0.55 |   |
| Expired                            |       | (482,091                                 | )          | 1.02                                             |       | (41,500 | ) | 0.80 |   |
| Outstanding, end of period         |       | 8,224,083                                |       | $                                                | 0.56       |   | 7,029,258 |   | $ | 0.56 |   |
| Options exercisable, end of period |       | 6,069,833                                |       | $                                                | 0.51       |   | 5,875,789 |   | $ | 0.53 |   |

 

As of June 30, 2010, the exercise prices, weighted averageremaining contractual life and intrinsic values of outstanding options were asfollows:

 
| ** **         | ** ** | **Options outstanding** | ** ** | **Options exercisable**                          | ** ** |
|--------------------|------------|-------------------------|------------|--------------------------------------------------|------------|
| **Exercise price** | ** ** | **Number  outstanding** | ** ** | **Weighted  average  exercise price  per share** | ** ** | **Weighted  average  remaining  contractual  life (years)** | ** ** | **Aggregate  intrinsic  value** | ** ** | **Number  exercisable** | ** ** | **Weighted  average  exercise price  per share** | ** ** | **Aggregate  intrinsic  value** | ** ** |
| $0.31-$0.49        |       | 3,699,379               |       | $                                                | 0.38       |   | 3.0 |   | $ | 954,432 |   | 3,699,379 |   | $ | 0.38 |   | $ | 954,432 |   |
| $0.56-$0.70        |       | 3,357,454               |       | $                                                | 0.64       |   | 5.5 |   | 88,787 |   | 1,434,954 |   | $ | 0.59 |   | 73,887 |   |
| $0.80-$0.99        |       | 1,167,250               |       | $                                                | 0.86       |   | 3.5 |   | — |   | 935,500 |   | $ | 0.86 |   | — |   |
|               |       | 8,224,083               |       | $                                                | 0.56       |   | 4.1 |   | $ | 1,043,219 |   | 6,069,833 |   | $ | 0.51 |   | $ | 1,028,319 |   |

 

Total unrecognized compensation cost relating to unvested stock optionsat June 30, 2010, prior to the consideration of expected forfeitures,was approximately $748,000 and is expected to be recognized over a weightedaverage period of 3.1 years.

 

The Company recorded stock-based compensation of $101,049 and $82,508for the three months ended June 30, 2010 and 2009, respectively.

 

The Company recorded stock-based compensation of $157,485 and $131,708for the six months ended June 30, 2010 and 2009, respectively.

 

TheCompany has not capitalized any stock-based compensation expense as part of thecost of an asset.

 

(b)                               Restricted stock awards

 

During the three and six months ended June 30, 2010, norestricted stock awards were granted to any employees of the Company.

 

Restricted stock awards generally vest annually over a four yearperiod. Holders of restricted stock may not sell, assign, transfer, pledge orotherwise dispose of an unvested stock. Unvested shares of restricted stock areheld in escrow by the Company until the holder’s interest in such shares vests.

 

Holders of restricted stock shall have full shareholder rights withrespect to any shares of Company stock issued to the participant under a stockaward, whether or not the holder’s interest in those shares is vested. Accordingly,the holder shall have the right to vote such shares and to receive any regularcash dividends paid on such shares.

 

Total unrecognized compensation cost relating to unvested restrictedstock awards at June 30, 2010, prior to the consideration of expectedforfeitures, was approximately $2,000 and is expected to be recognized over aweighted average period of 2.8 years.

 

The Company recorded stock-based compensation associated withrestricted stock awards of $224 and $230 for the three months ended June 30, 2010and 2009, respectively.

 

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The Company recorded stock-based compensation associated withrestricted stock awards of $417 and $230 for the six months endedJune 30, 2010 and 2009, respectively.

 

**13.FAIR VALUE MEASUREMENT**

 

ASC Topic 820, “*Fair Value Measurementsand Disclosures”*establishes a valuation hierarchy for disclosure ofthe inputs to valuation used to measure fair value. This hierarchy prioritizesthe inputs into three broad levels. Level 1 inputs are quoted prices(unadjusted) in active markets for identical assets or liabilities. Level 2inputs are quoted prices for similar assets and liabilities in active marketsor inputs that are observable for the asset or liability, either directly orindirectly through market corroboration, for substantially the full term of thefinancial instrument. Level 3 inputs are unobservable inputs based on the Company’sown assumptions used to measure assets and liabilities at fair value. Afinancial asset or liability’s classification within the hierarchy isdetermined based on the lowest level input that is significant to the fairvalue measurement.

 

Thefollowing table provides a summary of the fair values of the Company’sderivative instrument assets and liabilities measured at fair value on arecurring basis at June 30, 2010:

 
| ** **                      | ** ** | **June 30, 2010**                      | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **Fair Value Measurements Using** | ** ** | **Assets at** | ** ** |
| ** **                      | ** ** | **Level 1**                                      | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Fair Value** | ** ** |
|                            |       |                                             |       |   |   |   |   |   |   |
| Derivative instrument asset     |       | $                                                | —     |   | $ | 664,765 |   | $ | — |   | $ | 664,765 |   |
| Total Assets                    |       | $                                                | —     |   | $ | 664,765 |   | $ | — |   | $ | 664,765 |   |
|                            |       |                                             |       |   |   |   |   |   |   |
| Derivative instrument liability |       | $                                                | —     |   | $ | (271,107 | ) | $ | — |   | $ | (271,107 | ) |
| Total Liabilities               |       | $                                                | —     |   | $ | (271,107 | ) | $ | — |   | $ | (271,107 | ) |

 

The following table provides a summary of the fair values of theCompany’s derivative instrument assets measured at fair value on a recurringbasis as at December 31, 2009:

 
| ** **                      | ** ** | **December 31, 2009**                  | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **Fair Value Measurements Using** | ** ** | **Assets at** | ** ** |
| ** **                      | ** ** | **Level 1**                                      | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Fair Value** | ** ** |
|                            |       |                                             |       |   |   |   |   |   |   |
| Derivative instrument asset     |       | $                                                | —     |   | $ | 2,220,378 |   | $ | — |   | $ | 2,220,378 |   |
| Total Assets                    |       | $                                                | —     |   | $ | 2,220,378 |   | $ | — |   | $ | 2,220,378 |   |
|                            |       |                                             |       |   |   |   |   |   |   |
| Derivative instrument liability |       | $                                                | —     |   | $ | (15,708 | ) | $ | — |   | $ | (15,708 | ) |
| Total Liabilities               |       | $                                                | —     |   | $ | (15,708 | ) | $ | — |   | $ | (15,708 | ) |

 

**14.RECLASSIFICATION**

 

Certain of the prior periods’ comparative figures have beenreclassified to conform with the presentation adopted in the current period.

 

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

 

**SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

ThisQuarterly Report on Form 10-Q contains, in addition to historicalinformation, forward-looking statements by us with regard to our expectationsas to financial results and other aspects of our business that involve risksand uncertainties and may constitute forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. Words such as “may,”“should,” “anticipate,” “believe,” “plan,” “estimate,” “expect” and “intend,”and other similar expressions are intended to identify forward-lookingstatements. The forward-looking statements contained in this report includestatements regarding, among other things, the Company’s foreign currencyrequirements, specifically for the Canadian dollar; the estimated annual cashsweep payment due under the Company’s credit facility; the number of new,renewed and transferred-in domain names, our valuations of certain deferred taxassets, our expectation to collect our outstanding receivables, net of ourallowance for doubtful accounts; the potential impact of current and pendingclaims on our business; our expectation regarding fluctuations in certainexpense and cost categories; our expectations regarding future revenue from ourpatent assignments, our expectations regarding our unrecognized tax benefit andthe timing or completion of certain audits of our US tax returns, ourexpectations regarding cash from operations to fund our business, our beliefthat the market for domain name registration will trend upward gradually andmay be affected by market volatility; our belief that a slowing economy maylead to a decrease in advertising spending and the effect of changes in ourcontractual relationships on our revenue These statements are based onmanagement’s current expectations and are subject to a number of uncertaintiesand risks that could cause actual results to differ materially from thosedescribed in the forward-looking statements. Many factors affect our ability toachieve our objectives and to successfully develop and commercialize our servicesincluding:

 

·                  Our ability tocontinue to generate sufficient working capital to meet our operatingrequirements;

 

·                  Our ability tomaintain a good working relationship with our vendors and customers;

 

·                  The ability ofvendors to continue to supply our needs;

 

·                  Actions by ourcompetitors;

 

·                  Our ability toachieve gross profit margins at which we can be profitable;

 

·                  Our ability toattract and retain qualified personnel in our business;

 

·                  Our ability toeffectively manage our business;

 

·                  Our ability toobtain and maintain approvals from regulatory authorities on regulatory issues;

 

·                  Pending or newlitigation; and

 

·                  Factors setforth under the caption “Item 1A Risk Factors” in our Annual Report onForm 10-K for the fiscal year ended December 31, 2009.

 

This list of factors that may affect our future performance andfinancial and competitive position and also the accuracy of forward-lookingstatements is illustrative, but it is by no means exhaustive. Accordingly, allforward-looking statements should be evaluated with the understanding of theirinherent uncertainty. All forward-looking statements included in this documentare based on information available to us as of the date of this document, andwe assume no obligation to update these cautionary statements or any forward-lookingstatements except to the extent of any obligations under the SecuritiesExchange Act of 1934 or the Securities Act of 1933. These statements are notguarantees of future performance.

 

We qualify all the forward-looking statements contained in thisForm 10-Q by the foregoing cautionary statements.

 

**OVERVIEW**

 

Our mission is to provide simple, useful services that help peopleunlock the power of the Internet. We accomplish this by reducing the complexityour customers’ experience as they acquire, deliver or use Internet servicessuch as domain name registration, email and other Internet services.

