Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

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**FORM 10-Q**

 

**x****     ****QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended March 31, 2010**

 

**OR**

 

**o****         TRANSITION REPORT PURSUANT TO SECTION 13OR 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 of 1934during 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 in Rule 12b-2of the Exchange Act):  Yes o  No x

 

As of May 14, 2010,there were 59,803,124 outstanding shares of common stock, no par value, of theregistrant.

 

 

 

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**TUCOWS INC.**

**Form 10-QQuarterly Report**

**INDEX**

 
| **PART  I  FINANCIAL INFORMATION**  |
|-------------------------------------|
| ** **                          | ** ** | ** ** | ** ** |
| Item 1.                             | Consolidated  Financial Statements |   | 3 |
|                                |   |   |   |
|                                | Consolidated Balance  Sheets as of March 31, 2010 (unaudited) and December 31, 2009 |   | 3 |
|                                | Consolidated  Statements of Operations (unaudited) for the three months ended  March 31, 2010 and 2009 |   | 4 |
|                                | Consolidated  Statements of Cash Flows (unaudited) for the three months ended  March 31, 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 4T.                            | Controls  and Procedures |   | 33 |
|                                |   |   |   |
| **PART II  OTHER INFORMATION** |
| ** **                          | ** ** | ** ** | ** ** |
| Item 1.                             | Legal Proceedings |   | 33 |
|                                |   |   |   |
| Item 1A.                            | Risk Factors |   | 33 |
|                                |   |   |   |
| Item 6.                             | Exhibits |   | 35 |
|                                |   |   |   |
| Signatures                          |   | 36 |

 

**TRADEMARKS,TRADE NAMES AND SERVICE MARKS**

Tucows®, Butterscotch® and OpenSRS® are registeredtrademarks of Tucows, Inc. or its subsidiaries. Other service marks,trademarks and trade names of Tucows, Inc. or its subsidiaries may be usedin this Annual Report on From 10-K (the “Annual Report”). All other servicemarks, trademarks and trade names referred to in the Annual Report are theproperty of their respective owners. Solely for convenience, any trademarksreferred to in the Annual 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.

 

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**PART I.FINANCIAL INFORMATION**

 

**Item 1.Consolidated Financial Statements**

 

**Tucows Inc.**

**Consolidated Balance Sheets**

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

** **
| ** **                                                                                                                                                                                                  | ** ** | **March 31,** | ** **  | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                                                  | ** ** | **2010**           | ** **  | **2009**              | ** ** |
| ** **                                                                                                                                                                                                  |       | **(unaudited)**    |        |                  |       |
| **Assets**                                                                                                                                                                                                  |       |               |        |                  |       |
|                                                                                                                                                                                                        |       |               |        |                  |       |
| Current assets:                                                                                                                                                                                             |       |               |        |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                  |       | $                  | 5,181,896   |                  | $          | 9,632,394 |   |
| Accounts receivable,  net of allowance for doubtful accounts of $110,000 as of March 31, 2010  and $110,000 as of December 31, 2009                                                               |       | 3,697,545          |        | 2,822,045             |       |
| Prepaid expenses and  deposits                                                                                                                                                                              |       | 2,860,624          |        | 2,498,922             |       |
| Derivative instrument  asset, current portion (note 6)                                                                                                                                                      |       | 2,185,688          |        | 2,107,825             |       |
| Prepaid domain name  registry and ancillary services fees, current portion                                                                                                                                  |       | 33,750,000         |        | 31,596,236            |       |
| Income taxes  recoverable                                                                                                                                                                                   |       | 358,000            |        | 674,000               |       |
| Total current assets                                                                                                                                                                                        |       | 48,033,753         |        | 49,331,422            |       |
|                                                                                                                                                                                                        |       |               |        |                  |       |
| Derivative instrument  asset, long-term portion (note 6)                                                                                                                                                    |       | 140,913            |        | 112,553               |       |
| Prepaid domain name  registry and ancillary services fees, long-term portion                                                                                                                                |       | 12,588,320         |        | 12,126,515            |       |
| Property and equipment                                                                                                                                                                                      |       | 1,779,999          |        | 1,986,768             |       |
| Deferred financing  charges                                                                                                                                                                                 |       | 33,600             |        | 41,000                |       |
| Deferred tax asset,  long-term portion (note 7)                                                                                                                                                             |       | 4,102,929          |        | 3,907,476             |       |
| Intangible assets (note  4)                                                                                                                                                                                 |       | 18,213,439         |        | 18,656,353            |       |
| Goodwill                                                                                                                                                                                                    |       | 17,990,807         |        | 17,990,807            |       |
| Total assets                                                                                                                                                                                                |       | $                  | 102,883,760 |                  | $          | 104,152,894 |   |
|                                                                                                                                                                                                        |       |               |        |                  |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                              |       |               |        |                  |       |
|                                                                                                                                                                                                        |       |               |        |                  |       |
| Current liabilities:                                                                                                                                                                                        |       |               |        |                  |       |
| Accounts payable                                                                                                                                                                                            |       | $                  | 1,738,878   |                  | $          | 1,547,863 |   |
| Accrued liabilities                                                                                                                                                                                         |       | 1,763,176          |        | 1,889,980             |       |
| Customer deposits                                                                                                                                                                                           |       | 3,895,116          |        | 3,624,317             |       |
| Loan payable, current  portion (note 5)                                                                                                                                                                     |       | 2,741,564          |        | 3,220,125             |       |
| Deferred revenue,  current portion                                                                                                                                                                          |       | 42,837,249         |        | 40,211,766            |       |
| Accreditation fees  payable, current portion                                                                                                                                                                |       | 594,968            |        | 530,656               |       |
| Deferred tax liability,  current portion (note 7)                                                                                                                                                           |       | 1,102,929          |        | 907,476               |       |
| Total current  liabilities                                                                                                                                                                                  |       | 54,673,880         |        | 51,932,183            |       |
|                                                                                                                                                                                                        |       |               |        |                  |       |
| Derivative instrument  liability, long-term portion                                                                                                                                                         |       | 7,958              |        | 15,708                |       |
| Deferred revenue,  long-term portion                                                                                                                                                                        |       | 16,677,922         |        | 16,098,812            |       |
| Accreditation fees  payable, long-term portion                                                                                                                                                              |       | 169,705            |        | 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; 59,792,816 shares issued and  outstanding as of March 31, 2010 and 67,080,353 shares issued and  outstanding as of December 31, 2009 |       | 12,579,210         |        | 14,030,384            |       |
| Additional paid-in  capital                                                                                                                                                                                 |       | 43,587,383         |        | 47,287,351            |       |
| Deficit                                                                                                                                                                                                     |       | (29,652,298        | )           | (30,221,164           | )          |
| Total stockholders’  equity                                                                                                                                                                            |       | 26,514,295         |        | 31,096,571            |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                            |       | $                  | 102,883,760 |                  | $          | 104,152,894 |   |

 

See accompanying notes to unaudited consolidated financial statements

 

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**Tucows Inc.**

**Consolidated Statements of Operations**

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

**(unaudited)**

** **
| ** **                                                           | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                           | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| ** **                                                           | ** ** | **(unaudited)**                       | ** ** |
|                                                                 |       |                                  |       |   |   |
| Net revenues (note 9)                                                |       | $                                     | 20,445,153 |   | $ | 20,091,424 |   |
|                                                                 |       |                                  |       |   |   |
| Cost of revenues:                                                    |       |                                  |       |   |   |
| Cost of revenues (*)                                                 |       | 14,924,874                            |       | 13,785,398 |   |
| Depreciation of  property and equipment                              |       | 310,058                               |       | 392,947 |   |
| Amortization of  intangible assets (note 4)                          |       | 74,802                                |       | 29,199 |   |
| Total cost of revenues  (note 9)                                     |       | 15,309,734                            |       | 14,207,544 |   |
|                                                                 |       |                                  |       |   |   |
| Gross profit                                                         |       | 5,135,419                             |       | 5,883,880 |   |
|                                                                 |       |                                  |       |   |   |
| Operating expenses:                                                  |       |                                  |       |   |   |
| Sales and marketing (*)                                              |       | 1,862,336                             |       | 1,353,176 |   |
| Technical operations  and development (*)                            |       | 1,243,013                             |       | 1,104,139 |   |
| General and  administrative (*)                                      |       | 815,580                               |       | 1,869,896 |   |
| Depreciation of  property and equipment                              |       | 43,889                                |       | 82,453 |   |
| Amortization of  intangible assets (note 4)                          |       | 360,540                               |       | 360,540 |   |
| Gain on change in fair  value of forward exchange contracts          |       | (113,973                              | )          | (85,343 | ) |
| Total expenses                                                       |       | 4,211,385                             |       | 4,684,861 |   |
|                                                                 |       |                                  |       |   |   |
| Income from operations                                               |       | 924,034                               |       | 1,199,019 |   |
|                                                                 |       |                                  |       |   |   |
| Other income :                                                       |       |                                  |       |   |   |
| Interest income  (expense), net                                      |       | (39,168                               | )          | (63,462 | ) |
| Total other income                                                   |       | (39,168                               | )          | (63,462 | ) |
|                                                                 |       |                                  |       |   |   |
| Income before provision  for income taxes                            |       | 884,866                               |       | 1,135,557 |   |
|                                                                 |       |                                  |       |   |   |
| Provision for income  taxes (note 7)                                 |       | 316,000                               |       | 107,425 |   |
| Net income for the  period                                           |       | $                                     | 568,866    |   | $ | 1,028,132 |   |
|                                                                 |       |                                  |       |   |   |
|                                                                 |       |                                  |       |   |   |
| Basic earnings per  common share (note 8)                            |       | $                                     | 0.01       |   | $ | 0.01 |   |
|                                                                 |       |                                  |       |   |   |
| Shares used in  computing basic earnings per common share (note 8)   |       | 61,265,903                            |       | 72,655,213 |   |
|                                                                 |       |                                  |       |   |   |
| Diluted earnings per  common share (note 8)                          |       | $                                     | 0.01       |   | $ | 0.01 |   |
|                                                                 |       |                                  |       |   |   |
| Shares used in  computing diluted earnings per common share (note 8) |       | 63,338,084                            |       | 72,657,604 |   |

 

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(*) Stock-basedcompensation has been included in expenses as follows:

 
| Cost of revenues                      |   | $      | 3,628  |   | $      | 5,000 |   |
|---------------------------------------|--------|--------|--------|--------|--------|-------|--------|
| Sales and marketing                   |   | 15,686 |   | 14,900 |   |
| Technical operations  and development |   | 14,581 |   | 10,600 |   |
| General and  administrative           |   | 22,734 |   | 18,700 |   |

 

See accompanying notes to unaudited consolidated financial statements

 

