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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

For the quarterly period ended March 31, 2009

OR

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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, 2009, there were 68,903,392 outstanding shares of common stock, no par value, of the registrant.

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TUCOWS INC.

Form 10-Q Quarterly Report

INDEX

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PART I.
FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

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

See accompanying notes to unaudited consolidated financial statements

Subsequent events (note 14).

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

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)

See accompanying notes to unaudited consolidated financial statements

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION OF THE COMPANY:

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

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 office is located in Toronto, Ontario and we have offices in the United Kingdom and the United States.

2. BASIS OF PRESENTATION:

The accompanying unaudited interim consolidated balance sheets, 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, 2009 and the results of operations and cash flows for the interim periods ended March 31, 2009 and 2008. 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 unaudited interim consolidated financial statements have been prepared by Tucows 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 Company’s audited financial statements and notes thereto for the year ended December 31, 2008 included in Tucows’ 2008 Annual Report on Form 10-K filed with the SEC on March 27, 2009.

There have been no material changes to our significant accounting policies during the three months ended March 31, 2009 as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

3. NEW ACCOUNTING POLICIES:

Recent Accounting Pronouncements Adopted

In December 2007, FASB issued SFAS 141R, Business Combinations. The statement will require all business acquisitions to be measured at fair value, the existing definition of a business would be expanded, pre-acquisition contingencies would be measured at fair value, most acquisition-related costs would be recognized as expenses as incurred as well as other changes. The statement is effective for business combinations for which the acquisition date is on or after the beginning of the first annual period beginning on or after December 15, 2008. The Company adopted SFAS No. 141R on January 1, 2009, and the adoption had no impact on the Company’s financial statements or disclosures.

In December 2007, FASB issued SFAS 160, Non-controlling Interests in Financial Statements. The statement will improve the relevance, comparability and transparency of the financial information that a reporting Company provides in its financial statements by establishing new accounting and reporting standards. The statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company adopted SFAS No. 160 on January 1, 2009, and the adoption had no impact on the Company’s financial statements or disclosures.

In March 2008, FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging Activities. This statement enhances disclosures regarding an entity’s derivative and hedging activities. This statement is effective for the financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company adopted SFAS No. 161 on January 1, 2009, and the adoption had no impact on the Company’s financial statements or disclosures.

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In May 2008, FASB issued SFAS 163, Accounting for Financial Guarantee Insurance Contracts. This statement is geared towards removing inconsistencies in the recognition and measurement of claim liabilities. The statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company adopted SFAS No. 163 on January 1, 2009, and the adoption had no impact on the Company’s financial statements or disclosures.

Recent Accounting Pronouncements Not Yet Adopted

In June 2008, the SEC announced that it has approved a one-year extension of the compliance date for smaller public companies to meet the Section 404(b) auditor attestation requirement of the Sarbanes-Oxley Act. As a result, the Company will now be required to provide the attestation reports in their annual reports for the fiscal years ending on or after December 31, 2009.

In April 2009, the FASB issued FSP SFAS No. 107-1 and Accounting Principles Board Opinion (APB) 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP SFAS No. 107-1 and APB Opinion No. 28-1), which amends SFAS No. 107 and APB Opinion No. 28, Interim Financial Reporting, to require disclosures about fair value of financial instruments in interim and annual reporting periods. FSP SFAS No. 107-1 and APB Opinion No. 28-1 is effective for interim reporting periods ending after June 15, 2009. This FSP will be adopted by the Company for the quarter ended June 30, 2009.

4. INTANGIBLE ASSETS:

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

A summary of acquired intangible assets for the three months ended March31, 2009 is as follows:

5. LOAN PAYABLE:

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

Pursuant to the terms of the facility, the Company is required to make an annual cash sweep payment based on excess cash flow as defined in the credit facility agreement, as well as equal monthly capital repayments of approximately $160,000. Based on the assessment of the audited results for its 2008 fiscal year, the Company made a cash sweep payment for Fiscal 2009 amounted to $0.7 million which amount was paid on May 1, 2009.  For its 2007 fiscal year, the cash sweep

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payment was $1.0 million, which was paid in May 2008.  As the cash sweep payment for the fiscal year ended December 31, 2009 has not been determined, no such amount has been classified as a current liability for this period.

