UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

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, 2006

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)

 

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)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x  No o

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

Large Accelerated Filer o

Accelerated Filer o

Non-Accelerated Filer x

 

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

As of November 8, 2006, there were 75,822,106 outstanding shares of common stock, no par value, of the registrant.

 

 

TUCOWS INC.
Form 10-Q Quarterly Report
INDEX

PART I
FINANCIAL INFORMATION

Item 1		Financial Statements		3
		Consolidated Balance Sheets as of September 30, 2006 (unaudited) and December 31, 2005		3
		Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2006 and 2005		4
		Consolidated Statements of Cash Flows (unaudited) for the three and nine months ended September 30, 2006 and 2005		5
		Notes to Consolidated Financial Statements		6
Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3		Quantitative and Qualitative Disclosures About Market Risk		26
Item 4		Controls and Procedures		26
		PART II OTHER INFORMATION		27
Item 1		Legal Proceedings		27
Item 1A		Risk Factors		27
Item 6		Exhibits		29
Signatures				29

 

 

PART I.
FINANCIAL INFORMATION

Item 1. Financial Statements

Tucows Inc.

Consolidated Balance Sheets

(Dollar amounts in U.S. dollars)

		September 30,			December 31,
		2006			2005
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	3,546,933		$	17,348,088
Short-term investments		—			1,771,569
Restricted cash		262,834			60,000
Interest receivable		—			39,574
Accounts receivable, net of allowance for doubtful accounts of $70,000 as of September 30, 2006 and $51,250 as of December 31, 2005		5,757,226			1,439,329
Prepaid expenses and deposits		2,297,150			1,999,820
Prepaid domain name registry and other Internet services fees, current portion		21,777,022			18,175,988
Deferred tax asset, current portion		1,000,000			1,000,000
Total current assets		34,641,165			41,834,368
Prepaid domain name registry and other Internet services fees, long-term portion		9,330,713			7,701,939
Deferred acquisition costs		—			46,034
Property and equipment		5,698,689			1,542,671
Deferred tax asset, long-term portion		2,000,000			2,000,000
Intangible assets		18,851,277			1,006,080
Goodwill (note 3)		11,977,086			1,951,067
Investment		353,737			353,737
Cash held in escrow (note 3(a))		801,725			621,412
Total assets		$	83,654,392		$	57,057,308
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable		$	2,595,011		$	1,655,195
Accrued liabilities		3,227,884			1,417,035
Customer deposits		2,851,428			2,276,637
Deferred revenue, current portion		31,522,474			26,790,166
Accreditation fees payable, current portion		504,966			651,811
Total current liabilities		40,701,763			32,790,844
Deferred revenue, long-term portion		13,213,970			11,079,537
Accreditation fees payable, long-term portion		152,197			94,785
Promissory note payable (note 3)		6,000,000			—
Deferred tax liability		5,396,000			—
Stockholders' equity
Preferred stock - no par value, 1,250,000 shares authorized; none issued and outstanding		—			—
Common stock - no par value, 250,000,000 shares authorized; 75,732,220 shares issued and outstanding as of September 30, 2006 and 71,945,303 shares issued and outstanding as of December 31, 2005		15,287,732			12,403,422
Additional paid-in capital		50,271,866			50,061,866
Deficit		(47,369,136		)	(49,373,146		)
Total stockholders' equity		18,190,462			13,092,142
Total liabilities and stockholders' equity		$	83,654,392		$	57,057,308

 

See accompanying notes to unaudited consolidated financial statements

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Tucows Inc.

Consolidated Statements of Operations

(Dollar amounts in U.S. dollars)

(unaudited)

		Three months ended September 30,						Nine months ended September 30,
		2006			2005			2006			2005
Net revenues		$	16,864,320		$	12,054,796		$	47,830,296		$	35,858,640
Cost of revenues:
Cost of revenues (*)		10,464,829			7,676,713			30,458,945			22,484,530
Depreciation of property and equipment		695,624			113,539			1,889,799			319,619
Amortization of intangible assets		66,550			19,290			143,628			57,870
Total cost of revenues		11,227,003			7,809,542			32,492,372			22,862,019
Gross profit		5,637,317			4,245,254			15,337,924			12,996,621
Operating expenses:
Sales and marketing (*)		1,706,951			1,150,674			4,738,397			3,669,185
Technical operations and development (*)		1,924,435			1,468,624			6,335,874			4,147,467
General and administrative (*)		1,698,012			820,860			4,265,529			3,358,347
Depreciation of property and equipment		43,025			99,883			125,116			412,546
Amortization of intangible assets		230,291			39,750			436,175			119,250
Total operating expenses		5,602,714			3,579,791			15,901,091			11,706,795
Income (loss) from operations		34,603			665,463			(563,167		)	1,289,826
Other income (expenses):
Interest income (expenses), net		(70,297		)	122,755			135,256			296,859
Other income		1,873,420			—			2,347,026			—
Total other income		1,803,123			122,755			2,482,282			296,859
Income before provision for income taxes		1,837,726			788,218			1,919,115			1,586,685
Recovery of income taxes		(96,895		)	—			(84,895		)	(151,975		)
Net income for the period		$	1,934,621		$	788,218		$	2,004,010		$	1,738,660
Basic earnings per common share		$	0.03		$	0.01		$	0.03		$	0.03
Shares used in computing basic earnings per common share		75,706,078			69,602,723			73,418,358			68,126,691
Diluted earnings per common share		$	0.02		$	0.01		$	0.03		$	0.02
Shares used in computing diluted earnings per common share		78,214,560			73,145,627			75,852,576			72,243,523
(*) Stock-based compensation has been included in expenses as follows:
Cost of revenues		$	2,200		$	—		$	7,700		$	—
Sales and marketing		$	23,200		$	—		$	79,200		$	—
Technical operations and development		$	14,800		$	—		$	50,800		$	—
General and administrative		$	21,300		$	—		$	72,300		$	—

