Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

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**FORM 10-Q**

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

 

**For the quarterly period ended September 30,2009**

 

**OR**

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

 

**For the transition period from          to          **

 

**Commission file number 1-32600**

 

**TUCOWS INC.**

(Exact Name of Registrant as Specified in Its Charter)

 

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

 

**96 Mowat Avenue,**

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

(Address of Principal Executive Offices) (Zip Code)

 

**(416) 535-0123**

(Registrant’s Telephone Number, Including Area Code)

 

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

 

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

 

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

 

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

 

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

 

As of November 13, 2009,there were 67,080,353 outstanding shares of common stock, no par value, of theregistrant.

 

 

 

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Table of Contents

** **

**TUCOWSINC.**

**Form 10-Q Quarterly Report**

**INDEX**

 
| ** **  | **PART I   FINANCIAL INFORMATION**                                                                                      | ** ** | ** ** |
|-------------|------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **  | ** **                                                                                                                   | ** ** | ** ** |
| Item 1.     | Consolidated  Financial Statements                                                                                           |       | 3          |
|        |                                                                                                                         |       |       |
|        | Consolidated Balance Sheets as of September 30,  2009 (unaudited) and December 31, 2008                       |       | 3          |
|        | Consolidated Statements of Operations (unaudited) for  the three and nine months ended September 30, 2009 and 2008 |       | 4          |
|        | Consolidated Statements of Cash Flows (unaudited) for  the three and nine months ended September 30, 2009 and 2008 |       | 5          |
|        |                                                                                                                         |       |       |
|        | Notes to Consolidated Financial Statements (unaudited)                                                                       |       | 6          |
|        |                                                                                                                         |       |       |
| Item 2.     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                  |       | 18         |
|        |                                                                                                                         |       |       |
| Item 3.     | Quantitative  and Qualitative Disclosures About Market Risk                                                                  |       | 34         |
|        |                                                                                                                         |       |       |
| Item 4T.    | Controls and  Procedures                                                                                                     |       | 35         |
|        |                                                                                                                         |       |       |
| ** **  | **PART II   OTHER INFORMATION**                                                                                         |       |       |
| ** **  | ** **                                                                                                                   | ** ** | ** ** |
| Item 1.     | Legal Proceedings                                                                                                            |       | 36         |
|        |                                                                                                                         |       |       |
| Item 1A.    | Risk Factors                                                                                                                 |       | 36         |
|        |                                                                                                                         |       |       |
| Item 6.     | Exhibits                                                                                                                     |       | 37         |
|        |                                                                                                                         |       |       |
| Signatures. |                                                                                                                         | 38         |

 

2

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Table of Contents

 

**PART I.**

**FINANCIAL INFORMATION**

 

**Item 1.Consolidated Financial Statements**

 

**Tucows Inc.**

**Consolidated Balance Sheets**

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

 
| ** **                                                                                                                                                                                                      | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                                                      | ** ** | **2009**               | ** **  | **2008**              | ** ** |
| ** **                                                                                                                                                                                                      | ** ** | **(unaudited)**        | ** **  | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                      |       |                   |        |                  |       |
|                                                                                                                                                                                                            |       |                   |        |                  |       |
| Current  assets:                                                                                                                                                                                                |       |                   |        |                  |       |
| Cash  and cash equivalents                                                                                                                                                                                      |       | $                      | 8,154,455   |                  | $          | 5,427,467 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $125,000 as of  September 30, 2009 and $125,000 as of December 31, 2008                                                               |       | 3,929,882              |        | 3,200,362             |       |
| Prepaid  expenses and deposits                                                                                                                                                                                  |       | 2,743,505              |        | 2,274,043             |       |
| Derivative  instrument assets (note 6)                                                                                                                                                                          |       | 1,927,475              |        | —                |       |
| Prepaid  domain name registry and ancillary services fees, current portion                                                                                                                                      |       | 31,513,882             |        | 29,212,610            |       |
| Deferred  tax asset, current portion                                                                                                                                                                            |       | 590,000                |        | 590,000               |       |
| Total  current assets                                                                                                                                                                                           |       | 48,859,199             |        | 40,704,482            |       |
|                                                                                                                                                                                                            |       |                   |        |                  |       |
| Prepaid  domain name registry and ancillary services fees, long-term portion                                                                                                                                    |       | 12,143,175             |        | 11,855,971            |       |
| Property  and equipment                                                                                                                                                                                         |       | 2,148,509              |        | 3,072,958             |       |
| Deferred  financing charges                                                                                                                                                                                     |       | 49,300                 |        | 78,500                |       |
| Deferred  tax asset, long-term portion                                                                                                                                                                          |       | 2,410,000              |        | 2,410,000             |       |
| Intangible  assets (note 4)                                                                                                                                                                                     |       | 19,041,083             |        | 20,206,996            |       |
| Goodwill                                                                                                                                                                                                        |       | 17,990,807             |        | 17,990,807            |       |
| Investment                                                                                                                                                                                                      |       | —                 |        | 200,000               |       |
| Total  assets                                                                                                                                                                                                   |       | $                      | 102,642,073 |                  | $          | 96,519,714 |   |
|                                                                                                                                                                                                            |       |                   |        |                  |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                   |       |                   |        |                  |       |
|                                                                                                                                                                                                            |       |                   |        |                  |       |
| Current  liabilities:                                                                                                                                                                                           |       |                   |        |                  |       |
| Accounts  payable                                                                                                                                                                                               |       | $                      | 1,373,068   |                  | $          | 1,633,830 |   |
| Accrued  liabilities                                                                                                                                                                                            |       | 1,888,427              |        | 2,000,146             |       |
| Customer  deposits                                                                                                                                                                                              |       | 3,764,320              |        | 3,319,241             |       |
| Derivative  instrument liabilities (note 6)                                                                                                                                                                     |       | —                 |        | 1,974,919             |       |
| Loan  payable, current portion (note 5)                                                                                                                                                                         |       | 3,698,685              |        | 2,624,242             |       |
| Deferred  revenue, current portion                                                                                                                                                                              |       | 40,303,458             |        | 37,985,821            |       |
| Accreditation  fees payable, current portion                                                                                                                                                                    |       | 508,180                |        | 510,548               |       |
| Total  current liabilities                                                                                                                                                                                      |       | 51,536,138             |        | 50,048,747            |       |
|                                                                                                                                                                                                            |       |                   |        |                  |       |
| Deferred  revenue, long-term portion                                                                                                                                                                            |       | 16,198,501             |        | 16,201,804            |       |
| Accreditation  fees payable, long-term portion                                                                                                                                                                  |       | 187,285                |        | 187,374               |       |
| Loan  payable, long-term portion (note 5)                                                                                                                                                                       |       | —                 |        | 3,235,125             |       |
| Deferred  tax liability, long-term portion                                                                                                                                                                      |       | 4,899,000              |        | 5,396,000             |       |
|                                                                                                                                                                                                            |       |                   |        |                  |       |
| 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; 67,865,096 shares issued  and outstanding as of September 30, 2009 and 73,073,782 shares issued  and outstanding as of December 31, 2008 |       | 14,187,313             |        | 15,198,358            |       |
| Additional  paid-in capital                                                                                                                                                                                     |       | 47,601,377             |        | 48,714,676            |       |
| Deficit                                                                                                                                                                                                         |       | (31,967,541            | )           | (42,462,370           | )          |
| Total  stockholders’ equity                                                                                                                                                                                |       | 29,821,149             |        | 21,450,664            |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                |       | $                      | 102,642,073 |                  | $          | 96,519,714 |   |

 

See accompanying notes to unaudited consolidated financial statements

 

Subsequent events (note14).

 

3

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**Tucows Inc.**

**Consolidated Statements of Operations**

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

**(unaudited)**

 
| ** **                                                                  | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                  | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                  | ** ** | **(unaudited)**                           | ** ** | **(unaudited)**                          | ** ** |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Net revenues                                                                |       | $                                         | 20,496,129 |                                     | $          | 20,147,195 |   | $ | 60,609,673 |   | $ | 59,308,731 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Cost of revenues:                                                           |       |                                      |       |                                     |       |   |   |   |   |
| Cost of revenues (*)                                                        |       | 14,770,868                                |       | 13,981,247                               |       | 42,942,314 |   | 40,794,276 |   |
| Depreciation of property and equipment                                      |       | 475,445                                   |       | 795,445                                  |       | 1,416,834 |   | 2,437,542 |   |
| Amortization of intangible assets                                           |       | 29,199                                    |       | 29,199                                   |       | 87,597 |   | 134,597 |   |
| Total cost of revenues                                                      |       | 15,275,512                                |       | 14,805,891                               |       | 44,446,745 |   | 43,366,415 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Gross profit                                                                |       | 5,220,617                                 |       | 5,341,304                                |       | 16,162,928 |   | 15,942,316 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Expenses:                                                                   |       |                                      |       |                                     |       |   |   |   |   |
| Sales and marketing (*)                                                     |       | 1,568,727                                 |       | 1,705,512                                |       | 4,261,070 |   | 5,132,380 |   |
| Technical operations and development (*)                                    |       | 1,142,331                                 |       | 1,527,237                                |       | 3,421,825 |   | 4,666,832 |   |
| General and administrative (*)                                              |       | 1,145,951                                 |       | 1,714,563                                |       | 4,608,173 |   | 4,805,853 |   |
| Depreciation of property and equipment                                      |       | 64,704                                    |       | 57,386                                   |       | 230,336 |   | 177,317 |   |
| Loss  on disposition of property and equipment                              |       | 40,369                                    |       | 498,529                                  |       | 40,369 |   | 498,529 |   |
| Amortization of intangible assets                                           |       | 360,540                                   |       | 360,540                                  |       | 1,081,620 |   | 1,122,655 |   |
| (Gain) / loss in fair value of forward exchange  contracts                  |       | (1,878,230                                | )          | 525,571                                  |       | (3,902,394 | ) | 555,364 |   |
| Total expenses                                                              |       | 2,444,392                                 |       | 6,389,338                                |       | 9,740,999 |   | 16,958,930 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Income (loss) from operations                                               |       | 2,776,225                                 |       | (1,048,034                               | )          | 6,421,929 |   | (1,016,614 | ) |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Other income (expenses):                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Interest income (expense), net                                              |       | (52,887                                   | )          | (90,859                                  | )          | (178,669 | ) | (467,264 | ) |
| Other income                                                                |       | 1,880,000                                 |       | 1,098,245                                |       | 4,493,190 |   | 2,631,010 |   |
| Total other income (expenses)                                               |       | 1,827,113                                 |       | 1,007,386                                |       | 4,314,521 |   | 2,163,746 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Income (loss) before provision for income taxes                             |       | 4,603,338                                 |       | (40,648                                  | )          | 10,736,450 |   | 1,147,132 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Income tax (recovery) expense (note 7)                                      |       | (447,455                                  | )          | 30,000                                   |       | 241,621 |   | 91,134 |   |
| Net income (loss) for the period                                            |       | $                                         | 5,050,793  |                                     | $          | (70,648 | ) | $ | 10,494,829 |   | $ | 1,055,998 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Basic earnings (loss) per common share (note 8)                             |       | $                                         | 0.07       |                                     | $          | (0.00 | ) | $ | 0.15 |   | $ | 0.01 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Shares used in computing basic earnings (loss) per  common share (note 8)   |       | 68,008,871                                |       | 73,923,542                               |       | 69,841,981 |   | 73,903,998 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Diluted earnings (loss) per common share (note 8)                           |       | $                                         | 0.07       |                                     | $          | (0.00 | ) | $ | 0.15 |   | $ | 0.01 |   |
|                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Shares used in computing diluted earnings (loss)  per common share (note 8) |       | 68,874,517                                |       | 74,817,244                               |       | 70,156,521 |   | 75,245,047 |   |

 

See accompanyingnotes to consolidated financial statements

 

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

 
| Cost of revenues                     |   | $ | 3,860  |   | $ | 5,500  |   | $ | 12,227  |   | $ | 14,600  |   |
|--------------------------------------|--------|---|--------|--------|---|--------|--------|---|---------|--------|---|---------|--------|
| Sales and marketing                  |   | $ | 12,807 |   | $ | 17,200 |   | $ | 42,764  |   | $ | 48,500  |   |
| Technical operations and development |   | $ | 12,395 |   | $ | 13,100 |   | $ | 34,116  |   | $ | 41,800  |   |
| General and administrative           |   | $ | 70,748 |   | $ | 52,500 |   | $ | 142,641 |   | $ | 128,600 |   |

 