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**Tucows Inc.**

**Consolidated Statements of Cash Flows**

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

**(unaudited)**

** **
| ** **                                                          | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                          | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| ** **                                                          | ** ** | **(unaudited)**                       | ** ** |
| Cash provided by (used  in):                                        |       |                                  |       |   |   |
| Operating activities:                                               |       |                                  |       |   |   |
|                                                                |       |                                  |       |   |   |
| Net income for the  period                                          |       | $                                     | 568,866    |   | $ | 1,028,132 |   |
| Items not involving  cash:                                          |       |                                  |       |   |   |
| Depreciation of  property and equipment                             |       | 353,947                               |       | 475,400 |   |
| Amortization of  deferred financing charges                         |       | 7,400                                 |       | 10,400 |   |
| Amortization of  intangible assets                                  |       | 435,342                               |       | 389,739 |   |
| Disposal of domain  names                                           |       | 7,572                                 |       | 973 |   |
| Unrealized gain in the  fair value of forward exchange contracts    |       | (113,973                              | )          | (85,343 | ) |
| Stock-based  compensation                                           |       | 56,629                                |       | 49,200 |   |
| Change in non-cash  operating working capital:                      |       |                                  |       |   |   |
| Accounts receivable                                                 |       | (875,500                              | )          | (516,993 | ) |
| Prepaid expenses and  deposits                                      |       | (361,702                              | )          | (578,568 | ) |
| Prepaid fees for domain  name registry and ancillary services fees  |       | (2,615,569                            | )          | (2,125,399 | ) |
| Income tax recoverable                                              |       | 316,000                               |       | 85,182 |   |
| Accounts payable                                                    |       | 186,569                               |       | (180,821 | ) |
| Accrued liabilities                                                 |       | (126,804                              | )          | 128,773 |   |
| Customer deposits                                                   |       | 270,799                               |       | (309,502 | ) |
| Deferred revenue                                                    |       | 3,204,593                             |       | 2,463,376 |   |
| Accreditation fees  payable                                         |       | 64,397                                |       | 78,607 |   |
|                                                                |       |                                  |       |   |   |
| Net cash provided by  operating activities                          |       | 1,378,566                             |       | 913,156 |   |
|                                                                |       |                                  |       |   |   |
| Financing activities:                                               |       |                                  |       |   |   |
| Proceeds received on  exercise of stock options                     |       | 4,501                                 |       | — |   |
| Repurchase of common  stock                                         |       | (5,212,272                            | )          | (1,811,179 | ) |
| Repayment of loan payable                                           |       | (478,561                              | )          | (478,561 | ) |
|                                                                |       |                                  |       |   |   |
| Net cash used in  financing activities                              |       | (5,686,332                            | )          | (2,289,740 | ) |
|                                                                |       |                                  |       |   |   |
| Investing activities:                                               |       |                                  |       |   |   |
| Cost of domain names  acquired                                      |       | —                                |       | (5,900 | ) |
| Additions to property  and equipment                                |       | (142,732                              | )          | (42,240 | ) |
| Net cash used in  investing activities                              |       | (142,732                              | )          | (48,140 | ) |
|                                                                |       |                                  |       |   |   |
| Decrease in cash and  cash equivalents                              |       | (4,450,498                            | )          | (1,424,724 | ) |
|                                                                |       |                                  |       |   |   |
| Cash and cash  equivalents, beginning of period                     |       | 9,632,394                             |       | 5,427,467 |   |
| Cash and cash  equivalents, end of period                           |       | $                                     | 5,181,896  |   | $ | 4,002,743 |   |
|                                                                |       |                                  |       |   |   |
| Supplemental cash flow  information:                                |       |                                  |       |   |   |
| Interest paid                                                       |       | $                                     | 39,276     |   | $ | 65,521 |   |
|                                                                |       |                                  |       |   |   |
| Supplementary  disclosure of non-cash investing activity:           |       |                                  |       |   |   |
| Property and equipment  acquired during the period not yet paid for |       | $                                     | 98,040     |   | $ | 2,784 |   |

 

See accompanying notes to unaudited consolidated financial statements

 

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

**1.ORGANIZATION OF THE COMPANY:**

 

Tucows Inc., a Pennsylvania corporation (referred to throughout this report as the “Company”,“Tucows”, “we”, “us” or through similar expressions), together with ourconsolidated subsidiaries, is a global distributor of Internet services,including domain name registration, security and identity products throughdigital certificates and email through its distribution network of InternetService Providers, web hosting companies and other providers of Internetservices to end-users.

 

Wewere incorporated under the laws of the Commonwealth of Pennsylvania in November 1992under the name Infonautics, Inc. In August 2001, we completed ouracquisition of Tucows Inc., a Delaware corporation, and we changed our namefrom Infonautics, Inc. to Tucows Inc. Our principal executive office islocated in Toronto, Ontario and we have offices in the United Kingdom and theUnited States.

 

**2. BASISOF PRESENTATION:**

 

The accompanyingunaudited interim consolidated balance sheets, and the related consolidatedstatements of operations and cash flows reflect all adjustments, consisting ofnormal recurring adjustments, that are, in the opinion of management, necessaryfor a fair presentation of the financial position of Tucows and itssubsidiaries as at March 31, 2010 and the results of operations andcash flows for the interim periods ended March 31, 2010 and 2009. Theresults of operations presented in this Quarterly Report on Form 10-Q arenot necessarily indicative of the results of operations that may be expectedfor future periods.

 

The accompanyingunaudited interim consolidated financial statements have been prepared byTucows in accordance with the rules and regulations of the Securities andExchange Commission (the “SEC”). Certain information and footnote disclosurenormally included in the Company’s annual audited consolidated financialstatements and accompanying notes have been condensed or omitted. These interimconsolidated financial statements and accompanying notes follow the sameaccounting policies and methods of application used in the annual financialstatements and should be read in conjunction with the Company’s auditedconsolidated financial statements and notes thereto for the year ended December 31, 2009included in Tucows’ 2009 Annual Report on Form 10-K filed with the SEC on March 22, 2010.

 

There have been nomaterial changes to our significant accounting policies during the three monthsended March 31, 2010 as compared to the significant accountingpolicies described in our Annual Report on Form 10-K for the fiscal yearended December 31, 2009.

 

During the first quarterof fiscal 2010, the Company recorded out-of-period adjustments relating to rentexpense and the amortization of intangible assets. These immaterial correctionsof errors reduced net income after taxes by $0.1 million for the three monthsended March 31, 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.

 

**3. NEW ACCOUNTING POLICIES:**

 

*Recent Accounting Pronouncements Adopted*

 

In January 2010,the Financial Accounting Standards Board, or FASB, issued Accounting StandardsUpdate 2010-06, “Fair Value Measurements and Disclosures (Topic: 820):Improving Disclosures about Fair Value Measurements”. Update 2010-06 requiresadditional fair value disclosures for significant transfers between levels ofthe fair value hierarchy and gross presentation of items within the Level 3reconciliation. This guidance also clarifies that entities need to disclosefair value information for each class of asset and liability measured at fairvalue and that valuation techniques need to be provided for all non-marketobservable measurements. Our adoption of this guidance on January 1, 2010,did not impact our Consolidated Financial Statements as the Company does nothave any such transfers and no items classified as Level 3.

 

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*Recent Accounting Pronouncements NotYet Adopted*

 

In October 2009, the SEC announced that publiccompanies with a public float below $75 million must begin to comply with thefinal stage of Section 404 that requires auditor attestation of theeffectiveness of internal control over financial reporting, beginning withannual reports for fiscal years ending on or after June 15, 2010. Theprevious effective date was for fiscal years ending on or after December 15,2009. As a result, the Company will now be required to provide the attestationreports commencing for its fiscal year ending December 31, 2010.

 

In October 2009, the FASB issued AccountingStandards Update 2009-13, “Revenue Recognition (Topic 605):Multiple-Deliverable Revenue Arrangements” (Update 2009-13). Update 2009-13applies to multiple-deliverable revenue arrangements that are currently withinthe scope of FASB ASC Subtopic 605-25 (previously included in Emerging IssuesTask Force Issue no. 00-21, “Revenue Arrangements with Multiple Deliverables”).Update 2009-13 provides principles and application guidance on whether multipledeliverables exist, how the arrangement should be separated, and theconsideration allocated. It also requires an entity to allocate revenue in anarrangement using estimated selling prices of deliverables if a vendor does nothave vendor-specific objective evidence or third-party evidence of sellingprice. The guidance eliminates the use of the residual method, requiresentities to allocate revenue using the relative-selling-price method, andsignificantly expands the disclosure requirements for multiple-deliverablerevenue arrangements. Update 2009-13 is effective on a prospective basis forrevenue arrangements entered into or materially modified in fiscal yearsbeginning on or after June 15, 2010. We are currently assessing the impactof Update 2009-13 on our future consolidated financial statements.

 

**4****.****INTANGIBLE ASSETS****:**

 

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.

 

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A summary of acquiredintangible assets for the three months ended March 31, 2010 is asfollows:

** **
| ** **                                | ** ** | **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                      |       | —                         |       | —           |       | —                         |       | (649                           | )          | (6,923                                        | )          | (7,572     | )          |
| Amortization expense                      |       | (74,802                        | )          | (41,760          | )          | (318,780                       | )          | —                         |       | —                                        |       | (435,342   | )          |
| Net book value,  March 31, 2010 |       | $                              | 250,126    |             | $          | 645,060                        |       | $                              | 3,089,600  |                                          | $          | 12,131,759 |       | $ | 2,096,894 |   | $ | 18,213,439 |   |

 

**5. LOAN PAYABLE:**

 

TheCompany entered into a non-revolving, reducing credit facility in the amount of$9.6 million with a Canadian chartered bank (the “credit facility”) tofinance the purchase of Innerwise, Inc. in July 2007. Effective February 23,2009, the Company agreed to amend the interest rate payable from the bank’s USBase rate plus 0.50% per annum to the bank’s US Base rate plus 1.50% per annum.The principal and accrued interest on the loan is payable monthly over the termof the loan, which is five years. Tucows may prepay this loan in full orin part without any premium or penalty. The credit facility provides that wemaintain certain financial and operating covenants which include, among otherprovisions, maintaining specific leverage and coverage ratios during the termof the loan. Certain covenants under the credit facility may limit the amountof our capital expenditures. The credit facility is collateralized by a firstlien on, and pledge of, the majority of the Company and our subsidiariespresent and future property and assets (subject to certain exclusions). As of March 31,2010, the Company continued to comply with all covenants of the creditfacility.

 

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 its2008 fiscal year, the Company made a cash sweep payment for its 2008 fiscal yearamounting to $0.7 million, which was paid on May 1, 2009. As of March 31, 2010,The Company estimated that the cash sweep payment for its 2009 fiscal year,payable during the three months ending June 30, 2010, will repay in fullthe $2,741,564 outstanding balance of our non-revolving, reducing creditfacility.

 

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 at March 31, 2010was $2,749,897, compared to a carrying amount of $2,741,564 at March 31, 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 March 31, 2010was a net unrealized gain of $2.3 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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AtMarch 31, 2010, the Company had the following outstanding forward exchangecontracts to trade U.S. dollars in exchange for Canadian dollars:

 
| ** **                        | ** ** | **Notional**     | ** ** | **Weighted  average** | ** ** | ** **     | ** ** |
|-----------------------------------|------------|------------------|------------|-----------------------|------------|----------------|------------|
| ** **                        | ** ** | **amount of**    | ** ** | **exchange rate of**  | ** ** | ** **     | ** ** |
| **Maturity date**                 | ** ** | **U.S. dollars** | ** ** | **U.S. dollars**      | ** ** | **Fair value** | ** ** |
|                              |       |             |       |                  |       |           |       |
| April - June 2010       |       | $                | 4,939,000  |                  | 0.8427     |           | $          | 834,551 |   |
| July - September 2010   |       | 5,400,000        |       | 0.8596                |       | 785,784        |       |
| October - December 2010 |       | 5,400,000        |       | 0.9236                |       | 350,015        |       |
| 2010                              |       | 15,739,000       |       | 0.8749                |       | 1,970,350      |       |
|                              |       |             |       |                  |       |           |       |
| January — March, 2011   |       | 3,900,000        |       | 0.9302                |       | 215,338        |       |
| April - June 2011       |       | 3,900,000        |       | 0.9635                |       | 64,335         |       |
| July - September 2011   |       | 3,900,000        |       | 0.9604                |       | 68,620         |       |
| 2011                              |       | 11,700,000       |       | 0.9511                |       | 348,293        |       |
|                              |       |             |       |                  |       |           |       |
| Total                             |       | $                | 27,439,000 |                  | 0.9058     |           | $          | 2,318,643 |   |

 

During the three months ended March 31, 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$6.5 million, whereby US$650,000 isconverted into Canadian dollars on a semi-monthly basis from May 2011 to September 2011at an average foreign exchange rate of US$1.00: Cdn$1.0390.

