UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q/A
(Amendment No. 1)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended March 31, 2007
	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 May 14, 2007, there were 74,750,742 outstanding shares of common stock, no par value, of the registrant.

 

EXPLANATORY NOTE

This Amendment No. 1 on Form 10-Q/A (“Amendment”) to the Tucows Inc. (the “Issuer”) Quarterly Report on Form 10-Q for the quarter ended March 31, 2007, filed with the Securities and Exchange Commission on May 15, 2007 (the “Form 10-Q”), is being filed solely to correct the following inadvertent errors: (1) the pro forma net revenues, net loss and basic loss per common share relating to the three months ended March 31, 2006 disclosed in the table in footnote 3(b) to the Notes to Unaudited Consolidated Financial Statements were misreported; (2) the required disclosure of the Issuers repurchase of its equity securities under Item 2 of Part II was omitted from the Form 10-Q; and (3) the certifications pursuant to 18 U.S.C. Section 1350 provided in Exhibits 32.1 and 32.2 were not currently dated.

Except for correcting the errors noted above, no information included in the Form 10-Q is amended by this Amendment.  This Amendment speaks only as of the date of the Form 10-Q and, except as noted above, we have not undertaken to amend, supplement or update any information contained in the Form 10-Q to give effect to subsequent events.  This Amendment amends and restates the Form 10-Q in its entirety.

 

TUCOWS INC.
Form 10-Q Quarterly Report
INDEX

PART I
FINANCIAL INFORMATION

 

2

 

PART I.
FINANCIAL INFORMATION

Item 1. Financial Statements

Tucows Inc.
Consolidated Balance Sheets
(Dollar amounts in U.S. dollars)

		March 31,			December 31,
		2007			2006
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	5,819,984		$	6,256,392
Restricted cash		767,785			1,019,423
Accounts receivable, net of allowance for doubtful accounts of $131,500 as of March 31, 2007 and $147,500 as of December 31, 2006		3,822,620			2,969,997
Prepaid expenses and deposits		3,121,863			2,394,627
Prepaid domain name registry and other Internet services fees, current portion		23,708,449			22,168,558
Deferred tax asset, current portion		1,000,000			1,000,000
Total current assets		38,240,701			35,808,997
Prepaid domain name registry and other Internet services fees, long-term portion		9,952,103			9,511,341
Property and equipment		6,740,768			5,647,532
Deferred tax asset, long-term portion		2,000,000			2,000,000
Intangible assets (note 4)		18,286,331			18,554,436
Goodwill (note 3)		12,184,867			12,094,817
Investment		353,737			353,737
Cash held in escrow (note 3(a))		—			694,579
Total assets		$	87,758,507		$	84,665,439
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	3,221,473		$	2,867,814
Accrued liabilities		2,999,362			2,567,012
Customer deposits		2,968,995			3,144,119
Deferred revenue, current portion		33,787,876			31,658,081
Accreditation fees payable, current portion		841,928			847,325
Total current liabilities		43,819,634			41,084,351
Deferred revenue, long-term portion		14,245,655			13,478,525
Accreditation fees payable, long-term portion		168,677			163,988
Promissory note payable (note 3)		6,000,000			6,000,000
Deferred tax liability (note 3(b))		5,396,000			5,396,000
Stockholders’ equity (note 9)
Preferred stock - no par value, 1,250,000 shares authorized; none issued and outstanding		—			—
Common stock - no par value, 250,000,000 shares authorized; 74,713,234 shares issued and outstanding as of March 31, 2007 and 75,978,502 shares issued and outstanding as of December 31, 2006		15,282,470			15,395,381
Additional paid-in capital		49,309,088			50,359,906
Deficit		(46,463,017		)	(47,212,712		)
Total stockholders’ equity		18,128,541			18,542,575
Total liabilities and stockholders’ equity		$	87,758,507		$	84,665,439

 

See accompanying notes to unaudited consolidated financial statements

3

 

Tucows Inc.
Consolidated Statements of Operations
(Dollar amounts in U.S. dollars)
(unaudited)