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 September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                              | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                              | ** ** | **(unaudited)**                           | ** ** | **(unaudited)**                          | ** ** |
| Cash provided by (used  in):                                            |       |                                      |       |                                     |       |   |   |   |   |
| Operating activities:                                                   |       |                                      |       |                                     |       |   |   |   |   |
|                                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Net income (loss) for the period                                        |       | $                                         | 5,050,793  |                                     | $          | (70,648 | ) | $ | 10,494,829 |   | $ | 1,055,998 |   |
| Items not involving cash:                                               |       |                                      |       |                                     |       |   |   |   |   |
| Depreciation of property and equipment                                  |       | 540,149                                   |       | 852,831                                  |       | 1,647,170 |   | 2,614,859 |   |
| Loss  on disposition of property and equipment                          |       | 40,369                                    |       | 498,529                                  |       | 40,369 |   | 498,529 |   |
| Amortization of deferred financing charges                              |       | 9,100                                     |       | 12,200                                   |       | 29,200 |   | 38,400 |   |
| Amortization of intangible assets                                       |       | 389,739                                   |       | 389,739                                  |       | 1,169,217 |   | 1,257,252 |   |
| Gain on disposal of investment in Afilias                               |       | (1,880,000                                | )          | —                                   |       | (3,890,395 | ) | — |   |
| Gain on sale of customer relationships                                  |       | —                                    |       | (921,384                                 | )          | — |   | (2,042,449 | ) |
| Reduction of deferred tax liability                                     |       | (497,000                                  | )          | —                                   |       | (497,000 | ) | — |   |
| Disposal of domain names                                                |       | 649                                       |       | 4,705                                    |       | 2,596 |   | 4,705 |   |
| Unrealized  (gain)/loss in the fair value of forward exchange contracts |       | (1,878,230                                | )          | 525,571                                  |       | (3,902,394 | ) | 555,364 |   |
| Stock-based compensation                                                |       | 99,810                                    |       | 88,300                                   |       | 231,748 |   | 233,500 |   |
| Change in non-cash operating working capital:                           |       |                                      |       |                                     |       |   |   |   |   |
| Accounts receivable                                                     |       | (465,454                                  | )          | (518,310                                 | )          | (729,520 | ) | (234,387 | ) |
| Prepaid expenses and deposits                                           |       | 419,761                                   |       | 641,629                                  |       | (469,462 | ) | 536,392 |   |
| Prepaid fees for domain name registry and ancillary  services fees      |       | 33,425                                    |       | (775,955                                 | )          | (2,588,476 | ) | (4,482,752 | ) |
| Accounts payable                                                        |       | (977,967                                  | )          | (480,839                                 | )          | (597,560 | ) | (231,770 | ) |
| Accrued liabilities                                                     |       | (115,362                                  | )          | (177,701                                 | )          | (111,719 | ) | (868,765 | ) |
| Customer deposits                                                       |       | 592,612                                   |       | (167,691                                 | )          | 445,079 |   | (148,692 | ) |
| Deferred revenue                                                        |       | (398,657                                  | )          | (9,699                                   | )          | 2,314,334 |   | 3,767,955 |   |
| Accreditation fees payable                                              |       | (46,762                                   | )          | 6,245                                    |       | (2,457 | ) | 40,365 |   |
| Income taxes payable                                                    |       | (835,398                                  | )          | —                                   |       | — |   | — |   |
|                                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Net cash provided by (used in) operating activities                     |       | 81,577                                    |       | (102,478                                 | )          | 3,585,559 |   | 2,594,504 |   |
|                                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Financing activities:                                                   |       |                                      |       |                                     |       |   |   |   |   |
| Proceeds received on exercise of stock options                          |       | —                                    |       | —                                   |       | 25,422 |   | 9,450 |   |
| Repurchase of common stock                                              |       | (570,335                                  | )          | —                                   |       | (2,381,514 | ) | — |   |
| Repayment of loan payable                                               |       | (478,561                                  | )          | (478,561                                 | )          | (2,160,682 | ) | (8,435,681 | ) |
|                                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Net cash used in financing activities                                   |       | (1,048,896                                | )          | (478,561                                 | )          | (4,516,774 | ) | (8,426,231 | ) |
|                                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Investing activities:                                                   |       |                                      |       |                                     |       |   |   |   |   |
| Cost of domain names acquired                                           |       | —                                    |       | —                                   |       | (5,900 | ) | (8,944 | ) |
| Additions to property and equipment                                     |       | (281,282                                  | )          | (627,024                                 | )          | (426,292 | ) | (1,922,764 | ) |
| Sale of customer relationships                                          |       | —                                    |       | 921,384                                  |       | — |   | 2,343,114 |   |
| Proceeds on disposition of property and equipment                       |       | —                                    |       | 66,039                                   |       | — |   | 66,039 |   |
| Proceeds on disposal of investment in Afilias                           |       | 1,980,000                                 |       | —                                   |       | 4,090,395 |   | — |   |
| Decrease in cash held in escrow                                         |       | —                                    |       | (5,396                                   | )          | — |   | (18,161 | ) |
| Net cash provided by investing activities                               |       | 1,698,718                                 |       | 355,003                                  |       | 3,658,203 |   | 459,284 |   |
|                                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Increase (decrease) in cash and cash equivalents                        |       | 731,399                                   |       | (226,036                                 | )          | 2,726,988 |   | (5,372,443 | ) |
|                                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Cash and cash equivalents, beginning of period                          |       | 7,423,056                                 |       | 2,947,069                                |       | 5,427,467 |   | 8,093,476 |   |
| Cash and cash equivalents, end of period                                |       | $                                         | 8,154,455  |                                     | $          | 2,721,033 |   | $ | 8,154,455 |   | $ | 2,721,033 |   |
|                                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Supplemental cash flow information:                                     |       |                                      |       |                                     |       |   |   |   |   |
| Interest paid                                                           |       | $                                         | 52,983     |                                     | $          | 100,060 |   | $ | 181,012 |   | $ | 552,298 |   |
|                                                                    |       |                                      |       |                                     |       |   |   |   |   |
| Supplementary disclosure of non-cash investing  activity:               |       |                                      |       |                                     |       |   |   |   |   |
| Property and equipment acquired during the period  not yet paid for     |       | $                                         | 343,777    |                                     | $          | 117,733 |   | $ | 343,777 |   | $ | 117,733 |   |

 

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 September 30, 2009 and the results of operationsand cash flows for the interim periods ended September 30, 2009 and2008. The results of operations presented in this Quarterly Report on Form 10-Qare not necessarily indicative of the results of operations that may beexpected for 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 financial statementsand 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, 2008included in Tucows’ 2008 Annual Report on Form 10-K filed with the SEC on March 27, 2009.

 

There have been nomaterial changes to our significant accounting policies during the nine monthsended September 30, 2009 as compared to the significant accountingpolicies described in our Annual Report on Form 10-K for the fiscal yearended December 31, 2008.

 

Subsequent events

 

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. Subsequent events havebeen evaluated through November 13, 2009, the date of the issuance ofthese unaudited interim consolidated financial statements.

 

**3. NEW ACCOUNTING POLICIES:**

 

*Recent Accounting Pronouncements Adopted*

 

In April 2009,the Financial Accounting Standards Board (“FASB”) issued ASC Subtopic825-10-65, “Interim Disclosures about Fair Value of Financial Instruments”which requires disclosures about fair value of financial instruments in interimand annual reporting periods. The guidance is effective for interim reportingperiods ending after June 15, 2009 and was adopted by the Company. Thedisclosures required by the guidance are presented in Note 5 “Loan payable.”

 

In May 2009,FASB issued ASC Subtopic 855-10, “Subsequent Events”. This topic establishes generalstandards of accounting for and disclosure of events that occur after thebalance sheet date but before financial statements are issued or are availableto be issued. ASC Subtopic 855-10 also clarifies the types of subsequent eventsa Company shall, or shall not, recognize in the financial statements. Thestatement is effective for financial statement periods ending after June 15,2009. 

 

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The Company adopted ASCSubtopic 855-10 on June 30, 2009 and the adoption did not result insignificant changes in our recognition or disclosure of subsequent events inthe financial statements. However, it does require us to disclose the datethrough which we have evaluated subsequent events and the basis for that date.Our evaluation of subsequent events is disclosed in Note 2 “Basis of Presentation.”

 

In June 2009,we adopted FASB ASC Subtopic 820-10-65-4, “Determining Fair Value When theVolume and Level of Activity for the Asset or Liability Have SignificantlyDecreased and Identifying Transactions That Are Not Orderly” which addresses measuringfair value for situations in which there has been a significant decrease intrading activity for an asset or liability. The adoption of this guidance inthe second quarter of 2009 did not have a material impact on our interimconsolidated financial statements.

 

In June 2009,the FASB issued Statement No. 168 “The FASB Accounting StandardsCodification and the Hierarchy of Generally Accepted Accounting Principles, areplacement of FASB Statement No. 162” (the “Codification”).  The Codification has become the single sourceof authoritative non-government U.S generally accepted accounting principles (“GAAP”),superseding various existing authoritative accounting pronouncements.  The Codification eliminates the GAAPhierarchy contained in Statement No. 162 and establishes one level ofauthoritative GAAP.  All other U.S. GAAPliterature is considered non-authoritative. This Codification is effective for financial statements issued forinterim and annual periods ending after September 15, 2009.  We have adopted the Codification in our thirdquarter of Fiscal 2009.  There was nochange to our consolidated financial statements due to the implementation ofthe Codification other than changes in reference to various authoritativeaccounting pronouncements in our Notes to consolidated financial statements.

 

*Recent Accounting Pronouncements NotYet Adopted*

 

In August 2009, the FASB issued Accounting Standards Update2009-05, “Fair Value Measurements and Disclosures (Topic 820) — MeasuringLiabilities at Fair Value” (“Update 2009-05”). Update 2009-05 provides clarification that in circumstances in which aquoted price in an active market for the identical liability is not available,a reporting entity is required to measure fair value of such liability usingone or more of the techniques prescribed by the update.  This guidance is effective for interim andannual periods beginning after August 27, 2009, which will be our fourthquarter of 2009, and applies to all fair-value measurements of liabilitiesrequired by GAAP.  We are currentlyassessing the impact of Update 2009-05 on our future consolidated financialstatements.

 

In October 2009, the SEC announced that public companies with apublic float below $75 million must begin to comply with the final stage of Section 404that requires auditor attestation of the effectiveness of internal control overfinancial reporting, beginning with annual reports for fiscal years ending onor after June 15, 2010. The previous effective date was for fiscal yearsending on or after December 15, 2009. As a result, the Company will now be required to provide the attestationreports commencing with its fiscal year ending December 31, 2010.

 

In October 2009, the FASB issued Accounting Standards Update2009-13, “Revenue Recognition (Topic 605): Multiple-Deliverable RevenueArrangements” (“Update 2009-13”). Update 2009-13 applies tomultiple-deliverable revenue arrangements that are currently within the scopeof FASB ASC Subtopic 605-25 (previously included in Emerging Issues Task ForceIssue no. 00-21, “Revenue Arrangements with Multiple Deliverables”). Update2009-13 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 impact of Update 2009-13 on our futureconsolidated 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, with the exception of the surname and portfoliodomain names that have been determined to have an indefinite life.

 

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A summary of acquiredintangible assets for the three months ended September 30, 2009 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, June 30, 2009      |       | $                              | 383,326    |             | $          | 770,340                        |       | $                              | 4,045,940  |                                          | $          | 12,134,355 |       | $ | 2,097,510 |   | $ | 19,431,471 |   |
| Sale  of domain names                    |       | —                         |       | —           |       | —                         |       | (649                           | )          | —                                        |       | (649       | )          |
| Amortization  expense                    |       | (29,199                        | )          | (41,760          | )          | (318,780                       | )          | —                         |       | —                                        |       | (389,739   | )          |
| Net  book value, September 30, 2009 |       | $                              | 354,127    |             | $          | 728,580                        |       | $                              | 3,727,160  |                                          | $          | 12,133,706 |       | $ | 2,097,510 |   | $ | 19,041,083 |   |

 

A summary of acquired intangible assets for the nine months ended September 30, 2009is as follows:

** **
| ** **                               | ** ** | **Technology**                 | ** ** | **Brand**        | ** ** | **Customer  relationships**    | ** ** | **Surname domain  names** | ** ** | **Direct navigation  domain names** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|--------------------------------|------------|------------------|------------|--------------------------------|------------|--------------------------------|------------|-----------------------------------------------|------------|------------|------------|
| **Amortization period**             | ** ** | **2 - 7 years** | ** ** | **7 years** | ** ** | **4 - 7 years** | ** ** | **indefinite life**       | ** ** | **indefinite life**                      | ** ** | **Total**  | ** ** |
|                                     |       |                           |       |             |       |                           |       |                           |       |                                          |       |       |       |
| Net book value,  December 31, 2008  |       | $                              | 441,724    |             | $          | 853,860                        |       | $                              | 4,683,500  |                                          | $          | 12,131,502 |       | $ | 2,096,410 |   | $ | 20,206,996 |   |
| Purchase of  domain names                |       | —                         |       | —           |       | —                         |       | 4,800                          |       | 1,100                                         |       | 5,900      |       |
| Sale of domain  names                    |       | —                         |       | —           |       | —                         |       | (2,596                         | )          | —                                        |       | (2,596     | )          |
| Amortization  expense                    |       | (87,597                        | )          | (125,280         | )          | (956,340                       | )          | —                         |       | —                                        |       | (1,169,217 | )          |
| Net book value,  September 30, 2009 |       | $                              | 354,127    |             | $          | 728,580                        |       | $                              | 3,727,160  |                                          | $          | 12,133,706 |       | $ | 2,097,510 |   | $ | 19,041,083 |   |

 

**5. LOAN PAYABLE:**

 

TheCompany entered into a non-revolving, reducing credit facility in the amount of$9.6 million with a Canadian chartered bank to finance the purchase ofInnerwise, Inc. in July 2007. Effective February 23, 2009, theCompany agreed to amend the interest rate payable from the bank’s US Base rateplus 0.50% per annum to the bank’s US Base rate plus 1.50% per annum. Theprincipal and accrued interest on the loan is payable monthly over the term ofthe loan, which is five years. Tucows may prepay this loan in full or inpart 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 combined Company’s present andfuture property and assets (subject to certain exclusions). As of September 30,2009, the Company continued to comply with all covenants of the creditfacility.

 

Pursuant to the terms of the facility, the Company is required to makean annual cash sweep payment based on excess cash flow as defined in the creditfacility agreement, as well as equal 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 fiscalyear amounting to $0.7 million which was paid on May 1, 2009. TheCompany currently estimates that the cash sweep payment for its 2009 fiscalyear, 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. Accordingly, this amount has now been classified as acurrent liability at September 30, 2009.