Principal loan repayments are as follows:

6 DERIVATIVE INSTRUMENT LIABILITY:

On September 29, 2008, the Company entered into a series of forward plus contracts to hedge a portion of the Company’s expected Canadian dollar requirements. These contracts, collectively, have a notional value of US$9 million, whereby US$500,000 is converted into Canadian dollars on a semi-monthly basis through September 2009. On each currency option transaction expiry date, being the end of each semi-monthly period through to maturity in September 2009, provided that the limit rate (US$1.00: Cdn$ 1.09) has not been reached during such period, the Company will sell US$500,000 and buy Canadian dollars at the then current exchange rate or at the base rate of US$1.00: Cdn$ 1.02, whichever is more beneficial. Should the limit rate be reached during the semi-monthly period before the expiration date of each contract, then the contract will be fixed at the base rate of US$1.00: Cdn$1.02 for delivery on its value dates.

On October 10, 2008, the Company entered into a series of foreign exchange forward contracts designed to meet estimated Canadian dollar needs for its 2009 fiscal year. These contracts, collectively, have a notional value of US$12 million, whereby US$500,000 is converted into Canadian dollars on a semi-monthly basis from January 2009 to December 2009 at foreign exchange rates varying from US$1.00: Cdn$1.1560 to US$1.00: Cdn$1.1670.

On March 30, 2009, the Company entered into a series of foreign exchange forward contracts to begin to hedge a portion of its 2010 fiscal year expected Canadian dollar requirements. These contracts, collectively, have a notional value of US$6 million, whereby US$500,000 is converted into Canadian dollars on a semi-monthly basis from January 2010 to June 2010 at a foreign exchange rate of US$1.00: Cdn$1.2442.

The Company does not apply hedge accounting, and therefore, for the three months ended March 31, 2009, the Company recorded a gain of $85,343 in the fair value of forward contracts in its consolidated statements of operations. For the three months ended March 31, 2008, the Company recorded a loss on forward contracts of $255,433. As of March 31, 2009, the Company has outstanding forward exchange contracts with a notional value of $21 million.

7. INCOME TAXES

For the three months ended March 31, 2009, the Company recorded a current tax expense of $107,000 on income before income taxes of $1.1 million using an estimated effective tax rate for its 2009 fiscal year that accounts for the utilization of remaining net operating loss carry forwards and alternative minimum tax credits available to the Company. Comparatively, for the three months ended March 31, 2008, the Company recorded an income tax expense of $31,000 before income taxes of $1.1 million primarily related to our estimate for federal alternative minimum tax obligations for our 2008 fiscal year and Pennsylvania state franchise tax related to prior years.

As of December 31, 2008, the Company recorded a valuation allowance of $10.8 million and a net deferred tax asset of $3.0 million. The net deferred tax asset has been allocated on a pro rata basis between current and non-current deferred tax assets, resulting in current deferred tax assets of $0.6 million and non-current deferred tax assets of $2.4 million as at December 31, 2008. No significant changes have occurred during the three month period ended March 31, 2009.

The Company analyzes the carrying value of its deferred tax asset on a regular basis. In determining future taxable income, assumptions are made to forecast federal, state and international operating income, the reversal of temporary timing differences, and the implementation of any feasible and prudent tax planning strategies. The assumptions require significant judgment regarding the forecasts of future taxable income, and are consistent with forecasts used to manage the business.

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During the three months ended March 31, 2009, there was no reversal of the valuation allowance. The valuation allowance will be maintained until sufficient evidence exists to support a reversal of, or decrease in, the valuation allowance.

The Company follows the provisions of Financial Accounting Standards Board (FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes- an interpretation of FASB Statement No. 109 (“FIN 48”), in accounting for income tax exposures.  The application of this interpretation requires a two-step accounting process that separates recognition of uncertain tax benefits from measurement thereof.