		Three months ended March 31,
		2007			2006
Net revenues		$	17,771,217		$	15,287,120
Cost of revenues:
Cost of revenues (*)		11,232,789			9,927,854
Depreciation of property and equipment		809,666			524,919
Amortization of intangible assets		63,532			38,540
Total cost of revenues		12,105,987			10,491,313
Gross profit		5,665,230			4,795,807
		`
Expenses:
Sales and marketing (*)		1,344,444			1,459,156
Technical operations and development (*)		1,812,279			2,320,716
General and administrative (*)		1,498,769			1,619,053
Depreciation of property and equipment		61,524			37,050
Amortization of intangible assets		233,301			93,293
Total expenses		4,950,317			5,529,268
Income (loss) from operations		714,913			(733,461		)
Other income (expenses):
Interest income (expense), net		(41,649		)	102,891
Other income, net (note 6)		88,431			473,606
Total other income		46,782			576,497
Income (loss) before provision for income taxes		761,695			(156,964		)
Provision for income taxes		12,000			—
Net income (loss) for the period		$	749,695		$	(156,964	)
Basic earnings per common share		$	0.01		$	0.00
Shares used in computing basic earnings per common share		75,459,822			71,980,393
Diluted earnings per common share		$	0.01		$	0.00
Shares used in computing diluted earnings per common share		77,959,165			71,980,393
(*) Stock-based compensation has been included in operating expenses as follows:
Cost of revenues		$	2,500		$	2,400
Sales and marketing		$	14,200		$	17,400
Technical operations and development		$	20,100		$	23,700
General and administrative		$	25,900		$	26,700

 

See accompanying notes to unaudited consolidated financial statements

4

Tucows Inc.

Consolidated Statements of Cash Flows

(Dollar amounts in U.S. dollars)

(unaudited)

		Three months ended March 31,
		2007			2006
Cash provided by (used in):
Operating activities:
Net income (loss) for the period		$	749,695		$	(156,964	)
Items not involving cash:
Depreciation of property and equipment		871,190			561,969
Amortization of intangible assets		296,833			131,833
Unrealized change in the fair value of forward contracts		(216,789		)	182,944
Stock-based compensation		62,700			70,200
Change in non-cash operating working capital:
Interest receivable		—			37,594
Accounts receivable		(852,623		)	(1,827,642		)
Prepaid expenses and deposits		(727,236		)	3,413
Prepaid domain name registry and other Internet services fees		(1,980,653		)	(2,313,048		)
Accounts payable		(408,137		)	492,667
Accrued liabilities		649,139			1,327,080
Customer deposits		(175,124		)	147,834
Deferred revenue		2,896,925			3,044,520
Accreditation fees payable		(708		)	131,264
Cash provided by operating activities		1,165,212			1,833,664
Financing activities:
Proceeds received on exercise of stock options		101,071			28,009
Repurchase of shares		(1,327,500		)	—
Cash (used in) provided by financing activities		(1,226,429		)	28,009
Investing activities:
Cost of domain names acquired		(28,728		)	—
Additions to property and equipment		(1,202,630		)	(886,279		)
Decrease in investment in short-term investments		—			1,699,569
Decrease (increase) in restricted cash - being margin security against forward exchange contracts		251,638			(552,500		)
Acquisition of Hosted Messaging Assets, net of cash acquired		(90,050		)	(6,583,454		)
Decrease (increase) in cash held in escrow		694,579			(1,766,504		)
Cash used in investing activities		(375,191		)	(8,089,168		)
Decrease in cash and cash equivalents		(436,408		)	(6,227,495		)
Cash and cash equivalents, beginning of period		6,256,392			17,348,088
Cash and cash equivalents, end of period		$	5,819,984		$	11,120,593
Supplemental cash flow information:
Interest paid		$	105,000		$	—
Non-cash investing activity:
Capital assets acquired during during the period not yet paid for		$	1,146,066		$	—
Dividend receivable		$	88,431		$	—

 

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), together with its consolidated subsidiaries, seeks to make the Internet easier and more effective for Internet users and to reduce complexity for its customers as they acquire, deliver or use Internet services.

Our principle source for distributing Internet services is our global network of over 7,000 hosting companies, Internet Service Providers, or ISPs, and other providers of Internet services, collectively referred to as Service Providers. Service Providers play a critical role in connecting users to the Internet as they interact with individuals and businesses ranging from small business to large corporations. Our wholesale product offerings and our outsourced service management capability allows us to offer Service Providers innovative value-added services that allow these Service Providers to focus their time and resources on customer acquisition and retention while still being able to enhance per customer revenue by offering additional services along with their core services.

In addition to other Internet services, we provision millions of email boxes and manage over 7 million domains. We also have one of the most popular download sites on the Internet, where we connect advertisers to a global audience of Internet users.

We were among the first group of 34 registrars to be accredited by the Internet Corporation for Assigned Names and Numbers (ICANN) in 1999. ICANN maintains a list of accredited registrars at www.icann.org /registrars/accredited-list.html.