 

Principalloan repayments are as follows:

 
| Current portion (including an estimate for a cash sweep payment which  will be based on our audited 2009 results and will be payable during the  three months ending June 30, 2010, which we believe will be sufficient  to fully retire the remaining balance of our non-revolving, reducing credit  facility): |   |   |      |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|-----------|
| October 2009 — June 2010                                                                                                                                                                                                                                                                               |   | $      | 3,698,685 |   |
|                                                                                                                                                                                                                                                                                                                       |        |        |           |  |

 

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The Company uses interest rates that are currently available to theCompany for issuance of loans on similar terms and remaining maturities toestimate the fair value of the Company’s loan payable. The estimated fair valueof the Company’s loan payable at September 30, 2009 was $ 3,688,326,compared to a carrying amount of $3,698,685 at September 30, 2009.

 

**6.********DERIVATIVEINSTRUMENT ASSETS / 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 September 30,2009 was a net unrealized gain of $1.9 million (as compared to a net unrealizedloss of $2.0 million at December 31, 2008). The unrealized gains /losses are a result of fluctuations in foreign exchange rates between the datethe currency forward contracts were entered into and the valuation date atperiod end. The net unrealized gain of our foreign currency contracts duringthe three and nine months ended September 30, 2009 is due primarily to thefavorable movement in exchange rates between the Canadian and U.S. dollars andthe settlement of contracts with significant losses.

 

AtSeptember 30, 2009, the Company had forward exchange contracts to tradeU.S. dollars in exchange for Canadian dollars as follows:

 
| ** **                         | ** ** | **Notional**     | ** ** | **Weighted average** | ** ** | ** **     | ** ** |
|------------------------------------|------------|------------------|------------|----------------------|------------|----------------|------------|
| ** **                         | ** ** | **amount of**    | ** ** | **exchange rate of** | ** ** | **Fair value** | ** ** |
| **Maturity date**                  | ** ** | **U.S. dollars** | ** ** | **U.S. dollars**     | ** ** | **gain**       | ** ** |
|                               |       |             |       |                 |       |           |       |
| October -  December 2009 |       | $                | 3,000,000  |                 | 0.8651     |           | $          | 245,924 |   |
| January -  March 2010    |       | 4,278,000        |       | 0.8297               |       | 547,750        |       |
| April -  June 2010       |       | 4,439,000        |       | 0.8328               |       | 549,508        |       |
| July -  September 2010   |       | 3,000,000        |       | 0.8034               |       | 494,324        |       |
| October -  December 2010 |       | 2,500,000        |       | 0.9032               |       | 89,969         |       |
| Total                              |       | $                | 17,217,000 |                 | 0.8369     |           | $          | 1,927,475 |   |

 

During the three months ended September 30, 2009, no new foreigncurrency contracts were entered into by the Company.

 

The Company is not required to apply hedge accounting and, therefore,for the three months ended September 30, 2009, the Company recorded again of $1.9 million in the fair value of forward contracts in itsconsolidated statements of operations. For the three months ended September 30, 2008,the Company recorded a loss on forward contracts of $0.5 million. For the ninemonths ended September 30, 2009, the Company recorded a gain of$3.9 million in the fair value of forward contracts in its consolidatedstatements of operations. For the nine months ended September 30, 2008,the Company recorded a loss on forward contracts of $0.6 million.

 

**7. INCOME TAXES**

 

For the nine months endedSeptember 30, 2009, the Company recorded an income tax expense of$242,000, which included current tax expense of $913,000 on income before taxesof $10.7 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 the Company. Includedin the income tax expense is a recovery of $174,000 for investment tax creditsearned during the period, as well as a reduction of $497,000 in the Company’srecorded deferred tax liability. The reduction in the deferred tax liabilityrelates to the rate at which the Company expects the temporary differencesresulting from its unlimited life intangibles to reverse. This change inestimate arose as a result of the Company no longer being subject to state taxin the United States given the change in the jurisdictions in which the Companynow operates.

 

Comparatively, for thenine months ended September 30, 2008, the Company recorded a currenttax expense of $91,000 on income before taxes of $1.1 million primarilyrelated to our estimate for federal alternative minimum tax obligations for our2008 fiscal year and Pennsylvania state franchise tax related to prior years.

 

As of December 31,2008, the Company recorded a valuation allowance of $10.8 million and a netdeferred tax asset of $3.0 million. The net deferred tax asset has beenallocated on a pro rata basis between current and non-current deferred tax 

 

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assets, resulting incurrent deferred tax assets of $0.6 million and non-current deferred tax assetsof $2.4 million as at December 31, 2008. No significant changes haveoccurred during the nine month period ended September 30, 2009.

 

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 forecasts usedto manage the business. During the nine months ended September 30, 2009,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 Accounting Standards Codification (“FASB ASC”): Topic740, *Income Taxes*, in accounting for incometax exposures. The application of this interpretation requires a two-stepaccounting process that separates recognition of uncertain tax benefits frommeasurement thereof.

 

The Company hadapproximately $301,000 of gross unrecognized tax benefit as of December 31,2008 and $209,000 of gross unrecognized tax benefit as of September 30, 2009,which if recognized, would favorably affect its income tax rate in futureperiods.  The unrecognized tax benefitrelates to non-recognition of refundable research and development tax creditsin Canada earned during its 2008 fiscal year and certain state tax exposuresfrom prior periods. During the nine months ended September 30, 2009,the Company’s unrecognized tax benefits decreased by $205,000 as a result ofthe settlement of the Company’s 2006 and 2007 Canadian research and developmenttax credit claims. The Company increased its unrecognized tax benefits by$113,000 related to its 2008 research and development tax credit claim. TheCompany expects its 2009 research and development tax credit claim to beinsignificant.

 

The Companyrecognizes accrued interest and penalties to unrecognized tax benefit as a taxexpense. The Company has not accrued any interest or penalties as of December 31,2008 and September 30, 2009. The Company believes it is reasonablypossible that $209,000 of the unrecognized tax benefit will decrease in thenext twelve months as it is anticipated that the Canadian tax authorities willconclude its review of the Company’s 2008 research and development claim forthe credits, and that the state tax matters will also be settled, within thatperiod.

 

**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.

 

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

 
| ** **                                                   | ** ** | **Three months  ended  September 30,  2009** | ** ** | **Three months  ended  September 30,  2008** | ** ** | **Nine months  ended  September 30,  2009** | ** ** | **Nine months  ended  September 30,  2008** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| Numerator for basic and diluted earnings per common share:   |       |                                              |       |                                              |       |                                             |       |                                             |       |
| Income for the period                                        |       | $                                                 | 5,050,793  |                                              | $          | (70,648                                          | )          | $                                                | 10,494,829 |   | $ | 1,055,998 |   |
| Denominator for basic and diluted earnings per common share: |       |                                              |       |                                              |       |                                             |       |                                             |       |
| Basic weighted average number of common shares outstanding   |       | 68,008,871                                        |       | 73,923,542                                        |       | 69,841,981                                       |       | 73,903,998                                       |       |
| Effect of outstanding stock options                          |       | 865,646                                           |       | 893,702                                           |       | 314,540                                          |       | 1,341,049                                        |       |
| Diluted weighted average number of shares outstanding        |       | 68,874,517                                        |       | 74,817,244                                        |       | 70,156,521                                       |       | 75,245,047                                       |       |
| Basic earnings per common share                              |       | $                                                 | 0.07       |                                              | $          | 0.00                                             |       | $                                                | 0.15       |   | $ | 0.01 |   |
| Diluted earnings per common share                            |       | $                                                 | 0.07       |                                              | $          | 0.00                                             |       | $                                                | 0.15       |   | $ | 0.01 |   |

 

Options to purchase 3,468,420 common shares thatwere outstanding as of the three months ended September 30, 2009 werenot included in the computation of diluted income per common share because allsuch options had an exercise price greater than the average market price of thecommon shares (during the three months ended September 30, 2008, optionsto purchase 3,217,828 shares of common stock were outstanding).

 

Options to purchase 4,015,587 common shares thatwere outstanding as of the nine months ended September 30, 2009 werenot included in the computation of diluted income per common share because allsuch options had an exercise price greater than the average market price of thecommon shares (during the nine months ended September 30, 2008, options topurchase 2,341,230 shares of common stock were outstanding).

 

OnMarch 23, 2009, 4,185,769 common shares were repurchased andcancelled under the terms of a modified Dutch auction tender offer, and on July 14, 2009,an additional 1,103,824 common shares were repurchased and cancelled under theterms of a second modified Dutch tender offer. This reduction in the number ofshares outstanding has been included in the computation of earnings per shareand diluted earnings per share for the three and nine months ended September 30, 2009(see note 11).

 

OnOctober 2, 2009, subsequent to the quarter end, the Companyrepurchased and cancelled an additional 784,643 common shares under the termsof a third modified Dutch auction tender offer (see note 14).

 

**9. SUPPLEMENTAL INFORMATION:**

 

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

 
| ** **              | ** ** | **Three months ended September 30,** | ** **       | **Nine months ended September 30,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------------|------------------------------------------|------------|
| ** **              | ** ** | **2009**                                  | ** **       | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| OpenSRS  :              |       |                                      |             |                                     |       |   |   |   |   |
| Domain  Services        |       | $                                         | 15,097,640       |                                     | $          | 13,688,084 |   | $ | 44,037,596 |   | $ | 39,828,983 |   |
| Email  Services         |       | 842,262                                   |             | 1,516,726                                |       | 2,838,052 |   | 4,642,977 |   |
| Other  Services         |       | 1,109,341                                 |             | 1,104,374                                |       | 3,295,789 |   | 3,339,758 |   |
| Total  OpenSRS Services |       | 17,049,243                                |             | 16,309,184                               |       | 50,171,437 |   | 47,811,718 |   |
|                    |       |                                      |             |                                     |       |   |   |   |   |
| YummyNames              |       | 1,781,725                                 |             | 1,264,903                                |       | 5,102,315 |   | 4,042,830 |   |
| Hover                   |       | 1,203,742                                 |             | 2,071,200                                |       | 3,763,155 |   | 5,757,890 |   |
| Butterscotch            |       | 461,419                                   |             | 501,908                                  |       | 1,572,766 |   | 1,696,293 |   |
|                    |       | $                                         |  20,496,129 |                                     | $          | 20,147,195 |   | $ | 60,609,673 |   | $ | 59,308,731 |   |

 

No customer accounted for more than 10% of revenue forthe three or nine months ended September 30, 2009 or the three ornine months ended September 30, 2008. Significant management judgmentis required at the time of recording of revenue to assess whether thecollection of the resulting receivables is reasonably assured. On an ongoingbasis, we assess the ability of our customers to make required payments. Basedon this assessment, we expect the carrying amount of our outstandingreceivables, net of allowance for doubtful accounts, to be fully collected.

 

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As of September 30, 2009, no customeraccounted for more than 10% of accounts receivable. As of September 30, 2008,two customers accounted for approximately 24% of accounts receivable.

 

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

** **
| ** **                                    | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                    | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| OpenSRS  :                                    | ** ** | ** **                                | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Domain  Services                              |       | $                                         | 12,325,620 |                                     | $          | 11,015,952 |   | $ | 35,624,222 |   | $ | 31,456,663 |   |
| Email  Services                               |       | 103,071                                   |       | 161,848                                  |       | 436,216 |   | 244,848 |   |
| Other  Services                               |       | 411,949                                   |       | 403,431                                  |       | 1,212,087 |   | 1,226,508 |   |
| Total  OpenSRS Services                       |       | 12,840,640                                |       | 11,581,231                               |       | 37,272,525 |   | 32,928,019 |   |
|                                          |       |                                      |       |                                     |       |   |   |   |   |
| YummyNames                                    |       | 218,371                                   |       | 182,614                                  |       | 654,456 |   | 542,065 |   |
| Hover                                         |       | 493,181                                   |       | 558,190                                  |       | 1,481,761 |   | 1,701,786 |   |
| Butterscotch                                  |       | 25,491                                    |       | 4,600                                    |       | 33,341 |   | 15,225 |   |
| Network,  other costs                         |       | 1,193,185                                 |       | 1,654,612                                |       | 3,500,231 |   | 5,607,181 |   |
| Network,  depreciation and amortization costs |       | 504,644                                   |       | 824,644                                  |       | 1,504,431 |   | 2,572,139 |   |
|                                          |       | $                                         | 15,275,512 |                                     | $          | 14,805,891 |   | $ | 44,446,745 |   | $ | 43,366,415 |   |

 

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

 
| ** **     | ** ** | **September 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------|------------|----------------------------------|------------|---------------------------------|------------|
|           |       |                             |       |                            |       |
| Canada         |       | $                                | 1,603,231  |                            | $          | 2,292,358 |   |
| United States  |       | 539,026                          |       | 752,274                         |       |
| United Kingdom |       | 6,252                            |       | 28,326                          |       |
|           |       | $                                | 2,148,509  |                            | $          | 3,072,958 |   |

 

**10.COMMITMENTS AND CONTINGENCIES:**

 

The Company is involved in various legal claims and lawsuits in connectionwith its ordinary business operations. The Company intends to vigorously defendthese claims. While the final outcome with respect to any actions or claimsoutstanding or pending as of September 30, 2009 cannot be predicted withcertainty, it is the opinion of management that their resolution will not havea material adverse effect on the Company’s financial position.