 

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Our primary distribution channel is a global network of more than10,000 resellers in more than 100 countries who typically provide theircustomers, the end-users of the Internet, with a critical component forestablishing and maintaining an online presence. Our primary focus is servingthe needs of this network of resellers by providing superior services,easy-to-use interfaces, proactive and attentive customer service,reseller-oriented technology and agile design and development processes. Weseek to provide superior customer service to our resellers by anticipatingtheir business needs and technical requirements. This includes providingeasy-to-use interfaces that enable resellers to quickly and easily integrateour services into their individual business processes, and offering brandableend-user interfaces that emphasize simplicity and visual appeal.  We also provide “second tier” support to ourresellers by email and phone in the event resellers experience issues orproblems with our services. In addition, our Network Operating Center providesproactive support to our resellers by monitoring all services and networkinfrastructure to address deficiencies before customer services are impacted.

 

We believe that the underlying platforms for our services are one ofthe most mature, reliable and functional reseller-oriented provisioning andmanagement platforms in our industry, and we continue to refine, evolve andimprove these services for both resellers and end-users.

 

To assist us in forecasting growth and to help us monitor theeffectiveness of our operational strategies, we categorize our revenue into thefollowing services:

 

OpenSRS, our wholesale service, manages over ten million domain names,under its ICANN accreditation, as well as names Tucows manages for otherregistrars under their own accreditations, millions of mailboxes and tens ofthousands of digital certificates through a network of over 10,000 web hosts, Internetservice providers, or ISPs, and other resellers around the world.

 

Platypus, our billing service, provides ISPs with an industry-specificsolution for billing, service provisioning and customer account management.

 

Hover, our retail service, offers services similar to those of OpenSRSto consumers and small businesses.

 

YummyNames, our domain portfolio service, manages tens of thousands ofdomain names, most of which generate advertising revenue and many of which weoffer for resale via our reseller network and other channels. Included in theYummyNames domain portfolio are over 42,000 domains that allow over two-thirdsof Americans to purchase a domain or email address based on their name.

 

Butterscotch, our content service, operates two advertising-supportedwebsites, butterscotch.com and tucows.com, which provide content to helpconsumers overcome the complexity of modern technology and the Internet, in theform of over 3,000 videos and over 185,000 software and mobile listings andarticles. Additionally, Butterscotch provides custom video production servicesfor technology manufacturers and ISPs.

 

Our business model is characterized by non-refundable, up-frontpayments, which lead to recurring revenue and positive operating cash flow. Weare an ICANN-accredited registrar and manage over ten million domains under ourICANN accreditation, as well as names we manage for other registrars undertheir own accreditations.

 

**NetRevenues**

 

*OpenSRS*

 

We derive revenue from our reseller network by providing them withreseller services that comprise (a) domain service, (b) email serviceand (c) other services. Other services primarily consist of secure socketslayer, or SSL, certificates and also include blogware and website buildingtools that are used by our resellers to create bundles of Internet services fortheir end-users along with billing solutions for ISPs.

 

OpenSRS Domain Service

 

Historically, our OpenSRS domain service has constituted the largestportion of our business and encompasses all of our services as an accreditedregistrar related to the registration, renewal, transfer and management ofdomain names. In addition, this service fuels other revenue categories as itoften is the initial service for which a customer will engage us, enabling usto follow on with other services and allowing us to add to our domain portfolioby purchasing names registered through us upon their expiration. We alsoprovide resellers with the ability to sell personal names. This service allowsresellers the opportunity to sell email addresses based on our domain portfolioof surname domain names.

 

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As of June 30, 2010, we offer registration services for thegeneric top-level domain (“gTLDs”) .com, .net, .org, .info, .name, .biz, .tel,..mobi and .asia and for the country code top-level domains (:ccTLDs”) .at, .be,..bz, .ca, .co, .cc, .ch, .cn, .de, .dk, .es, .eu, .fr, .in, .it, .li,.me, .mx..nl, .tv, .uk, .ws, and .us.

 

With respect to the sale of domain registrations, our pricing structurefor domain names provides visibility into the various fees that make up thecost of a domain name by breaking out the cost of the registry and ICANN feesseparately from our management fee. Effective July 2010, registry fees forthe .com and .net registrations were increased by the registry by an additional7%. The management fee provides our resellers with access to our provisioningand management tools to enable them to register and administer domain names andaccess to additional services like WHOIS privacy and DNS services, enhanceddomain name suggestion tools and access to our Premium Domain name services. Weearn fees in connection with each new, renewed and transferred-in registrationand from providing provisioning services to resellers and registrars on amonthly basis. Domain registrations are generally purchased for terms of one toten years, with a majority having a one-year term. Except for certain largecustomers with whom we have negotiated alternative arrangements, payments forthe full term of service, or billed revenue, is received at the time ofactivation of service. All fees received in connection with domain nameregistration are non-refundable, and where appropriate, are recorded asdeferred revenue and recognized as earned ratably over the term of provision ofservice. This accounting treatment reasonably approximates a recognitionpattern that corresponds with the provision of the services during the quartersand the year.

 

OpenSRS Email Service

 

We derive revenue from our hosted email service through our globaldistribution network. Our email service is offered on a per account, per monthbasis, and provides resellers with a reliable, scalable “white label” hostedemail solutions that can be customized to their branding and business modelrequirements. The email service also includes spam and virus filtering on allaccounts. End-users can access the email service via a full-featured,multi-language AJAX-enabled web interface, a WAP mobile interface, or throughtraditional desktop email clients, such as Microsoft Outlook or Apple Mail,using IMAP or POP/SMTP and 2GB of email storage.

 

We earn fees for email services when such services are activated. Emailservices are generally purchased monthly and, at month-end, are either deductedon a pre-authorized basis from reseller’s deposit account, or are invoiced.

 

Other OpenSRS Services

 

We derive revenue from other services primarily from provisioning SSLcertificates. In addition, we provision blogware and website building toolsthat are used by our resellers to create bundles of Internet services for theirend-users, as well as the provision of billing, provisioning and customer caresoftware solutions to ISPs through our Platypus billing software.

 

We earn fees from such services when a service is activated. Theseservices are generally purchased for terms of one month to three years.Platypus software is generally purchased for terms of one month to one year.Payments for services are for the full term of all services at the time ofactivation of service, are non-refundable and, where appropriate, are recordedas deferred revenue and recognized as earned ratably over the service term.This accounting treatment reasonably approximates a recognition pattern thatcorresponds with the provision of the services during the quarters and theyear.

 

*YummyNames*

 

We derive revenue from our portfolio of domain names by displayingadvertising on the domains and by making them available for sale or lease. Inaddition we display advertising on “parked pages” within OpenSRS. Parkedpages are domain names registered with us that do not yet contain anactive website. When a user types one of these domain names into a web browser,they are presented with dynamically generated links that are pay-per-clickadvertising. Every time a user clicks on one of these links, it generatesrevenue for us through our partnership with third-parties who providesyndicated pay-per-click advertising.

 

Portfolio names are sold through our premium domain name service,auctions or in negotiated sales. The size of our domain name portfolio variesover time, as we acquire and sell domains on a regular basis to maximize theoverall value and revenue generation potential of our portfolio. In evaluatingnames for sale, we consider the potential foregone revenue from pay-per-clickadvertising, as well as other factors. The name will be offered for sale if,based on our evaluation, the name is deemed non-essential to our business andmanagement believes that deriving proceeds from the sale is strategically morebeneficial to the Company.

 

Portfolio names that have been acquired from third-parties or throughacquisition are included as intangible assets with indefinite lives on ourconsolidated balance sheet.

 

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In addition, we also offer the same services to our customers, allowingthem to make available names registered by them for monetization on a similarbasis. For customer names, we earn a referral fee for premium names or namessold or leased, and participate on a revenue share basis for names offeredthrough our pay-per-click advertising program.

 

We recognize revenue from these services, net of any fees payable toresellers or customers, immediately upon completion of the service, or in thecase of advertising revenue, on a monthly basis once the advertising has beenserved.

 

*Hover*

 

We derive revenues from the providing and managing Internet services,on a retail basis, to consumers and small businesses through our Hover.comwebsite. These services include domain registration and other Internet servicessuch as email and personalized email through our portfolio of surname-baseddomain names, as well as an easy-to-use interface that allows users to connectdomain names to websites and email addresses through a unique DNS forwardingsystem. Depending on the service offered, we typically receive fees for ourservices.

 

Our customers generally purchase services for terms of one to tenyears, with a majority of services purchased for a one-year term. Certainservices are also offered on a monthly basis. Payments for the full term of allservices, or billed revenue, are received at the time of service activationand, where appropriate, are recorded as deferred revenue and recognized asearned ratably over the term of provision of service. This accounting treatmentreasonably approximates a recognition pattern that corresponds with the provisionof the services during quarterly and annual periods.

 

*Butterscotch*

 

We also generate advertising and other revenue through two ad-supportedcontent sites, butterscotch.com and tucows.com.

 

Butterscotch.com derives revenue from banner and text advertising onthe site, as well as from video advertising and product placement within thevideos that make up the bulk of the site. In addition, revenue is earnedthrough custom video production for technology manufacturers and Internetservices customers.

 

Tucows.com advertising revenue is generated from third-partyadvertisers and from software developers who rely on us as a primary source ofdistribution. Software developers use our Author Resource Center to submittheir products for inclusion on our site and to purchase promotional placementof their software. Software developers may also purchase other promotionalservices on a cost-per-click or flat rate basis. Software developers are ableto promote their software through advertising services including keyword searchplacements, banners, promotional placements, expedited reviews and premium dataservices. Revenue is also generated from companies that contract with us toprovide them with co-branded content.

 

Advertising and other revenue is recognized ratably over the period inwhich it is presented. To the extent that we do not meet the minimum number ofpost-presentation impressions that we guarantee to customers, we deferrecognition of the corresponding revenues until the guaranteed impressions areachieved. Custom video production revenue is recognized on acceptance of thecompleted video by the customer.