 

The Company does not apply hedge accounting and, therefore, for thethree months ended March 31, 2010, the Company recorded a gain of$113,973 in the fair value of forward contracts in its consolidated statementsof operations. For the three months ended March 31, 2009, the Companyrecorded a gain on forward contracts of $85,343.

 

**7. INCOME TAXES**

 

For the threemonths ended March 31, 2010, the Company recorded a provision for incometaxes of $316,000 on income before income taxes of $885,000 using an estimatedeffective tax rate for its 2010 fiscal year. Comparatively, for the threemonths ended March 31, 2009, the Company recorded a current tax expense of$107,000 on income before income taxes of $1.1 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 the Company.

 

As of December 31,2009, the Company recorded a valuation allowance of $4.3 million and a netdeferred tax asset of $3.0 million. As of March 31, 2010 the Company hasrecorded a non-current deferred tax asset of $4.1 million and current deferredtax liabilities of $1.1 million. As of March 31, 2010 and December 31, 2009,the Company has also recorded a non current deferred tax liability related tothe temporary difference arising on indefinite life intangibles of$4.8 million.

 

The Companyanalyzes the carrying value of its deferred tax asset on a regular basis. Indetermining future taxable income, assumptions are made to forecast federal,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 three months ended March 31, 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.

 

The Companyfollows the provisions of FASB ASC Topic 740, Income Taxes to account forincome tax exposures. The application of this interpretation requires atwo-step process that separates recognition of uncertain tax benefits frommeasurement thereof.

 

The Company hasapproximately $107,000 of total gross unrecognized tax benefit as of March 31,2010 and $124,000 of total gross unrecognized tax benefit as of December 31,2009, which if recognized would favorably affect our income tax rate in futureperiods. The unrecognized tax benefit relates to prior year Pennsylvania statefranchise taxes, other US state taxes. The unrecognized tax benefit hasdecreased by $17,000 when compared to the gross unrecognized tax benefits as ofDecember 31, 2009 we have now settled the claim for the Pennsylvaniafranchise taxes for the years December 31, 1996 to December 31, 2000.The Company does not expect the unrecognized tax benefit for the 2009 and 2010research and 

 

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development claim to besignificant. The Company recognizes accrued interest and penalties related totaxes in tax expense. The Company did not have significant interest andpenalties accrued as of March 31, 2010 and March 31, 2009, respectively.The Company believes it is reasonably possible that $107,000 of theunrecognized 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. BASICAND 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 todetermine the number of shares assumed to be purchased from the conversion ofcommon shares equivalents or the proceeds of option exercises.

 

Thefollowing table is a summary of the basic and diluted earnings per commonshare:

 
| ** **                                                    | ** ** | **Three months ended  March 31, 2010** | ** ** | **Three months ended  March 31, 2009** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Numerator  for basic and diluted earnings per common share:   |       |                                        |       |                                        |       |
| Income  for the period                                        |       | $                                           | 568,866    |                                        | $          | 1,028,132 |   |
| Denominator  for basic and diluted earnings per common share: |       |                                        |       |                                        |       |
| Basic  weighted average number of common shares outstanding   |       | 61,265,903                                  |       | 72,655,213                                  |       |
| Effect  of outstanding stock options                          |       | 2,072,181                                   |       | 2,391                                       |       |
| Diluted  weighted average number of shares outstanding        |       | 63,338,084                                  |       | 72,657,604                                  |       |
| Basic  earnings per common share                              |       | $                                           | 0.01       |                                        | $          | 0.01 |   |
| Diluted  earnings per common share                            |       | $                                           | 0.01       |                                        | $          | 0.01 |   |

 

For the three months ended March 31, 2010,options to purchase 1,374,967 common shares that were outstanding, and were notincluded in the computation of diluted income per common share because all suchoptions had exercise prices greater than the average market price of the commonshares. During the three months ended March 31, 2009, options to purchase7,167,669 shares of common stock were not included in the computation ofdiluted income per common share because all such options had exercise pricesgreater than the average market price of the common shares.

 

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

 

Duringthe three months ended March 31, 2010 an additional 956,000 commonshares were repurchased and cancelled under the terms of our stock repurchaseprogram announced in February 2010.

 

Thesereductions in the number of shares outstanding have been included in thecomputation of earnings per share and diluted earnings per share for the threemonths ended March 31, 2010(see note 11).

 

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**9. SUPPLEMENTAL INFORMATION:**

 

(a)           The following is a summary of the Company’srevenue earned from each significant revenue stream:

 
| ** **             | ** ** | **Three months ended March 31,** | ** ** |
|------------------------|------------|---------------------------------------|------------|
| ** **             | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| OpenSRS :              | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Domain Services        |       | $                                     | 15,403,010 |   | $ | 14,202,023 |   |
| Email Services         |       | 638,188                               |       | 1,121,935 |   |
| Other Services         |       | 1,093,711                             |       | 1,094,460 |   |
| Total OpenSRS Services |       | 17,134,909                            |       | 16,418,418 |   |
|                   |       |                                  |       |   |   |
| YummyNames             |       | 1,711,321                             |       | 1,865,033 |   |
| Hover                  |       | 1,129,497                             |       | 1,300,584 |   |
| Butterscotch           |       | 469,426                               |       | 507,389 |   |
|                   |       | $                                     | 20,445,153 |   | $ | 20,091,424 |   |

 

No customer accounted for more than 10% of revenue forthe three months ended March 31, 2010 or the three months ended March 31, 2009.Significant management judgment is required at the time of recording of revenueto assess whether the collection of the resulting receivables is reasonablyassured. On an ongoing basis, we assess the ability of our customers to makerequired payments. Based on this assessment, we expect the carrying amount ofour outstanding receivables, net of allowance for doubtful accounts, to befully collected.

 

As of March 31, 2010, two customersaccounted for 32% of accounts receivable, all of which has been paid subsequentto March 31, 2010. As of March 31, 2009, no customer accountedfor more than 10% of accounts receivable.

 

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

 
| ** **                                    | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                    | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| OpenSRS :                                     | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Domain Services                               |       | $                                     | 12,616,231 |   | $ | 11,354,762 |   |
| Email Services                                |       | 107,138                               |       | 179,918 |   |
| Other Services                                |       | 387,123                               |       | 388,852 |   |
| Total OpenSRS Services                        |       | 13,110,492                            |       | 11,923,532 |   |
|                                          |       |                                  |       |   |   |
| YummyNames                                    |       | 202,754                               |       | 185,554 |   |
| Hover                                         |       | 399,445                               |       | 513,210 |   |
| Butterscotch                                  |       | 18,859                                |       | 6,740 |   |
| Network, other costs                          |       | 1,193,324                             |       | 1,156,362 |   |
| Network, depreciation  and amortization costs |       | 384,860                               |       | 422,146 |   |
|                                          |       | $                                     | 15,309,734 |   | $ | 14,207,544 |   |

 

(c)                                  The following is a summary of the Company’sproperty and equipment by geographic region:

 
| ** **     | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------|------------|------------------------------|------------|---------------------------------|------------|
|           |       |                         |       |                            |       |
| Canada         |       | $                            | 1,348,232  |                            | $          | 1,475,056 |   |
| United States  |       | 428,314                      |       | 506,533                         |       |
| United Kingdom |       | 3,453                        |       | 5,179                           |       |
|           |       | $                            | 1,779,999  |                            | $          | 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 anyactions or claims outstanding or pending as of March 31, 2010 cannot bepredicted with certainty, it is the opinion of management that their resolutionwill not have a material adverse effect on the Company’s financial position.

 

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**11. STOCKHOLDERS’ EQUITY:**

 

The following unaudited table summarizes stockholders’equity transactions for the period ended March 31, 2010:

 
| ** **                                                           | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | ** **             | ** ** | **Total**  | ** **  |
|----------------------------------------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|------------------------|------------|------------|-------------|
| ** **                                                           | ** ** | **Common stock** | ** ** | **paid in** | ** ** | ** **     | ** ** | **stockholders’** | ** ** |
| ** **                                                           | ** ** | **Number**            | ** ** | **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 |   |

 

The following unaudited table summarizes stockholders’equity transactions for the period ended March 31, 2009:

 
| ** **                           | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | ** **             | ** ** | **Total**  | ** **  |
|--------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|------------------------|------------|------------|-------------|
| ** **                           | ** ** | **Common stock** | ** ** | **paid in** | ** ** | ** **     | ** ** | **stockholders’** | ** ** |
| ** **                           | ** ** | **Number**            | ** ** | **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 |       | (4,185,690            | )          | (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       |       | 68,888,092            |       | $                | 14,361,220 |           | $          | 47,789,835             |       | $          | (41,434,238 | ) | $ | 20,716,817 |   |

 

OnJanuary 13, 2010, the Company announced that it successfully concluded amodified “Dutch auction tender offer” that was previously announced on December 14,2009. Under the terms of the offer, the Company repurchased an aggregate of6,341,470 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 purchaseprice was funded from available cash. Of the 6,341,470 shares purchased,5,000,000 were shares the Company offered to purchase in the offer and1,341,470 where shares purchased pursuant to the Company’s right to purchase upto an additional 2% of the shares outstanding immediately prior to thecommencement of the tender offer. Due to over-subscription, the final prorationfactor for shares tendered at or below $0.70 per share was approximately 99.9%.For this purpose, shares tendered at $0.70 per share included shares tenderedby those persons who indicated, in their letter of transmittal, that they werewilling to accept the price determined in the offer. All shares purchased inthe tender offer received the same price.

 

On February 16, 2010, the Company’s Board of Directorsauthorized the repurchase of up to $10 million of the Company’s common stock atthe Company’s discretion. The Company has repurchased 956,000 shares under thisrepurchase program during the three months ended March 31, 2010.

 

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**12. SHARE-BASED PAYMENTS**

 

(a)                                  Stock options

 

TheCompany’s 1996 Stock Option Plan (the “1996 Plan”) was established for the benefitof the employees, officers, directors and certain consultants of the Company.The maximum number of common shares which may be set aside for issuance underthe 1996 Plan was 11,150,000 shares, provided that the Board of Directors ofthe Company has the right, from time to time, to increase such number subjectto the approval of the stockholders of the Company when required by law orregulatory authority. Generally, options issued under the 1996 Plan vest over afour-year period. The 1996 Plan expired on February 25, 2006 and nooptions have been issued from the 1996 Plan after that date.

 

OnNovember 22, 2006, the stockholders of the Company approved theimplementation of the Company’s 2006 Equity Compensation Plan (the “2006 Plan”),which serves as a successor to the 1996 Plan. The 2006 Plan has beenestablished for the benefit of the employees, officers, directors and certainconsultants of the Company. The 5,000,000 common shares that have been setaside for issuance under the 2006 Plan are to provide eligible persons with the opportunity toacquire a proprietary interest, or otherwise increase their proprietaryinterest, in Tucows. Generally, options issued under the 2006 Plan vestover a four-year period 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.

 

No stock options were granted during the periods ended March 31,2010 or March 31, 2009.