 

**11. STOCKHOLDERS’ EQUITY:**

 

The following unaudited table summarizes stockholders’equity transactions for the period ended September 30, 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 |   |
| Exercise of stock  options           |       | 68,707                |       | 46,858           |       | (21,436        | )          | —                 |       | 25,422     |        |
| Repurchase and  retirement of shares |       | (4,185,769            | )          | (837,138         | )          | (974,041       | )          | —                 |       | (1,811,179 | )           |
| Stock-based  compensation            |       | —                |       | —           |       | 131,938        |       | —                 |       | 131,938    |        |
| Issuance of  restricted stock        |       | 12,600                |       | —           |       | —         |       | —                 |       | —     |        |
| Cancellation of  restricted stock    |       | (100                  | )          | —           |       | —         |       | —                 |       | —     |        |
| Net income for  the period           |       | —                |       | —           |       | —         |       | 5,444,036              |       | 5,444,036  |        |
| Balances,  June 30, 2009        |       | 68,969,220            |       | 14,408,078       |       | 47,851,137     |       | (37,018,334            | )          | 25,240,881 |        |
|                                 |       |                  |       |             |       |           |       |                   |       |       |        |
| Stock-based  compensation            |       | —                |       | —           |       | 99,810         |       | —                 |       | 99,810     |        |
| Cancellation of  restricted stock    |       | (300                  | )          | —           |       | —         |       | —                 |       | —     |        |
| Repurchase and  retirement of shares |       | (1,103,824            | )          | (220,765         | )          | (349,570       | )          | —                 |       | (570,335   | )           |
| Net income for  the period           |       | —                |       | —           |       | —         |       | 5,050,793              |       | 5,050,793  |        |
| Balances,  September 30, 2009   |       | 67,865,096            |       | $                | 14,187,313 |           | $          | 47,601,377             |       | $          | (31,967,541 | ) | $ | 29,821,149 |   |

 

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The following unaudited table summarizes stockholders’equity transactions for the period ended September 30, 2008:

 
| ** **                         | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | ** **             | ** ** | **Total**  | ** **  |
|------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|------------------------|------------|------------|-------------|
| ** **                         | ** ** | **Common stock** | ** ** | **paid in** | ** ** | ** **     | ** ** | **stockholders’** | ** ** |
| ** **                         | ** ** | **Number**            | ** ** | **Amount**       | ** ** | **capital**    | ** ** | **Deficit**            | ** ** | **equity** | ** **  |
|                               |       |                  |       |             |       |           |       |                   |       |       |        |
| Balances, December 31, 2007   |       | 73,888,542            |       | $                | 15,350,915 |           | $          | 48,537,313             |       | $          | (44,537,179 | ) | $ | 19,351,049 |   |
| Stock-based compensation           |       | —                |       | —           |       | 145,200        |       | —                 |       | 145,200    |        |
| Exercise of stock options          |       | 35,000                |       | 17,395           |       | (7,945         | )          | —                 |       | 9,450      |        |
| Net income for the period          |       | —                |       | —           |       | —         |       | 1,126,646              |       | 1,126,646  |        |
| Balances, June 30, 2008       |       | 73,923,542            |       | 15,368,310       |       | 48,674,568     |       | (43,410,533            | )          | 20,632,345 |        |
|                               |       |                  |       |             |       |           |       |                   |       |       |        |
| Stock-based compensation           |       | —                |       | —           |       | 88,300         |       | —                 |       | 88,300     |        |
| Net loss for the period            |       | —                |       | —           |       | —         |       | (70,648                | )          | (70,648    | )           |
| Balances,  September 30, 2008 |       | 73,923,542            |       | $                | 15,368,310 |           | $          | 48,762,868             |       | $          | (43,481,181 | ) | $ | 20,649,997 |   |

 

OnMarch 23, 2009, the Company announced that it successfully concluded amodified “Dutch auction tender offer” that was previously announced on February 12,2009. Under the terms of the offer, the Company repurchased an aggregate of4,185,769 shares of its common stock at a purchase price of $0.41 per share,for a total of $1,716,132, excluding transaction costs of $95,046. The purchaseprice was funded from available cash. Of the 4,185,769 shares purchased,4,000,000 were shares the Company offered to purchase in the offer and 185,769where shares purchased pursuant to the Company’s right to purchase up to anadditional 2% of the shares outstanding immediately prior to the commencementof the tender offer. Due to over-subscription, the final proration factor forshares tendered at or below $0.41 per share was approximately 99.42%. For thispurpose, shares tendered at $0.41 per share included shares tendered by thosepersons who indicated, in their letter of transmittal, that they were willingto accept the price determined in the offer. All shares purchased in the tenderoffer received the same price. As a result of the completion of the tenderoffer, as of March 23, 2009, the Company had 68,888,092 shares issued andoutstanding, as all shares repurchased were immediately retired.

 

OnJuly 14, 2009 the Company announced that it successfully concluded asecond modified Dutch auction tender offer that was previously announced May 26,2009. Under the terms of the offer, the Company repurchased an aggregate of1,103,824 shares of its common stock at a purchase price of $0.45 per share,for a total of $496,721, excluding transaction costs of $73,614. The purchaseprice was funded from available cash. Of the 1,103,824 shares purchased,1,000,000 were shares the Company offered to purchase in the offer and 103,824where shares purchased pursuant to the Company’s right to purchase up to anadditional 2% of the shares outstanding immediately prior to the commencementof the tender offer. Due to over-subscription, the final proration factor forshares tendered at or below $0.45 per share was approximately 99.82%. For thispurpose, shares tendered at $0.45 per share included shares tendered by thosepersons who indicated, in their letter of transmittal, that they were willingto accept the price determined in the offer. All shares purchased in the tenderoffer received the same price. As a result of the completion of the tenderoffer, as of July 14, 2009, the Company had 67,865,396 shares issued andoutstanding, as all shares repurchased were immediately retired.

 

OnOctober 2, 2009, subsequent to the quarter end, the Companyrepurchased and cancelled an additional 784,643 common shares under the termsof a third modified Dutch auction tender offer (see note 14).

 

On May 6, 2008, the Company’s Board ofDirectors authorized the repurchase of up to $10 million of the Company’scommon stock at the Company’s discretion. The Company had repurchased 849,760shares under this repurchase program, which expired on May 11, 2009.

 

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**12. SHARE-BASED PAYMENTS**

 

(a)                                  Stock options:

 

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

 

During the three months ended September 30, 2009, 200,000stock options were granted as compared to 180,000 stock options granted duringthe three months ended September 30, 2008.

 

During the nine months ended September 30, 2009, 225,000stock options were granted as compared to 1,251,000 stock options grantedduring the nine months ended September 30, 2008.

 

Thefair value of stock options granted during the three and nine months ended September 30,2009 and during the three and nine months ended September 30, 2008 wasestimated using the following assumptions:

 
| ** **                                                                                                                         | ** ** | **Three  months  ended  September  30, 2009** | ** ** | **Three  months  ended  September  30, 2008** | ** ** | **Nine months  ended  September  30, 2009** | ** ** | **Nine months  ended  September  30, 2008** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| Volatility                                                                                                                         |       | 82.0                                               | %          | 60.6                                               | %          | 81.6                                             | %          | 65.4                                             | %          |
| Risk-free interest rate                                                                                                            |       | 1.2                                                | %          | 2.7                                                | %          | 1.2                                              | %          | 2.9                                              | %          |
| Expected life (in years)                                                                                                           |       | 2.50                                               |       | 4.75                                               |       | 2.50                                             |       | 4.75                                             |       |
| Dividend yield                                                                                                                     |       | —                                             | %          | —                                             | %          | —                                           | %          | —                                           | %          |
| The weighted average grant date fair value for options issued, with  the exercise price equal to market value on the date of grant |       | $                                                  | 0.28       |                                               | $          | 0.19                                             |       | $                                                | 0.26       |   | $ | 0.31 |   |
|                                                                                                                                    |            |                                                    |            |                                                    |            |                                                  |            |                                                  |            |  |  |  |  |

 

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Details of stock optiontransactions for thethree months ended September 30, 2009 and 2008 are as follows:

 
| ** **                         | ** ** | **Three  months ended  September 30, 2009** | ** ** | **Three  months ended  September 30, 2008** | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                         | ** ** | **Number of  shares**                            | ** ** | **Weighted  average  exercise price  per share** | ** ** | **Number of  shares** | ** ** | **Weighted  average  exercise price  per share** | ** ** |
| Outstanding, beginning of period   |       | 7,029,258                                        |       | $                                                | 0.56       |   | 4,974,111 |   | $ | 0.48 |   |
| Granted                            |       | 200,000                                          |       | 0.56                                             |       | — |   | — |   |
| Exercised                          |       | —                                           |       | —                                           |       | — |   | — |   |
| Forfeited                          |       | (35,656                                          | )          | 0.72                                             |       | (2,313 | ) | 0.92 |   |
| Expired                            |       | —                                           |       | —                                           |       | — |   | — |   |
| Outstanding, end of period         |       | 7,193,602                                        |       | $                                                | 0.56       |   | 4,971,798 |   | $ | 0.48 |   |
| Options exercisable, end of period |       | 6,060,574                                        |       | $                                                | 0.53       |   | 4,949,204 |   | $ | 0.48 |   |

 

Details of stock optiontransactions for thenine months ended September 30, 2009 and 2008 are as follows:

 
| ** **                         | ** ** | **Nine months  ended  September 30, 2009** | ** ** | **Nine months  ended  September 30, 2008**  | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                         | ** ** | **Number of  shares**                           | ** ** | **Weighted  average  exercise price  per share** | ** ** | **Number of  shares** | ** ** | **Weighted  average  exercise price  per share** | ** ** |
| Outstanding, beginning of period   |       | 7,282,777                                       |       | $                                                | 0.56       |   | 5,048,517 |   | $ | 0.48 |   |
| Granted                            |       | 225,000                                         |       | 0.54                                             |       | — |   | — |   |
| Exercised                          |       | (68,707                                         | )          | 0.37                                             |       | (35,000 | ) | 0.27 |   |
| Forfeited                          |       | (203,968                                        | )          | 0.58                                             |       | (36,719 | ) | 0.675 |   |
| Expired                            |       | (41,500                                         | )          | 0.80                                             |       | (5,000 | ) | 0.27 |   |
| Outstanding, end of period         |       | 7,193,602                                       |       | $                                                | 0.56       |   | 4,971,798 |   | $ | 0.48 |   |
| Options exercisable, end of period |       | 6,060,574                                       |       | $                                                | 0.53       |   | 4,949,204 |   | $ | 0.48 |   |

 

The stock options expire on various dates through 2016.

 

Asof September 30, 2009, the exercise prices, weighted average remainingcontractual life of outstanding options and intrinsic values were as follows:

 
| ** **         | ** ** | **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        |       | 3,725,182               |       | $                                                | 0.38       |   | 3.8 |   | $ | 848,956 |   | 3,725,144 |   | $ | 0.38 |   | $ | 848,947 |   |
| $0.52-$0.69        |       | 1,807,829               |       | $                                                | 0.59       |   | 5.2 |   | 37,592 |   | 1,150,789 |   | $ | 0.58 |   | 31,771 |   |
| $0.80-$0.99        |       | 1,630,417               |       | $                                                | 0.87       |   | 3.2 |   | — |   | 1,154,469 |   | $ | 0.88 |   | — |   |
| $2.21-$4.84        |       | 30,174                  |       | $                                                | 2.82       |   | 0.4 |   | — |   | 30,172 |   | $ | 2.82 |   | — |   |
|               |       | 7,193,602               |       | $                                                | 0.56       |   |   |   | $ | 886,548 |   | 6,060,574 |   | $ | 0.53 |   | $ | 880,718 |   |

 

Total unrecognized compensation cost relating to unvested stock optionsat September 30, 2009, prior to the consideration of expectedforfeitures, was approximately $383,000 and is expected to be recognized over aweighted average period of 2.1 years.

 

The Company recorded stock-based compensation of $99,810 and $88,300for the three months ended September 30, 2009 and 2008, respectively. TheCompany recorded stock-based compensation of $231,748 and $233,500 for the ninemonths ended September 30, 2009 and 2008, respectively.

 

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

 

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(b)                               Restricted stock awards:

 

Duringthe three months ended June 30, 2009, under the terms of the 2006Plan, the Company issued 12,600 restricted stock awards to eligible employeesof the Company.

 

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

 

Holders of restricted stock awards shall have full shareholder rightswith respect to any shares of Company stock issued to the participant under astock award, whether or not the participant’s interest in those shares isvested. Accordingly, the participant shall have the right to vote such sharesand to receive any regular cash dividends paid on such shares.

 

The fair value of restricted stock awards granted during the ninemonths ended September 30, 2009 was estimated using the closing shareprice of the Company’s common stock on the NYSE Amex on the date preceding thedate that the restricted stock awards were issued.

 

Details of restricted stockawards transactions forthe nine months ended September 30, 2009 and 2008 are as follows:

 
| ** **                                         | ** ** | **Nine months  ended  September 30, 2009** | ** ** | **Nine months  ended  September 30, 2008** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                         | ** ** | **Number of  shares**                           | ** ** | **Weighted  average  fair value  per share**    | ** ** | **Number of  shares** | ** ** | **Weighted  average  fair value  per share** | ** ** |
| Outstanding, beginning of period                   |       | —                                          |       | $                                               | —     |   | — |   | — |   |
| Granted                                            |       | 12,600                                          |       | 0.32                                            |       |   |   |   |   |
| Forfeited                                          |       | 400                                             |       | 0.32                                            |       | — |   | — |   |
| Outstanding, end of period                         |       | 12,200                                          |       | $                                               | 0.32       |   | — |   | — |   |
| Restricted stock awards exercisable, end of period |       | —                                          |       | —                                          |       | — |   | — |   |

 

Total unrecognized compensation cost relating to unvested restrictedstock awards at September 30, 2009, prior to the consideration ofexpected forfeitures, was approximately $3,000 and is expected to be recognizedover a weighted average period of 3.5 years.

 

The Company recorded stock-based compensation of $221 for the threemonths ended September 30, 2009 and $451 for the nine months ended September 30,2009.

