Tucows - 10-Q quarterly report FY

TUCOWS INC.
Form 10-Q Quarterly Report
INDEX

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PART I.
FINANCIAL INFORMATION

Item 1. Financial Statements

Tucows Inc.

Consolidated Balance Sheets

(Dollar amounts in U.S. dollars)

Subsequent events (note 10)

See accompanying notes to unaudited consolidated financial statements

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Tucows Inc.

Consolidated Statements of Operations

(Dollar amounts in U.S. dollars)

(unaudited)

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

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. 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 June 30, 2007 and the results of operations and cash flows for the interim periods ended June 30, 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 six months ended June 30, 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.

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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 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 had 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. At June 30, 2007 Tucows’ unrecognized tax benefits remain substantially unchanged. 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 June 30, 2007 as the tax benefit relates entirely to refundable research and development tax credits. Tucows believes it is reasonably possible that all of the unrecognized tax benefit will decrease in the next twelve months as it is anticipated that the Canadian tax authorities will review the Company’s research and development claim for the credits within that period. 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.

Recent Accounting Pronouncements Not Yet Adopted

In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements”. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is effective for all fiscal year beginning after November 15, 2007 and interim periods within those fiscal years. Earlier application is encouraged. The Company is currently evaluating the impact of this statement on its financial statements.

In February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. This statement expands the use of fair value measurement and applies to entities that elect the fair value option. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact of this statement on its financial statements.

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 and six months ended June 30, 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.

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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. During the three months ended June 30, 2007, goodwill was increased by an amount of $4,900, as certain customers renewed their support contracts in accordance with the escrow agreement established upon the closing of the Boardtown acquisition. Due to the early release of the escrow account as described above, this amount was paid to the former shareholders of Boardtown Corporation directly by Tucows.

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.

A summary of acquired intangible assets for the three months ended June 30, 2007, is as follows:

A summary of acquired intangible assets for the six months ended June 30, 2007, is as follows:

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5. BASIC AND DILUTED EARNINGS PER COMMON SHARE:

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

The diluted earnings per common share have been calculated using the weighted average number of common shares outstanding and potentially dilutive common shares outstanding during the periods. Options to purchase 3,931,238 shares of common stock were outstanding during the three months ended June 30, 2007 (during the three months ended June 30, 2006, options to purchase 3,161,318 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. Options to purchase 255,999 shares of common stock were outstanding during the six months ended June 30, 2007 (during the six months ended June 30, 2006, options to purchase 749,676 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. SUPPLEMENTAL INFORMATION:

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

(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:

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7. COMMITMENTS AND CONTINGENCIES:

As of June 30, 2007, we had outstanding foreign currency forward contracts with a notional value of $10.2 million, whereby $850,000 is converted into Canadian dollars on a semi-monthly basis from July 2007 to December 2007 at foreign exchange rates varying from U.S.$1:Cdn$1.1250 to U.S.$1:Cdn$1.1299. During the three months ended June 30, 2007, Tucows recorded a gain in fair value in respect of its foreign exchange forward contracts in the amount of $886,000, and during the six months ended June 30, 2006 the Company recorded a gain in fair value in respect of its foreign exchange forward contracts, in the amount of $1.1 million. These amounts have been recorded in the general and administrative expense.

8. STOCKHOLDERS’ EQUITY:

The following unaudited table summarizes stockholders’ equity transactions for the period ended June 30, 2007:

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

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9. 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 June 30, 2007, options to purchase an aggregate of 5,273,729 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 June 30, 2007 is as follows:

A summary of unaudited option activity under the Company’s 1996 Stock Option Plan for the six months ended June 30, 2007 is as follows:

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Total unrecognized compensation cost relating to unvested stock options at June 30, 2007, prior to the consideration of expected forfeitures, is approximately $198,000 and is expected to be recognized over a weighted average period of 2.1 years

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

(b)           2006 Equity Compensation Plan

As of June 30, 2007, options to purchase an aggregate of 1,398,500 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 June 30, 2007 is as follows:

A summary of unaudited option activity under the Company’s 2006 Equity Compensation Plan for the six months ended June 30, 2007 is as follows:

Total unrecognized compensation cost relating to unvested stock options at June 30, 2007, prior to the consideration of expected forfeitures, is approximately $681,000 and is expected to be recognized over a weighted average period of 4.5 years

For the three months ended June 30, 2007, the weighted-average fair value of options granted, as of the grant date, during the period was $0.35, using the following assumptions: expected volatility of 51%; risk-free interest rate of 4.3%, expected dividend yield of 0%; and expected life of 4.75 years. A total of 70,000 options were granted during the three months ended June 30, 2007.