Tucows had approximately $301,000 of gross unrecognized tax benefit as of December 31, 2008 and $293,000 of gross unrecognized tax benefit as of March 31, 2009, which if recognized, would favorably affect its income tax rate in future periods.  The unrecognized tax benefit relates to non-recognition of refundable research and development tax credits in Canada earned during its 2006 and 2007 fiscal years and certain state tax exposures from prior periods. The unrecognized tax benefit for its 2008 fiscal year for the research and development claim is expected to be insignificant. During the three months ended March 31, 2009, the Company did not recognize any new uncertain tax positions and did not recognize any increase or decrease to reserves for uncertain tax positions. Changes to the Company’s uncertain tax benefits relate solely to foreign exchange fluctuations.

The Company recognizes accrued interest and penalties to unrecognized tax benefit as a tax expense. The Company has not accrued any interest or penalties as of December 31, 2008 and March 31, 2009. The Company believe it is reasonably possible that $293,000 of the unrecognized tax benefit will decrease in the next twelve months as it is anticipated that the Canadian tax authorities will conclude its review of the Company’s 2006 and 2007 research and development claim for the credits, and that the state tax matters will also be settled, within that period.

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

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

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

For the three months ended March 31, 2008, 3,528,513 potentially dilutive common shares outstanding during that period were not included in the computation of diluted loss per common share. Of these options, 1,668,798 were not included, as to do so would have been anti-dilutive, and 1,859,715 were not included as the options’ exercise price was greater than the average market price of the common shares.

Options to purchase 7,169,669 common shares were outstanding during the three months ended March 31, 2009 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. The options which expire in years 2009 to 2016 were still outstanding at March 31, 2009.

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9. SUPPLEMENTAL INFORMATION:

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

No customer accounted for more than 10% of revenue for the three months ended March 31, 2009 or the three months ended March 31, 2008. 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.

As of March 31, 2009, no customer accounted for more than 10% of accounts receivable. As of March 31, 2008, one customer accounted for more than 10% of accounts receivable.

(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:

10. COMMITMENTS AND CONTINGENCIES:

The Company is involved in various legal claims and lawsuits in connection with its ordinary business operations. The Company intends to vigorously defend these claims. While the final outcome with respect to any actions or claims outstanding or pending as of March 31, 2009 cannot be predicted with certainty, it is the opinion of management that their resolution will not have a material adverse effect on the Company’s financial position.

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11. STOCKHOLDERS’ EQUITY:

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

The following unaudited table summarizes stockholders’ equity transactions for the period ended March 31, 2008:

On March 23, 2009 the Company announced that it successfully concluded a modified “Dutch Auction Tender Offer” that was previously announced on February 12, 2009. Under the terms of the offer, the Company repurchased an aggregate of 4,185,690 shares of its common stock at a purchase price of $0.41 per share, for a total of $1,716,132.90, excluding transaction costs of $95,046. The purchase price was funded from available cash. Of the 4,185,690 shares purchased, 4,000,000 were shares the Company offered to purchase in the offer and 185,690 where shares purchased pursuant to the Company’s right to purchase up to an additional 2%of the shares outstanding immediately prior to the commencement of the tender offer. Due to over-subscription, the final proration factor for shares tendered at or below $0.41 per share was approximately 99.42%. For this purpose, shares tendered at $0.41 per share included shares tendered by those persons who indicated, in their letter of transmittal, that they were willing to accept the price determined in the offer. All shares purchased in the tender offer received the same price. As a result of the completion of the tender offer, as of March 23, 2009, the Company had 68,888,092 shares issued and outstanding, as all shares repurchased were immediately retired.

On May 6, 2008, the Company’s Board of Directors authorized the repurchase of up to $10 million of the Company’s common stock at the Company’s discretion. To date, the Company has repurchased 849,760 shares under this repurchase program.

12. SHARE-BASED PAYMENTS

The Company’s 1996 Stock Option Plan (the “1996 Plan”) was established for the benefit of the employees, officers, directors and certain consultants of the Company. The maximum number of common shares which may be set aside for issuance under the 1996 Plan was 11,150,000 shares, provided that the Board of Directors of the Company has the right, from time to time, to increase such number subject to the approval of the stockholders of the Company when required by law or regulatory authority. Generally, options issued under the Plan vest over a four-year period. The 1996 Plan expired on February 25, 2006; no options were issued from this plan after that date.