 

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,
		2006			2005			2006			2005
Cash provided by (used in):
Operating activities:
Net income for the period		$	1,934,621		$	788,218		$	2,004,010		$	1,738,660
Items not involving cash:
Depreciation of property and equipment		738,649			213,422			2,014,915			732,165
Amortization of intangible assets		296,841			59,040			579,803			177,120
Unrealized change in the fair value of forward contracts		145,177			(290,177		)	(50,725		)	(182,549		)
Stock-based compensation		61,500			—			210,000			—
Change in non-cash operating working capital:
Interest receivable		5,027			(115,739		)	39,574			(115,739		)
Accounts receivable		(2,100,231		)	(91,828		)	(4,262,944		)	(251,805		)
Prepaid expenses and deposits		388,487			240,682			367,608			651,485
Prepaid domain name registry and other Internet services fees		(1,058,139		)	(535,643		)	(5,229,809		)	(3,373,252		)
Accounts payable		(2,213,494		)	292,579			857,048			231,866
Accrued liabilities		135,838			(269,556		)	1,202,952			(944,895		)
Customer deposits		6,534			31,497			574,791			(77,372		)
Deferred revenue		1,506,423			674,016			6,702,773			4,068,481
Accreditation fees payable		19,402			(204,296		)	(89,434		)	268,056
Cash (used in) provided by operating activities		(133,365		)	792,215			4,920,562			2,922,221
Financing activities:
Proceeds received on exercise of stock options		43,550			65,177			98,960			251,616
Net proceeds received on issuance of common stock, net of issue costs		—			2,024,025			—			1,574,675
Repayment of promissory note payable		(2,122,930		)	—			(2,122,930		)	—
Cash (used in) provided by financing activities		(2,079,380		)	2,089,202			(2,023,970		)	1,826,291
Investing activities:
Additions to property and equipment		(787,824		)	(301,604		)	(4,079,249		)	(1,127,681		)
Decrease (increase) in investment in short-term investments		—			—			1,771,569			(7,771,453		)
Decrease (increase) in restricted cash - being margin security against forward exchange contracts		159,623			(300,000		)	(202,835		)	160,398
Acquisition of Mailbank.com Inc., net of cash acquired		(655,830		)	—			(6,486,732		)	—
Acquisition of Hosted Messaging Assets, net of cash acquired		(1,037,303		)	—			(7,456,788		)	—
Acquisition of Boardtown Corporation, net of cash acquired		(22,700		)	—			(22,700		)	—
Decrease (increase) in cash held in escrow		1,563,999			(2,320		)	(221,012		)	390,568
Cash used in investing activities		(780,035		)	(603,924		)	(16,697,747		)	(8,348,168		)
(Decrease) increase in cash and cash equivalents		(2,992,780		)	2,277,493			(13,801,155		)	(3,599,656		)
Cash and cash equivalents, beginning of period		6,539,713			8,037,839			17,348,088			13,914,988
Cash and cash equivalents, end of period		$	3,546,933		$	10,315,332		$	3,546,933		$	10,315,332
Supplemental cash flow information:
Interest paid		$	—		$	—		$	—		$	300
Supplementary disclosure of non-cash investing and financing activities:
Common stock issued on the acquisition of Mailbank.com Inc.		$	—		$	—		$	2,877,070		$	—
Common stock issued on the acquisition of Boardtown Corporation		$	—		$	285,238		$	—		$	986,601
Promissory notes payable issued on the acquisition of Mailbank.com Inc.		$	—		$	—		$	8,122,930		$	—

 

See accompanying notes to unaudited consolidated financial statements

 

5

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. BUSINESS AND BASIS OF PRESENTATION:

Tucows Inc., a Pennsylvania corporation (referred to throughout this report as the “Company”, “Tucows”, “we”, “us” or through similar expressions), provides Internet services and downloadable software through a global network of service providers, including web hosting companies and other providers of services over the Internet. Tucows’ services include domain registration services, digital certificates, billing, provisioning and customer care software solutions, email and anti-spam services, blogware and website building tools.

The accompanying unaudited interim consolidated balance sheet, and the related consolidated statements of operations and cash flows reflect all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair presentation of the financial position of Tucows and its subsidiaries as at September 30, 2006 and the results of operations and cash flows for the interim periods ended September 30, 2006 and 2005.

The accompanying interim consolidated financial statements have been prepared by Tucows without audit, in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) and do not include all information and notes normally provided in annual financial statements. Except as outlined in note 2, these interim financial statements follow the same accounting policies and methods of application used in the annual financial statements and should be read in conjunction with the audited financial statements and notes thereto of Tucows for the year ended December 31, 2005 included in Tucows 2005 Annual Report on Form 10-K filed with the SEC on March 17, 2006.

Tucows considers investments in highly liquid instruments purchased with an original maturity of 90 days or less to be cash equivalents. Tucows maintains its cash balances in highly rated financial institutions. At times, such cash balances exceed the Federal Deposit Insurance Corporation limit.

Tucows’ short-term investments are invested in United States Treasury Bonds, Certificates of Deposit and Commercial Papers. These short-term investments are reported at amortized cost, while any accrued interest on these investments is included in interest income within Tucows’ Consolidated Statements of Operations, and in Accounts Receivable, on Tucows’ Consolidated Balance Sheets.