 

**CriticalAccounting Policies**

 

The following is a discussion of our critical accounting policies andmethods. Critical accounting policies are defined as those that are bothimportant to the portrayal of our financial condition and results of operationsand are reflective of significant judgments and uncertainties made bymanagement that may result in materially different results under differentassumptions and conditions. Note 2 to the consolidated financialstatements for the year ended December 31, 2009, or Fiscal 2009, includesfurther information on the significant accounting policies and methods used inthe preparation of our consolidated financial statements.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the U.S. requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, we evaluate the application of these estimates, including thoserelated to the useful lives and valuation of intangible assets, valuation ofgoodwill, fair value measurement of assets and liabilities, product developmentcosts, revenue recognition and deferred revenue and accounting for incometaxes. We base our estimates on historical experience and on various otherassumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual amounts could differ significantly from these estimates.

 

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**Revenuerecognition policy**

 

We earn revenues from the following services;

 

·                  OpenSRS (Domain, Email andOther Services);

 

·                  YummyNames;

 

·                  Hover; and

 

·                  Butterscotch.

 

With respect to the sale of domain registrations and other Internetservices, we earn registration fees in connection with each new, renewed andtransferred-in registration and from providing provisioning services toresellers and registrars on a monthly basis. We also enter into revenuearrangements in which a reseller may purchase a combination of services(multiple element arrangements). When fair value exists for all elements, weallocate revenue to each element based on the relative fair value of each ofthe elements. Fair value is established by the price charged when that elementis sold separately. For arrangements where fair value exists only for theundelivered elements, we defer the fair value of the undelivered elements andrecognize the difference between the total arrangement fee and the amountdeferred for the undelivered items as revenue related to the delivered items,assuming all other criteria for revenue recognition have been met. Payments forthe full term of all services, or billed revenue, are received at the time ofactivation of service and where appropriate are recorded as deferred revenueand are recognized as earned ratably over the term of provision of service.This accounting treatment reasonably approximates a recognition pattern thatcorresponds with the provision of the services during the quarters and theyear.

 

Revenue from the sale of domain names consists primarily of amountsearned for the transfer of rights to domain names that are currently under theCompany’s control. Collectability of revenues generated is subject to a highlevel of uncertainty; accordingly revenues are recognized only when payment isreceived, except where a fixed contract has been negotiated, in which caserevenues are recognized once all the terms of the contract have been satisfied.

 

We also generate advertising and other revenue through our onlinelibraries of shareware, freeware and online services presented at our websites,tucows.com and butterscotch.com. Advertising and other revenue is recognizedratably over the period in which it is presented. To the extent that theminimum number of post-presentation impressions we guarantee to customers isnot met, we defer recognition of the corresponding revenues until the guaranteedimpressions are achieved. Custom video production revenue is recognized onacceptance of the completed video by the customer.

 

Changes to contractual relationships in the future could impact theamounts and timing of revenue recognition.

 

In those cases where payment is not received at the time of sale,additional conditions for recognition of revenue apply. The conditions are(i) that the collection of sales proceeds is reasonably assured and(ii) that we have no further performance obligations. We record expectedrefunds, rebates and credit card charge-backs as a reduction of revenues at thetime of the sale based on historical experiences and current expectations.Should these expectations not be met, adjustments will be required in futureperiods.

 

We establish reserves for possible uncollectible accounts receivableand other contingent liabilities which may arise in the normal course ofbusiness. The allowance for doubtful accounts is calculated by taking intoaccount factors such as our historical collection and write-off experience, thenumber of days the customer is past due and the status of the customer’saccount with respect to whether or not the customer is continuing to receiveservice. The contingent liability estimates are based on management’shistorical experience and various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the reported amounts of liabilities and expenses thatare not readily apparent from other sources. Historically, credit losses havebeen within our expectations and the reserves we have established have beenappropriate. However, we have, on occasion, experienced issues which have ledto accounts receivable not being fully collected. Should these issues occurmore frequently, additional reserves may be required.

 

**Valuationof intangible assets, goodwill and long-lived assets**

 

Goodwill represents the excess of purchase price over the fair valuesassigned to the net assets acquired in business combinations. Intangible assetsconsist of acquired technology, brand, customer relationships, non-competitionagreements, surname domain names and direct navigation domain names. Intangibleassets, which include technology, brand value, customer relationships andnon-competition arrangements related to the acquisition of BoardtownCorporation in April 2004, the acquisition of the Hosted 

 

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MessagingBusiness of Critical Path, Inc. in January 2006, the acquisition ofMailbank.com Inc. in June 2006 and the acquisition ofInnerwise, Inc. in July 2007, are being amortized on a straight-linebasis over periods of two to seven years.

 

Goodwill and indefinite life intangibles are not be amortized, but aretested for impairment annually or more frequently if circumstances indicatepotential impairment, through a comparison of fair value to carrying amount.Goodwill and indefinite life intangibles are tested for impairment annually atthe same time every year, and when an event occurs or circumstances change suchthat it is reasonably possible that impairment may exist. We review goodwilland indefinite life intangibles at least annually for possible impairment inthe fourth quarter of each year.

 

We have other finite life intangible assets consisting of patented andnon-patented technologies. These intangible assets are amortized over theirexpected economic lives. The lives are determined based upon the expected useof the asset, the estimated average life of the replacement parts of thereporting units products, the stability of the industry, expected changes inand replacement value of distribution networks and other factors deemedappropriate.

 

With regards to property, equipment and definite life intangibleassets, we continually evaluate whether events or circumstances have occurredthat indicate the remaining estimated useful lives of its definite-lifeintangible assets may warrant revision or that the remaining balance of suchassets may not be recoverable. We use an estimate of the related undiscountedcash flows over the remaining life of the asset in measuring whether the assetis recoverable. There was no impairment recorded on definite-life intangibleassets and property and equipment during the three months endedJune 30, 2010 or during the three months endedJune 30, 2009.

 

Determining the number of reporting units and the fair value of areporting unit requires us to make judgments and involves the use ofsignificant estimates and assumptions. These estimates and assumptions includerevenue growth rates and operating margins used to calculate projected futurecash flows, risk-adjusted discount rates, future economic and marketconditions, and determination of appropriate market comparables. We base ourfair value estimates on assumptions we believe to be reasonable but that areunpredictable and inherently uncertain. The long-term financial forecast representsthe best estimate that we have at this time and we believe that its underlyingassumptions are reasonable. However, actual performance in the near-term andlonger-term could be materially different from these forecasts, which couldimpact future estimates of fair value of our reporting units and may result ina charge to earnings in future periods due to the potential for a write-down ofgoodwill in connection with such tests.

 

**Accountingfor income taxes**

 

We are subject to income taxes in the U.S. and numerous foreignjurisdictions. Significant judgment is required in evaluating our uncertain taxpositions and determining our provision for income taxes. We apply a two-stepapproach to recognizing and measuring uncertain tax positions. The first step isto evaluate the tax position for recognition by determining if on the weight ofavailable evidence; it is more likely than not that the position will besustained on audit, including resolution of related appeals or litigationprocesses, if any. The second step is to measure the tax benefit that is morethan 50% likely to be realized upon settlement.

 

Although we believe we have adequately reserved for our uncertain taxpositions, no assurance can be given that the final tax outcome of thesematters will not be different. We adjust these reserves in light of changingfacts and circumstances, such as the closing of a tax audit or the refinementof an estimate. To the extent that the final tax outcome of these matters isdifferent than the amounts recorded, such differences will impact the provisionfor income taxes in the period in which such determination is made.

 

As we account for income taxes under the asset and liability method, werecognize deferred tax assets or liabilities for the anticipated future taxeffects of temporary differences between the financial statement basis and thetax basis of our assets and liabilities. We record a valuation allowance toreduce the net deferred tax assets when it is more likely than not that thebenefit from the deferred tax assets will not be realized. In assessing theneed for a valuation allowance, historical and future levels of income,expectations and risks associated with estimates of future taxable income andongoing tax planning strategies are considered. In the event that it isdetermined that the deferred tax assets to be realized in the future would bein excess of the net recorded amount, an adjustment to the deferred tax assetvaluation allowance would be recorded. This adjustment would increase income inthe period that such determination was made. Likewise, should it be determinedthat all or part of a recorded net deferred tax asset would not be realized inthe future, an adjustment to increase the deferred tax asset valuationallowance would be charged to income in the period that such determinationwould be made.

 

On a periodic basis, we evaluate the probability that our deferred taxassets will be recovered to assess its realizability. To the extent we believeit is more likely than not that some portion of our deferred tax assets willnot be realized, we will increase the valuation allowance against the deferredtax assets. Realization of our deferred tax assets is dependent primarily uponfuture taxable income. Our judgments regarding future profitability may changedue to future market conditions, changes in U.S. or international tax

 

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lawsand other factors. These changes, if any, may require possible materialadjustments to these deferred tax assets, impacting net income or net loss inthe period when such determinations are made.