 

**13. FAIR VALUE MEASUREMENT**

 

FASB ASC: Topic 820, *Fair ValueMeasurements and Disclosures*establishes a valuation hierarchy fordisclosure of the inputs to valuation used to measure fair value. Thishierarchy prioritizes the inputs into three broad levels. Level 1 inputs arequoted prices (unadjusted) in active markets for identical assets orliabilities. Level 2 inputs are quoted prices for similar assets andliabilities in active markets or inputs that are observable for the asset orliability, either directly or indirectly through market corroboration, forsubstantially the full term of the financial instrument. Level 3 inputs areunobservable inputs based on the Company’s own assumptions used to measureassets and liabilities at fair value. A financial asset or liability’sclassification within the hierarchy is determined based on the lowest levelinput that is significant to the fair value measurement.

 

Thefollowing table provides a summary of the fair values of the Company’s assetsmeasured at fair value on a recurring basis:

 
| ** **              | ** ** | **September 30, 2009**                 | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|
| ** **              | ** ** | **Fair Value Measurements Using** | ** ** | **Assets  at** | ** ** |
| ** **              | ** ** | **Level 1**                                      | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Fair  Value** | ** ** |
|                    |       |                                             |       |   |   |   |   |   |   |
| Forward  Plus Contracts |       | $                                                | —     |   | $ | 1,927,475 |   | $ | — |   | $ | 1,927,475 |   |
| Total  Assets           |       | $                                                | —     |   | $ | 1,927,475 |   | $ | — |   | $ | 1,927,475 |   |

 

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**14. SUBSEQUENT EVENTS**

 

During October 2009, the Company entered into foreign exchangeforward contracts to hedge a portion of its 2010 fiscal year expected Canadiandollar requirements. These contracts have a notional value of$5.8 million, whereby $5.8 million is converted into Canadian dollarsduring 2010 at an average foreign exchange rate of US$1.00: Cdn$1.0617.

 

During October 2009, the Company entered into foreign exchangeforward contracts to hedge a portion of its 2011 fiscal year expected Canadiandollar requirements. These contracts have a notional value of$5.2 million, whereby $5.2 million is converted into Canadian dollarsduring 2011 at an average foreign exchange rate of US$1.00: Cdn$1.0669.

 

OnOctober 2, 2009, the Company announced that it successfully concluded athird modified “Dutch auction tender offer” that was previously announced on August 20,2009. Under the terms of the offer, the Company repurchased an aggregate of784,643 shares of its common stock at a purchase price of $0.60 per share, fora total of $470,786, excluding transaction costs of $48,440. The purchase pricewas funded from available cash. All shares purchased in the tender offerreceived the same price. As a result of the completion of the tender offer, asof October 2, 2009, the Company had 67,080,453 shares issued andoutstanding, as all shares repurchased were immediately retired.

 

**15. 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, the competition we expect to encounteras our business develops and competes in a broad range of Internet services,our valuations of certain deferred tax assets, our expectation to collect ouroutstanding receivables, net of our allowance for doubtful accounts; thepotential impact of current and pending claims on our business; our expectationregarding fluctuations in certain expense and cost categories; our belief thatthe market for domain name registration will trend upward gradually and may beaffected by market volatility; our belief that, by increasing the number ofapplications and services we offer, we will be able to generate higherrevenues; and our belief that the actions we have taken have positioned theCompany for long-term growth. These statements are based on management’scurrent expectations and are subject to a number of uncertainties and risksthat could cause actual results to differ materially from those described inthe forward-looking statements. Many factors affect our ability to achieve ourobjectives and to successfully develop and commercialize our servicesincluding:

 

·                  Our ability to continue to generate sufficient workingcapital to meet our operating requirements;

 

·                  Our ability to maintain a good working relationshipwith 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 31,2008.

 

This list offactors that may affect our future performance and financial and competitiveposition and also the accuracy of forward-looking statements is illustrative,but it is by no means exhaustive. Accordingly, all forward-looking statementsshould be evaluated 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.

 

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**OVERVIEW**

 

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

 

Our primary distribution channel is a global network of more than 9,000resellers, in more than 100 countries who typically provide their customers,the end-users of the Internet, with a critical component for establishing andmaintaining an online presence. Our primary focus is serving the needs of this networkof resellers by providing superior services, easy-to-use interfaces, proactiveand attentive customer service, reseller-oriented technology and agile designand development processes. We seek to provide superior customer service to ourresellers by anticipating their business needs and technical 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, reliable and functional reseller-oriented provisioningand management platforms in our industry, and we continue to refine, evolve andimprove these services for both resellers and end-users.

 

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

 

OpenSRS, ourwholesale service, manages over nine million domain names, millions ofmailboxes and tens of thousands of digital certificates through a network ofover 9,000 web hosts, Internet service providers, or ISPs, and other resellersaround the world, including Platypus, our billing service, which provides ISPswith an industry-specific solution for billing, service provisioning andcustomer account management.

 

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

 

YummyNames, ourdomain portfolio service, manages tens of thousands of domain names, most ofwhich generate advertising revenue and many of which we offer for resale viaour reseller network and other channels. Included in the YummyNames domainportfolio are over 30,000 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, that provide content to help consumers overcome the complexityof modern technology and the Internet, in the form of over 1,500 videos andover 46,000 software listings and articles. Additionally, Butterscotch providescustom video production services for technology manufacturers and Internetservices providers.

 

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 acquired Innerwise, Inc.,or IYD, a privately held, Internet Corporation for Assigned Names and Numbers,or ICANN, accredited registrar offering domain services through a worldwidewholesale 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.

 

·                  To expand our presence in the email market,on January 3, 2006, we acquired all of the Hosted Messaging assets ofCritical Path, Inc.

 

Our business model is characterized by non-refundable, up-frontpayments, which lead to recurring revenue and positive operating cash flow. Weare an ICANN-accredited registrar and manage over eight million domains.

 

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**NetRevenues**

 

***OpenSRS***

 

We derive revenue from our reseller network by providing them withreseller services that comprise (a) domain services, (b) emailservices and (c) other services currently consisting of secure socketslayer, or SSL, certificates, 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

 

Historically, the domain services provided by OpenSRS Domain Servicehas been the largest portion of our business and encompasses all of ourservices as an accredited registrar related to the registration, renewal,transfer and management of domain names. In addition, this service fuels otherrevenue categories as it often is the initial service for which a customer willengage us, enabling us to follow on with other services and allowing us to addto our domain portfolio by purchasing names registered through us upon theirexpiration. We also provide resellers with the ability to sell personal names.This service allows resellers the opportunity to sell email addresses based onour domain portfolio of surname domain names.

 

On August 7, 2007, in advance of the announced October 2007registry fee increases, we modified our pricing structure for domain names toprovide greater visibility into the various fees that make up the cost of adomain name, by breaking out the cost of the registry and ICANN fees separatelyfrom our management fee. The management fee provides our resellers with accessto our provisioning and management tools to enable them to register andadminister domain names and access to additional services like WHOIS privacyand DNS services, enhanced domain name suggestion tools and access to ourPremium Domain name services.

 

As of September 30, 2009, we offer registration services for thegTLDs .com, .net, .org, .info, .name, .biz, .tel, .mobi and .asia and for thecountry code top-level domains, or ccTLDs. at, .be, .ca, .cc, .ch, .cn, .de,..dk, .es, .eu, .fr, .it, .li, .me, .mx .nl, .tv, .uk, and .us.

 

With respect to the sale of domain registrations, we earn fees inconnection with each new, renewed and transferred-in registration and fromproviding provisioning services to resellers and registrars on a monthly basis.Domain registrations are generally purchased for terms of one to ten years,with a majority having a one-year term. Except for certain large customers withwhom we have negotiated alternative arrangements, payments for the full term ofservice, or billed revenue, is received at the time of activation of service.All fees received in connection with domain name registration arenon-refundable, and where appropriate, are recorded as deferred revenue andrecognized as earned ratably over the term of provision of service. Thisaccounting treatment reasonably approximates a recognition pattern thatcorresponds with the provision of the services during the quarters and theyear.

 

OpenSRS Email Service

 

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

 

We earn fees for email services when they are activated. Email servicesare generally purchased monthly and at month-end, are either deducted on apre-authorized basis from reseller’s deposit account, or are invoiced.

 

Other OpenSRS Services

 

Other services currently consist of SSL certificates; blogware andwebsite building tools that are used by our resellers to create bundles ofInternet services for their end-users, as well as the provision of billing,provisioning and customer care software solutions to Internet Service Providersthrough our Platypus billing software.

 

We earn fees from such services when a service is activated. Theseservices are generally purchased for terms of one month to three years.Platypus software is generally purchased for terms of one month to one year.Payments for services are for the full term of all services at the time ofactivation of service, are non-refundable and, where appropriate, are recordedas 

 

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deferredrevenue and recognized as earned ratably over the service term. This accountingtreatment reasonably approximates a recognition pattern that corresponds withthe provision of the services during the quarters and the year.

 

***YummyNames***

 

We derive revenue from our portfolio of domain names by displayingadvertising on the domains and by making them available for sale or lease. Inaddition we display advertising on “Parked Pages” within OpenSRS. Parked Pages aredomain names registered with us that do not yet contain an active website. Whena user types one of these domain names into a web browser, they are presentedwith dynamically generated links which are pay-per-click advertising. Everytime a user clicks on one of these links, it generates revenue for us throughour partnership with third-parties who provide syndicated pay-per-clickadvertising.

 

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

 

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

 

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

 

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

 

***Hover***

 

We generate revenues from the provisioning and management of Internetservices, on a retail basis, to consumers and small businesses through our *Hover.com* website. These services includedomain registration and other Internet services such as email and personalizedemail through our portfolio of surname-based domain names, as well as aneasy-to-use interface that allows users to connect domain names to websites andemail addresses through a unique DNS forwarding system. Depending on theservice offered, we typically receive fees for our services.

 

Our customers generally purchase services for terms of one to tenyears, with a majority of services 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 generate advertising and other revenue through two ad-supportcontent sites, *butterscotch.com andtucows.com*.

 

*Butterscotch.com* derives revenue from bannerand text advertising on the site, as well as video advertising and productplacement within the videos that make up the bulk of the site. In addition,revenue is earned through custom video production for technology manufacturersand Internet services customers.

 

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

 

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Advertising and other revenue is recognized ratably over the period inwhich it is presented. To the extent that we do not meet the minimum number ofimpressions that we guarantee to customers post-presentation, 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.

 

**Critical AccountingPolicies**

** **

In preparing our consolidated financial statements, wemake assumptions, judgments and estimates that can have a significant impact onamounts reported in our consolidated financial statements. We base ourassumptions, judgments and estimates on historical experience and various otherfactors that we believe to be reasonable under the circumstances, the resultsof which form the basis for making estimates about the carrying values ofassets and liabilities that are not readily apparent from other sources. Actualresults could differ materially from these estimates under differentassumptions or conditions.

 

During the nine monthsended September 30, 2009, there have been no significant changes in ourcritical accounting policies as compared to the critical accounting policiesdisclosed in Management’s Discussion and Analysis of Financial Condition andResults of Operations included in our Annual Report on Form 10-K for thefiscal year ended December 31, 2008.

 

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**RESULTSOF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009AS COMPARED TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008**

 

The following tablepresents our net revenues, by revenue source:

 
| ** **                        | ** ** | **Three months ended September 30,** | ** **       | **Nine months ended September 30,** | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------------|------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                  | ** **       | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| OpenSRS  :                        |       |                                      |             |                                     |       |   |   |   |   |
| Domain  Services                  |       | $                                         | 15,097,640       |                                     | $          | 13,688,084 |   | $ | 44,037,596 |   | $ | 39,828,983 |   |
| Email  Services                   |       | 842,262                                   |             | 1,516,726                                |       | 2,838,052 |   | 4,642,977 |   |
| Other  Services                   |       | 1,109,341                                 |             | 1,104,374                                |       | 3,295,789 |   | 3,339,758 |   |
| Total  OpenSRS Services           |       | 17,049,243                                |             | 16,309,184                               |       | 50,171,437 |   | 47,811,718 |   |
|                              |       |                                      |             |                                     |       |   |   |   |   |
| YummyNames                        |       | 1,781,725                                 |             | 1,264,903                                |       | 5,102,315 |   | 4,042,830 |   |
| Hover                             |       | 1,203,742                                 |             | 2,071,200                                |       | 3,763,155 |   | 5,757,890 |   |
| Butterscotch                      |       | 461,419                                   |             | 501,908                                  |       | 1,572,766 |   | 1,696,293 |   |
|                              |       | $                                         |  20,496,129 |                                     | $          | 20,147,195 |   | $ | 60,609,673 |   | $ | 59,308,731 |   |
| Increase  over comparative period |       | $                                         | 348,934          |                                     |       |   | $ | 1,300,942 |   |   |   |
| Increase  - percentage            |       | 2                                         | %                |                                     |       | 2 | % |   |   |

 

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

 
| ** **              | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **              | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| OpenSRS  :              |       |                                      |       |                                     |       |   |   |   |   |
| Domain  Services        |       | 74                                        | %          | 69                                       | %          | 73 | % | 66 | % |
| Email  Services         |       | 4                                         | %          | 8                                        | %          | 5 | % | 8 | % |
| Other  Services         |       | 5                                         | %          | 5                                        | %          | 5 | % | 6 | % |
| Total  OpenSRS Services |       | 83                                        | %          | 82                                       | %          | 83 | % | 80 | % |
|                    |       |                                      |       |                                     |       |   |   |   |   |
| YummyNames              |       | 9                                         | %          | 6                                        | %          | 8 | % | 7 | % |
| Hover                   |       | 6                                         | %          | 10                                       | %          | 6 | % | 10 | % |
| Butterscotch            |       | 2                                         | %          | 2                                        | %          | 3 | % | 3 | % |
|                    |       | 100                                       | %          | 100                                      | %          | 100 | % | 100 | % |

 

Deferred revenuefrom domain name registrations and other services at September 30, 2009increased to $56.5 million from $54.4 million at September 30,2008.