 

Details of stock optiontransactions for thethree months ended March 31, 2010 and March 31, 2009 are as follows:

 
| ** **                         | ** ** | **Three  months ended  March 31, 2010** | ** ** | **Three  months ended  March 31, 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                            |       | —                                       |       | —                                           |       | — |   | — |   |
| Exercised                          |       | (10,433                                      | )          | 0.43                                             |       | — |   | — |   |
| Forfeited                          |       | (15,000                                      | )          | 0.64                                             |       | (155,718 | ) | 0.53 |   |
| Expired                            |       | (383,374                                     | )          | 0.98                                             |       | (1,500 | ) | 3.75 |   |
| Outstanding, end of period         |       | 6,795,170                                    |       | $                                                | 0.53       |   | 7,125,559 |   | $ | 0.56 |   |
| Options exercisable, end of period |       | 5,942,169                                    |       | $                                                | 0.51       |   | 5,763,923 |   | $ | 0.52 |   |

 

The stock options expire on various dates through 2016.

 

Asof March 31, 2010, the exercise prices, weighted average remainingcontractual life of outstanding options and intrinsic values were as follows:

 

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| ** **         | ** ** | **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        |       | 3,717,249               |       | $                                                | 0.38       |   | 3.3 |   | $ | 1,218,892 |   | 3,717,249 |   | $ | 0.38 |   | $ | 1,218,892 |   |
| $0.56-$0.69        |       | 1,806,704               |       | $                                                | 0.59       |   | 4.7 |   | 210,927 |   | 1,189,704 |   | $ | 0.59 |   | 147,557 |   |
| $0.80-$0.99        |       | 1,262,500               |       | $                                                | 0.86       |   | 3.5 |   | — |   | 1,026,500 |   | $ | 0.86 |   | — |   |
| $2.21-$4.84        |       | 8,717                   |       | $                                                | 4.32       |   | 0.1 |   | — |   | 8,716 |   | $ | 4.32 |   | — |   |
|               |       | 6,795,170               |       | $                                                | 0.53       |   |   |   | $ | 1,429,819 |   | 5,942,169 |   | $ | 0.51 |   | $ | 1,366,449 |   |

 

Total unrecognized compensation cost relating to unvested stock optionsat March 31, 2010, prior to the consideration of expectedforfeitures, was approximately $272,000 and is expected to be recognized over aweighted average period of 1.8 years.

 

The Company recorded stock-based compensation of $56,436 and $49,200for the three months ended March 31, 2010 and 2009, respectively.

 

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

 

(b)                               Restricted stock awards

 

Duringthe three months ended March 31, 2010, no restricted stock awardswere 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 receiveany regular cash dividends paid on such shares.

 

Total unrecognized compensation cost relating to unvested restrictedstock awards at March 31, 2010, prior to the consideration ofexpected forfeitures, was approximately $3,000 and is expected to be recognizedover a weighted average period of 3.0 years.

 

The Company recorded stock-based compensation associated withrestricted stock awards of $193 for the three months ended March 31, 2010.

 

**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 theCompany’s own assumptions used to measure assets and liabilities at fair value.A financial asset or liability’s classification within the hierarchy isdetermined based on the lowest level input that is significant to the fairvalue measurement.

 

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The following table provides a summary of the fairvalues of the Company’s derivative instrument assets and liabilities measuredat fair value on a recurring basis at March 31, 2010:

 
| ** **                       | ** ** | **March 31, 2010**                     | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|
| ** **                       | ** ** | **Fair Value Measurements Using** | ** ** | **Assets at** | ** ** |
| ** **                       | ** ** | **Level 1**                                      | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Fair Value** | ** ** |
|                             |       |                                             |       |   |   |   |   |   |   |
| Derivative  instrument asset     |       | $                                                | —     |   | $ | 2,326,601 |   | $ | — |   | $ | 2,326,601 |   |
| Total Assets                     |       | $                                                | —     |   | $ | 2,326,601 |   | $ | — |   | $ | 2,326,601 |   |
|                             |       |                                             |       |   |   |   |   |   |   |
| Derivative  instrument liability |       | $                                                | —     |   | $ | (7,958 | ) | $ | — |   | $ | (7,958 | ) |
| Total  Liabilities               |       | $                                                | —     |   | $ | (7,958 | ) | $ | — |   | $ | (7,958 | ) |

 

The followingtable provides a summary of the fair values of the Company’s derivativeinstrument assets measured at fair value on a recurring basis 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 theprior periods’ comparative figures have been reclassified to conform with thepresentation adopted in the current period.

 

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**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

**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 belief that the market for domain nameregistration will trend upward gradually and may be affected by marketvolatility; our belief that a slowing economy may lead to a decrease inadvertising spending and the effect of changes in our contractual relationshipson our revenue These statements are based on management’s current expectationsand are subject to a number of uncertainties and risks that could cause actualresults to differ materially from those described in the forward-lookingstatements. Many factors affect our ability to achieve our objectives and to successfullydevelop and commercialize our services including:

 

·                  Our ability to continue to generatesufficient working capital to meet our operating requirements;

 

·                  Our ability to maintain a good workingrelationship with our vendors and customers;

 

·                  The ability of vendors to continue to supply ourneeds;

 

·                  Actions by our competitors;

 

·                  Our ability to achieve gross profit margins at whichwe can be profitable;

 

·                  Our ability to attract and retain qualified personnelin our business;

 

·                  Our ability to effectively manage our business;

 

·                  Our ability to obtain and maintain approvals fromregulatory authorities on regulatory issues;

 

·                  Pending or new litigation; and

 

·                  Factors set forth under the caption “Item 1A RiskFactors” in our Annual Report on Form 10-K for the fiscal year ended December 31,2009.

 

This list of factorsthat may affect our future performance and financial and competitive positionand also the accuracy of forward-looking statements is illustrative, but it isby no means exhaustive. Accordingly, all forward-looking statements should beevaluated with the understanding of their inherent uncertainty. Allforward-looking statements included in this document are based on informationavailable to us as of the date of this document, and we assume no obligation toupdate these cautionary statements or any forward-looking statements except tothe extent of any obligations under the Securities Exchange Act of 1934 or theSecurities Act of 1933. These statements are not guarantees of futureperformance.

 

We qualify all theforward-looking statements contained in this Form 10-Q by the foregoingcautionary statements.

 

**OVERVIEW**

 

Our mission is toprovide simple, useful services that help people unlock the power of theInternet. We accomplish this by reducing the complexity our customers’experience as they acquire, deliver or use Internet services such as domainname registration, email and other Internet services.

 

Our primarydistribution channel is a global network of more than 10,000 resellers in morethan 100 countries who typically provide their customers, the end-users of theInternet, with a critical component for establishing and maintaining an onlinepresence. Our primary focus is serving the needs of this network of resellersby providing superior services, easy-to-use interfaces, proactive and attentivecustomer service, reseller-oriented technology and agile design and developmentprocesses. We seek to provide superior customer service to our resellers byanticipating their business needs and technical 

 

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requirements. Thisincludes providing easy-to-use interfaces that enable resellers to quickly andeasily integrate our services into their individual business processes, andoffering brandable end-user interfaces that emphasize simplicity and visualappeal.  We also provide “second tier”support to our resellers by email and phone in the event resellers experienceissues or problems with our services. In addition, our Network Operating Centerprovides proactive support to our resellers by monitoring all services andnetwork infrastructure to address deficiencies before customer services areimpacted.

 

We believe thatthe underlying platforms for our services are one of the most mature, reliableand functional reseller-oriented provisioning and management platforms in ourindustry, and we continue to refine, evolve and improve these services for bothresellers and end-users.

 

To assist us inforecasting growth and to help us monitor the effectiveness of our operationalstrategies, we categorize our revenue into the following services:

 

OpenSRS, ourwholesale service, manages over ten million domain names, under its ICANNaccreditation, as well as names Tucows manages for other registrars under theirown accreditations, millions of mailboxes and tens of thousands of digitalcertificates through a network of over 10,000 web hosts, Internet serviceproviders, or ISPs, and other resellers around the world.

 

Platypus, our billingservice, provides ISPs with an industry-specific solution for billing, serviceprovisioning and customer account management.

 

Hover, our retailservice, offers services similar to those of OpenSRS to consumers and smallbusinesses.

 

YummyNames, our domainportfolio service, manages tens of thousands of domain names, most of whichgenerate advertising revenue and many of which we offer for resale via ourreseller network and other channels. Included in the YummyNames domainportfolio are over 41,000 domains that allow over two-thirds of Americans topurchase a domain or email address based on their name.

 

Butterscotch, ourcontent service, operates two advertising-supported websites, butterscotch.comand tucows.com, which provide content to help consumers overcome the complexityof modern technology and the Internet, in the form of over 2,600 videos andover 170,000 software and mobile listings and articles. Additionally,Butterscotch provides custom video production services for technologymanufacturers and ISPs.

 

We periodicallyacquire companies or technology when we determine that the related products ortechnology are strategic or complementary to our current or future serviceofferings, as opportunities arise. For example:

 

·                  On July 25, 2007, we acquiredInnerwise, Inc., or IYD, a privately held ICANN accredited registraroffering domain services through a worldwide wholesale affiliate network.

 

·                  On June 19, 2006, we acquiredMailbank.com, Inc. (doing business as NetIdentity). We use the assets fromthis acquisition to offer personalized Internet services directly to end-usersthrough Hover and to resellers through OpenSRS’ Personal Names Service, as wellas to generate income from the parked page of each domain address.

 

·                  On January 3, 2006, we acquired allof the Hosted Messaging assets of Critical Path, Inc. to expand ourpresence in the email market.

 

Our business modelis characterized by non-refundable, up-front payments, which lead to recurringrevenue and positive operating cash flow. We are an ICANN-accredited registrarand manage over ten million domains under our ICANN accreditation, as well asnames we manage for other registrars under their own accreditations.

** **

**NetRevenues**

* *

*OpenSRS*

 

We derive revenuefrom our reseller network by providing them with reseller services thatcomprise (a) domain services, (b) email services and (c) otherservices. Other services primarily consist of secure sockets layer, or SSL,certificates and also include blogware and website building tools that are usedby our resellers to create bundles of Internet services for their end-usersalong with billing solutions for ISPs.

 

OpenSRS Domain Service

 

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Historically, ourOpenSRS domain services has constituted the largest portion of our business andencompasses all of our services as an accredited registrar related to theregistration, renewal, transfer and management of domain names. In addition,this service fuels other revenue categories as it often is the initial servicefor which a customer will engage us, enabling us to follow on with otherservices and allowing us to add to our domain portfolio by purchasing namesregistered through us upon their expiration. We also provide resellers with theability to sell personal names. This service allows resellers the opportunityto sell email addresses based on our domain portfolio of surname domain names.

 

As of March 31,2010, we offer registration services for the gTLDs .com, .net, .org, .info,..name, .biz, .tel, .mobi and .asia and for the country code top-level domains,or ccTLDs .at, .be, .bz, .ca, .cc, .ch, .cn, .de, .dk, .es, .eu, .fr, .in, .it,..li,.me, .mx .nl, .tv, .uk, .ws, and .us.

 

With respect tothe sale of domain registrations, we modified our pricing structure for domainnames to provide greater visibility into the various fees that make up the costof a domain name, by breaking out the cost of the registry and ICANN feesseparately from our management fee. In October 2007 and October 2008,registry fees were increased by 7% respectively by the major gTLD registries.Effective July 2010, registry fees for the .com and .net registrationswill increase by an additional 7%. The management fee provides our resellerswith access to our provisioning and management tools to enable them to registerand administer domain names and access to additional services like WHOISprivacy and DNS services, enhanced domain name suggestion tools and access toour Premium Domain name services. We earn fees in connection with each new,renewed and transferred-in registration and from providing provisioningservices to resellers and registrars on a monthly basis. Domain registrationsare generally purchased for terms of one to ten years, with a majority having aone-year term. Except for certain large customers with whom we have negotiatedalternative arrangements, payments for the full term of service, or billed revenue,is received at the time of activation of service. All fees received inconnection with domain name registration are non-refundable, and whereappropriate, are recorded as deferred revenue and recognized as earned ratablyover the term of provision of service. This accounting treatment reasonablyapproximates a recognition pattern that corresponds with the provision of theservices during the quarters and the year.