We were incorporated under the laws of the Commonwealth of Pennsylvania in November 1992 under the name Infonautics, Inc. In August 2001, we completed our acquisition of Tucows Inc., a Delaware corporation, and we changed our name from Infonautics, Inc. to Tucows Inc. Our principal executive offices are located in Toronto, Ontario and we have offices in Europe and the United States.

2. NEW ACCOUNTING POLICIES:

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 March 31, 2007 and the results of operations and cash flows for the interim periods ended March 31, 2007 and 2006. The results of operations presented in this Quarterly Report on Form 10-Q are not necessarily indicative of the results of operations that may be expected for future periods.

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”). Certain information and footnote disclosure normally included in the Company’s annual audited consolidated financial statements and accompanying notes have been condensed or omitted. These interim financial statements and accompanying notes 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, 2006 included in Tucows 2006 Annual Report on Form 10-K filed with the SEC on March 29, 2007.

Other than the adoption of FIN 48 described below, there have been no material changes in our significant accounting policies during the three months ended March 31, 2007 as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

Reclassification

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

Recent Accounting Pronouncements Adopted

In June 2006, the FASB ratified the consensus reached on Emerging Issues Task Force (EITF) Issue No. 06-03, “How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income

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Statement (that is, Gross Versus Net Presentation)” (EITF 06-03). The EITF reached a consensus that the presentation of taxes on either a gross or net basis is an accounting policy decision that requires disclosure. EITF 06-03 is effective for the first interim or annual reporting period beginning after December 15, 2006. Tucows adopted EITF 06-03 on January 1, 2007. Any amounts we collect, which under common trade practices are referred to as sales taxes, are and have been recorded on a net basis. The Company has no intention of modifying this accounting policy; therefore, the adoption of EITF 06-03 does not have any effect on the Company’s financial position or results of operations.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an income tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for the first interim or annual reporting period beginning after December 15, 2006. The implementation of FIN 48 had no impact on Tucows opening deficit.

Tucows has approximately $180,000 of total gross unrecognized benefits as of the adoption of FIN 48 on January 1, 2007 which if recognized would favorably affect the income tax rate in future periods. Tucows recognizes accrued interest and penalties related to unrecognized tax benefit in tax expense. Tucows does not have any interest and penalties accrued as of January 1, 2007 and March 31, 2007 as the tax benefit relates entirely to refundable tax credits. Tucows does not expect that any of the unrecognized tax benefit will decrease in the next twelve months. Generally, all tax years are open for examination by the major taxing jurisdictions to which the Company is subject including federal, state and foreign jurisdictions.

3. ACQUISITIONS

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

To expand our presence in the email market, on January 3, 2006, Tucows.com Co., one of the Company’s wholly owned subsidiaries, completed the purchase of all of the Hosted Messaging Assets from Critical Path, Inc.

In January 2007, an amount of $90,050 was released from escrow and paid to Critical Path. This amount was reflected as additional goodwill. Critical Path’s portion of the $50,019 interest earned on the escrow account to date amounted to $36,433 and was paid to them in January 2007.

b.             Acquisition of Mailbank.com Inc.:

The results of Mailbank.com Inc. acquired on June 19, 2006 have been included in the consolidated statements of operations since its date of acquisition. Unaudited pro forma results of operations for the three months ended March 31, 2006 are included below. Such pro forma information assumes that the above acquisition had occurred as of January 1, 2006 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 Mailbank.com Inc. been a combined entity during such period, nor does it purport to represent results of operations for any future periods.

 

c.             Acquisition of Boardtown Corporation:

On April 27, 2004, the Company finalized the acquisition of 100% of the outstanding capital stock of Boardtown Corporation (“Boardtown”).

In March 2007, the former shareholders of Boardtown agreed to an early release of the remaining $554,510 contingent consideration, inclusive of accrued interest, from the Boardtown escrow account to Tucows. The Company has agreed with the former shareholders that, to the extent that the performance milestones pertaining to renewing or converting potential support customers are met by April 27, 2007, this additional consideration will be paid to the former shareholders of Boardtown Corporation directly by Tucows, and its fair value will be recorded as additional goodwill at the time when the obligation becomes determinable. In May 2007, Tucows determined that an amount of $4,900 was payable.

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4. INTANGIBLE ASSETS:

Intangible assets consist of acquired technology, brand, customer relationships, non-competition agreements, surname domain names and direct navigation domain names. These balances, with the exception of the surname and direct navigation domain names that have been determined to have an indefinite life, are being amortized on a straight-line basis over the term of the intangible assets, as reflected in the table below.