On November 22, 2006, the Shareholders of the Company approved the implementation of the Company’s 2006 Equity Compensation Plan (the “2006 Plan”), which serves as a successor to the 1996 Plan. The Company’s 2006 Plan has been established for the benefit of the employees, officers, directors and certain consultants of the Company. The maximum number of common shares which have been set aside for issuance under the 2006 Plan is 5,000,000 shares. Generally, options issued under the 2006 Plan vest over a four-year period and have a term not exceeding seven years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model, consistent with the provisions of SFAS 123R and Staff Accounting Bulletin No. 107, “Share-based payment” (“SAB 107”). Because option-pricing models require the use of subjective assumptions, changes in these assumptions can materially affect

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the fair value of the options. The assumptions presented in the table below represent the weighted average of the applicable assumption used to value stock options at their grant date. The Company calculates expected volatility based on historical volatility of the Company’s common shares. The expected term, which represents the period of time that options granted are expected to be outstanding, is estimated based on historical exercise experience. The Company evaluated historical exercise behavior when determining the expected term assumptions. The risk-free rate assumed in valuing the options is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option. The Company determines the expected dividend yield percentage by dividing the expected annual dividend by the market price of our common shares at the date of grant.

No stock options were granted during the three months ended March 31, 2009.

The fair value of stock options granted during the three months ended March 31, 2008 was estimated using the following assumptions:

Details of stock option transactions are as follows:

The stock options expire at various dates through 2016.

As of March 31, 2009, the exercise prices, weighted average remaining contractual life of outstanding options and intrinsic values were as follows:

Total unrecognized compensation cost relating to unvested stock options at March 31, 2009, prior to the consideration of expected forfeitures, was approximately $519,000 and is expected to be recognized over a weighted average period of 5.7 years.

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The Company recorded stock-based compensation of $49,200 and $72,200 for the three months ended March 31, 2009 and 2008, respectively.

The Company has not capitalized any share-based compensation expense as part of the cost of an asset.

13. FAIR VALUE MEASUREMENT

SFAS No. 157 “Fair Value Measurements” establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

The following table provides a summary of the fair values of the Company’s liabilities measured at fair value on a recurring basis:

14. SUBSEQUENT EVENTS

On April 1, 2009, the Company entered into a series of foreign exchange forward contracts to hedge a portion of its 2010 fiscal year expected Canadian dollar requirements. These contracts, collectively, have a notional value of US$3 million, whereby US$500,000 is converted into Canadian dollars on a semi-monthly basis from July 2010 to September 2010 at a foreign exchange rate of US$1.00: Cdn$1.2447.

On November 4, 2008, Tucows (Delaware) Inc. (“Tucows DE”), a wholly owned subsidiary of the Company entered into a stock redemption agreement with Afilias Limited (“Afilias”), whereby Tucows DE sold its 353,722 Class A ordinary shares of Afilias to Afilias, for an aggregate purchase price of $7,502,444, or $21.21 per share, less one-half of the stamp duty required to be paid under Irish law, which duty amounted to $37,512.  Pursuant to the terms of the agreement, Afilias redeemed 153,722 shares during November 2008 and, contingent on Afilias having sufficient distributable reserves, will acquire the remaining 200,000 shares in two equal installments, one on or before June 30, 2009 (the “Second Closing”) and one on or before December 31, 2009 (“the Third Closing”).

During April 2009 Afilias completed the Second Closing and redeemed an additional 100,000 shares for an aggregate price of $2.1 million. The $2.0 million gain on disposition of this portion of the Afilias investment will be accounted for during the three months ending June 30, 2009.

15. RECLASSIFICATION

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

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

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains, in addition to historical information, forward-looking statements by us with regard to our expectations as to financial results and other aspects of our business that involve risks and uncertainties and may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “may,” “should,” “anticipate,” “believe,” “plan,” “estimate,” “expect” and “intend,” and other similar expressions are intended to identify forward-looking statements. The forward-looking statements contained in this report include statements regarding, among other things, the number of new, renewed and transferred-in domain names, the competition we expect to encounter as our business develops and competes in a broad range of Internet services, our valuations of certain deferred tax assets, our expectation to collect our outstanding receivables, net of our allowance for doubtful accounts; the potential impact of current and pending claims on our business; our expectation regarding fluctuations in certain expense and cost categories; our belief that the market for domain name registration will trend upward gradually and may be affected by market volatility; our belief that, by increasing the number of applications and services we offer, we will be able to generate higher revenues; and our belief that the actions we have taken have positioned the Company for long-term growth. These statements are based on management’s current expectations and are subject to a number of uncertainties and risks that could cause actual results to differ materially from those described in the forward-looking statements. 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;