Certain comparative figures have been reclassified to conform with the current period’s presentation.

2. NEW ACCOUNTING POLICIES:

The following new accounting policy was adopted by Tucows in the nine months ended September 30, 2006:

Share-based payment:

On January 1, 2006, Tucows adopted the fair value-based method for measurement and cost recognition of employee share-based compensation arrangements under the provisions of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123R”), using the modified prospective application transitional approach. Previously, Tucows had elected to account for employee share-based compensation using the intrinsic value method based upon Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations. The intrinsic value method generally did not result in any compensation cost being recorded for employee stock options since the exercise price was equal to the market price of the underlying shares on the date of grant.

Under the modified prospective transitional approach, share-based compensation is recognized for awards granted, modified, repurchased or cancelled subsequent to the date of adoption of SFAS 123R. In addition, share-based compensation is recognized, subsequent to the date of adoption of SFAS 123R, for the remaining portion of unvested outstanding awards granted prior to the date of adoption. Prior periods have not been adjusted and Tucows continues to provide pro forma disclosure as if it had accounted for employee share-based payments in all periods prior to the adoption of SFAS 123R in accordance with the fair value provisions of SFAS No. 123, “Accounting for Stock-based Compensation”, which is presented below.

Tucows measures share-based compensation costs on the grant date, based on the calculated fair value of the award. Tucows has elected to treat awards with graded vesting as a single award when estimating fair value. Compensation cost is recognized on a straight-line basis over the employee requisite service period, which in Tucows’ circumstances is the stated vesting period of the award, provided that total compensation cost recognized at least equals the pro rata value of the award that has vested. Compensation cost is initially based on the estimated number of options for which the requisite service is expected to be rendered. This estimate is adjusted to the vesting date once actual forfeitures are known.

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Had Tucows adopted the fair value-based method for accounting for share-based compensation in all prior periods presented, the pro-forma impact on net income and net income per share would be as follows:

 

Refer to Note 8 “Share-Based Payments” in these condensed consolidated financial statements for details of stock options and share-based compensation cost recorded during the three and nine months ended September 30, 2006.

3. ACQUISITIONS

a.             Acquisition of the Hosted Messaging Assets from Critical Path Inc. :

On January 3, 2006, Tucows.com Co., one of Tucows’ wholly owned subsidiaries, completed the purchase of the Hosted Messaging Assets from Critical Path, Inc. for a purchase price of $6.25 million in cash. An additional $1.75 million of consideration was held in escrow, and is payable by Tucows, contingent on certain future customer orders being renewed through October 2006. During the three months ended September 30, 2006, $1,037,304 of the monies in escrow were released to Critical Path as certain customers renewed their contracts in terms of the escrow agreement, while $527,114 was released from escrow to Tucows as one of the renewing customers did not meet all of the contingent requirements. The term of the escrow for the amount of $185,582 remaining in escrow has been extended to November 21, 2006. This additional contingent consideration will be recorded when the amount becomes fixed and determinable and will be reflected as additional goodwill at that time.

The total aggregate consideration paid for the Hosted Messaging Assets amounted to $7,666,792, and is composed of:

·                  $6,250,000 paid in cash in January 2006

·                  $1,037,304 released from escrow in August 2006

·                  $379,488 of transaction costs.

The allocation of the fair value of the net assets acquired based on the consideration paid, is as follows:

 

During the three months ended June 30, 2006, goodwill was reduced by an amount of $163,969 to give effect to a pre-acquisition contingency that was settled during the period.

During the three months ended September 30, 2006, goodwill was increased by an amount of $1,037,304 as certain customers renewed their contracts in accordance with the escrow agreement established on acquisition.

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Intangible assets relate to acquired technology and customer relationships, and are being amortized over their respective useful lives of 2 and 5 years.

b.             Acquisition of Mailbank.com Inc. :

On June 19, 2006, Tucows (Delaware) Inc., one of Tucows’ wholly owned subsidiaries, acquired all of the issued and outstanding shares of Mailbank.com Inc. (doing business as NetIdentity) via merger. The total aggregate consideration, amounting to $18,022,161, is composed of:

·                  $6,085,305, paid in cash at closing, and $655,830, paid in cash subsequent to the closing date,

·                  $2,877,070, being the fair value of 3,596,337 shares of Tucows common stock (which amount does not take into account $95,000 of expenses associated with the issuance of shares),

·                  $6,000,000 unsecured promissory note due to the former shareholders of Mailbank.com Inc., repayable with accrued interest on June 19, 2008,

·                  $2,122,930 unsecured promissory note that was repaid to the former shareholders of Mailbank.com Inc., with accrued interest at the rate of 9% per annum, in full on August 19, 2006, and

·                  $186,026 of estimated transaction costs.

The promissory notes payable are both due to the former shareholders of Mailbank.com Inc.

The first unsecured promissory note is in the amount of $6,000,000 and bears simple interest at the rate of 7% per annum. The interest on the promissory note is payable quarterly in arrears, beginning October 1, 2006. The principal, together with any unpaid interest is payable on June 19, 2008. Tucows may prepay this promissory note in full or in part without any premium or penalty. This promissory note is shown as a non-current liability. The accrued interest payable as of September 30, 2006 amounting to $117,658 is included in accrued liabilities.