Acquired intangible assets consist of the following:

		Technology			Brand			Customer relationships			Non-compete agreements			Surname domain names			Direct navigation domain names			Total
Amortization period		2 - 7 years			7 years			4 - 7 years			3 years			indefinite life			indefinite life
Net book value, December 31, 2006		$	558,352		$	105,040		$	3,669,924		$	21,120		$	12,100,000		$	2,100,000		$	18,554,436
Purchase of domain names		—			—			—			—			29,048			—			29,048
Disposition of domain names		—			—			—			—			(320		)	—			(320		)
Amortization expense		(63,532		)	(6,060		)	(211,401		)	(15,840		)	—			—			(296,833		)
Net book value, March 31, 2007		$	494,820		$	98,980		$	3,458,523		$	5,280		$	12,128,728		$	2,100,000		$	18,286,331

 

5. BASIC AND DILUTED EARNINGS PER COMMON SHARE:

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

The diluted earnings (loss) per common share have been calculated using the weighted average number of common shares outstanding and potentially dilutive common shares outstanding during the periods. Options to purchase 710,693 shares of common stock were outstanding during the three months ended March 31, 2007 (during the three months ended March 31, 2006, options to purchase 266,347 shares of common stock were outstanding) but were not included in the computation of diluted income per common share because the options’ exercise price was greater than the average market price of the common shares.

6. OTHER INCOME:

During the three months ended March 31, 2007, Tucows accrued a dividend declared by Afilias, Inc. in the amount of $88,000. This was the first dividend received from Afilias, Inc.

7. SUPPLEMENTAL INFORMATION:

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

 

 

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

 

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

 

8. COMMITMENTS AND CONTINGENCIES:

As of March 31, 2007, we had outstanding foreign currency forward contracts with a notional value of $15.3 million, whereby $850,000 is converted into Canadian dollars on a semi-monthly basis from April 2007 to December 2007 at foreign exchange rates varying from U.S.$1:Cdn$1.1250 to U.S.$1:Cdn$1.1362. During the three months ended March 31, 2007, Tucows recorded a gain in fair value in respect of its foreign exchange forward contracts, in the amount of $217,000. This amount has been recorded in the general and administrative expense.

9. STOCKHOLDERS’ EQUITY:

The following unaudited table summarizes stockholders’ equity transactions for the period ended March 31, 2007:

		Common stock					Additional paid in						Total stockholders’
		Number		Amount			capital			Deficit			equity
Balances, December 31, 2006		75,978,502		$	15,395,381		$	50,359,906		$	(47,212,712	)	$	18,542,575
Exercise of stock options		234,732		187,089			(86,018		)	—			101,071
Repurchase of shares		(1,500,000	)	(300,000		)	(1,027,500		)	—			(1,327,500		)
Stock-based compensation (note 10)		—		—			62,700			—			62,700
Net income for the period		—		—			—			749,695			749,695
Balances, March 31, 2007		74,713,234		$	15,282,470		$	49,309,088		$	(46,463,017	)	$	18,128,541

 

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The following unaudited table summarizes stockholders’ equity transactions for the period ended March 31, 2006:

 

		Common stock					Additional paid in						Total Stockholders’ 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		65,301		28,009			—			—			28,009
Acquisition of Boardtown Corporation		3,569		3,281			—			—			3,281
Stock-based compensation		—		—			70,200			—			70,200
Net loss for the period		—		—			—			17,400			17,400
Balances, March 31, 2006		72,014,173		$	12,434,712		$	50,132,066		$	(49,355,746	)	$	13,211,032

 

10. SHARE-BASED PAYMENTS

Valuation method:

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.

No cash is used by the Company to settle equity instruments granted under share-based compensation arrangements.

Summary of Outstanding Stock Options:

(a)            1996 Stock Options Plan

As of March 31, 2007, options to purchase an aggregate of 5,515,982 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.

A summary of unaudited option activity under the Company’s 1996 Stock Option Plan for the three months ended March 31, 2007 is as follows:

 

Total unrecognized compensation cost relating to unvested stock options at March 31, 2007, prior to the consideration of expected forfeitures, is approximately $297,000 and is expected to be recognized over a weighted average

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period of 2.6 years

For the three months ended March 31, 2006, the weighted-average fair value of options granted, as of the grant date, during the period 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 four years. 233,000 options were granted during the three months ended March 31, 2006.

(b)           2006 Equity Compensation Plan

As of March 31, 2007, options to purchase an aggregate of 1,451,500 shares of common stock are outstanding under the Company’s 2006 Equity Compensation Plan. Stock options that have been issued under the 2006 Equity Compensation Plan vest over four years and expire seven 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 of grant.