 

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**RESULTSOF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2010 ASCOMPARED TO THE THREE AND SIX MONTHS ENDED JUNE 30, 2009**

 

The following table presents our net revenues, by revenue source:

 
| ** **                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| OpenSRS :                        | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Domain Services                  |       | $                                    | 15,748,912 |                               | $          | 14,737,932 |   | $ | 31,151,922 |   | $ | 28,939,954 |   |
| Email Services                   |       | 580,658                              |       | 873,855                            |       | 1,218,846 |   | 1,995,790 |   |
| Other Services                   |       | 1,084,943                            |       | 1,091,988                          |       | 2,178,654 |   | 2,186,448 |   |
| Total OpenSRS Services           |       | 17,414,513                           |       | 16,703,775                         |       | 34,549,422 |   | 33,122,192 |   |
|                             |       |                                 |       |                               |       |   |   |   |   |
| YummyNames                       |       | 1,631,848                            |       | 1,455,557                          |       | 3,343,169 |   | 3,320,590 |   |
| Hover                            |       | 1,110,962                            |       | 1,258,828                          |       | 2,240,459 |   | 2,559,413 |   |
| Butterscotch                     |       | 689,275                              |       | 603,959                            |       | 1,158,701 |   | 1,111,348 |   |
|                             |       | $                                    | 20,846,598 |                               | $          | 20,022,119 |   | $ | 41,291,751 |   | $ | 40,113,543 |   |
| Increase over comparative period |       | $                                    | 824,479    |                               |       |   | $ | 1,178,208 |   |   |   |
| Increase - percentage            |       | 4                                    | %          |                               |       | 3 | % |   |   |

 

The following table presents our revenues, by revenue source, as apercentage of total revenues:

** **
| ** **             | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **             | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| OpenSRS :              |       |                                 |       |                               |       |   |   |   |   |
| Domain Services        |       | 76                                   | %          | 75                                 | %          | 76 | % | 73 | % |
| Email Services         |       | 3                                    | %          | 4                                  | %          | 3 | % | 5 | % |
| Other Services         |       | 5                                    | %          | 5                                  | %          | 5 | % | 5 | % |
| Total OpenSRS Services |       | 84                                   | %          | 84                                 | %          | 84 | % | 83 | % |
|                   |       |                                 |       |                               |       |   |   |   |   |
| YummyNames             |       | 8                                    | %          | 7                                  | %          | 8 | % | 8 | % |
| Hover                  |       | 5                                    | %          | 6                                  | %          | 5 | % | 6 | % |
| Butterscotch           |       | 3                                    | %          | 3                                  | %          | 3 | % | 3 | % |
|                   |       | 100                                  | %          | 100                                | %          | 100 | % | 100 | % |

 

Deferred revenue from domain name registrations and other services atJune 30, 2010 increased to $60.0 million from $56.9 million atJune 30, 2009.

 

No customer accounted for more than 10% of revenue during the three andsix months ended June 30, 2010 and, at June 30, 2010, twocustomers accounted for 25% of accounts receivable all of which has been paidsubsequent to June 30, 2010. Significant management judgment isrequired at the time of recording of revenue to assess whether the collectionof the resulting receivables is reasonably assured. On an ongoing basis we assessthe ability of our customers to make required payments. Based on thisassessment, we expect the carrying amount of our outstanding receivables, netof allowance for doubtful accounts, to be fully collected.

 

***OpenSRS***

 

Net revenues from OpenSRS services for the three months endedJune 30, 2010 as compared to the three months endedJune 30, 2009, increased by $0.7 million to $17.4 million. Thisincrease resulted from an increase in domain services revenue of$1.0 million to $15.7 million, primarily resulting from increased volumesfrom new clients and retention of existing customers.

 

During the three months ended June 30, 2010, the revenue fromall new, renewed and transferred-in domain name registrations that we processedincreased by 0.2 million to 1.8 million as compared to the threemonths ended June 30, 2009. This increase in domain services revenuewas partially offset by a decrease in email services revenue of $0.3 million,primarily resulting from the loss of certain media portal email customers during2009. Our marketing efforts to date have generated revenues that only partiallyoffset these customer losses, which continue to adversely impact our results ofoperations for email services for the three months ended June 30, 2010.

 

Net revenues from OpenSRS services for the six months endedJune 30, 2010 as compared to the six months endedJune 30, 2009, increased by $1.4 million to $34.5 million,primarily the result of domain services net revenues increasing by $2.2 millionto $31.2 million being partially offset by email services decreasing by $0.8million for the reasons noted above.

 

During the six months ended June 30, 2010, the revenue fromall new, renewed and transferred-in domain name registrations that we processedincreased by 0.3 million to 3.8 million as compared to the six monthsended June 30, 2009.

 

While we anticipate that the number of new, renewed and transferred-indomain name registrations will continue to incrementally increase, thevolatility in the market could affect the growth of domain names that wemanage. As of June 30, 2010, the total domain names under ourmanagement increased by 0.4 million to 8.4 million, when compared toJune 30, 2009. In addition, we provide provisioning services on a monthlybasis to accredited registrars who use our technical systems to process domain 

 

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registrationswith their own accreditation. As of June 30, 2010, we managed1.7 million domain names on behalf of other accredited registrars, anincrease of 0.5 million compared to the 1.2 million managed foraccredited registrars as of June 30, 2009.

 

***YummyNames***

 

Net revenues from our YummyNames domain portfolio service for the threemonths ended June 30, 2010 as compared to the three months endedJune 30, 2009 increased by $0.2 million, or 12%, to$1.6 million. This increase resulted primarily from an increase in thesale of domain names by $0.4 million to $1.1 million. This increasewas partially offset by a reduction in our pay-per-click advertising or parkedpages revenue by $0.2 million to $0.3 million during the three monthsended June 30, 2010, primarily the result of the lower inventory of namesavailable for parking purposes as we continue to sell non-strategic names.

 

Net revenues from our YummyNames domain portfolio service for the sixmonths ended June 30, 2010 as compared to the six months endedJune 30, 2009 remained relatively flat at $3.3 million, with the$0.4 million increase in revenue from the sale of domain names to$2.3 million and increased revenues from our auction initiatives of$0.1 million to $0.3 million being offset by a $0.5 millionreduction in our pay-per-click advertising or parked pages revenue to$0.7 million.

 

The market for monetization of domain names is rapidly evolving andthere is no guarantee that we will be able to continue to acquire the samecaliber of names for our portfolio from future expiring domains or that nameswe acquire in future will provide the same revenue impact as we haveexperienced from past acquisitions. In addition, the revenue we derive fromdomain portfolio services is driven by general macroeconomic factors thataffect internet advertising. Our advertising expenditures are typicallysensitive to economic conditions and tend to decline in recessionary periodsand other periods of economic uncertainty.

 

***Hover***

 

Net revenues from Hover for the three months endedJune 30, 2010 as compared to the three months endedJune 30, 2009 decreased by $0.1 million, or 12%, to$1.1 million.

 

Net revenues from Hover for the six months endedJune 30, 2010 as compared to the six months endedJune 30, 2009 decreased by $0.3 million, or 12%, to$2.2 million.

 

During fiscal 2009, Hover undertook significant development efforts toprovide our retail customers a more streamlined platform to register and managedomain names and email addresses. During this initiative, we de-emphasized newcustomer acquisitions and concentrated on stabilizing renewal rates and thetransitioning of our retail customers from our Domain Direct, NetIdentity andIYD services to Hover. These initiatives resulted in a decrease in the deferredrevenue balance during fiscal 2009 as the cash receipts added to deferredrevenue were lower than the revenue being recognized from prior periods. Duringthe six months ended June 30, 2010, we concentrated on launching long-termprograms to drive new customer acquisitions, which has resulted in increasedsales volumes and cash receipts.

 

***Butterscotch***

 

Net revenues from Butterscotch for the three and six months endedJune 30, 2010 as compared to the three and six months endedJune 30, 2009 remained relatively flat when compared to the three andsix months ended June 30, 2009 at $0.7 million and $1.2 million,respectively.

 

The primary reason for revenues remaining relatively flat is due to thecontinuing preference of advertisers for more content rich traffic, which hassignificantly shifted the sales mix over the past several quarters, in whichour advertising revenue from the Tucows.com website and our Author ResourceCenter has steadily declined. We have also experienced a dramatic decline in AdSense revenue due to Google’s elimination of their enterprise level AdSenseprogram. These decreases have been offset by increased video advertising andcorporate video revenue as advertisers continue to migrate their advertisingspend towards more content rich websites such as Butterscotch.com.

 

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**COST OFREVENUES**

 

***OpenSRS***

 

OpenSRS Domain Service

 

Cost of revenues for domain registrations represents the amortizationof registry fees on a basis consistent with the recognition of revenues fromour customers, namely ratably over the term of provision of the service.Registry fees, the primary component of cost of revenues, are paid in full whenthe domain is registered, and are initially recorded as prepaid domain registryfees. This accounting treatment reasonably approximates a recognition patternthat corresponds with the provision of the services during the period.

 

OpenSRS Email Service

 

Cost of revenues for email services are payable to third-partyproviders for licensing and royalty costs related to the provision of certaincomponents of our email services. Fees payable for these components areincluded in the cost of revenues in the month they are incurred.

 

Other OpenSRS Services

 

Costs of revenues for other reseller services include fees paid tothird-party service providers, primarily for SSL certificates and for printingservices in connection with Platypus. Fees payable for SSL certificates areamortized on a basis consistent with the provision of service, generally oneyear, while monthly printing fees are included in cost of revenues in the monththey are incurred.

 

***YummyNames***

 

Costs of revenues for our domain portfolio service represent theamortization of registry fees for domains added to our portfolio over therenewal period, which is generally one year, the value attributed underintangible assets to any domain name sold and any impairment charges that mayarise from our assessment of our domain name intangible assets. As the totalnames in our portfolio continue to grow, this cost will become a moresignificant component of our cost of revenues. Payments for domainregistrations are payable for the full term of service at the time ofactivation of service and are recorded as prepaid domain registry fees and areexpensed ratably over the renewal term.

 

***Hover***

 

Costs of revenues for our provision and management of Internet serviceson a retail basis include the amortization of registry fees on a basisconsistent with the recognition of revenues from our customers, namely ratablyover the term of provision of the service and includes the amortization ofregistry fees payable to renew the domains in our surname portfolio. Registryfees, the primary component of cost of revenues, are paid in full when thedomain is registered, and are recorded as prepaid domain registry fees.

 

***Butterscotch***

 

Costs of revenues for our ad-supported content sites include the feespaid to third-party service providers, primarily for digital certificates soldthrough our content sites and content license fees.

