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DigitalTown, Inc. - Quarter Report: 2011 August (Form 10-Q)

10Q

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-Q


(Mark One)


| X |

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


 

For the quarterly period ended: August 31, 2011

 


|__|

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



Commission file number: 000-27225

 


DigitalTown, Inc.

(Name of registrant in its charter)


Minnesota

41-1427445

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

 

11974 Portland Avenue, Burnsville, Minnesota

55337

(Address of principal executive offices)

(Zip Code)

 

 

Registrant's telephone number: (952) 890-2362



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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

 


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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).        [ X ]  Yes  [   ]  No  


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







Large Accelerated Filer [  ]

Accelerated Filer [  ]

Non-Accelerated Filer [  ]

Smaller reporting company [X]


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      [  ]  Yes  [X]  No


There were 29,013,833 shares of the registrant’s common stock outstanding as of September 30, 2011.


ii







TABLE OF CONTENTS


 

PART I

 

 

 

 

 

Item 1.

Financial Statements

 1-16

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17-23

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

23

 

 

 

Item 4.

Controls and Procedures

24

 

 

 

PART II

 

 

 

 

 

Item 1.

Legal Proceedings

25

 

 

 

Item 1A

Risk Factors

25

 

 

 

Item 2.

Unregistered sales of Equity Securities and Use of Proceeds

25

 

 

 

Item 3.

Defaults Upon Senior Securities

25

 

 

 

Item 4.

(Removed and Reserved)

25

 

 

 

Item 5.

Other Information

25

 

 

 

Item 6.

Exhibits

26

 

 

 

 

 


 


iii









PART I


ITEM 1.  FINANCIAL STATEMENTS


 

 Page

 

 

Financial Statements:

 

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Cash Flows

Notes to Financial Statements

4-16







DigitalTown, Inc.

CONSOLIDATED BALANCE SHEETS


ASSETS

 

 

August 31,
2011

 

February 28,
2011

 

 

(unaudited)

 

(audited)

Current assets:

 

 

 

 

Cash

 

 $      817,289

 

 $      103,310

     Prepaid domain name renewal fees

 

83,025

 

37,931

     Prepaid expense

 

12,917

 

30,425

 Total current assets

 

913,231

 

171,666

Property and equipment, net

 

26,669

 

20,306

Intangible assets, net

 

1,111,911

 

1,118,314

    Total assets

 

$   2,051,811

 

$   1,310,286

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:

 

 

 

 

Accounts payable

 

$       110,790

 

$       286,750

Loan from director/stockholder

 

37,088

 

137,088

     Accrued payroll

 

3,453

 

12,358

     Deferred officer compensation

 

-

 

50,288

Total current liabilities

 

151,331

 

486,484

Commitments and contingencies

 

 

 

 

Stockholders’ equity:

 

 

 

 

Common stock, $.01 par value, 2,000,000,000 shares authorized, 28,997,165 and 28,034,993 shares issued and outstanding at August 31, 2011 and  February 28, 2011, respectively

 

289,967

 

280,347

Additional paid-in-capital

 

23,383,549

 

21,797,023

Subscriptions receivable

 

    (1,299,654)

 

    (1,422,654)

Accumulated deficit

 

   (20,473,382)

 

   (19,830,914)

Total stockholders’ equity

 

1,900,480

 

823,802

     Total liabilities and stockholders’ equity

 

$    2,051,811

 

$    1,310,286



The accompanying notes are an integral part of these consolidated financial statements.


1





DigitalTown, Inc.


CONSOLIDATED STATEMENTS OF OPERATIONS


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

August 31,

 

August 31,

 

2011

 

2010  

 

2011

 

2010  

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

 

 

 

 

 

 

 

Revenues

$           5,105

 

$           5,077

 

$           10,525

 

$           9,147

 

 

 

 

 

 

 

 

Cost of revenues

64,619

 

51,843

 

130,510

 

108,497

 

 

 

 

 

 

 

 

Gross profit (loss)

(59,514)

 

(46,766)

 

(119,985)

 

(99,350)

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

Selling, general and administrative expenses

     286,890

 

     227,318

 

    518,931

 

    423,304

Loss from operations

(346,404)

 

(274,084)

 

(638,916)

 

(522,654)

 Other income (expense):

 

 

 

 

 

 

 

     Interest expense

(1,000)

 

(1,544)

 

(3,628)

 

(3,792)

     Other income

69

 

2,303

 

76

 

9,906

 Total other income (expense)

(931)

 

759

 

(3,552)

 

6,114

 

 

 

 

 

 

 

 

(Net loss before income taxes

 (347,335)

 

 (273,325)

 

 (642,468)

 

 (516,540)

IIncome tax provision

-

 

-

 

-

 

-

eNet loss

$      (347,335)

 

$     (273,325)

 

$   (642,468)

 

$   (516,540)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss per common share – basic and diluted

$        (0.01)

 

$      (0.01)

 

$        (0.02)

 

$        (0.02)

 

 

 

 

 

 

 

 

 Weighted average common shares outstanding – basic and diluted

28,820,142

 

27,810,431

 

28,441,830

 

27,645,077

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 The accompanying notes are an integral part of these consolidated financial statements.