A summary of unaudited option activity under the Company’s 2006 Equity Compensation Plan for the three months ended March 31, 2007 is as follows:

 

Total unrecognized compensation cost relating to unvested stock options at March 31, 2007, prior to the consideration of expected forfeitures, is approximately $791,000 and is expected to be recognized over a weighted average period of 4.7 years

For the three months ended March 31, 2007, the weighted-average fair value of options granted, as of the grant date, during the period was $0.58, using the following weighted-average assumptions: expected volatility of 85%; risk-free interest rate of 4.5%, expected dividend yield of 0%; and expected life of 4.75 years. A total of 1,402,500 options were granted during the three months ended March 31, 2007.

No options were granted during the three months ended March 31, 2006.

(c)            Share-based compensation expense included in the Statement of Operations for the three months ended March, 31, 2007 was $62,700 while share-based compensation expense included in the Statement of Operations for the three months ended March 31, 2006 was $70,200. The Company has not capitalized any share-based compensation expense as part of the cost of an asset.

 

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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, 2006 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 7,000 customers, or Service Providers, in more than 100 countries. We are an accredited registrar 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

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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.

Net Revenues

We generate net revenues primarily through the provision of domain registration and other Internet services. Additional revenue is generated from the sale of domain names and 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 has been derived from the sale of services provided as an accredited domain registrar. As of March 31, 2007, 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, digital certificates, billing, provisioning and customer care software solutions, hosted 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.

Domain name sales

We also generate revenue from the sale of domain names held in our portfolio of generic and surname domains. These names are included as intangible assets on our balance sheet.

 In evaluating these names for sale, we consider the potential foregone revenue from pay-per-click advertising as well as other factors. The name will be offered for sale if based on this evaluation the name is deemed non essential to our business, and management believes that the proceeds from this sale is strategically more beneficial to the Company. The cost of these names is included as intangible assets with indefinite lives on our consolidated balance sheet.

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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

In preparing our consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on amounts reported in our consolidated financial statements. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making estimates about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from these estimates under different assumptions or conditions.

Other than the adoption of EITF 06-03 and FIN 48 during the three months ended March 31, 2007, there have been no significant changes in our critical accounting estimates during the three months ended March 31, 2007 as compared to the critical accounting estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2006. As a result of the adoption of FIN 48 on January 1, 2007, we had approximately $180,000 of total gross unrecognized benefits which, if recognized, would favorably affect the income tax rate in future periods. We recognize accrued interest and penalties related to unrecognized tax benefit in tax expense. We did  not have any interest and penalties accrued as of January 1, 2007 and March 31, 2007 as the tax benefit relates entirely to refundable tax credits. We do not expect that any of the unrecognized tax benefit will decrease in the next twelve months.

 

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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2007 AS COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2006

NET REVENUES

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

		Three months ended March 31,
		2007			2006
Domain name and other Internet services:
Domain names, excluding Domain Direct		11,900,694			10,666,788
Other Internet services, including Domain Direct		4,399,963			3,776,324
Sale of domain names		82,500			—
Total domain name and other Internet services		16,383,157			14,443,112
Advertising and other revenue		1,388,060			844,008
		$	17,771,217		15,287,120
Increase over prior period		$	2,484,097
Increase - percentage		16		%

 

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

 

Total net revenues for the three months ended March31, 2007 increased to $17.8 million from $15.3 million for the three months ended March 31, 2006.

During the three months ended March 31, 2007, no customer accounted for more than 10% of billed revenue, and no customer accounted for more that 10% of accounts receivable at March 31, 2007. 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.

Domain name and other Internet services

Net revenues from domain name and other Internet services for the three months ended March 31, 2007 increased by $2.0 million, or 13.4%, to $16.4 million from $14.4 million for the three months ended March 31, 2006, primarily as a result of increased volumes from new and existing customers and the additional revenue we earned during the three months ended March 31, 2007 from the acquisition of the name-based domain assets from Mailbank.com, Inc. in June 2006.

During the three months ended March 31, 2007, the number of domain names that we processed increased by 171,000 to 1.3 million new, renewed and transferred-in domain name registrations, compared to the three months ended March 31, 2006. 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 March 31, 2007, compared to 72% for the three months ended March 31, 2006.

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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 March 31, 2007, the total number of domain names under our management increased by 1.1 million to 6.2 million, compared to the total number of domain names under our management as at March 31, 2006. As of March 31, 2007, 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 March 31, 2007, we managed 1.9 million domain names for these ten registrars, compared to 942,000 for five registrars at March 31, 2006, on their behalf.