 

No customeraccounted for more than 10% of revenue during the three and nine months ended September 30, 2009and, at September 30, 2009, no customer accounted for more than 10% ofaccounts receivable. 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 revenue for the three months ended September 30, 2009as compared to thethree months ended September 30, 2008, increased by $0.7 million to $17.0million.

 

The maincontributor to this increase was domain services which increased by$1.4 million to $15.1 million, primarily as a result of the impact of the7% registry price increase that was levied by some of our domain name suppliersin October 2008. This increase was partially offset by a decrease in emailservices revenue of $0.7 million during the period.

 

During the ninemonths ended September 30, 2009, OpenSRS revenue increased by$2.4 million to $50.2 million when compared to the nine months ended September 30,2008.

 

The maincontributor to this increase was domain services revenue, which increased by$4.2 million to $44.0 million, primarily as a result of the impact of the7% registry price increase that was levied by some of our domain name suppliersin October 2008 and from our continuing to aggressively compete to attractnew clients and retain existing customers. This increase was partially offsetby a decrease in email services revenue of $1.8 million during the period.

 

As previously disclosed, the decrease in email service revenue is primarilyattributable to two factors:

 

·                                          our decision to eliminate certainenterprise customers acquired as part of the Hosted Messaging Business ofCritical Path, Inc. in January 2006 that were not part of ourstrategic focus and who were receiving pricing that was not competitive in themarketplaces; and

 

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·                                          certain of ouremail customers, who are media portal companies and for whomemail is only a small component of their overall service offerings, who havechosen to include their email services as part of larger supply contracts forcompetitive and cost-control reasons.

 

Our original expectation wasthat the companies described above would have completed their migrations by March 2009.One of these customers has modified its migration plans and is now expected tomigrate away from our hosted email platform during the three months ending December 31,2009. As our marketing efforts to date have not yet been successful inoffsetting these customer losses, these customer losses have had a materialimpact on our results of operations for email services for the fiscal yearending December 31, 2009.

 

During the threemonths ended September 30, 2009, the total new, renewed andtransferred-in domain name registrations that we processed remained essentiallyflat at 1.6 million compared to the three months ended September 30, 2008.This result is primarily related to certain of our customers who own large nameportfolios restructuring their portfolios during the quarter. As such, webelieve this result is temporary and does not reflect a longer term trend.

 

During the ninemonths ended September 30, 2009, the total new, renewed andtransferred-in domain name registrations that we processed increased by0.2 million to 5.0 million as compared to the nine months ended September 30, 2008.This increase resulted primarily from our continuing to aggressively compete toattract new clients and retain existing customers.

 

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 September 30, 2009, the total domain names under ourmanagement increased by 0.4 million to 8.0 million, as compared tothe total domain names under our management as of September 30, 2008. Inaddition, we provide provisioning services on a monthly basis to accreditedregistrars who use our technical systems to process domain registrations withtheir own accreditation. As of September 30, 2009, we managed1.2 million domain names on behalf of other accredited registrars,consistent with the 1.2 million managed for accredited registrars as of September 30,2008.

 

***YummyNames***

 

Net revenues fromour YummyNames domain portfolio service for the three months ended September 30, 2009as compared to thethree months ended September 30, 2008 increased by $0.5 million, or 41%, to$1.8 million.

 

During the three months ended September 30, 2009, we earned $1.3million in revenue bymaking domain names in our portfolio available for sale or leasecompared to $0.5 million during the threemonths ended September 30, 2008. In addition we earned $0.4 millionfrom ourpay-per-click advertising or parked pages program during the three monthsended September 30, 2009 compared to $0.7 million for the three monthsended September 30, 2008.

 

This increase primarily reflects the timing of larger portfolio salesof domain names as well as the improved performance we are currentlyexperiencing with our auction initiatives. These increases have been partiallyoffset by the decrease in the delivery of third-party advertisements on Parked Pages of$0.3 million as a result of the impact of our domain name sales on ouradvertising revenue and the general economic conditions resulting in agenerally slower advertising environment.

 

During the nine months ended September 30, 2009, we earned $3.5million by makingdomain names in our portfolio available for sale or leasecompared to $1.8 million during the threemonths ended September 30, 2008. In addition we earned $1.6 millionfrom ourpay-per-click advertising or parked pages program during the three monthsended September 30, 2009 compared to $2.2 million for the three monthsended September 30, 2008.

 

This increase primarily reflects the timing of larger portfolio salesof domain names as well as the improved performance we are currentlyexperiencing with our auction initiatives. These increases have been partiallyoffset by the decrease in the delivery of third-party advertisements on Parked Pages of$0.6 million as a result of the impact of our domain name sales on ouradvertising revenue and the general economic conditions resulting in agenerally slower advertising environment.

 

The market formonetization of domain names is rapidly evolving and there is no guarantee thatwe will be able to grow revenue at the rate achieved during the three or ninemonths ended September 30, 2009, nor that we will be able to continueto acquire the same caliber of names for our portfolio from future expiringdomains or that names we acquire in

 

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future will provide thesame revenue impact as we have experienced from past acquisitions. In addition,the revenue we derive from domain portfolio services is driven by generalmacroeconomic 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. A slowingeconomy may thus be accompanied by a decrease in advertising spending whichcould adversely impact our ability to grow or maintain our domain portfolioservices revenue.

 

***Hover***

 

Net revenues from Hover for the three months ended September 30, 2009 as compared to the three months ended September 30, 2008 decreased by $0.9 million, or 42%,to $1.2 million.

 

Net revenues from Hover for the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008 decreased by $2.0 million, or 35%,to $3.8 million.

 

This decrease primarily resulted from the impact of the sale of ourretail hosting assets during the 2008 fiscal year on current period revenues.To a lesser extent, our decisions to reclassify certain retail customersacquired in the IYD acquisition that did not meet our definition of retailcustomers to OpenSRS and de-emphasize new customer acquisitions while wetransitioned our retail customers from our Domain Direct, NetIdentity and IYDservices to Hover also contributed to this decrease.

 

***Butterscotch***

 

Net revenues from Butterscotch for the three monthsended September 30, 2009 as compared to the three months ended September 30, 2008 remained relatively flat at$0.5 million.

 

Net revenues from Butterscotch for the nine monthsended September 30, 2009 as compared to the nine months ended September 30, 2008 decreased by $0.1 million, or 7%,to $1.6 million. This decrease is primarily a result of the contraction inthe yields from our syndicated Google feeds, and decreased revenue from our Author ResourceCenter of$0.3 million, offset by an increase in advertising and video revenue of$0.2 million.

 

**COST OF REVENUES**

** **

***OpenSRS***

 

·                  OpenSRS Domain Service

 

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.

 

·                  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

 

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name sold and anyimpairment charges that may arise from our assessment of our domain nameintangible assets. As the total names in our portfolio continue to grow, thiscost will become a more significant component of our cost of revenues. Paymentsfor domain registrations are payable for the full term of service at the timeof activation of service and are recorded as prepaid domain registry fees and areexpensed 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.

 

The followingtable presents our cost of revenues, by revenue source, for the periods presented

 
| ** **                                                                                                                | ** ** | **Three months ended September 30,** | ** **       | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------------|------------------------------------------|------------|
| ** **                                                                                                                | ** ** | **2009**                                  | ** **       | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| OpenSRS  :                                                                                                                | ** ** | ** **                                | ** **       | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Domain  Services                                                                                                          |       | $                                         |  12,325,620 |                                     | $          |  11,015,952 |   | $ |  35,624,222 |   | $ |  31,456,663 |   |
| Email  Services                                                                                                           |       | 103,071                                   |             | 161,848                                  |       | 436,216 |   | 244,848 |   |
| Other  Services                                                                                                           |       | 411,949                                   |             | 403,431                                  |       | 1,212,087 |   | 1,226,508 |   |
| Total  OpenSRS Services                                                                                                   |       | 12,840,640                                |             | 11,581,231                               |       | 37,272,525 |   | 32,928,019 |   |
|                                                                                                                      |       |                                      |             |                                     |       |   |   |   |   |
| YummyNames                                                                                                                |       | 218,371                                   |             | 182,614                                  |       | 654,456 |   | 542,065 |   |
| Hover                                                                                                                     |       | 493,181                                   |             | 558,190                                  |       | 1,481,761 |   | 1,701,786 |   |
| Butterscotch                                                                                                              |       | 25,491                                    |             | 4,600                                    |       | 33,341 |   | 15,225 |   |
| Network,  other costs                                                                                                     |       | 1,193,185                                 |             | 1,654,612                                |       | 3,500,231 |   | 5,607,181 |   |
| Network,  depreciation and amortization costs                                                                             |       | 504,644                                   |             | 824,644                                  |       | 1,504,431 |   | 2,572,139 |   |
|                                                                                                                      |       | $                                         |  15,275,512 |                                     | $          |  14,805,891 |   | $ |  44,446,745 |   | $ |  43,366,415 |   |
| Increase  over comparative period                                                                                         |       | $                                         |  469,621    |                                     |       |   | $ |  1,080,330 |   |   |   |
| Increase  - percentage                                                                                                    |       | 3                                         | %                |                                     |       | 2 | % |   |   |
|                                                                                                                      |       |                                      |             |                                     |       |   |   |   |   |
| The following table  presents our cost of revenues, as a percentage of total cost of revenues for  the periods presented: |
|                                                                                                                      |
| OpenSRS  :                                                                                                                |       |                                      |             |                                     |       |   |   |   |   |
| Domain  Services                                                                                                          |       | 81                                        | %                | 74                                       | %          | 81 | % | 72 | % |
| Email  Services                                                                                                           |       | 1                                         | %                | 1                                        | %          | 1 | % | 1 | % |
| Other  Services                                                                                                           |       | 3                                         | %                | 3                                        | %          | 3 | % | 3 | % |
| Total  OpenSRS Services                                                                                                   |       | 85                                        | %                | 78                                       | %          | 85 | % | 76 | % |
|                                                                                                                      |       |                                      |             |                                     |       |   |   |   |   |
| YummyNames                                                                                                                |       | 1                                         | %                | 1                                        | %          | 1 | % | 1 | % |
| Hover                                                                                                                     |       | 3                                         | %                | 4                                        | %          | 3 | % | 4 | % |
| Butterscotch                                                                                                              |       | 0                                         | %                | 0                                        | %          | 0 | % | 0 | % |
| Network,  other costs                                                                                                     |       | 8                                         | %                | 11                                       | %          | 8 | % | 13 | % |
| Network,  depreciation and amortization costs                                                                             |       | 3                                         | %                | 6                                        | %          | 3 | % | 6 | % |
|                                                                                                                      |       | 100                                       | %                | 100                                      | %          | 100 | % | 100 | % |

 

Prepaid domainregistration and other Internet services fees as of September 30, 2009increased by $3.0 million, or 7%, to $43.7 million from $40.7 millionat September 30, 2008.

 

***OpenSRS***

 

Costs for OpenSRSfor the three months ended September 30, 2009 increased by $1.3 million, or 11%,when compared to the three months ended September 30, 2008,while costs forOpenSRS for the nine months ended September 30, 2009 increased by $4.4 million, or 13%,when compared to the nine months ended September 30, 2008. Higher domain registration volumes andincreases in registration fees paid to the registries that were implemented in October

 

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2007 and October 2008accounted for $1.3 million of this increase for the three months ended September 30, 2009 when compared to the three months ended September 30, 2008and $4.2 millionof this increase for the nine months ended September 30, 2009 when compared to the nine months ended September 30, 2008. In addition, $0.2 million of theincrease resulted from licensing and royalty costs payable to third-partyservice providers foremail services.

 

***YummyNames***

 

Costs forYummyNames for the three months ended September 30, 2009 as compared to the three months ended September 30, 2008remained relativelyflat at $0.2 million.

 

Costs for YummyNamesfor the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008increased by$0.1 million, to $0.7 million, as the total names in our portfoliocontinued to increase.

 

***Hover***

 

Costs for Hoverfor the three and nine months ended September 30, 2009 as compared to the three and nine monthsended September 30, 2008 decreased by $0.1 million and $0.2 million,respectively, to $0.5 million and $1.5 million, respectively, andprimarily reflect the lower revenue experienced during the periods as well as the impact thatthe sale of our retail hosting assets during the 2008 fiscal year has had onour retail gross margins.

 

***Network costs***

 

Network costs before depreciation and amortization forthe three and nine months ended September 30, 2009 decreased by$0.5 million, or 28%, to $1.2 million, and $2.1 million, or 38%,to $3.5 million, respectively primarily as a result of lower bandwidth,support contract and workforce costs. The decrease is primarily attributable tothe lower co-location costs stemming from the closure and relocation of ourUS-based co-location facilities during September 2008 and therestructuring we implemented in November 2008. Network depreciation andamortization costs for the three and nine months ended September 30, 2009decreased by $0.3 million, or 39%, to $0.5 million, and $1.1 million,or 42%, to $1.5 million, respectively primarily as a result of certain of ourolder computer hardware being fully depreciated and not requiring replacement.

 

In addition, as asignificant portion of our expenses are incurred in Canadian dollars, theweakening of the Canadian dollar relative to the U.S. dollar has positivelyimpacted network costs, during the three and nine months ended September 30,2009 when compared to the three and nine months ended September 30, 2008,.Exchange rates are, however, subject to significant and rapid fluctuations, andtherefore we cannot predict the prospective impact of exchange ratefluctuations on our business, results of operations and financial condition.

 

Amortization ofintangible assets consists of amounts arising in connection with theacquisition of technology from each of the Boardtown Corporation in April 2004,the hosted messaging business of Critical Path, Inc. in January 2006,Mailbank.com Inc. in June 2006 and IYD in July 2007.

 

The technologypurchased in connection with the acquisition of Boardtown Corporation isamortized on a straight-line basis over seven years, and for IYD over threeyears, while the technology acquired in connection with each of theacquisitions of the hosted messaging assets of Critical Path, Inc. and thein-house software of Mailbank.com Inc. was amortized on a straight-linebasis over two years.