·                  Pending or new litigation; and

·                  Factors set forth under the caption “Item 1A Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

This list of factors that may affect our future performance and financial and competitive position and also the accuracy of forward-looking statements is illustrative, but it is by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty. All forward-looking statements included in this document are based on information available to us as of the date of this document, 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

Our mission is to make the Internet easier and more effective for users. We accomplish this by reducing the complexity our customers experience as they acquire, deliver or use Internet services such as domain name registration, hosted email and other Internet services.

Our primary distribution channel is a global distribution network of more than 9,000 resellers, in more than 100 countries who typically provide their customers, the end-users of the Internet, with a critical component for establishing and

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maintaining an online presence. Our primary focus is serving the needs of this network of resellers by providing superior services, easy-to-use interfaces, proactive and attentive customer service, reseller-oriented technology and agile design and development processes. We seek to provide superior customer service to our resellers by anticipating their business needs and technical requirements. This includes providing easy-to-use interfaces that enable resellers to quickly and easily integrate our services into their individual business processes, and offering brandable end-user interfaces that emphasize simplicity and visual appeal.  We also provide “second tier” support to our resellers by email and phone in the event resellers experience issues or problems with our services. In addition, our Network Operating Center provides proactive support to our resellers by monitoring all services and network infrastructure to address deficiencies before customer services are impacted.

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

Our services are supplied through four service group:

Our Reseller Services group, OpenSRS, manages over eight million domain names, millions of mailboxes and tens of thousands of digital certificates through a network of over 9,000 web hosts, ISPs, and other resellers around the world.

Our Retail Services group, Hover, offers these services to consumers and small businesses.

Our Domain Portfolio group, YummyNames, manages tens of thousands of domain names, most of which generate advertising revenue and many of which we offer for resale via our reseller network and other channels. Included in the Domain Portfolio are over 30,000 domains that are the basis of our Personal Names Service that allows over two-thirds of Americans to purchase a domain or email address based on their name.

Additionally, our Content group, Butterscotch.com, generates advertising revenue through several sites including tucows.com, one of the oldest and most popular software download sites on the Internet.

We periodically acquire companies or technology when we determine that the related products or technology are strategic or complementary to our current or future service offerings, as opportunities arise. For example:

·                  On July 25, 2007, we acquired Innerwise, Inc., a privately held, Internet Corporation for Assigned Names and Numbers (“ICANN”) -accredited registrar offering domain services through a worldwide wholesale affiliate network.

·                  On June 19, 2006, we acquired Mailbank.com, Inc. (doing business as NetIdentity). We use these assets to offer personalized Internet services directly to end-users through Hover, and to resellers through OpenSRS’ Personal Names Service, as well as to generate income from the parked page of each domain address. To expand our presence in the email market, on January 3, 2006, we acquired all of the Hosted Messaging assets of Critical Path, Inc.

Our business model is characterized by non-refundable, up-front payments, which lead to recurring revenue and positive operating cash flow. We are an ICANN-accredited registrar and manage over nine million domains.

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, advertising and other services. To assist us in forecasting growth and to help us monitor the effectiveness of our operational strategies we categorize our revenue as follows:

Traditional Domain Registration Services

Historically, traditional domain registration has been the largest portion of our business and encompasses all of our services as an accredited registrar related to the registration, renewal, transfer and management of domain names through our global reseller distribution network. We also provide resellers with the ability to sell personal names. This service allows resellers the opportunity to sell email addresses based on our domain portfolio of surname domain names. In addition, traditional domain registration fuels other revenue categories as it often is the initial service for which a customer will engage us, enabling us to follow on with other services, and allowing us to add to our domain portfolio by purchasing names registered through us once they expire.

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On August 7, 2007, in advance of the announced October 2007 registry fee increases, we modified our pricing structure for traditional domain names to provide greater visibility into the various fees that make up the cost of a domain name, by breaking out the cost of the registry and ICANN fees separately from our management fee. The management fee provides our resellers with access to our provisioning and management tools to enable them to register and administer domain names and access to additional services like WHOIS privacy and Managed DNS services, enhanced domain name suggestion tools and access to our Premium Domain name services.