 

***Network costs***

 

Network costs include personnel and related expenses, depreciation andamortization, communication costs, equipment maintenance, stock-basedcompensation and employee and related costs directly associated with themanagement and maintenance of our network. Communication costs includebandwidth, co-location and provisioning costs we incur to support the supply ofall our services.

 

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The following table presents our cost of revenues, by revenue source,for the three and six months ended June 30, 2010 andJune 30, 2009:

** **
| ** **                                   | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                   | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| OpenSRS :                                    | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Domain Services                              |       | $                                    | 13,089,345 |                               | $          | 11,943,842 |   | $ | 25,705,576 |   | $ | 23,298,602 |   |
| Email Services                               |       | 117,319                              |       | 153,228                            |       | 224,457 |   | 333,146 |   |
| Other Services                               |       | 400,342                              |       | 411,287                            |       | 787,465 |   | 800,139 |   |
| Total OpenSRS Services                       |       | 13,607,006                           |       | 12,508,357                         |       | 26,717,498 |   | 24,431,887 |   |
|                                         |       |                                 |       |                               |       |   |   |   |   |
| YummyNames                                   |       | 253,740                              |       | 250,529                            |       | 456,495 |   | 436,084 |   |
| Hover                                        |       | 350,288                              |       | 475,369                            |       | 749,733 |   | 988,579 |   |
| Butterscotch                                 |       | 25,380                               |       | 1,110                              |       | 44,238 |   | 7,850 |   |
| Network, other costs                         |       | 1,219,572                            |       | 1,150,683                          |       | 2,412,896 |   | 2,307,046 |   |
| Network, depreciation and amortization costs |       | 327,859                              |       | 605,618                            |       | 712,719 |   | 1,027,765 |   |
|                                         |       | $                                    | 15,783,845 |                               | $          | 14,991,666 |   | $ | 31,093,579 |   | $ | 29,199,211 |   |
| Increase over comparative period             |       | $                                    | 792,179    |                               |       |   | $ | 1,894,368 |   |   |   |
| Increase - percentage                        |       | 5                                    | %          |                               |       | 6 | % |   |   |

 

The following table presents our cost of revenues, as a percentage oftotal cost of revenues for the three and six months endedJune 30, 2010 and June 30, 2009:

** **
| ** **                                   | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                   | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                   | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| OpenSRS :                                    |       |                                 |       |                               |       |   |   |   |   |
| Domain Services                              |       | 82                                   | %          | 79                                 | %          | 83 | % | 81 | % |
| Email Services                               |       | 1                                    | %          | 1                                  | %          | 1 | % | 1 | % |
| Other Services                               |       | 3                                    | %          | 3                                  | %          | 3 | % | 3 | % |
| Total OpenSRS Services                       |       | 86                                   | %          | 83                                 | %          | 87 | % | 85 | % |
|                                         |       |                                 |       |                               |       |   |   |   |   |
| YummyNames                                   |       | 2                                    | %          | 2                                  | %          | 1 | % | 1 | % |
| Hover                                        |       | 2                                    | %          | 3                                  | %          | 2 | % | 3 | % |
| Butterscotch                                 |       | 0                                    | %          | 0                                  | %          | 0 | % | 0 | % |
| Network, other costs                         |       | 8                                    | %          | 8                                  | %          | 8 | % | 8 | % |
| Network, depreciation and amortization costs |       | 2                                    | %          | 4                                  | %          | 2 | % | 3 | % |
|                                         |       | 100                                  | %          | 100                                | %          | 100 | % | 100 | % |

 

Prepaid domain registration and other Internet services fees as ofJune 30, 2010 increased by $3.5 million, or 8%, to$47.2 million from $43.7 million at June 30, 2009.

 

***OpenSRS***

 

Costs for OpenSRS for the three months ended June 30, 2010increased by $1.1 million, or 9%, to $13.6 million, when compared tothe three months ended June 30, 2009. This increase was primarily aresult of increased domain registration volume experienced during the threemonths ended June 30, 2010 when compared to the three months endedJune 30, 2009.

 

Costs for OpenSRS for the six months ended June 30, 2010increased by $2.3 million, or 9%, to $26.7 million, when compared tothe six months ended June 30, 2009. This increase was primarily aresult of increased domain registration volume experienced during the sixmonths ended June 30, 2010 when compared to the six months endedJune 30, 2009.

 

This increase was partially offset by decreased email services costs ascertain costs incurred in the six months ended June 30, 2009 wereone-time costs.

 

***YummyNames***

 

Costs for YummyNames for the three and six months ended June 30, 2010as compared to the three and six months ended June 30, 2009 remainedrelatively flat at $0.3 million and $0.5 million, respectively.

 

***Hover***

 

Costs for Hover for the three months ended June 30, 2010 ascompared to the three months ended June 30, 2009 decreased by$0.1 million, to $0.4 million.

 

Costs for Hover for the six months ended June 30, 2010 ascompared to the six months ended June 30, 2009 decreased by$0.2 million, to $0.7 million.

 

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These decreases resulted primarily from the introduction of new emailservice products, such as our family plan, which have resulted in a change inour sales mix such that email services, which have a relatively lower cost ofsales, account for n increasing proportion of our Hover services as compared toour domain name services.

 

***Network costs***

 

Networkcosts before depreciation and amortization for the three months ended June 30, 2010remained relatively flat at $1.2 million as compared to the three monthsended June 30, 2009, despite the significant strengthening, onaverage, of the Canadian dollar relative to the U.S. dollar by approximately12% as compared to the three months ended June 30, 2009, and reflectsour improved efficiency in operating and managing our co-location facilities.

 

Networkcosts before depreciation and amortization for the six months endedJune 30, 2010 increased by $0.1 million, or 5%, to$2.4 million as compared to the six months ended June 30, 2009.This increase was predominantly a result of the significant strengthening, onaverage, of the Canadian dollar relative to the U.S. dollar by approximately13% as compared to the six months ended June 30, 2009, and reflectsour improved efficiency in operating and managing our co-location facilities.

 

Asignificant portion of our operating and network expenses are incurred inCanadian dollars, as a result, the strengthening of the Canadian dollarrelative to the U.S. dollar has negatively impacted all of our operating costs,during the three and six months ended June 30, 2010 when compared tothe three and six months ended June 30, 2009. Exchange rates are,however, subject to significant and rapid fluctuations, and we therefore cannotpredict the prospective impact of exchange rate fluctuations on our business,results of operations and financial condition.

 

Networkdepreciation and amortization costs for the three months endedJune 30, 2010 decreased by $0.3 million to $0.3 million,primarily as a result of certain of our older computer hardware now being fullydepreciated.

 

Networkdepreciation and amortization costs for the six months endedJune 30, 2010 decreased by $0.3 million to $0.7 million,primarily as a result of certain of our older computer hardware now being fullydepreciated.

 

Excluding movements in exchange rates, we expect network costs todecrease slightly for the fiscal year ending December 31, 2010 as comparedto the fiscal year ended December 31, 2009.

 

**SALESAND MARKETING**

 

Sales and marketing expenses consist primarily of personnel costs.These costs include commissions and related expenses of our sales, productmanagement, public relations, call center, support and marketing personnel. Othersales and marketing expenses include customer acquisition costs, advertisingand other promotional costs.

** **
| ** **                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Sales and marketing              |       | $                                    | 1,786,893  |                               | $          | 1,339,167 |   | $ | 3,649,229 |   | $ | 2,692,343 |   |
| Increase over comparative period |       | $                                    | 447,726    |                               |       |   | $ | 956,886 |   |   |   |
| Increase - percentage            |       | 33                                   | %          |                               |       | 36 | % |   |   |
| Percentage of net revenues       |       | 9                                    | %          | 7                                  | %          | 9 | % | 7 | % |
|                                  |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

Sales and marketing expenses for the three months endedJune 30, 2010 increased by $0.4 million, or 33%, to$1.8 million when compared to the three months endedJune 30, 2009. This increase was primarily due to higher workforcecosts that resulted from additional people employed in both our marketing andcustomer service areas as well as the negative impact of the approximately 12%strengthening, on average, in the Canadian dollar relative to the U.S. dollarcompared to the three months ended June 30, 2009.

 

Sales and marketing expenses for the six months endedJune 30, 2010 increased by $1.0 million, or 36%, to$3.6 million when compared to the six months endedJune 30, 2009. This increase was primarily due to higher workforcecosts that resulted from an increase in the number of people employed in bothour marketing and customer service departments, undertaking additionalmarketing campaigns, participating in additional trade shows and the negativeimpact of the approximate 13% strengthening, on average, in the Canadian dollarrelative to the U.S. dollar compared to the six months ended June 30, 2009.

 

Included in sales and marketing expenses for the six months ended June 30,2010 is a non-recurring cost of approximately $0.1 million related toseverance costs incurred during that time.

 

Excluding movements in exchange rates, we expect sales and marketingexpenses to increase slightly during Fiscal 2010, in absolute dollars, as weadjust our marketing programs and sales and customer support strategies to meetfuture opportunities in the marketplace.

 

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**TECHNICALOPERATIONS AND DEVELOPMENT**

 

Technical operations and development expenses consist primarily ofpersonnel costs and related expenses required to support the development of newor enhanced service offerings and the maintenance and upgrading of existinginfrastructure. This includes expenses incurred in the research, design anddevelopment of technology that we use to register domain names, email, retail,domain portfolio and other Internet services, as well as to distribute ourdigital content services. Editorial costs relating to the rating and review ofthe software content libraries are included in the costs of productdevelopment. Costs incurred during the application development stage arecapitalized and primarily include personnel costs for employees directlyrelated to the development project. As no material expenditures for qualifiedapplication development stage initiatives were incurred during the three monthsended March 31, 2010 or March 31, 2009, no amounts havebeen capitalized. All other costs are expensed as incurred.