 

We expect networkcosts to decrease for the fiscal year ending December 31, 2009 as comparedto the fiscal year ending December 31, 2008 as we realize thebenefits from completing the consolidation of some of the multiple systems wesupport, thereby reducing our overall space and resource utilization at ourdata centers.

 

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**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 September 30,** | ** **      | **Nine months ended September 30,** | ** ** |
|-----------------------------------|------------|-------------------------------------------|-----------------|------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                  | ** **      | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Sales  and marketing              |       | $                                         |  1,568,727 |                                     | $          |  1,705,512 |   | $ |  4,261,070 |   | $ |  5,132,380 |   |
| Decrease  over comparative period |       | $                                         |  (136,785  | )                                        |       |   | $ |  (871,310 | ) |   |   |
| Decrease  - percentage            |       | (8                                        | )%              |                                     |       | (17 | )% |   |   |
| Percentage  of net revenues       |       | 8                                         | %               | 8                                        | %          | 7 | % | 9 | % |
|                                   |            |                                           |                 |                                          |            |  |  |  |  |  |  |  |  |

 

Sales and marketingexpenses for the three months ended September 30, 2009 decreased by$0.1 million, or 8%, to $1.6 million for the three months ended September 30, 2008.This decrease was primarily due to lower workforce costs that resulted from therestructuring we undertook in November 2008, which was slightly offset byand higher marketing expenses incurred during the period.

 

Sales andmarketing expenses for the nine months ended September 30, 2009decreased by $0.8 million, or 17%, to $4.3 million for the ninemonths ended September 30, 2008. This decrease was primarily due tolower workforce costs that resulted from the restructuring we undertook in November 2008.This decrease was partially offset by an increase in marketing and travelrelated costs of $0.1 million for the nine months ended September 30 2009,as compared to the nine months ended September 30, 2008.

 

In addition, as asignificant portion of our expenses are incurred in Canadian dollars, theweakening of the Canadian dollar relative to the U.S. dollar has positivelyimpacted sales and marketing expenses during the three and nine months ended September 30,2009 when compared to the three and nine months ended September 30, 2008.Exchange rates are, however, subject to significant and rapid fluctuations, andtherefore we cannot predict the prospective impact of exchange ratefluctuations on our business, results of operations and financial condition.

 

We expect salesand marketing expenses will increase slightly, in absolute dollars, as weadjust our marketing programs and sales and customer support strategies to meetfuture opportunities in the marketplace.

 

**TECHNICALOPERATIONS AND DEVELOPMENT**

 

Technical operationsand development expenses consist primarily of personnel costs and relatedexpenses 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. Inaccordance with FASB ASC: Topic 350-40, Goodwill and Other Internal-UseSoftware, costs incurred during the application development stage arecapitalized and primarily include personnel costs for employees directlyrelated to the development project. All other costs are expensed as incurred.

** **
| ** **                            | ** ** | **Three months ended September 30,** | ** **      | **Nine months ended September 30,** | ** ** |
|---------------------------------------|------------|-------------------------------------------|-----------------|------------------------------------------|------------|
| ** **                            | ** ** | **2009**                                  | ** **      | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Technical  operations and development |       | $                                         |  1,142,331 |                                     | $          |  1,527,237 |   | $ |  3,421,825 |   | $ |  4,666,832 |   |
| Decrease  over comparative period     |       | $                                         |  (384,906  | )                                        |       |   | $ |  (1,245,007 | ) |   |   |
| Decrease  - percentage                |       | (25                                       | )%              |                                     |       | (27 | )% |   |   |
| Percentage  of net revenues           |       | 6                                         | %               | 8                                        | %          | 6 | % | 8 | % |
|                                       |            |                                           |                 |                                          |            |  |  |  |  |  |  |  |  |

 

Technicaloperations and development expenses for the three months ended September 30, 2009decreased by $0.4 million, or 25%, to $1.1 million as compared to thethree months ended September 30, 2008.

 

Technicaloperations and development expenses for the nine months ended September 30, 2009decreased by $1.3 million, or 27%, to $3.4 million as compared to thenine months ended September 30, 2008.

 

This decrease forthe three and nine months ended September 30, 2009 resulted primarilyfrom a decrease in workforce-related costs, including contract and outsideservice costs, that resulted from the restructuring we undertook in November 2008.

 

In addition, as asignificant portion of our expenses are incurred in Canadian dollars, theweakening of the Canadian dollar relative to the U.S. dollar has positivelyimpacted technical operations and development expenses during the three and

 

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nine months ended September 30,2009 when compared to the three and nine months ended September 30, 2008.Exchange rates are however subject to significant and rapid fluctuations, andtherefore we cannot predict the prospective impact of exchange ratefluctuations on our business, results of operations and financial condition.

 

We expecttechnical operations and development expenses to increase slightly, in absolutedollars, as our business continues to grow and as we further develop ourapplications and services.

 

**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 September 30,** | ** **      | **Nine months ended September 30,** | ** ** |
|-----------------------------------|------------|-------------------------------------------|-----------------|------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                  | ** **      | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| General  and administrative       |       | $                                         |  1,145,951 |                                     | $          |  1,714,563 |   | $ |  4,608,173 |   | $ |  4,805,853 |   |
| Decrease  over comparative period |       | $                                         |  (568,612  | )                                        |       |   | $ |  (197,680 | ) |   |   |
| Decrease  - percentage            |       | (33                                       | )%              |                                     |       | (4 | )% |   |   |
| Percentage  of net revenues       |       | 6                                         | %               | 9                                        | %          | 8 | % | 8 | % |
|                                   |            |                                           |                 |                                          |            |  |  |  |  |  |  |  |  |

 

General andadministrative expenses for the three months ended September 30, 2009decreased by $0.6 million, or 33%, to $1.1 million as compared to thethree months ended September 30, 2008.

 

General andadministrative expenses for the nine months ended September 30, 2009decreased by $0.2 million, or 4%, to $4.6 million as compared to thenine months ended September 30, 2008.

 

As a significantportion of our expenses are incurred in Canadian dollars, the weakening of theCanadian dollar relative to the U.S. dollar has positively impacted general andadministrative expenses during the three and nine months ended September 30,2009 when compared to the three and nine months ended September 30, 2008.Exchange rates are however subject to significant and rapid fluctuations, andtherefore we cannot predict the prospective impact of exchange ratefluctuations on our business, results of operations and financial condition.

 

General andadministrative expenses decreased during the three months ended September 30,2009 compared to the three months ended September 30, 2008 primarily as aresult a reduction of professional fees of $0.2 million, a decrease in netbank charges of $0.2 million as a result of our initiative introduced in January 2009to recover payment processing fees and as a result of our recording a foreignexchange gain of $49,000 during the three months ended September 30, 2009as compared to a foreign exchange loss of $0.2 million during the three monthsended September 30, 2008. The $0.2 million increase inforeign exchange was primarily due to the impact of translating our Canadiandollars to our functional currency of U.S. dollars, and the weakening of theCanadian dollar relative to the U.S. dollar compared to the three months ended September 30, 2008.These decreases were offset by an increase in workforce related costs of$0.1 during the three months ended September 30, 2009, ascompared to the three months ended September 30, 2008.

 

General andadministrative expenses decreased during the nine months ended September 30,2009 compared to the nine months ended September 30, 2008 primarily as aresult a reduction in professional fees of $0.4 million, a decrease in netbank charges of $0.7 million as a result of our initiative introduced in January 2009to recover payment processing fees and a decrease in facility costs, telephone,investor and public relations costs of $0.3 million. These decreases wereoffset by our recognizing a foreign exchange loss of $1.0 million duringthe nine months ended September 30, 2009 as compared to a foreignexchange loss of $13,000 during the nine months ended September 30, 2008.This $1.0 million increase was primarily due to the impact oftranslating our Canadian dollar net assets on hand at September 30, 2009,to our functional currency of U.S. dollars. This impact has resulted from thesignificant weakening of the Canadian dollar relative to the U.S. dollar compared to the nine months ended September 30, 2008.In addition, general and administrative expenses increased by $0.2 millionas a result of additional public listing and workforce related costs incurredduring the period.

 

**DEPRECIATIONOF PROPERTY AND EQUIPMENT**

 

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

 
| ** **                              | ** ** | **Three months ended September 30,** | ** **   | **Nine months ended September 30,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------|--------------|------------------------------------------|------------|
| ** **                              | ** ** | **2009**                                  | ** **   | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Depreciation  of property and equipment |       | $                                         |  64,704 |                                     | $          |  57,386 |   | $ |  230,336 |   | $ |  177,317 |   |
| Increase  over comparative period       |       | $                                         |  7,318  |                                     |       |   | $ |  53,019 |   |   |   |
| Increase  - percentage                  |       | 13                                        | %            |                                     |       | 30 | % |   |   |
|                                         |            |                                           |              |                                          |            |  |  |  |  |  |  |  |  |

 

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**LOSS ONDISPOSITION OF PROPERTY AND EQUIPMENT**

 
| ** **                                     | ** ** | **Three months ended September 30,** | ** **     | **Nine months ended September 30,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------|----------------|------------------------------------------|------------|
| ** **                                     | ** ** | **2009**                                  | ** **     | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Loss  on disposition of property and equipment |       | $                                         |  40,369   |                                     | $          |  498,529 |   | $ |  40,369 |   | $ |  498,529 |   |
| Decrease  over comparative period              |       | $                                         |  (458,160 | )                                        |       |   | $ |  (458,160 | ) |   |   |
|                                                |            |                                           |                |                                          |            |  |  |  |  |  |  |  |  |

 

Aspart of our ongoing initiatives to improve the efficiency of our productionenvironment, we retired some older computer hardware at our co-locationfacilities during the three months ended September 30, 2009, whichresulted in a loss on the disposition of such equipment of $40,000.

 

Duringthe three months ended September 30, 2008, as part of our consolidation ofthe multiple systems that we were supporting, we disposed of some or our oldercomputer hardware at co-location facilities that we no longer intend to deploy,and incurred a loss on the disposition of such equipment of $0.5 million.

 

**AMORTIZATIONOF INTANGIBLE ASSETS**

** **
| ** **                         | ** ** | **Three months ended September 30,** | ** **    | **Nine months ended September 30,** | ** ** |
|------------------------------------|------------|-------------------------------------------|---------------|------------------------------------------|------------|
| ** **                         | ** ** | **2009**                                  | ** **    | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Amortization  of intangible assets |       | $                                         |  360,540 |                                     | $          |  360,540 |   | $ |  1,081,620 |   | $ |  1,122,655 |   |
| Decrease  over comparative period  |       | $                                         |  —  |                                     |       |   | $ |  (41,035 | ) |   |   |
| Decrease  - percentage             |       | —                                    | %             |                                     |       | (4 | )% |   |   |
|                                    |            |                                           |               |                                          |            |  |  |  |  |  |  |  |  |

 

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, the acquisitionof Mailbank.com Inc. in June 2006 and the acquisition of IYD 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.

 

In connection withthe acquisition of Mailbank.com Inc., customer relationships purchased areamortized on a straight-line basis over five years.

 

In connection withthe acquisition of IYD, the brand and customer relationships purchased areamortized on a straight-line basis over seven years.

 

**(GAIN) LOSS 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 September 30,** | ** **       | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------|------------------|------------------------------------------|------------|
| ** **                                                | ** ** | **2009**                                  | ** **       | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| (Gain)/loss  on change in fair value of forward contracts |       | $                                         |  (1,878,230 | )                                        | $          |  525,571 |   | $ |  (3,902,394 | ) | $ |  555,364 |   |
| Decrease  over comparative period                         |       | $                                         |  (2,403,801 | )                                        |       |   | $ |  (4,457,758 | ) |   |   |
|                                                           |            |                                           |                  |                                          |            |  |  |  |  |  |  |  |  |

 

We have entered into forward exchange contracts to meet a portion ofour future Canadian dollar requirements through December 2010. The impactof the fair value adjustment on unrealized foreign exchange on these contractsfor the three monthsended September 30, 2009 was a net gain of$1.9 million, as compared to a net loss of $0.5 million for the three months ended September 30, 2008.This net gain in fair value of forward contracts results from a combination ofthe impact

 

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from the change inforeign exchange rates over time, as well as from the impact of the settlementof forward exchange contracts as they mature. The impact of the fairvalue adjustment on unrealized foreign exchange on these contracts for the nine months ended September 30, 2009 was a net gainof $4.0 million, as compared to a net loss of $0.6 million for the nine months ended September 30, 2008.

 

At September 30, 2009, we reflect a derivative instrumentasset of $1.9 million on our balance sheet as a result of the foreign exchangecontracts we have entered into.  Untiltheir respective maturity dates, these contracts will fluctuate in value inline with movements in the Canadian vs. U.S. dollar pair. As all of theremaining contracts pertaining to the 2009 fiscal year will have matured duringthe course of the 2009 fiscal year, a derivative instrument asset pertaining to2009 fiscal year contracts of $0.2 million will reverse during the 2009 fiscalyear and will result in our recognizing an additional non-cash loss of thisamount by December 31, 2009. This loss will, however, be impacted by anyadditional contracts, with maturity dates after September 30, 2009, thatwe may enter into and fluctuations in the value of our existing contracts thatmature during the 2009fiscal year and the 2010 fiscal year.

 

**OTHERINCOME AND EXPENSES**

** **
| ** **                    | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                    | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Other  income (expenses), net |       | $                                         | 1,827,113  |                                     | $          | 1,007,386 |   | $ | 4,314,521 |   | $ | 2,163,746 |   |
|                               |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |

 

Other income, net,increased by $0.8 million, or 81%, to $1.8 million as compared to the threemonths ended September 30, 2008 and by $2.1 million, or 99%, to $4.3million as compared to the nine months ended September 30, 2008.