Mark Cuban, who on June 19, 2006 was an 8.5% shareholder of Tucows, was also a significant shareholder of Mailbank.com Inc., with holdings of approximately 22.8%. Rawleigh H. Ralls, IV, who on June 19, 2006 was a 1% shareholder of Tucows, held approximately 35.4% of Mailbank.com Inc. Both Mr. Cuban and Mr. Ralls were signatories to the Mailbank.com Inc. merger agreement and separately voted to approve the adoption of the merger, the merger agreement and other related transactions.

The allocation of the fair value of the net assets acquired based on the consideration paid, is as follows:

 

During the three months ended September 30, 2006, goodwill increased as a result of adjustments to working capital and intangible assets to reflect final audit and valuation reports. In addition, acquisition and share issuance expenses increased by $81,026.

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Intangible assets relate to acquired software technology and customer relationships, which are being amortized over their respective useful lives of 2 and 5 years, as well as to surname and direct navigation domain names, which have an indefinite life and as such are not being amortized.

c.             Acquisition of Boardtown Corporation :

During the three months ended September 30, 2006, goodwill was increased by an amount of $22,700, as certain customers renewed their support contracts in accordance with the escrow agreement established upon the closing of the Boardtown acquisition. As of September 30, 2006, a total of $570,354, inclusive of accrued interest remains in the Boardtown escrow account. Such remaining amount still has to be assessed for October 31, 2006 and April 30, 2007. Any additional amounts paid to the former shareholders of Boardtown Corporation for the October 31, 2006 assessment, will be effective October 31, 2006..

d.             Pro forma Results of Operations (unaudited) :

The results of the Hosted Messaging Assets from Critical Path, Inc. on January 3, 2006 and the results of Mailbank.com Inc. acquired on June 19, 2006 have been included in the consolidated statements of operations since their respective dates of acquisition. Unaudited pro forma results of operations for the three and nine months ended September 30, 2006 are included below. Such pro forma information assumes that the above acquisitions had occurred as of January 1, 2005 and is presented in accordance with our accounting policies. This summary is not necessarily indicative of what our results of operations would have been had the Hosted Messaging Assets from Critical Path, Inc. and Mailbank.com Inc. been combined entities during such periods, nor does it purport to represent results of operations for any future periods.

 

4. BASIC AND DILUTED EARNINGS PER COMMON SHARE:

The Company’s basic earnings per common share have been calculated by dividing net income by the weighted average number of common shares outstanding.

The diluted earnings per common share have been calculated using the weighted average number of common shares outstanding and potentially dilutive common shares outstanding during the periods. These potentially dilutive common shares outstanding are excluded from the computation of diluted earnings per common share if their effect is anti-dilutive.

5. OTHER INCOME:

In 2002, Tucows assigned to an unrelated third party (our “Partner”), various patents that Tucows acquired in its merger with Infonautics in 2001.  In connection with the assignment of these patents, Tucows retained the right to a revenue share relating to any cash flow received by its Partner relating to the commercialization of these patents.  On August 15, 2006, Tucows was informed by its Partner that it had assigned certain of these patents to another unrelated third party.  As a result of this assignment, during the three months ended September 30, 2006, Tucows recognized $1.9 million in other revenue. This amount was fully paid to Tucows on October 20, 2006.

In connection with the patents discussed above, during the nine months ended September 30, 2006, Tucows received $2.3 million from the assignment of the patents. Tucows does not expect to receive any additional revenue share from this arrangement in the future.

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6. SUPPLEMENTAL INFORMATION:

		Three months ended September 30,						Nine months ended September 30,
		2006			2005			2006			2005
		(unaudited)						(unaudited)
Revenue from :		$	15,576,585		$	11,330,963		$	44,623,865		$	33,432,161
Domain name and ancillary services		1,287,735			723,833			3,206,431			2,426,479
Advertising and other revenue		$	16,864,320		$	12,054,796		$	47,830,296		$	35,858,640

 

7. COMMITMENTS AND CONTINGENCIES:

As of September 30, 2006, we had outstanding foreign currency forward contracts with a notional value of $4.5 million, whereby $750,000 is converted into Canadian dollars on a semi-monthly basis from October 2006 to December 2006 at foreign exchange rates varying from U.S.$1:Cdn$1.1470 to U.S.$1:Cdn$1.1493. During the three months ended September 30, 2006, Tucows recorded a loss in fair value in respect of its foreign exchange forward contracts of $145,000 and during the nine months ended September 30, 2006 the Company recorded a gain on fair valuing its foreign exchange forward contracts of $51,000.

8. STOCKHOLDERS’ EQUITY:

The following unaudited table summarizes stockholders’ equity transactions for the period ended September 30, 2006:

													Total
							Additional						stockholders’
		Common stock					paid in						equity
		Number		Amount			capital			Deficit			(deficiency)
Balances, December 31, 2005		71,945,303		$	12,403,422		$	50,061,866		$	(49,373,146	)	$	13,092,142
Exercise of stock options		122,011		55,409			—			—			55,409
Acquisition of Boardtown Corporation		3,569		3,281			—			—			3,281
Acquisition of Mailbank.com Inc., net of share issuance costs		3,596,337		2,803,070			—			—			2,803,070
Stock-based compensation		—		—			148,500			—			148,500
Net income for the period		—		—			—			69,389			69,389
Balances, June 30, 2006		75,667,220		15,265,182			50,210,366			(49,303,757		)	16,171,791
Exercise of stock options		65,000		43,550			—			—			43,550
Acquisition of Mailbank.com Inc., net of share issuance costs		—		(21,000		)	—			—			(21,000		)
Stock-based compensation		—		—			61,500			—			61,500
Net income for the period		—		—			—			1,934,621			1,934,621
Balances, September 30, 2006		75,732,220		$	15,287,732		$	50,271,866		$	(47,369,136	)	$	18,190,462

 

9. SHARE-BASED PAYMENTS

Summary of Outstanding Stock Options

As of September 30, 2006, options to purchase an aggregate of 6,256,933 shares of common stock are outstanding under the Company’s 1996 Stock Option Plan. No further shares of common stock may be issued under this option plan. Stock options that have been issued under the 1996 Stock Option Plan generally vest over four years and expire ten years from the date of the grant. The exercise price of options granted is equivalent to the fair market value of the stock on the day prior to date of grant.