Deferred revenue from domain name registrations and other Internet services at March 31, 2007 increased to $48.0 million from $41.1 million at March 31, 2006.

Advertising and other revenue

Advertising and other revenue for the three months ended March 31, 2007 increased by $544,000, or 64.5%, to $1.4 million from $844,000 for the three months ended March 31, 2006. This increase was primarily as a result of our delivery of third party advertisements on parked pages amounting to $528,000 for the three months ended March 31, 2007 compared to $53,000 for the three months ended March 31, 2006.

During the three months ended March 31, 2007, revenue from advertising and other revenue comprised 7.8% of total revenue, compared to 5.5% for the three months ended March 31, 2006. This percentage increase was primarily the result of our delivery of third party advertisements on parked pages as mentioned above.

COST OF REVENUES

Cost of revenues includes the costs associated with providing domain registration, other Internet services, the costs of domain name sales, advertising and other revenue and network costs.

Cost of revenues for domain registrations represents the amortization of registry fees on a basis consistent with the recognition of revenues from our customers, namely ratably over the term of provision of the service. Registry fees, the primary component of cost of revenues, are paid in full when the domain is registered, and are recorded as prepaid domain registry fees.

Costs of revenues for other Internet services, includes the cost incurred for the renewal of surname domain names and any impairment charges that may arise from our assessment of the domain name intangible assets as well as fees paid to third-party service providers. Fees paid to third-party service providers and renewal fees are recognized ratably over the periods in which the services are provided.

Cost of revenues for the sale of domain names includes the value ascribed to it under intangible assets and is expensed as cost of revenues at the time of the sale.

Cost of revenues for advertising and other revenues, includes the renewal cost of domain names in our portfolio of generic domain names, which are amortized ratably over the term of provision of the renewal, as well as any impairment charges that may arise from our assessment of the domain name intangible assets. These cost of revenues are not likely to be material in relation to advertising and other revenues earned, thus any increase or decrease in advertising and other revenue will impact our gross profit by approximately the same amount.

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

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

		Three months ended March 31,
		2007			2006
Domain name and other Internet services:
Domain names, excluding Domain Direct		8,781,899			7,674,802
Other Internet services, including Domain Direct		1,014,705			932,149
Sale of domain names		320			—
Advertising and other revenue		52,334			—
Total domain name and other Internet services		9,849,258			8,606,951
Network, other costs		1,383,531			1,320,903
Network, depreciation and amortization costs		873,198			563,459
		$	12,105,987		10,491,313
Increase over prior period		$	1,614,674
Increase - percentage		15		%

 

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

		Three months ended  March 31,
		2007			2006
Domain name and other Internet services:
Domain names, excluding Domain Direct		72.6		%	73.1	%
Other Internet services, including Domain Direct		8.4		%	8.9	%
Sale of domain names		0.0		%	0.0	%
Advertising and other revenue		0.4		%	0.0	%
Total domain name and other Internet services		81.4		%	82.0	%
Network, other costs		11.4		%	12.6	%
Network, depreciation and amortization costs		7.2		%	5.4	%
		$	100.0	%	100.0	%

 

Cost of revenues for the three months ended March 31, 2007 increased to $12.1 million from $10.5 million for the three months ended March 31, 2006, primarily as a result of higher costs attributable to higher volumes of domain registrations and other Internet services of $1.2 million and an increase in network costs of $372,000. The increase in network costs was primarily a result of the additional labor, bandwidth and co-location costs required to manage the data centers of $628,000, depreciation of additional information technology assets acquired or purchased of $285,000 and additional amortization of $25,000 resulting from acquisitions.

These increases were offset in part by a reversal in March 2007 of a contingency of $220,000 that was accrued for a planned network operation initiative that the Company did not pursue. As the relevant statute of limitations covering this initiative has expired, this accrual is no longer required.  In addition, transitional costs incurred during the three months ended March 31, 2006 in the amount of $340,000 as a result of the acquisition of the Hosted Messaging Assets of Critical Path Inc. were not incurred during the three months ended March 31, 2007.

Registry fees, the primary component of cost of revenues, are paid in full when the domain is registered. Registry fees are recorded as prepaid domain registry fees and are recognized ratably over the term of provision of the service. Other Internet service costs and ICANN accreditation transaction fees are generally paid either monthly or quarterly. Services provided over periods longer than one month are recognized ratably over the term of provision of the service.