** **
| ** **                           | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                           | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Technical operations and development |       | $                                    | 1,189,937  |                               | $          | 1,175,355 |   | $ | 2,432,950 |   | $ | 2,279,494 |   |
| Increase over comparative period     |       | $                                    | 14,582     |                               |       |   | $ | 153,456 |   |   |   |
| Increase - percentage                |       | 1                                    | %          |                               |       | 7 | % |   |   |
| Percentage of net revenues           |       | 6                                    | %          | 6                                  | %          | 6 | % | 6 | % |
|                                      |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

Technical operations and development expenses for the three monthsended June 30, 2010 remained relatively flat at $1.2 millionwhen compared to the three months ended June 30, 2009, primarily dueto the productivity improvements that have resulted from our adoption of anagile development model, which teams our development, quality assurance,product management and operations employees into smaller groups, offsetting theapproximate 12% strengthening, on average, in the Canadian dollar relative tothe U.S. dollar when compared to the three months ended June 30, 2009.

 

Technical operations and development expenses for the six months endedJune 30, 2010 increased by $0.2 million, or 4%, to$2.4 million when compared to the six months endedJune 30, 2009, primarily due to the increase in workforce-relatedcosts, including contract and outside service cost increases and theapproximate 13% strengthening, on average, in the Canadian dollar relative tothe U.S. dollar when compared to the six months ended June 30, 2009.

 

Excluding movements in exchange rates, we expect technical operationsand development expenses, in absolute dollars, for the fiscal year endingDecember 31, 2010  to remainrelatively flat when compared to the fiscal year endedDecember 31, 2009.

 

**GENERALAND ADMINISTRATIVE**

 

General and administrative expenses consist primarily of compensationand related costs for managerial and administrative personnel, fees forprofessional services, public listing expenses, rent and other generalcorporate expenses.

** **
| ** **                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| General and administrative       |       | $                                    | 600,776    |                               | $          | 1,592,325 |   | $ | 1,416,356 |   | $ | 3,462,221 |   |
| Decrease over comparative period |       | $                                    | (991,549   | )                                  |       |   | $ | (2,045,865 | ) |   |   |
| Decrease - percentage            |       | (62                                  | )%         |                               |       | (59 | )% |   |   |
| Percentage of net revenues       |       | 3                                    | %          | 8                                  | %          | 3 | % | 9 | % |
|                                  |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

General and administrative expenses for the three months endedJune 30, 2010 decreased by $1.0 million, or 62%, to$0.6 million as compared to the three months endedJune 30, 2009. This was primarily as a result of our recording aforeign exchange gain of $0.8 million during the three months endedJune 30, 2010 as compared to a foreign exchange loss of $0.3 millionduring the three months ended June 30, 2009. This gain in foreignexchange was primarily the result of the strengthening, on average, of theCanadian dollar relative to the U.S. dollar by approximately 12% from the threemonths ended June 30, 2009. This decrease was offset mainly by anincrease in workforce related costs of $0.1 million during the three monthsended June 30, 2010, as compared to the three months endedJune 30, 2009.

 

General and administrative expenses for the six months endedJune 30, 2010 decreased by $2.0 million, or 59%, to$1.4 million as compared to the six months ended June 30, 2009.This was primarily as a result of our recording a foreign exchange gain of$1.3 million during the six months ended June 30, 2010 ascompared to a foreign exchange loss of $1.1 million during the six months endedJune 30, 2009. This gain in foreign exchange was primarily the resultof the strengthening, on average, of the Canadian dollar relative to the U.S.dollar by approximately 13% from the six months ended June 30, 2009.This decrease was offset mainly by an increase in workforce related costs,facility costs and public listing costs of $0.4million during the six monthsended June 30, 2010, as compared to the six months endedJune 30, 2009.

 

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**DEPRECIATIONOF PROPERTY AND EQUIPMENT**

 

Property and equipment is depreciated on a straight-line basis over theestimated useful life of the assets.

 
| ** **                             | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                             | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Depreciation of property and equipment |       | $                                    | 43,431     |                               | $          | 92,363 |   | $ | 87,320 |   | $ | 174,816 |   |
| Decrease over comparative period       |       | $                                    | (48,932    | )                                  |       |   | $ | (87,496 | ) |   |   |
| Decrease - percentage                  |       | (53                                  | )%         |                               |       | (50 | )% |   |   |
|                                        |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

Depreciationcosts for the three months ended June 30, 2010 decreased by $49,000,or 53%, to $43,000, primarily as a result of certain of our older assets beingfully depreciated.

 

Depreciationcosts for the six months ended June 30, 2010 decreased by $87,000, or50%, to $87,000, primarily as a result of certain of our older assets beingfully depreciated.

 

**AMORTIZATION OF INTANGIBLE ASSETS**

 
| ** **                        | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Amortization of intangible assets |       | $                                    | 360,540    |                               | $          | 360,540 |   | $ | 721,080 |   | $ | 721,080 |   |
| Decrease over comparative period  |       | $                                    | —     |                               |       |   | $ | — |   |   |   |
| Decrease - percentage             |       | —                               | %          |                               |       | — | % |   |   |
| Percentage of net revenues        |       | 2                                    | %          | 2                                  | %          | 2 | % | 2 | % |
|                                   |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

Amortization of intangible assets consists of amounts arising inconnection with the acquisition of Boardtown in April 2004, theacquisition of the hosted messaging assets of Critical Path Inc. inJanuary 2006, the acquisition of Mailbank.com Inc. in June 2006and the acquisition of IYD in July 2007.

 

Brand and customer relationships acquired in connection with theacquisition of Boardtown Corporation and IYD are amortized on a straight-linebasis over seven years,

 

Customer relationships acquired in connection with the acquisition ofMailbank.com Inc. and the hosted messaging assets of Critical Path Inc.are each amortized on a straight-line basis over five years.

 

**LOSS (GAIN) ON CHANGE IN FAIR VALUE OF FORWARDEXCHANGE CONTRACTS**

 

Although our functional currency is the U.S. dollar, a major portion ofour fixed expenses are incurred in Canadian dollars. Our goal with regard toforeign currency exposure is, to the extent possible; to achieve operationalcost certainty, manage financial exposure to certain foreign exchangefluctuations and to neutralize some of the impact of foreign currency exchangemovements. Accordingly, we enter into foreign exchange contracts to mitigatethe exchange rate risk on portions of our Canadian dollar exposure.

 

As we are not required to comply with the documentation requirementsfor hedge accounting, we account for the fair value of the derivativeinstruments within the consolidated balance sheet as a derivative financialasset or liability and the corresponding change in fair value is recorded inthe consolidated statement of operations.

 
| ** **                                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Loss (gain) on change in fair value of forward  contracts |       | $                                    | 1,924,985  |                               | $          | (1,938,821 | ) | $ | 1,811,012 |   | $ | (2,024,164 | ) |
| Increase over comparative period                          |       | $                                    | 3,863,806  |                               |       |   | $ | 3,835,176 |   |   |   |
| Increase - percentage                                     |       | (199                                 | )%         |                               |       | (189 | )% |   |   |
| Percentage of net revenues                                |       | 9                                    | %          | 10                                 | %          | 4 | % | 5 | % |
|                                                           |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

We have entered into forward exchange contracts to meet a portion ofour future Canadian dollar requirements through November 2011. The impactof the fair value adjustment on unrealized foreign exchange on these contractsfor the three months ended June 30, 2010 was a net loss of$1.9 million, as compared to a net gain of $1.9 million for the threemonths ended June 30, 2009. This net loss in fair value of forwardcontracts resulted from the impact of the change in foreign exchange rates overtime and the settlement of forward exchange contracts as they matured.

 

The impact of the fair value adjustment on unrealized foreign exchangeon these contracts for the six months ended June 30, 2010 was a netloss of $1.8 million, as compared to a net gain of $2.0 million forthe six months ended June 30, 2009. This net loss in fair value offorward contracts resulted from the impact of the change in foreign exchangerates over time and the settlement of forward exchange contracts as theymatured.

 

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At June 31, 2010, we reflect a net derivative instrumentasset of $0.4 million on our balance sheet as a result of our foreignexchange contracts. Until their respective maturity dates, these contracts willfluctuate in value in line with movements in the Canadian vs. U.S. dollar pair.As all of the remaining contracts pertaining to the 2010 fiscal year will havematured during the course of the 2010 fiscal year, a derivative instrumentasset pertaining to 2010 fiscal year contracts of $0.6 million willreverse during the 2010 fiscal year and will result in our recognizing anadditional non-cash loss of this amount by December 31, 2010. This lossmay, however, be impacted by any additional contracts, with maturity datesafter June 30, 2010, that we may enter into and fluctuations in the valueof our existing contracts that mature during the 2010 and 2011 fiscal years.

 

**OTHER INCOME AND EXPENSES**

 
| ** **                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Other income (expenses), net     |       | $                                    | (33,727    | )                                  | $          | 2,550,870 |   | $ | (72,895 | ) | $ | 2,487,408 |   |
| Decrease over comparative period |       | $                                    | (2,584,597 | )                                  |       |   | $ | (2,560,303 | ) |   |   |
| Decrease - percentage            |       | (101                                 | )%         |                               |       | (103 | )% |   |   |
| Percentage of net revenues       |       | —                               | %          | 13                                 | %          | — | % | 6 | % |
|                                  |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

Otherexpenses for the three and six months ended June 30, 2010 primarily relateto interest payable pursuant to the terms of our Bank of Montreal creditfacility. As we have continued to reduce the amount outstanding under thecredit facility through monthly principal payments, the interest payable hasdecreased when compared to the three and six months endedJune 30, 2009.

 

Otherincome for the three and six months ended June 30, 2009 primarily relatesto the receipt of $2.1 million from Afilias Inc. (“Afilias”) to complete thesecond closing under the terms of a stock redemption agreement signed in November 2008,whereby Tucows DE agreed to sell its investment in Afilias to Afilias in threestages for an aggregate purchase price of $7.5 million. This sale resulted in again of $2.0 million for the quarter. In addition, in June 2009, wereceived an additional payment of $0.6 million in connection with Infonauticspatents that we assigned in 2002 to a third party who continues tocommercialize these patents. In connection with the assignment of thesepatents, we retained the right to share in certain revenue relating to any cashflow received by such third party. As the costs of commercializing the patentshave increased, we do not expect any future revenue received to be material.