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A summary of unaudited option activity under the Company’s stock option plans for the three and nine months ended September 30, 2006 is as follows:

 

The Company estimates the fair value of stock options using the Black-Scholes option pricing model, consistent with the provisions of SFAS 123R and SEC Staff Accounting Bulletin No. 107. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, while the options issued by the Company are subject to both vesting and restrictions on transfer. In addition, option-pricing models require input of subjective assumptions including the estimated life of the option and the expected volatility of the underlying stock over the estimated life of the option. The Company uses historical volatility as a basis for projecting the expected volatility of the underlying stock and estimates the expected life of its stock options based upon historical data.

The Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair value of the Company’s stock option grants. Estimates of fair value are not intended, however, to predict actual future events or the value ultimately realized by employees who receive equity awards.

For the nine months ended September 30, 2006, the weighted-average fair value of options granted, as of the grant date, was $0.83, using the following weighted average assumptions: expected volatility of 121%; risk-free interest rate of 4.5%; expected dividend yield of 0%; and expected life of 6 years. 233,000 options were granted during the nine months ended September 30, 2006.

No options were granted during the three months ended September 30, 2006.

For the nine months ended September 30, 2005, the weighted-average fair value of options granted, as of the grant date, during the period was $0.69, using the following weighted-average assumptions: expected volatility of 122%; risk-free interest rate of 3.7%, expected dividend yield of 0%; and expected life of 4 years. 203,875 options were granted during the nine months ended September 30, 2005.

For the three months ended September 30, 2005, the weighted-average fair value of options granted, as of the grant date, during the period was $0.78, using the following weighted-average assumptions: expected volatility of 114%; risk-free interest rate of 4.1%, expected dividend yield of 0%; and expected life of 4 years. 7,500 options were granted during the three months ended September 30, 2005.

In each of the above periods, no cash was used by the Company to settle equity instruments granted under share-based compensation arrangements.

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The fair value of awards granted prior to January 1, 2006 is not adjusted to be consistent with the provision of SFAS 123R from the amounts disclosed previously, on a pro forma basis, in the notes to the audited consolidated financial statements in the Company’s Forms 10-Q or in the notes to the unaudited condensed consolidated financial statements in the Company’s Form 10-Q’s. Had the fair value of awards granted prior to January 1, 2006 been adjusted to account for forfeitures, the stock-based compensation expense, on a pro forma basis, would have been reduced by $5,500 for the three months ended September 30, 2005 and reduced by $23,100 for the nine months ended September 30, 2005. As of September 30, 2006, the total compensation cost related to unvested stock awards not yet recognized in the statement of operations was $458,000, before adjusting for estimated forfeitures, which will be recognized over a weighted average period of approximately 2.9 years.

Share-based compensation expense included in the statement of operations for the nine months ended September, 30, 2006 was $210,000, while share-based compensation expense included in the statement of operations for the three months ended September 30, 2006 was $61,500. The Company has not capitalized any share-based compensation expense as part of the cost of an asset. The impact of adoption of SFAS 123R, for the nine month period ended September 30, 2006, was a decrease in net income of $210,000, and for the three months ended September 30, 2006, a decrease in net income of $61,500. These amounts did not change basic and diluted income per share.

10. RECENT ACCOUNTING PRONOUNCEMENTS:

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes that a company should use a more-likely-than-not recognition threshold based on the technical merits of the tax position taken. Tax positions that meet the more-likely-than-not recognition threshold should be measured in order to determine the tax benefit to be recognized in the financial statements. FIN 48 is effective in fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of FIN 48 on its consolidated results of operations and financial condition.

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. The guidance requires public companies to quantify errors using both a balance sheet and income statement approach and evaluate whether either approach results in quantifying a misstatement as material, when all relevant quantitative and qualitative factors are considered. The guidance in SAB 108 is effective for the company beginning in the fourth quarter of 2006. The company is currently assessing the effect of adopting SAB 108, but does not expect that it will have a material effect on the company’s Consolidated Financial Statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (“SFAS 157”), “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. We are currently evaluating the impact of SFAS 157, but do not expect the adoption of SFAS 157 to have a material impact on our consolidated financial position, results of operations or cash flows.

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

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-Q constitute forward-looking statements.

These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. While we believe that we have a reasonable basis for each forward-looking statement contained in this Form 10-Q, we caution you that these statements are based on a combination of facts and factors currently known by us and projections of the future, about which we cannot be certain or even relatively certain. Many factors affect our ability to achieve our objectives and to successfully develop and commercialize our services including:

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

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

·                  The ability of vendors to continue to supply our needs;

·                  Actions by our competitors;

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

·                  Our ability to attract and retain qualified personnel in our business;

·                  Our ability to effectively manage our business;

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

·                  Pending or new litigation.

In addition, you should refer to the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 and the “Risk Factors” section of this Form 10-Q for a discussion of other factors that may cause our actual results to differ materially from those implied by our forward-looking statements. As a result of these factors, we cannot assure you that the forward-looking statements in this Form 10-Q will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, if at all.