Prepaid domain registration and other Internet services fees at March 31, 2007 increased by $5.5 million, to approximately $33.7 million from $28.2 million at March 31, 2006.

We anticipate that cost of revenues will continue to increase in absolute dollars primarily as a result of continued growth in domain registration and other Internet services and as our network activity increases.

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SALES AND MARKETING

Sales and marketing expenses consist primarily of personnel costs. These costs include commissions and related expenses of our sales, product management, public relations, call center, support and marketing personnel. Other sales and marketing expenses include customer acquisition costs, advertising and other promotional costs.

		Three months ended March 31,
		2007			2006
Sales and marketing		$	1,344,444		$	1,459,156
Decrease over prior period		$	(114,712	)
Decrease - percentage		(8		)%
Percentage of net revenues		8		%	10		%

 

Sales and marketing expenses during the three months ended March 31, 2007 decreased to $1.3 million compared to $1.5 million during the three months ended March 31, 2006.

This decrease was primarily the result of the reversal of a contingency of $138,000 that was accrued for certain marketing initiatives that the Company did not persue. As the relevant statute of limitations covering these initiatives has expired, this accrual is no longer required. In addition, transitional costs incurred during the three months ended March 31, 2006 in the amount of $33,000, as a result of the acquisition of the Hosted Messaging Assets of Critical Path Inc., were not incurred during the three months ended March 31, 2007. Travel and other selling expenses also decreased by approximately $93,000 when compared to the same quarter last year. These decreases were partly offset by additional people costs of $149,000, predominantly in customer service and marketing as we continue to invest in customer service improvements.

We believe that sales and marketing expenses will continue to increase, in absolute dollars, as we adjust our marketing programs and sales strategies to meet future opportunities in the marketplace.

TECHNICAL OPERATIONS AND DEVELOPMENT

Technical operations and development expenses consist primarily of personnel costs and related expenses required to support the development of new or enhanced service offerings and the maintenance and upgrading of existing infrastructure. This includes expenses incurred in the research, design and development of technology that we use to register domain names and other Internet services and to distribute our digital content services. Editorial costs relating to the rating and review of the software content libraries are included in the costs of product development. In accordance with the American Institute of Certified Public Accountants Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, costs incurred during the application development stage are capitalized and primarily include personnel costs for employees directly related to the development project. All other costs are expensed as incurred.

		Three months ended March 31,
		2007			2006
Technical operations and development		$	1,812,279		$	2,320,716
Decrease over prior period		$	(508,437	)
Decrease - percentage		(22		)%
Percentage of net revenues		10		%	15		%

 

Technical operations and development expenses for the three months ended March 31, 2007 decreased by $508,000 to $1.8 million compared to $2.3 million during the three months ended March 31, 2006.

This decrease was primarily the result of our not incurring transitional costs relating to the acquisition of the Hosted Messaging Assets of Critical Path Inc. during the three months ended March 31, 2007 compared to $390,000 during the three months ended March 31, 2006. In addition, as a result of steps we took to streamline our operations in Flint, Michigan, people-related costs, including contract and outside service costs, decreased by approximately $93,000. Capitalized personnel costs for employees directly related to the application development stage of development projects increased by $3,000 to $32,000, compared to the three months ended March 31, 2006, which also contributed to the decrease in technical operations and development expenses for the three months ended March 31, 2007.

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We expect technical operations and development expenses to increase slightly, in absolute dollars, going forward as our business continues to grow and as we further develop our applications and services.

GENERAL AND ADMINISTRATIVE

General and administrative expenses consist primarily of compensation and related costs for managerial and administrative personnel, fees for professional services, public listing expenses, rent and other general corporate expenses.

		Three months ended March 31,
		2007			2006
General and administrative		$	1,498,769		$	1,619,053
Decrease over prior period		$	(120,284	)
Decrease - percentage		(7		)%
Percentage of net revenues		8		%	11		%

 

General and administrative expenses for the three months ended March 31, 2007 decreased to $1.5 million compared to $1.6 million during the three months ended March 31, 2006.

General and administrative expenses primarily decreased by $120,000 as a result of our recording a foreign exchange gain of approximately $52,000 for the three months ended March 31, 2007 compared to a loss of approximately $88,000 for the three months ended March 31, 2006. In addition, we did not incur any transitional costs relating to the acquisition of the Hosted Messaging Assets of Critical Path Inc. during the three months ended March 31, 2007 compared to $51,000 during the three months ended March 31, 2006. People-related costs, including contract and outside service costs, also decreased by approximately $93,000 compared to the three months ended March 31, 2006 primarily as a result of our incurring lower consulting fees in reviewing our long term compensation alternatives and training costs during the three months ended March 31, 2007. Other costs such as bad debts, state taxes and travel related expenses also decreased by approximately $32,000 for the three months ended March 31, 2007 compared to the three months ended March 31, 2006.