 

OpenSRS Email Service

 

We derive revenuefrom our hosted email service through our global distribution network. Ouremail service is offered on a per account, per month basis, and providesresellers with a reliable, scalable “white label” hosted email solutions thatcan be customized to their branding and business model requirements. The email servicealso includes spam and virus filtering on all accounts. End-users can accessthe email service via a full-featured, multi-language AJAX-enabled webinterface, a WAP mobile interface, or through traditional desktop emailclients, such as Microsoft Outlook or Apple Mail, using IMAP or POP/SMTP and2GB of email storage.

 

We earn fees foremail services when such services are activated. Email services are generallypurchased monthly and, at month-end, are either deducted on a pre-authorizedbasis from reseller’s deposit account, or are invoiced.

 

Other OpenSRS Services

 

We derive revenuefrom other services primarily from provisioning SSL certificates. In addition,we provision blogware and website building tools that are used by our resellersto create bundles of Internet services for their end-users, as well as theprovision of billing, provisioning and customer care software solutions to ISPsthrough our Platypus billing software.

 

We earn fees fromsuch services when a service is activated. These services are generallypurchased for terms of one month to three years. Platypus software is generallypurchased for terms of one month to one year. Payments for services are for thefull term of all services at the time of activation of service, arenon-refundable and, where appropriate, are recorded as deferred revenue andrecognized as earned ratably over the service term. This accounting treatmentreasonably approximates a recognition pattern that corresponds with theprovision of the services during the quarters and the year.

* *

*YummyNames*

 

We derive revenuefrom our portfolio of domain names by displaying advertising on the domains andby making them available for sale or lease. In addition we display advertisingon “parked pages” within OpenSRS. Parked pages are domain names registeredwith us that do not yet contain an active website. When a user types one ofthese domain names into a web browser, they are presented with dynamically generatedlinks that are pay-per-click advertising. Every time a user clicks on one ofthese links, it generates revenue for us through our partnership withthird-parties who provide syndicated pay-per-click advertising.

 

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Portfolio namesare sold through our premium domain name service, auctions or in negotiatedsales. The size of our domain name portfolio varies over time, as we acquireand sell domains on a regular basis to maximize the overall value and revenuegeneration potential of our portfolio. In evaluating names for sale, weconsider the potential foregone revenue from pay-per-click advertising, as wellas other factors. The name will be offered for sale if, based on ourevaluation, the name is deemed non-essential to our business and managementbelieves that deriving proceeds from the sale is strategically more beneficialto the Company.

 

Portfolio namesthat have been acquired from third-parties or through acquisition are includedas intangible assets with indefinite lives on our consolidated balance sheet.

 

In addition, wealso offer the same services to our customers, allowing them to make availablenames registered by them for monetization on a similar basis. For customernames, we earn a referral fee for premium names or names sold or leased, andparticipate on a revenue share basis for names offered through ourpay-per-click advertising program.

 

We recognizerevenue from these services, net of any fees payable to resellers or customers,immediately upon completion of the service, or in the case of advertisingrevenue, on a monthly basis once the advertising has been served.

 

*Hover*

 

We derive revenuesfrom the providing and managing Internet services, on a retail basis, toconsumers and small businesses through our Hover.com website. These servicesinclude domain registration and other Internet services such as email andpersonalized email through our portfolio of surname-based domain names, as wellas an easy-to-use interface that allows users to connect domain names towebsites and email addresses through a unique DNS forwarding system. Dependingon the service offered, we typically receive fees for our services.

 

Our customersgenerally purchase services for terms of one to ten years, with a majority ofservices purchased for a one-year term. Certain services are also offered on amonthly basis. Payments for the full term of all services, or billed revenue,are received at the time of service activation and, where appropriate, arerecorded as deferred revenue and recognized as earned ratably over the term ofprovision of service. This accounting treatment reasonably approximates arecognition pattern that corresponds with the provision of the services duringquarterly and annual periods.

 

*Butterscotch*

 

We also generateadvertising and other revenue through two ad-supported content sites,butterscotch.com and tucows.com.

 

Butterscotch.comderives revenue from banner and text advertising on the site, as well as fromvideo advertising and product placement within the videos that make up the bulkof the site. In addition, revenue is earned through custom video production fortechnology manufacturers and Internet services customers.

 

Tucows.comadvertising revenue is generated from third-party advertisers and from softwaredevelopers who rely on us as a primary source of distribution. Softwaredevelopers use our Author Resource Center to submit their products forinclusion on our site and to purchase promotional placement of their software.Software developers may also purchase other promotional services on acost-per-click or flat rate basis. Software developers are able to promotetheir 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 andother revenue is recognized ratably over the period in which it is presented.To the extent that we do not meet the minimum number of post-presentationimpressions that we guarantee to customers, we defer recognition of thecorresponding revenues until the guaranteed impressions are achieved. Customvideo production revenue is recognized on acceptance of the completed video bythe customer.

 

**CriticalAccounting Policies**

 

The following is adiscussion of our critical accounting policies and methods. Critical accountingpolicies are defined as those that are both important to the portrayal of ourfinancial condition and results of operations and are reflective of significantjudgments and uncertainties made by management that may result in materiallydifferent results under different assumptions and conditions. Note 2 tothe consolidated financial statements for the year ended December 31,2009, or Fiscal 

 

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2009, includes furtherinformation on the significant accounting policies and methods used in thepreparation of our consolidated financial statements.

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the U.S. requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities. On an on-going basis, weevaluate the application of these estimates, including those related to theuseful lives and valuation of intangible assets, valuation of goodwill, fairvalue measurement of assets and liabilities, product development costs, revenuerecognition and deferred revenue and accounting for income taxes. We base ourestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual amountscould differ significantly from these estimates.

 

**Revenuerecognition policy**

 

We earn revenuesfrom the following services;

 

·                  OpenSRS (Domain, Email and Other Services);

 

·                  YummyNames;

 

·                  Hover; and

 

·                  Butterscotch.

 

With respect tothe sale of domain registrations and other Internet services, we earnregistration fees in connection with each new, renewed and transferred-inregistration and from providing provisioning services to resellers andregistrars on a monthly basis. We also enter into revenue arrangements in whicha reseller may purchase a combination of services (multiple elementarrangements). When fair value exists for all elements, we allocate revenue toeach element based on the relative fair value of each of the elements. Fairvalue is established by the price charged when that element is sold separately.For arrangements where fair value exists only for the undelivered elements, wedefer the fair value of the undelivered elements and recognize the differencebetween the total arrangement fee and the amount deferred for the undelivereditems as revenue related to the delivered items, assuming all other criteria forrevenue recognition have been met. Payments for the full term of all services,or billed revenue, are received at the time of activation of service and whereappropriate are recorded as deferred revenue and are recognized as earnedratably over the term of provision of service. This accounting treatmentreasonably approximates a recognition pattern that corresponds with theprovision of the services during the quarters and the year.

 

Revenue from thesale of domain names consists primarily of amounts earned for the transfer ofrights to domain names that are currently under the Company’s control.Collectability of revenues generated is subject to a high level of uncertainty;accordingly revenues are recognized only when payment is received, except wherea fixed contract has been negotiated, in which case revenues are recognizedonce all the terms of the contract have been satisfied.

 

We also generateadvertising and other revenue through our online libraries of shareware,freeware and online services presented at our websites, tucows.com andbutterscotch.com. Advertising and other revenue is recognized ratably over theperiod in which it is presented. To the extent that the minimum number ofpost-presentation impressions we guarantee to customers is not met, 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.

 

Changes tocontractual relationships in the future could impact the amounts and timing ofrevenue recognition.

 

In those caseswhere payment is not received at the time of sale, additional conditions forrecognition of revenue apply. The conditions are (i) that the collectionof sales proceeds is reasonably assured and (ii) that we have no furtherperformance obligations. We record expected refunds, rebates and credit cardcharge-backs as a reduction of revenues at the time of the sale based onhistorical experiences and current expectations. Should these expectations notbe met, adjustments will be required in future periods.

 

We establishreserves for possible uncollectible accounts receivable and other contingentliabilities which may arise in the normal course of business. The allowance fordoubtful accounts is calculated by taking into account factors such as ourhistorical collection and write-off experience, the number of days the customeris past due and the status of the customer’s 

 

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account with respect towhether or not the customer is continuing to receive service. The contingentliability estimates are based on management’s historical experience and variousother assumptions that are believed to be reasonable under the circumstances,the results of which form the basis for making judgments about the reportedamounts of liabilities and expenses that are not readily apparent from othersources. Historically, credit losses have been within our expectations and thereserves we have established have been appropriate. However, we have, onoccasion, experienced issues which have led to accounts receivable not beingfully collected. Should these issues occur more frequently, additional reservesmay be required.

 

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

 

Goodwillrepresents the excess of purchase price over the fair values assigned to thenet assets acquired in business combinations. Intangible assets consist ofacquired technology, brand, customer relationships, non-competition agreements,surname domain names and direct navigation domain names. Intangible assets,which include technology, brand value, customer relationships andnon-competition arrangements related to the acquisition of BoardtownCorporation in April 2004, the acquisition of the Hosted MessagingBusiness of Critical Path, Inc. in January 2006, the acquisition ofMailbank.com Inc. in June 2006 and the acquisition of Innerwise, Inc.in July 2007, are being amortized on a straight-line basis over periods oftwo to seven years.

 

Goodwill andindefinite life intangibles are not be amortized, but are tested for impairmentannually or more frequently if circumstances indicate potential impairment,through a comparison of fair value to carrying amount. Goodwill and indefinitelife intangibles are tested for impairment annually at the same time everyyear, and when an event occurs or circumstances change such that it isreasonably possible that impairment may exist. We review goodwill andindefinite life intangibles at least annually for possible impairment in thefourth quarter of each year.

 

We have otherfinite life intangible assets consisting of patented and non-patentedtechnologies. These intangible assets are amortized over their expectedeconomic lives. The lives are determined based upon the expected use of theasset, the estimated average life of the replacement parts of the reportingunits products, the stability of the industry, expected changes in andreplacement value of distribution networks and other factors deemedappropriate.

 

With regards toproperty, equipment and definite life intangible assets, we continuallyevaluate whether events or circumstances have occurred that indicate theremaining estimated useful lives of its definite-life intangible assets maywarrant revision or that the remaining balance of such assets may not berecoverable. We use an estimate of the related undiscounted cash flows over theremaining life of the asset in measuring whether the asset is recoverable.There was no impairment recorded on definite-life intangible assets andproperty and equipment during the three months ended March 31, 2010or during the three months ended March 31, 2009.

 

Determining thenumber of reporting units and the fair value of a reporting unit requires us tomake judgments and involves the use of significant estimates and assumptions.These estimates and assumptions include revenue growth rates and operatingmargins used to calculate projected future cash flows, risk-adjusted discountrates, future economic and market conditions, and determination of appropriatemarket comparables. We base our fair value estimates on assumptions we believeto be reasonable but that are unpredictable and inherently uncertain. Thelong-term financial forecast represents the best estimate that we have at thistime and we believe that its underlying assumptions are reasonable. However,actual performance in the near-term and longer-term could be materiallydifferent from these forecasts, which could impact future estimates of fairvalue of our reporting units and may result in a charge to earnings in futureperiods due to the potential for a write-down of goodwill in connection withsuch tests.