You should read this Form 10-Q completely. In some cases, you can identify forward-looking statements by the following words: “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or the negative of these terms or other comparable terminology. All forward-looking statements included in this Form 10-Q are based on information available to us as of the date of this Form 10-Q, and we assume no obligation to update these cautionary statements or any forward-looking statements. These statements are not guarantees of future performance.

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

OVERVIEW

We provide Internet services and downloadable software through a global distribution network of more than 6,000 customers, or Service Providers, in more than 100 countries. We are an accredited registrar with the Internet Corporation for Assigned Names and Numbers, or ICANN, and we generate revenue primarily through the provision of domain registration and other Internet services to Service Providers who offer such services to their own customers in a process known as wholesale distribution

Our distribution network of Service Providers is comprised primarily of web hosting companies, Internet Service Providers, or ISPs, and providers of other services over the Internet. These Service Providers typically provide their customers, the end-users of the Internet, with a critical component to enable their use of the Internet. End-users typically consist of individuals and businesses ranging from small businesses to large corporations.

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Net Revenues

We generate net revenues primarily through the provision of domain registration and other Internet services. Additional revenue is generated from advertising and other services.

Domain registration and other Internet services

We generate revenues from the provision of Internet services on both a wholesale and retail basis. To date, the majority of net revenues have been derived from the sale of services provided as an accredited domain registrar. As of September 30, 2006, we offered registration services for the generic top-level domains, or gTLDs .com, .net, .org, .info, .name, .biz and .mobi and for the country code top-level domains, or ccTLDs .at, .be, .ca, .cc, .ch, .cn, ..de, .dk, .es, .eu, .fr, .it, .nl, .tv, .uk, .us and .vc.

We receive revenues for each domain registration or other Internet service processed through our system by Service Providers.

With respect to the sale of domain registrations, we earn registration fees in connection with each new, renewed and transferred-in registration and from providing provisioning services to Service Providers and registrars on a monthly basis. Domain registrations are generally purchased for terms of one to ten years. Payments for the full term of all services, or billed revenue, are received at the time of activation of service and where appropriate are recorded as deferred revenue and are recognized as earned ratably over the term of provision of service. This accounting treatment reasonably approximates a recognition pattern that corresponds with the provision of the services during the quarters and the year.

Other Internet services currently consist of the sale of expiring domain names and digital certificates, billing, provisioning and customer care software solutions, email and anti-spam services, blogware and website building tools which are used by our Service Providers to create bundles of Internet services for their end-users. We earn fees when a service is activated. Other Internet services are generally purchased for terms of one month to three years. Payments for domain registrations and other Internet services are for the full term of all services at the time of activation of service and where appropriate are recorded as deferred revenue and are recognized as earned ratably over the term of provision of service. This accounting treatment reasonably approximates a recognition pattern that corresponds with the provision of the services during the quarters and the year.

On a retail basis, we offer Internet services directly to end-users through our Domain Direct division. These services include domain registration and other Internet services such as email, personalized email through our portfolio of surname-based domain names, blogware, hosting and website creation. Depending on the service offered, Domain Direct receives standard fees for its services that are published on its website. In addition, Domain Direct offers referral commissions based on a percentage of net registration revenues to participants in its affiliate program.

Advertising and other revenue

We also generate advertising and other revenue through our online libraries of shareware, freeware and online services presented at our website, www.tucows.com, as well as from traffic and search sessions originating on our portfolio of domain names.

Our software libraries advertising revenue is generated from third-party advertisers and from software developers who rely on us as a primary source of distribution. Software developers use our Author Resource Center, or ARC, to submit their products for inclusion in our software libraries and to purchase promotional placement of their software in the library categories, as well as purchase other promotional services on a cost-per-click through or flat rate basis. Software developers are able to promote their software through advertising services including keyword search placements, banners, promotional placements, expedited reviews and premium data services. Revenue is also generated from companies who contract with us to provide them with co-branded content.

We offer pay-per-click advertising on the pages of certain domains within our domain name portfolio. When a user types one of these domain names into the command line of the browser (direct navigation), they are presented with dynamically generated links which are pay-per-click advertising. Every time a user clicks on one of the links listed on a web page, it generates revenue for us through our partnership with third-parties who provide syndicated pay-per-click results.

Advertising and other revenue is recognized ratably over the period in which it is presented.

Critical Accounting Policies

The following is a discussion of our critical accounting policies and methods. Critical accounting policies are defined as those that are both important to the portrayal of our financial condition and results of operations and are reflective of significant judgments and uncertainties made by management that may result in materially different results under different assumptions and conditions. Notes 1 and 2 to the unaudited consolidated financial statements for the three and nine months ended September  30, 2006 include further information on the significant accounting policies and methods used in the preparation of our consolidated financial statements.

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The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate the application of these estimates, including those related to the recoverability of investments, useful lives of intangible assets, valuation of goodwill, product development costs, revenue recognition and deferred revenue and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual amounts could differ significantly from these estimates.

Revenue recognition policy

We earn revenues from:

•         Domain registration fees on both a wholesale and retail basis and other Internet services; and

•         Advertising and other revenue.