These decreases were partially offset by professional fees increasing by $78,000 when compared to the three months ended March 31, 2006, primarily as a result of the incremental increase in accounting and legal fees required to manage our increased public profile and growing infrastructure. In addition, general and administrative expenses also increased by an additional $118,000 in the three months ended March 31, 2007 as a result of other cost increases such as credit card processing fees, public listing and investor relation costs, telephone and other miscellaneous expenses, when compared to the three months ended March 31, 2006.

We expect general and administrative expenses to continue to increase, in absolute dollars, as our business continues to grow and the impact of a higher Canadian dollar is recognized.

DEPRECIATION OF PROPERTY AND EQUIPMENT

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

		Three months ended March 31,
		2007			2006
Depreciation of property and equipment		$	61,524		$	37,050
Increase over prior period		$	24,474
Increase - percentage		66		%
Percentage of net revenues		0		%	0		%

 

The increase in depreciation for the three months ended March 31, 2007 compared to the three months ended March 31, 2006 was primarily due to the acquisition of additional computer equipment purchased to update our older equipment.

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AMORTIZATION OF INTANGIBLE ASSETS

		Three months ended March 31,
		2007			2006
Amortization of intangible assets		$	233,301		$	93,293
Increase over prior period		$	140,008
Increase - percentage		150		%
Percentage of net revenues		1		%	1		%

 

Amortization of intangible assets consists of amounts arising in connection with the acquisition of Boardtown Corporation in April 2004, from the acquisition of the Hosted Messaging Business of Critical Path, Inc. in January 2006, and the acquisition of Mailbank.com Inc. in September 2006.

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

Technology acquired in connection with the acquisition of the Hosted Messaging Assets of Critical Path, Inc. is amortized on a straight-line basis over two years, while the customer relationships are amortized on a straight-line basis over five years.

In connection with the acquisition of Mailbank.com Inc., customer and customer relationships purchased are amortized on a straight-line basis over five years, while in-house software purchased is amortized on a straight-line basis over two years.

OTHER INCOME AND EXPENSES

		Three months ended March 31,
		2007			2006
Other income (expenses), net		$	46,782		$	576,497

 

Other income includes interest income of $63,000 for the three months ended March 31, 2007, compared to $103,000 for the three months ended March 31, 2006. Interest income has decreased as we have lower investment balances available, primarily as a result of the acquisitions we made 2006. As a result of the promissory notes issued in association with the acquisition of Mailbank.com Inc. in June 2006, we also incurred an interest expense of $105,000 during the three months ended March 31, 2007.

In addition, Afilias Inc., a company in which we hold an investment, declared a divided payable to its shareholders of record as of March 31, 2007. An amount of $88,000 was thus accrued during the three months ended March 31, 2007 and was paid in April 2007.

In 2002, we assigned to an unrelated third party (our Partner), various patents which were acquired by us in the merger with Infonautics in 2001. In connection with the assignment of these patents, we retained the right to a revenue share relating to any cash flow received by our Partner relating to the commercialization of these patents. As a result of this assignment, during the three months March 31, 2006, we received $474,000 from the assignment of the patents. On August 15, 2006, we were informed by our Partner that it had assigned certain of these patents to another unrelated third party. We do not expect to receive any additional revenue share from this arrangement in the future.

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INCOME TAXES

In preparing our financial statements, we make estimates of our current tax obligations and temporary differences resulting from differences in reporting items for financial statement and tax purposes. We recognize deferred taxes by the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred taxes are recognized for differences between the financial statement and tax basis of assets and liabilities at enacted statutory tax rates in effect for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized as income or expense in the period that includes the enactment date. Valuation allowances based on management’s judgment are established when appropriate to reduce the carrying value of deferred tax assets to the amounts expected to be realized.

		Three months ended March 31,
		2007			2006
Provision for income taxes		$	12,000		$	—

 

We operate in various tax jurisdictions, and accordingly, our income is subject to varying rates of tax. Losses incurred in one jurisdiction cannot be used to offset income taxes payable in another. No provision for income taxes other than for alternative minimum tax has been recorded for the three months ended March 31, 2007 because we had net operating losses to offset against our operating income. Our ability to use income tax loss carryforwards and future income tax deductions is dependant upon our operations in the tax jurisdictions in which such losses or deductions arise.

 

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