 

**Accountingfor income taxes**

 

We are subject toincome taxes in the U.S. and numerous foreign jurisdictions. Significantjudgment is required in evaluating our uncertain tax positions and determiningour provision for income taxes. We apply a two-step approach to recognizing andmeasuring uncertain tax positions. The first step is to evaluate the taxposition for recognition by determining if on the weight of available evidence;it is more likely than not that the position will be sustained on audit,including resolution of related appeals or litigation processes, if any. Thesecond step is to measure the tax benefit that is more than 50% likely to berealized upon settlement.

 

Although webelieve we have adequately reserved for our uncertain tax positions, no assurancecan be given that the final tax outcome of these matters will not be different.We adjust these reserves in light of changing facts and circumstances, such asthe closing of a tax audit or the refinement of an estimate. To the extent thatthe final tax outcome of these matters is different than the amounts recorded,such differences will impact the provision for income taxes in the period inwhich such determination is made.

 

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As we account forincome taxes under the asset and liability method, we recognize deferred taxassets or liabilities for the anticipated future tax effects of temporarydifferences between the financial statement basis and the tax basis of ourassets and liabilities. We record a valuation allowance to reduce the netdeferred tax assets when it is more likely than not that the benefit from thedeferred tax assets will not be realized. In assessing the need for a valuationallowance, historical and future levels of income, expectations and risksassociated with estimates of future taxable income and ongoing tax planningstrategies are considered. In the event that it is determined that the deferredtax assets to be realized in the future would be in excess of the net recordedamount, an adjustment to the deferred tax asset valuation allowance would berecorded. This adjustment would increase income in the period that suchdetermination was made. Likewise, should it be determined that all or part of arecorded net deferred tax asset would not be realized in the future, anadjustment to increase the deferred tax asset valuation allowance would becharged to income in the period that such determination would be made.

 

On a periodicbasis, we evaluate the probability that our deferred tax assets will berecovered to assess its realizability. To the extent we believe it is morelikely than not that some portion of our deferred tax assets will not berealized, we will increase the valuation allowance against the deferred taxassets. 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 laws andother factors. These changes, if any, may require possible material adjustmentsto these deferred tax assets, impacting net income or net loss in the periodwhen such determinations are made.

 

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**RESULTSOF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2010 AS COMPAREDTO THE THREE MONTHS ENDED MARCH 31, 2009**

 

The followingtable presents our net revenues, by revenue source:

 
| ** **                        | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| OpenSRS :                         | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Domain Services                   |       | $                                     | 15,403,010 |   | $ | 14,202,023 |   |
| Email Services                    |       | 638,188                               |       | 1,121,935 |   |
| Other Services                    |       | 1,093,711                             |       | 1,094,460 |   |
| Total OpenSRS Services            |       | 17,134,909                            |       | 16,418,418 |   |
|                              |       |                                  |       |   |   |
| YummyNames                        |       | 1,711,321                             |       | 1,865,033 |   |
| Hover                             |       | 1,129,497                             |       | 1,300,584 |   |
| Butterscotch                      |       | 469,426                               |       | 507,389 |   |
|                              |       | $                                     | 20,445,153 |   | $ | 20,091,424 |   |
| Increase over  comparative period |       | $                                     | 353,729    |   |   |   |
| Increase - percentage             |       | 2                                     | %          |   |   |

 

The followingtable presents our revenues, by revenue source, as a percentage of totalrevenues:

 
| ** **             | ** ** | **Three months ended March 31,** | ** ** |
|------------------------|------------|---------------------------------------|------------|
| ** **             | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| OpenSRS :              |       |                                  |       |   |   |
| Domain Services        |       | 76                                    | %          | 71 | % |
| Email Services         |       | 3                                     | %          | 6 | % |
| Other Services         |       | 5                                     | %          | 5 | % |
| Total OpenSRS Services |       | 84                                    | %          | 82 | % |
|                   |       |                                  |       |   |   |
| YummyNames             |       | 8                                     | %          | 9 | % |
| Hover                  |       | 6                                     | %          | 6 | % |
| Butterscotch           |       | 2                                     | %          | 3 | % |
|                   |       | 100                                   | %          | 100 | % |

 

Deferred revenuefrom domain name registrations and other services at March 31, 2010increased to $59.5 million from $56.7 million at March 31, 2009.

 

No customeraccounted for more than 10% of revenue during the three months ended March 31, 2010and, at March 31, 2010, two customers accounted for 32% of accountsreceivable. Significant management judgment is required at the time ofrecording of revenue to assess whether the collection of the resultingreceivables is reasonably assured. On an ongoing basis we assess the ability ofour 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.

 

***OpenSRS***

 

Net revenues fromOpenSRS services for the three months ended March 31, 2010 as compared to the three months ended March 31, 2009, increased by $0.7 million to $17.1million.

 

This increaseresulted from an increase in domain services of $1.2 million to $15.4million, primarily the result of increased volumes of new clients and retentionof existing customers. During the three months ended March 31, 2010,the total new, renewed and transferred-in domain name registrations that weprocessed increased by 0.2 million to 2.0 million as compared to thethree months ended March 31, 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 March 31, 2010, the total domain names under ourmanagement increased by 0.4 million to 8.3 million, as compared tothe total domain names under our management as of March 31, 2009. Inaddition, we provide provisioning services on a monthly

 

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basisto accredited registrars who use our technical systems to process domainregistrations with their own accreditation. As of March 31, 2010, wemanaged 1.7 million domain names on behalf of other accredited registrars,an increase of 0.2 million compared to the 1.5 million managed foraccredited registrars as of March 31, 2009.

 

This increase fromdomain services was partially offset by $0.5 million to $0.6 million, primarilyas a result of the loss of certain media portal email customers as was fullydisclosed in prior filings. As our marketing efforts to date have not yetbeen successful in offsetting these customer losses, these customer losses havehad a material adverse impact on our results of operations for email servicesfor the three months ended March 31, 2010.

 

***YummyNames***

 

Net revenues fromour YummyNames domain portfolio service for the three months ended March 31, 2010as compared to thethree months ended March 31, 2009 decreased by $0.2 million, or 8%, to$1.7 million.

 

This decrease resultedfrom a reduction in our pay-per-click advertising or parked pages revenueby $0.2 million to $0.4 million during the three months ended March 31,2010, primarily the result of the lower inventory of names available forparking purposes as we continue to sell non-strategic names. In addition,revenue from the sale of domain names decreased by $0.1 million to $1.2million, primarily the result of the impact that our being able to sell thebulk of our backlog of non-strategic names during Fiscal 2009 has had on ourregular bi-monthly sale of names.

 

These decreases were partially offset by the improved performance weare currently experiencing with our auction initiatives.

 

The market formonetization of domain names is rapidly evolving and there is no guarantee thatwe will be able to continue to acquire the same caliber of names for ourportfolio from future expiring domains or that names we acquire in future willprovide the same revenue impact as we have experienced from past acquisitions.In addition, the revenue we derive from domain portfolio services is driven bygeneral macroeconomic factors that affect internet advertising. Our advertisingexpenditures are typically sensitive to economic conditions and tend to declinein recessionary periods and other periods of economic uncertainty.

 

***Hover***

 

Net revenues from Hover for the three months ended March 31, 2010 as compared to the three months ended March 31, 2009 decreased by $0.2 million, or 13%,to $1.1 million.

 

Hover has been focusing on improving our retail platform to provideretail customers with a cleaner, simpler way to register and manage domainnames and email addresses. During this initiative, we have been de-emphasizingnew customer acquisitions while we concentrated on renewals. With the completionof our transitioning our retail customers from our Domain Direct, NetIdentityand IYD services to Hover, we have again begun to concentrate on launchingprograms to drive new customer acquisitions..

 

***Butterscotch***

 

Net revenues from Butterscotch for the three monthsended March 31, 2010 as compared to the three months ended March 31, 2009 remained relatively flat at$0.5 million.

 

**COST OF REVENUES**

** **

***OpenSRS***

 

·                  OpenSRS DomainService

 

Cost of revenuesfor domain registrations represents the amortization of registry fees on abasis consistent with the recognition of revenues from our customers, namelyratably over the term of provision of the service. Registry fees, the primarycomponent of cost of revenues, are paid in full when the domain is registered,and are initially recorded as prepaid domain registry fees. This accountingtreatment reasonably approximates a recognition pattern that corresponds withthe provision of the services during the period.

 

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·                  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 revenuesfor other reseller services include fees paid to third-party service providers,primarily for SSL certificates and for printing services in connection withPlatypus. Fees payable for SSL certificates are amortized on a basis consistentwith the provision of service, generally one year, while monthly printing feesare included in cost of revenues in the month they are incurred.

 

***YummyNames***

 

Costs of revenuesfor our domain portfolio service represent the amortization of registry feesfor domains added to our portfolio over the renewal period, which is generallyone year, the value attributed under intangible assets to any domain name soldand any impairment charges that may arise from our assessment of our domainname intangible assets. As the total names in our portfolio continue to grow,this cost will become a more significant component of our cost of revenues.Payments for domain registrations are payable for the full term of service atthe time of activation of service and are recorded as prepaid domain registryfees and are expensed ratably over the renewal term.

 

***Hover***

 

Costs of revenuesfor our provision and management of Internet services on a retail basis includethe amortization of registry fees on a basis consistent with the recognition ofrevenues from our customers, namely ratably over the term of provision of theservice and includes the amortization of registry fees payable to renew thedomains in our surname portfolio. Registry fees, the primary component of costof revenues, are paid in full when the domain is registered, and are recordedas prepaid domain registry fees.

 

***Butterscotch***

 

Costs of revenuesfor our ad-supported content sites include the fees paid to third-party serviceproviders, primarily for digital certificates sold through our content sitesand content license fees.

 

***Network costs***

 

Network costsinclude personnel and related expenses, depreciation and amortization,communication costs, equipment maintenance, stock-based compensation andemployee and related costs directly associated with the management andmaintenance of our network. Communication costs include bandwidth, co-locationand provisioning costs we incur to support the supply of all our services.

 

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The following tablepresents our cost of revenues, by revenue source, for the periods presented:

 
| ** **                                    | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                    | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| OpenSRS :                                     | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Domain Services                               |       | $                                     | 12,616,231 |   | $ | 11,354,762 |   |
| Email Services                                |       | 107,138                               |       | 179,918 |   |
| Other Services                                |       | 387,123                               |       | 388,852 |   |
| Total OpenSRS Services                        |       | 13,110,492                            |       | 11,923,532 |   |
|                                          |       |                                  |       |   |   |
| YummyNames                                    |       | 202,754                               |       | 185,554 |   |
| Hover                                         |       | 399,445                               |       | 513,210 |   |
| Butterscotch                                  |       | 18,859                                |       | 6,740 |   |
| Network, other costs                          |       | 1,193,324                             |       | 1,156,362 |   |
| Network, depreciation  and amortization costs |       | 384,860                               |       | 422,146 |   |
|                                          |       | $                                     | 15,309,734 |   | $ | 14,207,544 |   |
| Increase over  comparative period             |       | $                                     | 1,102,190  |   |   |   |
| Increase - percentage                         |       | 8                                     | %          |   |   |

 

The followingtable presents our cost of revenues, as a percentage of total cost of revenuesfor the periods presented:

 
| ** **                                    | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                    | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| ** **                                    | ** ** | ** **                            | ** ** | ** ** | ** ** |
| OpenSRS :                                     |       |                                  |       |   |   |
| Domain Services                               |       | 81                                    | %          | 80 | % |
| Email Services                                |       | 1                                     | %          | 1 | % |
| Other Services                                |       | 3                                     | %          | 3 | % |
| Total OpenSRS Services                        |       | 85                                    | %          | 84 | % |
|                                          |       |                                  |       |   |   |
| YummyNames                                    |       | 1                                     | %          | 1 | % |
| Hover                                         |       | 3                                     | %          | 4 | % |
| Butterscotch                                  |       | 0                                     | %          | 0 | % |
| Network, other costs                          |       | 8                                     | %          | 8 | % |
| Network, depreciation  and amortization costs |       | 3                                     | %          | 3 | % |
|                                          |       | 100                                   | %          | 100 | % |

 

Prepaid domainregistration and other Internet services fees as of March 31, 2010increased by $3.1 million, or 7%, to $46.3 million from$43.2 million at March 31, 2009.