With respect to the sale of domain registrations, we earn registration fees in connection with each new, renewed and transferred-in registration and from providing provisioning services to Service Providers and registrars on a monthly basis. We also enter into revenue arrangements in which a Service Provider may purchase a combination of services (multiple element arrangements). When fair value exists for all elements, we allocate revenue to each element based on the relative fair value of each of the elements. Fair value is established by the price charged when that element is sold separately. For arrangements where fair value exists only for the undelivered elements, we defer the full fair value of the undelivered elements and recognize the difference between the total arrangement fee and the amount deferred for the undelivered items as revenue, assuming all other criteria for revenue recognition have been met. Payments for the full term of all services, or billed revenue, are received at the time of activation of service and where appropriate are recorded as deferred revenue and are recognized as earned ratably over the term of provision of service. This accounting treatment reasonably approximates a recognition pattern that corresponds with the provision of the services during the quarters and the year.

We also generate advertising and other revenue through our online libraries of shareware, freeware and online services presented at our website, www.tucows.com as well as from traffic and search sessions originating on our portfolio of domain names. Advertising and other revenue is recognized ratably over the period in which it is presented. To the extent that the minimum number of impressions we guarantee to customers is not met, we defer recognition of the corresponding revenues until the guaranteed impressions are achieved.

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

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

We establish reserves for possible uncollectible accounts receivable and other contingent liabilities which may arise in the normal course of business. Historically, credit losses have been within our expectations and the reserves we have established have been appropriate. However, we have, on occasion, experienced issues which have led to accounts receivable not being fully collected. Should these issues occur more frequently, additional reserves may be required.

Product development costs

We account for the costs of computer software developed or obtained for internal use in accordance with the American Institute of Certified Public Accountants Statement of Position 98-1: Accounting for the Cost of Computer Software Developed or Obtained for Internal Use, as more fully described in Note 2 to our audited consolidated financial statements for the year ended December 31, 2005. Our policy on capitalizing internally developed software costs determines the timing of its recognition of certain development costs. In addition, this policy determines whether the cost is classified as development expense or depreciation of property and equipment. Management reassesses these judgments on an ongoing basis. Changes in management’s assessment could impact the recognition of development costs in our accounts.

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Valuation of intangible assets, goodwill and long-lived assets

Our business acquisitions typically result in goodwill and other intangible assets, which affect the amount of future period amortization expense and possible impairment expense that we may incur. The determination of the value of such intangible assets requires management to make estimates and assumptions that affect our consolidated financial statements. In addition to annual evaluation of the carrying value of goodwill, we review our identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that we consider important that could trigger an impairment review include the following:

•         a significant underperformance relative to expected historical or projected future operating results;

•         a significant change in the manner of our use of the acquired asset or the strategy for our overall business; or

•         a significant negative industry or economic trend.

When we determine that the carrying value of intangibles, long-lived assets or goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow model using a discount rate determined by management to be commensurate with the risk inherent in our current business model. Management will base its estimates in preparing the discounted cash flows on historical experience and on various other assumptions, including current market trends and developments, ongoing customer developments and general economic factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Accounting for income taxes

We account for income taxes under the asset and liability method in accordance with Statement of Financial Accounting Standards No. 109. Under the asset and liability method, we recognize deferred tax assets or liabilities for the anticipated future tax effects of temporary differences between the financial statement basis and the tax basis of our assets and liabilities. We record a valuation allowance to reduce the net deferred tax assets when it is more likely than not that the benefit from the deferred tax assets will not be realized. In assessing the need for a valuation allowance, historical and future levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies are considered. In the event that it is determined that the deferred tax assets to be realized in the future would be in excess of the net recorded amount, an adjustment to the deferred tax asset valuation allowance would be recorded. This adjustment would increase income in the period such determination was made. Likewise, should it be determined that all or part of a recorded net deferred tax asset would not be realized in the future, an adjustment to increase the deferred tax asset valuation allowance would be charged to income in the period such determination would be made.

On a periodic basis, we evaluate the probability that our deferred tax asset balance will be recovered to assess its realizability. To the extent we believe it is more likely than not that some portion of our deferred tax assets will not be realized, we will increase the valuation allowance against the deferred tax assets. Realization of our deferred tax assets is dependent primarily upon future taxable income. Our judgments regarding future profitability may change due to future market conditions, changes in U.S. or international tax laws and other factors. These changes, if any, may require possible material adjustments to these deferred tax assets, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made.

Accounting for stock based employee compensation

In accordance with SFAS 123R, we measure compensation cost for stock awards at fair value and recognize compensation over the vesting period. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards and historical experience. Actual results, and future changes in estimates, may differ substantially from our current estimates.

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RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AS COMPARED TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005

NET REVENUES

The following table presents our revenues, by revenue source, for the periods presented (unaudited):

		Three Months Ended						Nine Months Ended
		September 30,			September 30,			September 30,			September 30,
		2006			2005			2006			2005
Domain name and other Internet services:
Domain names, excluding Domain Direct		$	11,271,809		$	9,461,936		$	32,498,060		$	27,984,725
Other Internet services, including Domain Direct		4,304,777			1,869,027			12,125,805			5,447,436
Total domain name and other Internet services		15,576,586			11,330,963			44,623,865			33,432,161
Advertising and other revenue		1,287,734			723,833			3,206,431			2,426,479
		$	16,864,320		$	12,054,796		$	47,830,296		$	35,858,640
Increase over prior period		$	4,809,524					$	11,971,656
Increase - percentage		40		%				33		%

 

The following table presents our revenues, by revenue source, as a percentage of total revenues for the periods presented (unaudited):

		Three Months Ended				Nine Months Ended
		September 30,		September 30,		September 30,		September 30,
		2006		2005		2006		2005
Domain name and other Internet services:
Domain names, excluding Domain Direct		66.8	%	78.5	%	67.9	%	78.0	%
Other Internet services, including Domain Direct		25.5		15.5		25.4		15.2
Total domain name and other Internet services		92.4		94.0		93.3		93.2
Advertising and other revenue		7.6		6.0		6.7		6.8
		100.0	%	100.0	%	100.0	%	100.0	%

 

Total net revenues for the three months ended September 30, 2006 increased to $16.9 million from $12.1 million for the three months ended September 30, 2005.