As of March 31, 2009, we offer registration services for the gTLDs.com, .net, .org, .info, .name, .biz, .tel, ..mobi and .asia and for the country code top-level domains, or ccTLDs. at, .be, ..ca, .cc, .ch, .cn, .de, .dk, .es, .eu, .fr, .it, .li, .me, .mx .nl, .tv, .uk, and .us.

With respect to the sale of domain registrations, we earn fees in connection with each new, renewed and transferred-in registration and from providing provisioning services to resellers and registrars on a monthly basis. Domain registrations are generally purchased for terms of one to ten years, with a majority having a one-year term. Except for certain large customers with whom we have negotiated alternative arrangements, payments for the full term of service, or billed revenue, is received at the time of activation of service. All fees received in connection with domain name registration are non-refundable, and where appropriate, are recorded as deferred revenue and 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.

Domain Portfolio Services

We derive revenue from our portfolio of domain names by making them available as part of our pay-per-click advertising or parked pages program and by making them available for sale or lease. Parked pages are domain names registered with us that do not yet contain an active website. 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. Portfolio names are sold through our premium domain name service, auctions or in negotiated sales. The size of our domain name portfolio varies over time, as we acquire and sell domains on a regular basis to maximize the overall value and revenue generation potential of our portfolio. In evaluating 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 our evaluation, the name is deemed non-essential to our business, and management believes that deriving proceeds from the sale is strategically more beneficial to the Company. Portfolio names that have been acquired from third-parties or through acquisition are included as intangible assets with indefinite lives on our consolidated balance sheet. In addition, we also offer the same services to our customers, allowing them to make available names registered by them for monetization on a similar basis. For customer names, we earn a referral fee for premium names or names sold or leased, and participate on a revenue share basis for names offered through our pay-per-click advertising program.

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

Email Services

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

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

Retail Services

We generate revenues from the provisioning and management of Internet services, on a retail basis, to consumers and small businesses through our Hover.com website. These services include domain registration and other Internet services

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such as email and personalized email through our portfolio of surname-based domain names, as well as an easy-to-use interface that allows users to connect domain names to websites and email addresses through a unique DNS forwarding system. Depending on the service offered, we typically receive standard fees for our services, which such fees are published on our website.

Our customers generally purchase services for terms of one to ten years, with a majority of services purchased for a one-year term.  Certain services are also offered on a monthly basis. Payments for the full term of all services, or billed revenue, are received at the time of service activation and, where appropriate, are recorded as deferred revenue and 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 quarterly and annual periods.

Other Services

Our other Internet services currently consist of digital certificates, billing, provisioning and customer care software solutions, blogware and website building tools that are used by our resellers 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 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 recognized as earned ratably over the term of the 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, or content revenue, through our online libraries of shareware, freeware and online services presented at our websites, tucows.com and butterscotch.com.

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. Software developers may also use our ARC to 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 that contract with us to provide them with co-branded content. Advertising and other revenue is recognized ratably over the period in which it is presented.

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

Advertising and other revenue is recognized ratably over the period in which it is presented. To the extent that we do not meet the minimum number of impressions post-presentation that we guarantee to customers, we defer recognition of the corresponding revenues until the guaranteed impressions are achieved. Custom video production revenue is recognized on acceptance of the completed video by the customer.

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 SFAS No. 141R, SFAS No. 160, SFAS No. 161 and SFAS No. 163 which are set forth in Note 3 above, during the three months ended March 31, 2009, there have been no significant changes in our critical accounting policies as compared to the critical accounting policies 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, 2008.

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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2009 AS COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2008

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

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

Total net revenues for the three months ended March 31, 2009 increased by $1.4 million, or 7%, to $20.1 million from $18.7 million for the three months ended March 31, 2008.

Deferred revenue from domain name registrations and other Internet services at March 31, 2009 increased to $56.7 million from $53.6 million at March 31, 2008.

No customer accounted for more than 10% of revenue during the three months ended March 31, 2009 and at March 31, 2009, no customer accounted for more than 10% of accounts receivable. 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.