 

**INCOMETAXES**

 

The following table presents our provision for income taxes for theperiods presented:

 
| ** **                 | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                 | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Provision for income taxes |       | $                                    | (105,758   | )                                  | $          | 581,651 |   | $ | 210,242 |   | $ | 689,076 |   |
|                            |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |

 

For the six months ended June 30, 2010, we recorded a provisionfor income taxes of $210,242 on income before income taxes of $7,330 using anestimated effective tax rate for its 2010 fiscal year adjusted for certainforeign exchange losses that we do not anticipate obtaining a current taxbenefit for. Included in the provision for income taxes is a recovery of$95,721 in respect of refundable Ontario research tax credits. Comparatively,for the six months ended June 30, 2009, we recorded a current tax expenseof $689,000 on income before income taxes of $6.1 million using an estimatedeffective tax rate for its 2009 fiscal year that accounts for the utilizationof remaining net operating loss carry forwards and alternative minimum taxcredits available to us.

 

As of December 31, 2009, we recorded a valuation allowance of $4.3million and a net deferred tax asset of $3.0 million. As of June 30, 2010we have recorded a non-current deferred tax asset of $3.6 million and currentdeferred tax liabilities of $0.6 million. As of June 30, 2010and December 31, 2009, we had also recorded a non current deferredtax liability related to the temporary difference arising on indefinite life intangiblesof $4.8 million.

 

We analyze the carrying value of our deferred tax asset on a regularbasis. In determining future taxable income, assumptions are made to forecastfederal, state and international operating income, the reversal of temporary timingdifferences, and the implementation of any feasible and prudent tax planningstrategies. The assumptions require significant judgment regarding theforecasts of future taxable income, and are consistent with other forecastsused to manage the business. During the six months ended June 30, 2010,there was no reversal of the valuation allowance. The valuation allowance willbe maintained until sufficient evidence exists to support a reversal of, ordecrease in, the valuation allowance.

 

We follow the provisions of FASB ASC: Topic 740, Income Taxes toaccount for income tax exposures. The application of this interpretationrequires a two-step process that separates recognition of uncertain taxbenefits from measurement thereof.

 

We have approximately $107,000 of total gross unrecognized tax benefitas of June 30, 2010 and $124,000 of total gross unrecognized tax benefitas of December 31, 2009, which if recognized would favorably affect ourincome tax rate in future periods. 

 

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Theunrecognized tax benefit relates primarily to prior year Pennsylvania statefranchise taxes and other insignificant US state taxes. The unrecognized taxbenefit has decreased by $17,000 when compared to the gross unrecognized taxbenefits as of December 31, 2009 as Pennsylvania have now settled theirclaim for the years December 31, 1996 to December 31, 2000. We do notexpect the unrecognized tax benefit for our 2010 research and development claimto be significant. We recognize accrued interest and penalties related to taxesin tax expense. We did not have significant interest and penalties accrued asof June 30, 2010 and June 30, 2009 respectively. We believe it isreasonably possible that $107,000 of the unrecognized tax benefit will decreasein the next twelve months as it is anticipated that the U.S. tax authoritieswill finalize their review of prior taxes owing in Pennsylvania within theperiod and certain other prior year state tax returns will be filed.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

As of June 30, 2010, our principal sources of liquidity werecash flows generated from operations and cash and cash equivalents of$4.1 million, as compared to $9.6 million at December 31, 2009.

 

Net cash provided by operating activities for the six months endedJune 30, 2010 decreased by $0.9 million to $2.6 million whencompared to $3.5 million for the six months ended June 30, 2009.

 

Net cash provided by operating activities, before changes in non-cashoperating working capital, decreased by $0.1 million to $3.3 million for thesix months ended June 30, 2010 from $3.4 million for the six months ended June 30,2009. Net cash provided by changes in non-cash operating working capital,decreased by $0.8 million to a net usage position of $0.7 million for the sixmonths ended June 30, 2010 compared to a net generation of $0.1 millionfor the six months ended June 30, 2009.

 

Cash used to fund other working capital increased primarily from anadditional $0.3 million in accounts receivable, largely the result of increasedsales to customers who receive credit terms from us, an increase in our prepaiddomain name registry and other Internet services fees of $0.8 million, areduction in accounts payable of $0.5 million and a reduction in income taxesreceivable of $0.6 million.

 

These uses of working capital were partially offset by an increase inour deferred revenue of $1.0 million and a reduction of the deposits wemaintain with our registry suppliers by $0.4 million during the six monthsended June 30, 2010 when compared to the six months ended June 30,2009.

 

Net cash used in financing activities during the six months endedJune 30, 2010 totaled $7.9 million. We used $4.5 million torepurchase 6.3 million of our shares pursuant to the terms of a Dutchauction tender offer completed during January 2010 and $2.4 millionto repurchase 3.4 million of our shares under the terms of our stockrepurchase program announced in February 2010. These initiatives haveresulted in a 15 % reduction in the number of shares we have in issue whencompared to the number of shares in issue at December 31, 2009. Pursuantto the terms of our credit facility with the Bank of Montreal, we also madeequal monthly principal repayments of approximately $160,000, for an aggregatepayment during the six months ended June 30, 2010 of approximately $1.0million. This reduced the balance owing under the facility as of June 30,2010 to $2.3 million.

 

Pursuant to the terms of the credit facility, we are required to makean annual cash sweep payment based on excess cash flow as defined in the creditfacility agreement, as well as monthly principal repayments of approximately$160,000. Based on the assessment of the audited results for our 2008 fiscalyear, we made a cash sweep payment of $0.7 million onMay 1, 2009. As of June 30, 2010, the estimated cash sweeppayment for the year ended December 31, 2009, which was payableduring the three months ended June 30, 2010, would have beensufficient to fully repay all amounts outstanding under the credit facility.However, since we would have then repaid the facility two years earlier thanoriginally contemplated prior to June 30, 2010, we began exploringwith the Bank of Montreal if an alternative facility should be put in place. Aspart of our discussions with the Bank of Montreal, they have deferred thepayment of the fiscal 2010 cash sweep payment pending the outcome of thesenegotiations.

 

Investing activities used net cash of $0.3 million to acquireadditional property and equipment during the six months endedJune 30, 2010, as compared to $0.1 million during the six monthsended June 30, 2009. During the six months ended June 30, 2009 wealso received proceeds of $2.1 million from the disposition of our investmentin Afilias.

 

Based on our operations, we believe that our cash flow from operationswill be adequate to meet our anticipated requirements for working capital,capital expenditures and our loan repayments for at least the next12 months.

 

We may choose to raise additional funds or seek other financingarrangements to facilitate more rapid expansion, develop new or enhanceexisting products or services, respond to competitive pressures or acquire orinvest in complementary businesses, technologies, services or products.

 

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If additional financing is required, we may not be able to raise it onacceptable terms, or at all, and additional financing may be dilutive toexisting investors. We may also evaluate potential acquisitions of otherbusinesses, products and technologies. To complete potential acquisitions, wemay issue additional securities or need additional equity or debt financing andany additional financing may be dilutive to existing investors. There arecurrently no material understandings, commitments or agreements regarding theacquisition of other businesses.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

We develop products in Canada and sell these services in North Americaand Europe. Our sales are primarily made in U.S. dollars, while a major portionof expenses are incurred in Canadian dollars. Our financial results could beaffected by factors such as changes in foreign currency exchange rates or weakeconomic conditions in foreign markets. Our interest income is sensitive tochanges in the general level of Canadian and U.S. interest rates, particularlysince the majority of our investments are in short-term instruments. Based onthe nature of our short-term investments, we have concluded that there is nomaterial interest rate risk exposure as of June 30, 2010. We are alsosubject to market risk exposure related to changes in interest rates on ournon-revolving, reducing credit facility with The Bank of Montreal. Any changesin interest rates are not expected to be material. Fluctuations in interestrates are beyond our control. We will continue to monitor and assess the risksassociated with interest expense exposure and may take additional actions inthe future to mitigate these risks.

 

Although our functional currency is the U.S. dollar, a substantialportion of our fixed expenses are incurred in Canadian dollars. Our policy withrespect to foreign currency exposure is to manage financial exposure to certainforeign exchange fluctuations with the objective of neutralizing some of theimpact of foreign currency exchange movements. Exchange rates are, however,subject to significant and rapid fluctuations, and therefore we cannot predictthe prospective impact of exchange rate fluctuations on our business, resultsof operations and financial condition. Accordingly, we have entered intoforeign exchange contracts to mitigate the exchange rate risk on portions ofour Canadian dollar exposure.