For the six months ended June 30, 2007, the weighted-average fair value of options granted, as of the grant date, during the period was $0.57, using the following assumptions: expected volatility of 83%; risk-free interest rate of 4.5%,

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expected dividend yield of 0%; and expected life of 4.75 years. A total of 1,472,500 options were granted during the six months ended June 30, 2007.

No options were granted during the six months ended June 30, 2006.

(c)                                Share-based compensation expense.

Share-based compensation expense included in the Statement of Operations for the three months ended June 30, 2007 was $111,500 while share-based compensation expense included in the Statement of Operations for the three months ended June 30, 2006 was $79,100

Share-based compensation expense included in the Statement of Operations for the six months ended June 30, 2007 was $174,200 while share-based compensation expense included in the Statement of Operations for the six months ended June 30, 2006 was $148,500.

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

10. SUBSEQUENT EVENTS:

(a)           Acquisition of Innerwise Inc. (dba ItsYourDomain.com) :

On July 25, 2007, Tucows (Delaware) Inc., one of the Company’s wholly owned subsidiaries, acquired Innerwise Inc.
(dba ItsYourDomain.com) (“IYD”), a privately held, ICANN-accredited registrar offering domain services through a worldwide wholesale network of over 2,500 affiliates.

Tucows paid $10.8 million in cash for IYD with additional contingent consideration of $1.1 million based on specific targets. Such additional contingent consideration will be recorded when the amount becomes fixed and determinable.

(b)           Non-revolving, reducing credit facility  :

In connection with the acquisition of Innerwise, Inc., on July 27, 2007, Tucows obtained a $9,579,201 non-revolving, reducing credit facility (the “Loan”) through Tucows.com Co., a wholly owned subsidiary of Tucows (the “Borrower”) from the Bank of Montreal (the “Bank”). Tucows, along with certain of its other subsidiaries, each executed Guaranty and Security Agreements, guaranteeing the obligations of the Borrower, and granting the Bank a security interest in substantially all of their assets.

The loan is repayable monthly in arrears, in equal installments of blended principal and interest, currently amounting to approximately $225,000, over five years, at an interest rate equal to prime rate plus 0.5% (which rate is currently 8.75% and is subject to annual assessment based on Borrower’s ratio of total funded debt to EBITDA). The loan requires that Tucows meet certain financial covenants, and limits the amount of our capital expenditures. Tucows is currently in compliance with these covenants.

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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 June 30, 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 and six months ended June 30, 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 June 30, 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 AND SIX MONTHS ENDED JUNE 30, 2007 AS COMPARED TO THE THREE AND SIX MONTHS ENDED JUNE 30, 2006

NET REVENUES

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

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 June 30, 2007 increased to $20.8 million from $15.7 million for the three months ended June 30, 2006.

Total net revenues for the six months ended June 30, 2007 increased to $38.6 million from $31.0 million for the six months ended June 30, 2006.

During the three months ended June 30, 2007, one customer accounted for 14.4% of revenue. During the six months ended June 30, 2007, no customer accounted for more than 10% of revenue.

During the three and six months ended June 30, 2007, one customer accounted for 12% of accounts receivable at June 30, 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 June 30, 2007 increased by $5.0 million, or 34.0%, to $19.6 million from $14.6 million for the three months ended June 30, 2006. This increase was primarily as a result of an atypically large sale of approximately 2,500 domain names from our portfolio of domain names for $3.0 million, as well as increased volumes from new and existing customers and the additional revenue we earned during the three months ended June 30, 2007 from the acquisition of the name-based domain assets from Mailbank.com, Inc. in June 2006. We may earn up to an additional $1.2 million from the sale of the 2,500 domain names in June 2008, if certain performance criteria are met.

Net revenues from domain name and other Internet services for the six months ended June 30, 2007 increased by $7.0 million, or 23.9%, to $36.0 million from $29.0 million for the six months ended June 30, 2006. This increase was primarily as a result of an atypically large sale of approximately 2,500 domain names from our portfolio of domain names for $3.0 million, as well as increased volumes from new and existing customers and the additional revenue we earned during the six months ended June 30, 2007 from the acquisition of the name-based domain assets from Mailbank.com, Inc. in June 2006. We may earn up to an additional $1.2 million from the sale of the 2,500 domain names in June 2008, if certain performance criteria are met.

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During the three months ended June 30, 2007, the number of domain names that we processed increased by 122,000 to 1.4 million new, renewed and transferred-in domain name registrations, compared to the three months ended June 30, 2006. This increase was 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, as well as increased volumes as a result of the acquisition of the name-based domain assets from Mailbank.com, Inc. in June 2006. 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.