 

***OpenSRS***

 

Costs for OpenSRSfor the three months ended March 31, 2010 increased by $1.1 million, or 8%,when compared to the three months ended March 31, 2009.This increase was primarily as a result of higher domain registration volumes experienced duringthe three months ended March 31, 2010 when compared to the three months ended March 31, 2009.

 

This increase waspartially offset by decreased email services costs as certain costs incurred inthe three months ended March 31, 2009 were one-time costs.

 

***YummyNames***

 

Costs forYummyNames for the three months ended March 31, 2010 as compared to the three months ended March 31, 2009remained relativelyflat at $0.2 million.

 

***Hover***

 

Costs for Hoverfor the three months ended March 31, 2010 as compared to the three months ended March 31, 2009decreased by$0.1 million, to $0.4 million. This decrease is a result of thedecrease in revenue as described above.

 

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***Network costs***

 

Network costs before depreciation and amortization forthe three months ended March 31, 2010 remained relatively flat at$1.2 million as compared to the three months ended March 31, 2009,despite the significant strengthening on average of the Canadian dollarrelative to the U.S. dollar by approximately 15% from theprior fiscal first quarter, and reflects the improved efficiency of operatingand managing our co-location facilities.

 

A significant portion of our operating and networkexpenses are incurred in Canadian dollars, as a result the strengthening of theCanadian dollar relative to the U.S. dollar has negatively impacted all of ouroperating costs, during the three months ended March 31, 2010 whencompared to the three months ended March 31, 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.

 

Network depreciation and amortization costs for thethree months ended March 31, 2010 remained relatively flat at$0.4 million, primarily as a result of certain of our oldercomputer hardware now being fully depreciated and not requiring replacement.

 

Excludingmovements in exchange rates, we expect network costs to decrease slightly forthe fiscal year ending December 31, 2010 as compared to the fiscal yearended December 31, 2009.

 

**SALES AND MARKETING**

 

Sales and marketingexpenses consist primarily of personnel costs. These costs include commissionsand related expenses of our sales, product management, public relations, callcenter, support and marketing personnel. Other sales and marketing expensesinclude customer acquisition costs, advertising and other promotional costs.

 
| ** **                        | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Sales and marketing               |       | $                                     | 1,862,336  |   | $ | 1,353,176 |   |
| Increase over  comparative period |       | $                                     | 509,160    |   |   |   |
| Increase - percentage             |       | 38                                    | %          |   |   |
| Percentage of net  revenues       |       | 9                                     | %          | 7 | % |
|                                   |            |                                       |            |  |  |  |  |

 

Sales andmarketing expenses for the three months ended March 31, 2010increased by $0.5 million, or 38%, to $1.9 million when compared tothe three months ended March 31, 2009. This increase was primarilydue to higher workforce costs that resulted from additional people employed inboth our marketing and customer service areas and the negative impact thesignificant strengthening on average of the Canadian dollar relative to theU.S. dollar by approximately 15% from the prior fiscal firstquarter has had onsales and marketing expenses during the three months ended March 31, 2010.

 

Included in sales and marketing expenses is a non-recurring cost of approximately$0.1 million related to severance costs incurred during the three monthsended March 31, 2010.

 

Excludingmovements in exchange rates, we expect sales and marketing expenses to increaseslightly during Fiscal 2010, in absolute dollars, as we adjust our marketingprograms and sales and customer support strategies to meet future opportunitiesin the marketplace.

 

**TECHNICALOPERATIONS AND DEVELOPMENT**

 

Technicaloperations and development expenses consist primarily of personnel costs andrelated expenses required to support the development of new or enhanced serviceofferings and the maintenance and upgrading of existing infrastructure. Thisincludes expenses incurred in the research, design and development oftechnology that we use to register domain names, email, retail, domainportfolio and other Internet services, as well as to distribute our digitalcontent services. Editorial costs relating to the rating and review of thesoftware content libraries are included in the costs of product development.Costs incurred during the application development stage are capitalized andprimarily include personnel costs for employees directly related to thedevelopment project. As no material expenditures for qualified applicationdevelopment stage initiatives were incurred during the three months ended March 31, 2010or March 31, 2009, no amounts have been capitalized. All other costsare expensed as incurred.

 

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| ** **                            | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------|------------|
| ** **                            | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Technical operations  and development |       | $                                     | 1,243,013  |   | $ | 1,104,139 |   |
| Increase over  comparative period     |       | $                                     | 138,874    |   |   |   |
| Increase - percentage                 |       | 13                                    | %          |   |   |
| Percentage of net revenues            |       | 6                                     | %          | 5 | % |
|                                       |            |                                       |            |  |  |  |  |

 

Technicaloperations and development expenses for the three months ended March 31, 2010increased by $0.1 million, or 13%, to $1.2 million when compared tothe three months ended March 31, 2009.

 

This increase forthe three months ended March 31, 2010 resulted primarily from anincrease in workforce-related costs, including contract and outside servicecosts, primarily the result of the significant strengthening on average of theCanadian dollar relative to the U.S. dollar by approximately 15% from theprior fiscal first quarter.

 

Excludingmovements in exchange rates, we expect technical operations and developmentexpenses, in absolute dollars, for the fiscal year ending December 31,2010  to remain relatively flat whencompared to the fiscal year ended December 31, 2009.

 

**GENERAL AND ADMINISTRATIVE**

 

General andadministrative expenses consist primarily of compensation and related costs formanagerial and administrative personnel, fees for professional services, publiclisting expenses, rent and other general corporate expenses.

 
| ** **                        | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| General and  administrative       |       | $                                     | 815,580    |   | $ | 1,869,896 |   |
| Decrease over  comparative period |       | $                                     | (1,054,316 | ) |   |   |
| Decrease - percentage             |       | (56                                   | )%         |   |   |
| Percentage of net  revenues       |       | 4                                     | %          | 9 | % |
|                                   |            |                                       |            |  |  |  |  |

 

General andadministrative expenses for the three months ended March 31, 2010decreased by $1.1 million, or 56%, to $0.8 million as compared to thethree months ended March 31, 2009. This was primarily as a result ofour recording a foreign exchange gain of $0.6 million during the threemonths ended March 31, 2010 as compared to a foreign exchange loss of$0.8 million during the three months ended March 31, 2009. This gainin foreign exchange was primarily the result of the strengthening on average ofthe Canadian dollar relative to the U.S. dollar by approximately 15% from thethree months ended March 31, 2009. This decrease was offset mainly by an increase inworkforce related costs, facility costs and professional fees of $0.3millionduring the three months ended March 31, 2010, as compared to thethree months ended March 31, 2009.

 

**DEPRECIATIONOF PROPERTY AND EQUIPMENT**

 

Property andequipment is depreciated on a straight-line basis over the estimated usefullife of the assets.

 
| ** **                              | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                              | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Depreciation of  property and equipment |       | $                                     | 43,889     |   | $ | 82,453 |   |
| Decrease over  comparative period       |       | $                                     | (38,564    | ) |   |   |
| Decrease - percentage                   |       | (47                                   | )%         |   |   |
| Percentage of net  revenues             |       | —                                | %          | — | % |
|                                         |            |                                       |            |  |  |  |  |

 

Depreciation costs for the three months ended March 31, 2010decreased by $39,000, or 47%, to $44,000, primarily the result of certain ofour older assets being fully depreciated.

 

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**AMORTIZATIONOF INTANGIBLE ASSETS**

 
| ** **                         | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|
| ** **                         | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Amortization of  intangible assets |       | $                                     | 360,540    |   | $ | 360,540 |   |
| Decrease over  comparative period  |       | $                                     | —     |   |   |   |
| Decrease - percentage              |       | —                                | %          |   |   |
| Percentage of net revenues         |       | 2                                     | %          | 2 | % |
|                                    |            |                                       |            |  |  |  |  |

 

Amortization ofintangible assets consists of amounts arising in connection with theacquisition of Boardtown in April 2004, the acquisition of the hostedmessaging assets of Critical Path Inc. in January 2006, theacquisition of Mailbank.com Inc. in June 2006 and the acquisition ofIYD in July 2007.

 

In connection withthe acquisition of Boardtown Corporation, the brand and customer relationshipspurchased are amortized on a straight-line basis over seven years, while thenon-competition agreements entered into with the former owners of BoardtownCorporation are amortized on a straight-line basis over three years.

 

Customerrelationships acquired in connection with the acquisition of the hostedmessaging assets of Critical Path Inc. are amortized on a straight-linebasis over five years.

 

Customerrelationships acquired in connection with the acquisition of Mailbank.com Inc.are amortized on a straight-line basis over five years.

 

The brand andcustomer relationships acquired in connection with the acquisition ofMailbank.com Inc. are amortized on a straight-line basis over seven years.

 

**GAIN ON CHANGE IN FAIR VALUE OF FORWARD EXCHANGECONTRACTS**

 

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 March 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Gain on change in fair  value of forward contracts |       | $                                     | (113,973   | ) | $ | (85,343 | ) |
| Increase over  comparative period                  |       | $                                     | (28,630    | ) |   |   |
| Increase - percentage                              |       | 34                                    | %          |   |   |
| Percentage of net  revenues                        |       | (1                                    | )%         | — | % |
|                                                    |            |                                       |            |  |  |  |  |

 

We have entered into forward exchange contracts to meet a portion ofour future Canadian dollar requirements through September 2011. The impactof the fair value adjustment on unrealized foreign exchange on these contractsfor the three monthsended March 31, 2010 was a net gain of$0.1 million, as compared to a net gain of $0.1 million for the three months ended March 31, 2009.This net gain in fair value of forward contracts results from a combination ofthe impact from the change in foreign exchange rates over time, as well as fromthe impact of the settlement of forward exchange contracts as they mature.

 

At March 31, 2010, we reflect a derivative instrument assetof $2.3 million on our balance sheet as a result of our foreign exchangecontracts. 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 $2.0 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 

 

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March 31,2010, that we may enter into and fluctuations in the value of our existingcontracts that mature during the 2010 and 2011 fiscal years.

 

**OTHERINCOME AND EXPENSES**

 
| ** **                        | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Other income  (expenses), net     |       | $                                     | (39,168    | ) | $ | (63,462 | ) |
| Increase over  comparative period |       | $                                     | 24,294     |   |   |   |
| Increase - percentage             |       | (38                                   | )%         |   |   |
| Percentage of net  revenues       |       | (0                                    | )%         | — | % |
|                                   |            |                                       |            |  |  |  |  |

 

Other income, net,primarily relates to interest payable pursuant to the terms of our Bank ofMontreal credit facility, and decreased when compared to the prior fiscal firstquarter as a result of the principal repayments we have made since March 2009.

 

**INCOME TAXES**

 

The following tablepresents our provision for income taxes for the periods presented:

 
| ** **                 | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------|------------|---------------------------------------|------------|
| ** **                 | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Provision for income taxes |       | $                                     | 316,000    |   | $ | 107,425 |   |
|                            |            |                                       |            |  |  |  |  |

 

For the threemonths ended March 31, 2010, we recorded a provision for income taxes of$316,000 on income before taxes of $885,000 using an estimated effective taxrate for its 2010 fiscal year. Comparatively, for the three months ended March 31,2009, we recorded a current tax expense of $107,000 on income before incometaxes of $1.1 million using an estimated effective tax rate for its 2009 fiscalyear that accounts for the utilization of remaining net operating loss carryforwards and alternative minimum tax credits available to us.