 

The net increase duringthe three and nine months ended September 30, 2009 when compared to thethree and nine months ended September 30, 2008 was primarily the result ofthe following:

 

·                  In April 2009, we received $2.1 million fromAfilias Inc. or Afilias, to complete the second closing under the terms of astock redemption agreement signed in November 2008 whereby one of oursubsidiaries agreed to sell its investment in Afilias back to Afilias in threestages for $7.5 million. This sale resulted in a gain of $2.0 million forthe corresponding quarter.

 

·                  In September 2009, we received $2.0 million fromAfilias to complete the third and final closing under the terms of a stockredemption agreement signed in November 2008 whereby one of oursubsidiaries agreed to sell its investment in Afilias back to Afilias in threestages for $7.5 million. This sale resulted in a gain of $1.9 million forthe corresponding quarter.

 

·                  In June 2009, we received an additional paymentof $0.6 million in connection with Infonautics patents that we assigned in 2002to a third party. In connection with the assignment of these patents, weretained the right to share in certain revenue relating to any cash flowreceived by the third party with respect to the commercialization of thesepatents. This revenue is comparable to the $0.2 million we recognized in June 2008in connection with these patents. As the third party’s costs of commercializingthe patents are expected to increase in the future, we do not expect any futurerevenue received to be material.

 

Interest expense, net,decreased during the three and nine months ended September 30, 2009 whencompared to the three and nine months ended September 30, 2008 by $38,000and $0.3 million, respectively, primarily as a result of the monthly capitalrepayments of $0.2 million and the annual cash sweep payment of$0.7 million we made in April 2009 pursuant to the terms of our Bankof Montreal credit facility.

 

As a result of the saleof certain shared hosting assets to Hostopia.com Inc., pursuant to the terms ofa purchase and sale agreement signed with Tucows.com Co., a wholly-ownedsubsidiary of the Company, on May 7, 2008, we recorded a profit on thesale of these customer relationships of $1.1 million. In another transaction inSeptember 2008, we sold the remaining shared hosting assets and recorded aprofit on the sale of these customer relationships of $0.9 million.

 

In June 2008 and September 2008,we received dividends in the amount of $0.2 million and $0.2 million,respectively, from Afilias, a company in which we held an investment. Afiliashas not paid any dividends during the three and nine months ended September 30,2009, and, effective September 2009, we sold our investment back toAfilias and no longer hold any interest in the Company.

 

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**INCOME TAXES**

 

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

 
| ** **                                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **2009**                                  | ** ** | **2008**                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| (Recovery  of) provision for income taxes |       | $                                         | (447,455   | )                                        | $          | 30,000 |   | $ | 241,621 |   | $ | 91,134 |   |
|                                           |            |                                           |            |                                          |            |  |  |  |  |  |  |  |  |

 

For the threemonths ended September 30, 2009, we recorded an income tax recovery of$447,000 on income before taxes of $4.6 million. Included in income taxrecovery is current income tax of $50,000 using an estimated effective tax ratefor our 2009 fiscal year that accounts for the utilization of remaining netoperating loss carry forwards and alternative minimum tax credits available tous. This tax expense was offset by a reduction of $497,000 in our recordeddeferred tax liability. The reduction in the deferred tax liability relates toa change in the rate at which we expect the temporary differences resultingfrom our unlimited life intangibles to reverse. This change in estimate aroseas a result of our no longer being subject to state taxes in the United Statesgiven the change in the jurisdictions in which we now operate. Comparatively,for the three months ended September 30, 2008, we recorded an income taxexpense of $30,000 on income before taxes primarily related to our estimate offederal alternative minimum tax obligations for our 2008 fiscal year andPennsylvania state franchise tax related to prior years.

 

For the nine months endedSeptember 30, 2009, we recorded an income tax expense of $242,000,which included current tax expense of $913,000 on income before income taxes of$10.7 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. Included in theincome tax expense is a recovery of $174,000 for investment tax credits earnedduring the three months ended June 30, 2009, as well as a reduction of$497,000 in our recorded deferred tax liability. The reduction in the deferredtax liability relates to the rate at which we expect the temporary differencesresulting from our unlimited life intangibles to reverse. This change inestimate arose as a result of our no longer being subject to state tax in theUnited States given the change in the jurisdictions in which we now operate in.

 

Comparatively, forthe nine months ended September 30, 2008, we recorded an income taxexpense of $91,000 on income before taxes of $1.1 million primarilyrelated to our estimate of federal alternative minimum tax obligations for our2008 fiscal year and Pennsylvania state franchise tax related to prior years.

 

As of December 31,2008, we recorded a valuation allowance of $10.8 million and a net deferred taxasset of $3.0 million. The net deferred tax asset has been allocated on a prorata basis between current and non-current deferred tax assets, resulting incurrent deferred tax assets of $0.6 million and non-current deferred tax assetsof $2.4 million as at December 31, 2008. No significant changes haveoccurred during the nine month period ended September 30, 2009.

 

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 nine months ended September 30, 2009, 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 hadapproximately $301,000 of gross unrecognized tax benefit as of December 31,2008 and $209,000 as of September 30, 2009, which if recognized wouldfavorably affect our income tax rate in future periods. The unrecognized taxbenefit relates to non-recognition of refundable research and development taxcredits in Canada earned during our 2008 fiscal year and certain state taxexposures from prior periods. During the nine months ended September 30, 2009,our unrecognized tax benefits decreased by $205,000 as a result of thesettlement of our 2006 and 2007 Canadian research and development tax creditclaims. We increased our unrecognized tax benefits by $113,000 related to our2008 research and development tax credit claim. We expect our 2009 research anddevelopment tax credit claim to be insignificant.

 

We recognizeaccrued interest and penalties to unrecognized tax benefit as a tax expense. Wehave not accrued any interest or penalties as of December 31, 2008 or September 30, 2009,as these amounts are not considered material. We believe it is reasonably possible that $209,000 of the unrecognizedtax benefit will decrease in the next twelve months as it is

 

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anticipated that theCanadian tax authorities will conclude its review of our 2008 research anddevelopment claim for the credits, and that the state tax matters will also besettled, within that period.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

As of September 30, 2009,our principal sources of liquidity were cash flows generated from operationsand cash and cash equivalents of $8.2 million, as compared to$5.4 million at December 31, 2008. Fluctuations in foreign exchangerates had a material impact on the balances of our assets and liabilitiesyear-over-year as reported in our condensed consolidated balance sheets, whichimpacted amounts shown in our condensed consolidated statement of cash flows.

 

Net cash providedby operating activities for the nine months ended September 30, 2009totaled $3.6 million, compared to $2.6 million for the nine monthsended September 30, 2008. This increased contribution of $1.0 millionwas primarily the result the restructuring we undertook in November 2008and the impact of the lower Canadian dollar. Operating activities for the ninemonths ended September 30, 2009 generated $5.1 million, after adjustmentfor non-cash and other items, including the net change in deferred revenue andprepaid domain name registry and other Internet services fees, depreciation,amortization, unrealized change in the fair value of forward contracts, thegain on disposal of our investment in Afilias and stock-based compensation,aggregating $4.9 million. This was partially offset by an increase in othernon-cash operating working capital of $1.5 million, which was primarily theresult of a reduction in accounts payable and accruals, as well an increase inaccounts receivable, prepaid expenses and customer deposits.

 

Net cash used infinancing activities during the nine months ended September 30, 2009totaled $4.5 million. We used $1.8 million to repurchase 4.2 million sharespursuant to the terms of a Dutch auction tender offer during March 2009and $0.6 million to repurchase 1.1 million shares pursuant to the terms of asecond Dutch auction tender offer during July 2009. Pursuant to theterms of our non-revolving, reducing credit facility, we also made equalmonthly principal repayments of $1.4 million. In addition, under thiscredit facility, based on our 2008 fiscal year operating results, we also madea cash sweep payment for the 2009 fiscal year of $0.7 million on May 1,2009. We currently estimate that the cash sweep payment which will be based onour audited 2009 results and will be payable during the three months ending June 30,2010 will be sufficient to pay off in full the outstanding balance of ournon-revolving, reducing credit facility.

 

Investingactivities generated net cash of $3.7 million for the nine months ended September 30,2009. This generation of cash is attributable to the $4.1 million we receivedon the second and third closings under the terms of the sale of our investmentin Afilias in May and September 2009. This increase in cash wasoffset by $0.4 million that we have invested during the nine months ended September 30,2009 to acquire 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,loan repayments and our third Dutch auction tender offer for at least the next12 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 additional securitiesor need additional equity or debt financing and any additional financing may bedilutive to existing investors. There are currently no material understandings,commitments or agreements regarding the acquisition of other 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 economic conditionsin foreign markets. Our interest income is sensitive to changes in the generallevel of Canadian and U.S. interest rates, particularly since the majority ofour investments are in short-term instruments. Based on the nature of ourshort-term investments, we have concluded that there is no material interestrate risk exposure as of September 30, 2009. We are also subject tomarket risk exposure related to changes in interest rates on our non-revolving,reducing credit facility with The Bank of Montreal. Any changes in interestrates are not expected to be material. Fluctuations in interest rates arebeyond our control. We will continue to monitor and assess the risks associatedwith interest expense exposure and may take additional actions in the future tomitigate 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.

 

AtSeptember 30, 2009, the Company had forward exchange contracts to tradeU.S. dollars in exchange for Canadian dollars as follows:

 
| ** **                         | ** ** | **Notional**     | ** **       | **Weighted average** | ** ** | ** **     | ** ** |
|------------------------------------|------------|------------------|------------------|----------------------|------------|----------------|------------|
| ** **                         | ** ** | **amount of**    | ** **       | **exchange rate of** | ** ** | **Fair value** | ** ** |
| **Maturity date**                  | ** ** | **U.S. dollars** | ** **       | **U.S. dollars**     | ** ** | **gain**       | ** ** |
|                               |       |             |             |                 |       |           |       |
| October -  December 2009 |       | $                |  3,000,000  |                 | 0.8651     |           | $          |  245,924 |   |
| January -  March 2010    |       | 4,278,000        |             | 0.8297               |       | 547,750        |       |
| April -  June 2010       |       | 4,439,000        |             | 0.8328               |       | 549,508        |       |
| July -  September 2010   |       | 3,000,000        |             | 0.8034               |       | 494,324        |       |
| October -  December 2010 |       | 2,500,000        |             | 0.9032               |       | 89,969         |       |
| Total                              |       | $                |  17,217,000 |                 | 0.8369     |           | $          |  1,927,475 |   |

 

During the three months ended September 30, 2009, no new foreigncurrency contracts were entered into by the Company.

 

During October 2009, the Company entered into foreign exchangeforward contracts to hedge a portion of its 2010 fiscal year expected Canadiandollar requirements. These contracts have a notional value of$5.8 million, whereby $5.8 million is converted into Canadian dollarsduring 2010 at an average foreign exchange rate of US$1.00: Cdn$1.0617.

 

During October 2009, the Company entered into foreign exchangeforward contracts to hedge a portion of its 2011 fiscal year expected Canadiandollar requirements. These contracts have a notional value of$5.2 million, whereby $5.2 million is converted into Canadian dollarsduring 2011 at an average foreign exchange rate of US$1.00: Cdn$1.0669.

 

As we are notrequired to 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.

 

We have performeda sensitivity analysis model for foreign exchange exposure over the threemonths ended September 30, 2009. The analysis used a modelingtechnique that compares the U.S. dollar equivalent of all expenses incurred inCanadian dollars, at the actual exchange rate, to a hypothetical 10% adversemovement in the foreign currency exchange rates against the U.S. dollar, withall other variables held constant. Foreign currency exchange rates used werebased on the market rates in effect during the three months ended September 30, 2009.The sensitivity analysis indicated that a hypothetical 10% adverse movement inforeign currency exchange rates would result in a decrease in net income forthe 

 

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three months ended September 30, 2009of approximately $0.4 million. There can be no assurances that the aboveprojected exchange rate decrease will materialize. Fluctuations of exchangerates are beyond our control. We will continue to monitor and assess the riskassociated with these exposures and may take additional actions in the futureto hedge or mitigate these risks.

 

**Credit Risk**

 

Financial instruments that potentially subject us to concentrations ofcredit risk consist principally of cash equivalents, marketable securities,foreign exchange contracts and accounts receivable. Our cash, cash equivalentsand short-term investments are in high-quality securities placed with major banksand financial institutions whom we have evaluated as highly creditworthy andcommercial 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 assurancethat all control issues and instances of fraud, if any, within a company havebeen detected.

 

(b)           Change in Internal Control overFinancial Reporting

 

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

 

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**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, 2008, 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.

 

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

 

OnJuly 14, 2009, the Company announced that it successfully concluded asecond modified “Dutch auction tender offer” that was previously announced on May 26,2009. Under the terms of the offer, the Company repurchased an aggregate of1,103,824 shares of its common stock at a purchase price of $0.45 per share,for a total of $496,720.80, excluding transaction costs of $56,936. Thepurchase price was funded from available cash. Of the 1,103,824 shares purchased,1,000,000 were shares the Company offered to purchase in the offer and 103,824where shares purchased pursuant to the Company’s right to purchase up to anadditional 2% of the shares outstanding immediately prior to the commencementof the tender offer. Due to over-subscription, the final proration factor forshares tendered at or below $0.45 per share was approximately 99.8%. For thispurpose, shares tendered at $0.45 per share included shares tendered by thosepersons who indicated, in their letter of transmittal, that they were willingto accept the price determined in the offer. All shares purchased in the tenderoffer received the same price. As a result of the completion of the tenderoffer, as of July 14, 2009, the Company had 67,852,896 shares issued andoutstanding, as all shares repurchased were immediately retired.

 

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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:  November 13, 2009 |   | 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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