During the six months ended June 30, 2007, the number of domain names that we processed increased by 292,000 to 2.8 million new, renewed and transferred-in domain name registrations, compared to the six months ended June 30, 2006. This increase was 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, as well as increased volumes as a result of the acquisition of the name-based domain assets from Mailbank.com, Inc. in June 2006. 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 continue to face pricing pressure and effective August 2007 have invested in a new cost-plus domain pricing structure and a reduction in our domain name pricing. These steps are likely to adversely impact our revenue and profitability in the short term and may or may not result in increased volumes, which would adversely impact our revenues and profitability in the longer term.

The renewal rate for domain name registrations remained relatively constant at 72% for the three months ended June 30, 2007, compared to the three months ended June 30, 2006.

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. At June 30, 2007, the total number of domain names under our management increased by 0.9 million to 6.3 million, compared to the total number of domain names under our management as at June 30, 2006. As of June 30, 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 June 30, 2007, we managed 1.9 million domain names for these ten registrars, compared to 1.5 million for seven registrars at June 30, 2006, on their behalf.

Deferred revenue from domain name registrations and other Internet services at June 30, 2007 increased to $49.0 million from $43.2 million at June 30, 2006.

Advertising and other revenue

Advertising and other revenue for the three months ended June 30, 2007 increased by $169,000, or 15.8%, to $1.2 million from $1.1 million for the three months ended June 30, 2006. This increase was primarily the result of our delivery of third party advertisements on parked pages amounting to $496,000 for the three months ended June 30, 2007 compared to $174,000 for the three months ended June 30, 2006. This increase was partially offset by a decline in our Google Adsense revenue of $124,000. This decrease was primarily the result of the further contraction in the yields from our syndicated Google feed, which impacts both our software library and direct navigation revenue.

Advertising and other revenue for the six months ended June 30, 2007 increased by $714,000, or 37.2%, to $2.6 million from $1.9 million for the six months ended June 30, 2006. This increase was primarily as a result of our delivery of third party advertisements on parked pages amounting to $1.0 million for the six months ended June 30, 2007 compared to $227,000 for the six months ended June 30, 2006. This increase was partially offset by a decline in our Google Adsense revenue of $50,000. This decrease was primarily the result of the further contraction in the yields from our syndicated Google feed, which impacts both our software library and direct navigation revenue.

During the three months ended June 30, 2007, revenue from advertising and other revenue comprised 6.0% of total revenue, compared to 6.9% for the three months ended June 30, 2006. This decrease resulted primarily from the impact of the atypically large sale of approximately 2,500 domain names from the Company’s portfolio of domain names during the three months ended June 30, 2007.

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During the six months ended June 30, 2007, revenue from advertising and other revenue comprised 6.8% of total revenue, compared to 6.2% for the six months ended June 30, 2006. This increase was also impacted by the atypically large sale of approximately 2,500 domain names from the Company’s portfolio of domain names during the three months ended June 30, 2007 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.

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

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

Cost of revenues for the three months ended June 30, 2007 increased to $13.2 million from $10.8 million for the three months ended June 30, 2006, primarily as a result of higher costs attributable to higher volumes of domain registrations and other Internet services of $1.6 million and an increase in network costs of $687,000. The increase in network costs was primarily a result of the additional labor, bandwidth and co-location and other costs required to manage the data centers of $541,000, depreciation of additional information technology assets acquired or purchased of $316,000 and additional amortization of $25,000 resulting from acquisitions.

These increases were offset in part by transitional costs incurred during the three months ended June 30, 2006 in the amount of $173,000 as a result of the acquisition of the Hosted Messaging Assets of Critical Path Inc., which were not incurred during the three months ended June 30, 2007, as well as a decrease in travel expenses during the period of $23,000.

Cost of revenues for the six months ended June 30, 2007 increased to $25.4 million from $21.3 million for the six months ended June 30, 2006, primarily as a result of higher costs attributable to higher volumes of domain registrations and other Internet services of $2.7 million and an increase in network costs of $1.1 million. The increase in network costs was primarily a result of the additional labor, bandwidth and co-location and other costs required to manage the data centers of $1.1 million, depreciation of additional information technology assets acquired or purchased of $601,000 and additional amortization of $49,000 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. Because the relevant statute of limitations covering this initiative has expired, this accrual is no longer required.  In addition, transitional costs incurred during the six months ended June 30, 2006 in the amount of $513,000 as a result of the acquisition of the Hosted Messaging Assets of Critical Path Inc. were not incurred during the six months ended June 30, 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 June 30, 2007 increased by $4.4 million, to approximately $34.4 million from $30.0 million at June 30, 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