 

At June 30, 2010, the Company had the following outstandingforward exchange contracts to trade U.S. dollars in exchange for Canadiandollars:

 
| ** **                        | ** ** | **Notional**     | ** ** | **Weighted  average** | ** ** | ** **     | ** ** |
|-----------------------------------|------------|------------------|------------|-----------------------|------------|----------------|------------|
| ** **                        | ** ** | **amount of**    | ** ** | **exchange rate of**  | ** ** | ** **     | ** ** |
| **Maturity  date**                | ** ** | **U.S. dollars** | ** ** | **U.S. dollars**      | ** ** | **Fair value** | ** ** |
|                              |       |             |       |                  |       |           |       |
| July - September 2010   |       | 5,400,000        |       | 0.8596                |       | 510,554        |       |
| October - December 2010 |       | 5,400,000        |       | 0.9236                |       | 97,388         |       |
| 2010                              |       | 10,800,000       |       | 0.8904                |       | 607,942        |       |
|                              |       |             |       |                  |       |           |       |
| January - March 2011    |       | 5,400,000        |       | 0.9307                |       | 49,286         |       |
| April - June 2011       |       | 3,900,000        |       | 0.9635                |       | (104,338       | )          |
| June - September 2011   |       | 3,900,000,       |       | 0.9604                |       | (98,981        | )          |
| October - December 2011 |       | 1,950,000        |       | 0.9644                |       | (60,251        | )          |
| 2011                              |       | 15,150,000       |       | 0.9508                |       | (214,284       | )          |
|                              |       |             |       |                  |       |           |       |
| Total                             |       | $                | 25,950,000 |                  | 0.9247     |           | $          | 393,658 |   |
|                                   |            |                  |            |                       |            |                |            |  |  |

 

During the six months ended June 30, 2010, the Company enteredinto a series of foreign exchange forward contracts to hedge a portion of our2011 fiscal year expected Canadian dollar requirements. These contracts,collectively, have a notional value of US$10.0 million, whereby amounts ofUS$250,000, US$400,000 or US$650,000 are converted into Canadian dollars on asemi-monthly basis from January 2011 to November 2011 at an averageforeign exchange rate of US$1.00: Cdn$1.0437.

 

The Company does not apply hedge accounting and, therefore, for thethree and six months ended June 30, 2010, the Company recorded a lossof $1.9 million and $1.8 million respectively, in the fair value offorward contracts in its consolidated statements of operations. For the threeand six months ended June 30, 2009, the Company recorded a gain onforward contracts of $1.9 million and $2.0 million respectively.

 

We have performed a sensitivity analysis model for foreign exchangeexposure over the three months ended June 30, 2010. The analysis useda modeling technique that compares the U.S. dollar equivalent of all expensesincurred in Canadian dollars, at the actual exchange rate, to a hypothetical10% adverse movement in the foreign currency exchange rates against the U.S.dollar, with all other variables held constant. Foreign currency exchange ratesused were based on the market rates in effect during the three months endedJune 30, 2010. The sensitivity analysis indicated that a hypothetical10% adverse movement in foreign currency exchange rates 

 

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wouldresult in a decrease in net income for the three months endedJune 30, 2010 of approximately $0.5 million. There can be noassurances that the above projected exchange rate decrease will materialize.Fluctuations of exchange rates are beyond our control. We will continue tomonitor and assess the risk associated with these exposures and may takeadditional actions in the future to hedge or mitigate these risks.

 

**Credit Risk**

 

Financial instruments that potentially subject us to concentrations ofcredit risk consist principally of cash equivalents, marketable securities,foreign exchange contracts and accounts receivable. Our cash, cash equivalentsand short-term investments are in high-quality securities placed with majorbanks and financial institutions whom we have evaluated as highly creditworthyand commercial paper. With respect to accounts receivable, we perform ongoingevaluations of our customers, generally granting uncollateralized credit termsto our customers, and maintaining an allowance for doubtful accounts based onhistorical experience and our expectation of future losses.

 

**Item 4. Controls andProcedures**

 

(a)           Evaluation of Disclosure Controls andProcedures

 

Ourmanagement, with the participation of our chief executive officer and chieffinancial officer, evaluated the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this report. Based on thatevaluation, our chief executive officer and chief financial officer concludedthat our disclosure controls and procedures as of the end of the period coveredby this report have been designed and are functioning effectively to providereasonable assurance that the information required to be disclosed by us inreports filed under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC’srules and is accumulated and communicated to our management, including ourprincipal executive and principal financial officers, or persons performingsimilar functions, as appropriate to allow timely decisions regarding requireddisclosure. We believe that a controls system, no matter how well designed andoperated, cannot provide absolute assurance that the objectives of the controlssystem are met, and no evaluation of controls can provide absolute assurancethat all control issues and instances of fraud, if any, within a company havebeen detected.

 

(b)           Change in Internal Control overFinancial Reporting

 

Nochange in our internal control over financial reporting occurred during ourmost recent fiscal quarter that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

**PART II.**

**OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

Weare involved in various investigations, claims and lawsuits arising in thenormal conduct of our business, none of which, in our opinion, will harm ourbusiness. We cannot assure that we will prevail in any litigation. Regardlessof the outcome, any litigation may require us to incur significant litigationexpense and may result in significant diversion of our attention.

 

**Item 1A. Risk factors**

 

Inaddition to the other information set forth in this Quarterly Report, youshould also carefully consider the risk factors discussed in Part I, “Item1A. Risk Factors” in our Annual Report on Form 10-K for the year endedDecember 31, 2009, all of which could materially affect our business,financial condition or operating results and should be considered before makingan investment decision regarding our securities. The risks described in ourAnnual Report on Form 10-K are not the only risks facing the Company.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may adversely affect our business,financial condition or operating results.

 

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**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds**

 

Inthe three months ended June 30, 2010 we used $1,708,234 to repurchase2,453,300 shares of the Company’s common stock pursuant to a normal courseissuer bid. All shares repurchased were cancelled. The following table showsthe monthly activity related to our stock repurchases for the three monthsended June 30, 2010.

 
| **Period**                                                | ** ** | **Total number of  shares purchased  (1)** | ** ** | **Average price paid per  share** | ** ** | **Total number of shares  purchased as part of  publicly announced plans  or programs** | ** ** | **Maximum number of shares  that may yet be purchased  under the plans or programs  (2)** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| June 1, 2010 through June 30, 2010         |       | 2,226,400                                                 |       | $                                                | 0.70       |                                                                                                                                 | 2,226,400  |                                                                                                                                             | 11,837,802 |   |
| May 1, 2010 through  May 31, 2010     |       | 226,900                                                   |       | 0.66                                             |       | 226,900                                                                                                                              |       | 14,261,693                                                                                                                                       |       |
| April 1, 2010 through  April 30, 2010 |       | —                                                    |       | —                                           |       | —                                                                                                                               |       | 12,208,834                                                                                                                                       |       |
| Total                                                     |       | 2,453,300                                                 |       | $                                                | 0.70       |                                                                                                                                 | 2,453,300  |                                                                                                                                             |       |   |

 

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(1)          On February 16, 2010,the Company’s Board of Directors authorized the Company to repurchase of up to$10 million of its common stock at its discretion under the terms of a normalcourse issuer bid that will expire on February 18, 2011.

 

(2)          During the three monthsended June 30, 2010, the Company purchased 2,453,300 shares of itscommon stock at an average purchase price of $0.70 per share, for a total of$1,708,234. Based on the market share price of $0.64 at close of business onJune 30, 2010, the Company is eligible to repurchase up to anadditional 11,837,802 shares of its common stock, on the NYSE Amex, under theterms of this normal course issuer bid. The maximum number of shares that may yetbe purchased is calculated by reducing the $10 million maximum repurchaseamount by the actual dollars spent during the duration of the repurchaseprogram to repurchase shares divided by the market price per share at the closeof business at the end of each month. The closing share prices on the lasttrading day of each month, being April 30, 2010,May 28, 2010 and June 30, 2010 were $0.76, $0.64 and $0.64respectively.

 

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**Item 6. Exhibits**

 

(a) Exhibits.

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                            |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **       | ** ** | ** **                                                                                                                                                                                                                                                 |
| 3.1              |       | Fourth  Amended and Restated Articles of Incorporation of Tucows Inc.  (Incorporated by reference to Exhibit 3.1 filed with Tucows’ current  report on Form 8-K, as filed with the SEC on November 29, 2007)                      |
| 3.2              |       | Second  Amended and Restated Bylaws of Tucows Inc. (Incorporated by reference to  Exhibit 3.2 filed with Tucows’ annual report on Form 10-K for the  year ended December 31, 2006, as filed with the SEC on March 29,  2007) |
| 31.1             |       | Chief  Executive Officer’s Rule 13a-14(a)/15d-14(a) Certification *                                                                                                                                                                         |
| 31.2             |       | Chief  Financial Officer’s Rule 13a-14(a)/15d-14(a) Certification *                                                                                                                                                                         |
| 32.1             |       | Chief  Executive Officer’s Section 1350 Certification †                                                                                                                                                                                     |
| 32.2             |       | Chief  Financial Officer’s Section 1350 Certification †                                                                                                                                                                                     |

 

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*Filed herewith.

†Furnished herewith.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| Date: August 13, 2010 | TUCOWS INC. |
|---------------------------------|------------------|
|                            |             |   |
|                            | By:              | /s/  Elliot Noss |
|                            |             | Elliot  Noss |
|                            |             | President  and Chief Executive Officer |
|                            |             |   |
|                            | By:              | /s/  Michael Cooperman |
|                            |             | Michael  Cooperman Chief Financial Officer |
|                            |             | (Principal  Financial and Accounting Officer) |

 

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**EXHIBIT INDEX**

 
| **Exhibit No** | ** ** | **Description**                                                                                                                                                                                                                                            |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                 |
| 3.1                 |       | Fourth  Amended and Restated Articles of Incorporation of Tucows Inc.  (Incorporated by reference to Exhibit 3.1 filed with Tucows’ current report  on Form 8-K, as filed with the SEC on November 29, 2007)                      |
| 3.2                 |       | Second  Amended and Restated Bylaws of Tucows Inc. (Incorporated by reference to  Exhibit 3.2 filed with Tucows’ annual report on Form 10-K for the  year ended December 31, 2006, as filed with the SEC on March 29,  2007) |
| 31.1                |       | Chief  Executive Officer’s Rule 13a-14(a)/15d-14(a) Certification *                                                                                                                                                                         |
| 31.2                |       | Chief  Financial Officer’s Rule 13a-14(a)/15d-14(a) Certification *                                                                                                                                                                         |
| 32.1                |       | Chief  Executive Officer’s Section 1350 Certification †                                                                                                                                                                                     |
| 32.2                |       | Chief  Financial Officer’s Section 1350 Certification †                                                                                                                                                                                     |

 

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*Filed herewith.

†Furnished herewith.

 

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