 

As of December 31,2009, we recorded a valuation allowance of $4.3 million and a net deferred taxasset of $3.0 million. As of March 31, 2010 we have recorded a deferredtax asset of $4.1 million which has been allocated to non-current deferred taxassets and $1.1 million which has been allocated to current deferred taxliabilities. As of March 31, 2010 and December 31, 2009, wehad also recorded a non current deferred tax liability related to the temporarydifference arising on indefinite life intangibles of $4.8 million.

 

We analyze thecarrying value of our deferred tax asset on a regular basis. In determiningfuture taxable income, assumptions are made to forecast federal, state andinternational operating income, the reversal of temporary timing differences,and the implementation of any feasible and prudent tax planning strategies. Theassumptions require significant judgment regarding the forecasts of futuretaxable income, and are consistent with other forecasts used to manage thebusiness. During the three months ended March 31, 2010, there was noreversal of the valuation allowance. The valuation allowance will be maintaineduntil sufficient evidence exists to support a reversal of, or decrease in, thevaluation allowance.

 

We follow theprovisions of FASB ASC: Topic 740, Income Taxes to account for income taxexposures. The application of this interpretation requires a two-step processthat separates recognition of uncertain tax benefits from measurement thereof.

 

We haveapproximately $107,000 of total gross unrecognized tax benefit as of March 31,2010 and $124,000 of total gross unrecognized tax benefit as of December 31,2009, which if recognized would favorably affect the income tax rate in futureperiods. The unrecognized tax benefit relates to prior year Pennsylvania statefranchise taxes and other US state taxes. The unrecognized tax benefit hasdecreased by $17,000 when compared to the gross unrecognized tax benefits as ofDecember 31, 2009 as Pennsylvania have now settled their claim for theyears December 31, 1996 to December 31, 2000. We do not expect theunrecognized tax benefit for the 2009 and 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 March 31, 2010 and March 31, 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.

 

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**LIQUIDITYAND CAPITAL RESOURCES**

 

As of March 31, 2010,our principal sources of liquidity were cash flows generated from operationsand cash and cash equivalents of $5.2 million, as compared to$9.6 million at December 31, 2009.

 

Net cash providedby operating activities for the three months ended March 31, 2010totaled $1.4 million, as compared to $0.9 million for the threemonths ended March 31, 2009. This increase of $0.5 million wasprimarily the result of improved management in working capital.

 

Net cash used infinancing activities during the three months ended March 31, 2010totaled $5.7 million. We used $4.5 million to repurchase6.4 million shares pursuant to the terms of a Dutch auction tender offercompleted during January 2010 and $0.7 million to repurchase 956,000of our shares under the terms of our stock repurchase program announced in February 2010.

 

Pursuant to theterms of our non-revolving, reducing credit facility, we also made equalmonthly principal repayments totalling $0.5 million. We currently estimatethat the cash sweep payment, which will be based on our audited 2009 resultsand will be payable during the three months ending June 30, 2010, will besufficient to pay off in full the outstanding balance of our non-revolving,reducing credit facility during the three months ended June 30, 2010.

 

Investingactivities used net cash of $0.1 million for the three months ended March 31, 2010,as compared to $48,000 in net cash used in the same period in Fiscal year 2009,primarily a result of the acquisition of additional property and equipment.

 

Based on ouroperations, we believe that our cash flow from operations will be adequate tomeet our anticipated requirements for working capital, capital expenditures andour loan repayments for at least the next 12 months.

 

We may choose toraise additional funds or seek other financing arrangements to facilitate morerapid expansion, develop new or enhance existing products or services, respondto competitive pressures or acquire or invest in complementary businesses,technologies, services or products.

 

If additionalfinancing is required, we may not be able to raise it on acceptable terms, orat all, and additional financing may be dilutive to existing investors. We mayalso evaluate potential acquisitions of other businesses, products andtechnologies. To complete potential acquisitions, we may issue additionalsecurities or need additional equity or debt financing and any additionalfinancing may be dilutive to existing investors. There are currently nomaterial understandings, commitments or agreements regarding the acquisition ofother businesses.

 

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

 

We developproducts in Canada and sell these services in North America and Europe. Oursales are primarily made in U.S. dollars, while a major portion of expenses areincurred in Canadian dollars. Our financial results could be affected byfactors such as changes in foreign currency exchange rates or weak economicconditions in foreign markets. Our interest income is sensitive to changes inthe general level of Canadian and U.S. interest rates, particularly since themajority of our investments are in short-term instruments. Based on the natureof our short-term investments, we have concluded that there is no materialinterest rate risk exposure as of March 31, 2010. We are also subjectto 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 ourfunctional currency is the U.S. dollar, a substantial portion of our fixedexpenses are incurred in Canadian dollars. Our policy with respect to foreigncurrency exposure is to manage financial exposure to certain foreign exchangefluctuations with the objective of neutralizing some of the impact of foreigncurrency exchange movements. Exchange rates are, however, subject tosignificant and rapid fluctuations, and therefore we cannot predict theprospective impact of exchange rate fluctuations on our business, results ofoperations and financial condition. Accordingly, we have entered into foreignexchange contracts to mitigate the exchange rate risk on portions of ourCanadian dollar exposure.

 

AtMarch 31, 2010, the Company had forward exchange contracts to trade U.S.dollars in exchange for Canadian dollars as follows:

 

| ** **                         | ** ** | **Notional**      | ** ** | **Weighted  average** | ** ** | ** **      | ** ** |
|------------------------------------|------------|-------------------|------------|-----------------------|------------|-----------------|------------|
| ** **                         | ** ** | **amount  of**    | ** ** | **exchange  rate of** | ** ** | ** **      | ** ** |
| **Maturity  date**                 | ** ** | **U.S.  dollars** | ** ** | **U.S.  dollars**     | ** ** | **Fair  value** | ** ** |
|                               |       |              |       |                  |       |            |       |
| April -  June 2010       |       | $                 | 4,939,000  |                  | 0.8427     |            | $          | 834,551 |   |
| July -  September 2010   |       | 5,400,000         |       | 0.8596                |       | 785,784         |       |
| October -  December 2010 |       | 5,400,000         |       | 0.9236                |       | 350,015         |       |
| Total 2010                         |       | 15,739,000        |       | 0.8749                |       | 1,970,350       |       |
|                               |       |              |       |                  |       |            |       |
| January —  March, 2011   |       | 3,900,000         |       | 0.9302                |       | 215,338         |       |
| April -  June 2011       |       | 3,900,000         |       | 0.9635                |       | 64,335          |       |
| July -  September 2011   |       | 3,900,000         |       | 0.9604                |       | 68,620          |       |
| Total 2011                         |       | 11,700,000        |       | 0.9511                |       | 348,293         |       |
|                               |       |              |       |                  |       |            |       |
| Total                              |       | $                 | 27,439,000 |                  | 0.9058     |            | $          | 2,318,643 |   |

 

During the three months ended March 31, 2010, the Company enteredinto a series of foreign exchange forward contracts to hedge a portion of its2011 fiscal year expected Canadian dollar requirements. These contracts,collectively, have a notional value of US$6.5 million, whereby US$650,000 isconverted into Canadian dollars on a semi-monthly basis from May 2011 to September 2011at an average foreign exchange rate of US$1.00: Cdn$1.0390.

 

As the Companydoes not comply with the documentation requirements for hedge accounting, weaccount for the fair value of the derivative instruments within theconsolidated balance sheet as a derivative financial asset or liability and thecorresponding change in fair value is recorded in our consolidated statement ofoperations. We have no other freestanding or embedded derivative instruments.

 

During the threemonths ended March 31, 2010, the Company recorded a gain of $114,000in the fair value of forward contracts in its consolidated statements ofoperations and a net derivative asset of $2.3 million. For the three monthsended March 31, 2009, the Company recorded a gain on forwardcontracts of $85,000 in the fair value of forward contracts in its consolidatedstatements of operations and a derivative liability of $1.9 million.

 

We have performeda sensitivity analysis model for foreign exchange exposure over the threemonths ended March 31, 2010. The analysis used a modeling techniquethat compares the U.S. dollar equivalent of all expenses incurred in Canadiandollars, at the actual exchange rate, to a hypothetical 10% adverse movement inthe foreign currency exchange rates against the U.S. dollar, with all othervariables held constant. Foreign currency exchange rates used were based on themarket rates in effect during the three months ended March 31, 2010.The sensitivity analysis indicated that a hypothetical 

 

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10% adverse movement inforeign currency exchange rates would result in a decrease in net income forthe three months ended March 31, 2010 of approximately$0.5 million. There can be no assurances that the above projected exchangerate decrease will materialize. Fluctuations of exchange rates are beyond ourcontrol. We will continue to monitor and assess the risk associated with theseexposures and may take additional actions in the future to hedge or mitigatethese 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 and Procedures**

 

(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’s rules andis accumulated and communicated to our management, including our principalexecutive and principal financial officers, or persons performing similarfunctions, 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 assurance thatall control issues and instances of fraud, if any, within a company have beendetected.

 

(b)                                 Change in Internal Control over FinancialReporting

 

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**

 

We areinvolved in various investigations, claims and lawsuits arising in the normalconduct of our business, none of which, in our opinion, will harm our business.We cannot assure that we will prevail in any litigation. Regardless of theoutcome, any litigation may require us to incur significant litigation expenseand may result in significant diversion of our attention.

 

**Item1A.  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 yearended December 31, 2009, all of which could materially affect ourbusiness, financial condition or operating results and should be consideredbefore making an investment decision regarding our securities. The risksdescribed in our Annual 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 Sale of Equity Securities andUse of Proceeds**

 

In thethree months ended March 31, 2010 we used $5,212,272 to repurchase7,297,470 shares of the Company’s common stock pursuant to a Dutch auctiontender offer and a normal course issuer bid. All shares repurchased were cancelled. The following table shows the monthly activity related to ourstock repurchases for the three months ended March 31, 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)** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|
| March 1,  2010 through March 31, 2010  |       | 954,400                                    |       | $                                 | 0.75       |                                                                                          | 954,400    |                                                                                      | 13,128,507 |   |
| February 1,  through February 28, 2010 |       | 1,600                                      |       | $                                 | 0.75       |                                                                                          | 1,600      |                                                                                      | 14,082,907 |   |
| January 1,  through January 31, 2010   |       | 6,341,470                                  |       | $                                 | 0.70       |                                                                                          | 6,341,470  |                                                                                      | —     |   |
| Total                                            |       | 7,297,470                                  |       | $                                 | 0.71       |                                                                                          | 7,297,470  |                                                                                      |       |   |

 

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(1)          On January 13, 2010, the Companyannounced that it successfully concluded a modified “Dutch auction tender offer”that was previously announced on December 14, 2009. Under the terms of theoffer, the Company repurchased an aggregate of 6,341,470 shares of its commonstock at a purchase price of $0.70 per share, for a total of $4,439,029,excluding transaction costs of $51,957. 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.

 

(2)          On February 16,2010, the Company’s Board of Directors authorized the Company to repurchase ofup to $10 million of its common stock at its discretion under the terms of a normal courseissuer bid. Based on the market share price of $0.71 at close of business on March 31, 2010,the Company is eligible to repurchase up to 14,084,507 shares of common stock,on the NYSE Amex, under the terms of this normal course issuer bid.

 

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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: May 14, 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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