Traditional Domain Registration Services

Net revenues from traditional domain registration services for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 increased by $1.3 million, or 10%, to $14.2 million. These increases were primarily a result of increased volumes from new and existing customers.

Our ongoing initiatives to improve our competitive position in the rapidly evolving and competitive internet services marketplace have contributed to the decline in our average selling price and have adversely impacted our revenue and profitability in the short term. While we believe that the steps we have taken have positioned the Company for longer term growth, we cannot be assured that the emerging trends will continue to result in increased volumes, which would adversely impact our revenues and profitability.

During the three months ended March 31, 2009, the total new, renewed and transferred-in domain name registrations that we processed increased by 0.2 million to 1.8 million as compared to the three months ended March 31, 2008. This increase resulted primarily from our continuing to compete aggressively to attract new clients and retain existing customers.

While we anticipate that the number of new, renewed and transferred-in domain name registrations will continue to incrementally increase, the volatility in the market could affect the growth of domain names that we manage. As of March 31, 2009, the total domain names under our management increased by 1.2 million to 7.9 million, as compared to the

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total domain names under our management as of March 31, 2008. In addition, we provide provisioning services on a monthly basis to accredited registrars who use our technical systems to process domain registrations with their own accreditation. As of March 31, 2009, we managed an additional 1.5 million domain names on behalf of other accredited registrars, as compared to an additional 1.1 million managed for accredited registrars as of March 31, 2008.

Domain Portfolio Services

Net revenues from our domain portfolio services for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 increased by $1.0 million, or 111%, to $1.9 million.

This increase resulted from a $1.2 million increase in the sale of names from our portfolio of domain names during the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. This increase was partially offset by a decrease of $0.2 million in revenue from the delivery of third-party advertisements on parked pages and auction revenue during the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. The increase in the sale of names from our portfolio of domain names was primarily due to the sale of a portfolio of 2,553 domain names to an unrelated third party on February 2, 2009 for an aggregate payment of $1.0 million, $0.9 million of which was recognized during the three months ended March 31, 2009. The remaining $0.1 million will be recognized when it is paid in two equal installments on August 9, 2009 and February 9, 2010. Under this sales agreement, the purchaser is entitled to purchase up to an additional $1.8 million of domain names from us at any time before June 2010 on terms similar to this sale.

Email Services

Net revenues from email services for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 decreased by $0.5 million, or 29%, to $1.1 million.

As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008 the decrease in email service revenue is primarily attributable to two factors;

(a)           our decision to eliminate certain enterprise customers acquired as part of the Hosted Messaging Business of Critical Path, Inc. in January 2006 that were not part of our strategic focus and who were receiving pricing that was not competitive in the marketplace, and

(b)           certain of our email customers, who are media portal companies and for whom email is only a small component of their overall service offerings, have chosen to include their email services as part of larger supply contracts for competitive and cost control reasons. Our original expectation was that these companies would have completed their migrations by March 2009. One of these customers has modified its migration plans and are now only expected to migrate off our hosted email platform during the three months ending September 30, 2009. If our efforts to market our email service to new customers are not successful in offsetting these customer losses, it is likely that the loss of these customers will have a material impact on our results of operations for email services for the fiscal year ended December 31, 2009.

Retail Services

Net revenues from retail services for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 decreased by $0.3 million, or 21%, to $1.3 million.

The primary contributor to this decrease was the impact that sale of our retail hosting assets during Fiscal 2008 had on the current quarter.

Other Services

Other services currently include revenue from digital certificates, billing, provisioning and customer care software solutions, blogware and website building tools, or other internet services, which are used by our resellers to create bundles of Internet services for their end-users and content. Other revenue for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008 decreased by $0.1 million, or 7%, to $1.6 million. This decrease was primarily due to a decline in content revenue, which primarily reflects the contraction in the yields from our syndicated Google feeds, and decreased revenue from our Author Resource Center.

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COST OF REVENUES

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

Traditional Domain Registration Services

Cost of revenues for traditional 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 initially recorded as prepaid domain registry fees. This accounting treatment reasonably approximates a recognition pattern that corresponds with the provision of the services during the period.

Domain Portfolio Services

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

Email Services

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