Total net revenues for the nine months ended September 30, 2006 increased to $47.8 million from $35.9 million for the nine months ended September 30, 2005.

During the three and nine months ended September 30, 2006, no customer accounted for more than 10% of billed revenue, and one customer accounted for 12.6% of accounts receivable at September 30, 2006. Significant management judgment is required at the time of recording of revenue to assess whether the collection of the resulting receivables is reasonably assured. On an ongoing basis we assess the ability of our customers to make required payments. Based on this assessment, we expect the carrying amount of our outstanding receivables, net of allowance for doubtful accounts, to be fully collected. In addition, accounts receivable includes an amount of $1.9 million for certain patents assigned to an unrelated third party. This amount is reflected in other income in the statement of operations and was fully paid on October 20, 2006.

Domain name and other Internet services

Net revenues from domain name and other Internet services for the three months ended September 30, 2006 increased by $4.2 million, or 37.5%, to $15.6 million from $11.3 million for the three months ended September 30, 2005, primarily as a result of increased volumes from new and existing customers and the additional revenue we earned during the three months ended September 30, 2006 from the Hosted Messaging Assets we acquired from Critical Path in January 2006, which have been integrated into other Internet services revenue streams.

Net revenues from domain name and other Internet services for the nine months ended September 30, 2006 increased by $11.2 million, or 33.5%, to $44.6 million from $33.4 million for the nine months ended September 30, 2005, primarily as a result of increased volumes from new and existing customers and the additional revenue we earned during the nine months ended September 30, 2006 from the Hosted Messaging Assets we acquired from Critical Path in January 2006, which have been integrated into other Internet services revenue streams.

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During the three months ended September 30, 2006, the number of domain names that we processed increased by 214,000 to 1.2 million new, renewed and transferred-in domain name registrations, compared to the three months ended September 30, 2005. During the nine months ended September 30, 2006, the number of domain names that we processed increased by 733,000 to 3.7 million new, renewed and transferred-in domain name registrations, compared to the nine months ended September 30, 2005. These increases were due primarily to the fact that we continued to compete aggressively to attract new clients and retain existing customers in order to protect our current market share and improve our competitive position. These actions have resulted in our average selling price declining, which has partially offset the impact of the increased transaction volume on our revenue and profitability. We may face continued pricing pressure in order to remain competitive, which would adversely impact our revenues and profitability.

The renewal rate for domain name registrations increased to 73% for the three months ended September 30, 2006, compared to 70% for the three months ended September 30, 2005.

During the three months ended September 30, 2006, revenue from domain names, excluding Domain Direct, comprised 66.8% of total revenue, compared to 78.5% for the three months ended September 30, 2005, 67.6% for the three months ended June 30, 2006 and 78.7% for the three months ended June 30, 2005. During the nine months ended September 30, 2006, revenue from domain names, excluding Domain Direct, comprised 68.0% of total revenue, compared to 78.0% for the nine months ended September 30, 2005. This percentage decrease primarily resulted from the recognition of revenues from the newly acquired Hosted Messaging Assets. This resulted in revenue from other Internet services, including Domain Direct, increasing to 25.5% of total revenue for the three months ended September 30, 2006, compared to 15.5% for the three months ended September 30, 2005, 25.5% for the three months ended June 30, 2006 and 15.3% for the three months ended June 30, 2005. Revenue from other Internet services, including Domain Direct, increased to 25.3% of total revenue for the nine months ended September 30, 2006, compared to 15.2% for the nine months ended September 30, 2005.

While we anticipate that the number of new, renewed and transferred-in domain name registrations will incrementally increase, the volatility in the market could affect the growth of domain names under our management. As at September 30, 2006, the total number of domain names under our management increased by 1.0 million to 5.7 million, compared to the total number of domain names under our management as at September 30, 2005. As of September 30, 2006, we provided provisioning services to ten registrars on a monthly basis, which registrars use our technical systems to process domain registrations with their accreditation. As of September 30, 2006, we managed 1.8 million domain names for these ten registrars, compared to 850,000 for six registrars at September 30, 2005, on their behalf.

Deferred revenue from domain name registrations and other Internet services at September 30, 2006 increased to $44.7 million from $37.3 million at September 30, 2005.

Advertising and other revenue

Advertising and other revenue for the three months ended September 30, 2006 increased by $564,000, or 77.9%, to $1.3 million from $724,000 for the three months ended September 30, 2005, and increased by $780,000, or 32.1%, to $3.2 million from $2.4 million for the nine months ended September 30, 2005. This increase was primarily as a result of our delivery of third party advertisements on parked pages amounting to $468,000 for the three months ended September 30, 2006 and $695,000 for the nine months ended September 30, 2006.

During the three months ended September 30, 2006, revenue from advertising and other revenue comprised 7.6% of total revenue, compared to 6.0% for the three months ended September 30, 2005, 6.9% for the three months ended June 30, 2006 and 6.0% for the three months ended June 30, 2005. During the nine months ended September 30, 2006, revenue from advertising and other revenue comprised 6.7% of total revenue, compared to 6.8% for the nine months ended September 30, 2005. This percentage decrease was primarily the result of the significant redesign of our software download website that we undertook during the second quarter of 2005 and the increase in our other Internet services revenue during the nine months ended September 30, 2006.

 

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