2





DigitalTown, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS



 

Six months ended August 31,

 

2011

 

2010

 

(unaudited)

 

(unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

Net loss

   $  (642,468)

 

   $  (516,540)

Adjustments to reconcile net loss to net cash flows used in operating activities:

 

 

 

Depreciation

4,856

 

2,926

Amortization of website development costs

36,617

 

3,893

Stock-based compensation expense

148,566

 

126,040

      Stock issued for director fees

14,860

 

13,859

      Stock issued for deferred officer compensation

-

 

28,204

      Changes in operating assets and liabilities:

 

 

 

         Prepaid domain name renewal fees

(45,094)

 

(29,997)

         Prepaid expense

17,508

 

-

         Accounts payable

(205,960)

 

90,965

         Accrued payroll

(8,905)

 

(1,232)

         Deferred officer compensation

(50,288)

 

3,565

         Other liability

-

 

(15,000)

Net cash used in operating activities

     

(730,308)

 

     

(293,317)

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

Purchase of property and equipment

(11,219)

 

(20,001)

Purchase of intangible asset-website development

-

 

(95,787)

Purchases of  intangible assets – domain names

(214)

 

(5,784)

Net cash used in investing activities

(11,433)

 

(121,572)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

Payments on loan – director/stockholder

(100,000)

 

(51,066)

Payments received on stockholder subscription receivables

123,000

 

431,450

Proceeds from issuance of stock

1,432,720

 

10,000

Net cash provided by financing activities

1,455,720

 

390,384

 

 

 

 

Net change in cash and cash equivalents

       713,979

 

       (24,505)

Cash and cash equivalents, beginning of period

103,310

 

34,178

Cash and cash equivalents, end of period

$       817,289

 

$       9,673

 

 

 

 


The accompanying notes are an integral part of these consolidated financial statements.





3




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)




Note 1. Basis of Presentation


The accompanying unaudited consolidated financial information has been prepared by DigitalTown, Inc. (the “Company”) in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (SEC).  Accordingly, it does not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of this financial information have been included.  Financial results for the interim period presented are not necessarily indicative of the results that may be expected for the fiscal year as a whole or any other interim period.  This financial information should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10K for the year ended February 28, 2011.


Note 2. Nature of Business and Summary of Significant Accounting Policies:


Nature of Business


The Company was founded in 1982 under the laws of the State of Minnesota as Command Small Computer Learning Center, Inc., a computer training company and operated under several different names in the computer hardware and training sector. In 2005, the Company began acquiring domain names.  On March 1, 2007, the Company changed its name to DigitalTown, Inc. and began developing a business plan to develop a platform to monetize the domain names. The Company’s headquarters are located at 11974 Portland Avenue, Burnsville, MN 55337, and its telephone and facsimile numbers are (952) 890-2362 and (952) 890-7451, respectively. The Company's Internet address is www.digitaltown.com.   The Company is traded in the over-the-counter market under the ticker DGTW.


The Company has sustained losses and negative cash flows from operations and expects these conditions to continue into the foreseeable future.  At August 31, 2011, the Company had an accumulated deficit of $20,473,382.  Subsequent to August 31, 2011, the Company has received cash proceeds of $25,002 from issuance of common stock.  The Company anticipates that existing cash, proceeds from issuance of common stock received to date, expected future proceeds from its stock subscriptions receivable and expected sales of its common stock should be sufficient to meet its working capital and capital expenditures needs through at least August 31, 2012.  In the event that we are unable to obtain additional capital in the future, we would be forced to reduce operating expenses and/or cease operations altogether.


Principles of Consolidation


The Company files consolidated financial statements that include its wholly-owned subsidiary Tiger Media. All material intercompany accounts and transactions have been eliminated in consolidation.






4




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)




Use of Estimates


The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period.  Actual results could differ from those estimates.


Revenue Recognition


The Company recognizes revenue when it is realized or realizable and has been earned.  Revenue is generated from commerce-based transactions generated from our websites and display of graphical advertisements (“display advertising”).


Intangible Assets – Domain Names/Website Development Costs


Domain name costs are accounted for in accordance with the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC 350-50) guidance pertaining to Intangibles-Goodwill and Other, Website Development Costs.  Certain modules and components of the Company’s overall website development are ready for their intended use and the Company’s resulting websites are currently operational. Accordingly, the annual domain name renewal fees are currently being amortized over one year and the purchase of any new domain names are the only amounts being capitalized.  Previously, during the infrastructure development stage of its websites, the Company capitalized the purchase of new domain names and the annual domain name renewal fees. Additionally, since the ownership of each domain name can be renewed for a nominal renewal fee each year prior to their expiration date, the useful lives of the domain names are deemed to be indefinite and no amortization of the capitalized costs for the domain names will be recorded.  


Website development costs are accounted for in accordance with the FASB Accounting Standards Codification (ASC 350-40) guidance pertaining to Intangibles-Goodwill and Other, Internal-Use Software which requires that all internal and external costs incurred to develop the internal-use software necessary to operate the websites be capitalized.  The guidance further states, amortization should begin when an individual module or component of the overall internal-use software is ready for its intended use.  The cost of such module or component will be amortized on a straight-line basis over its estimated useful life, as determined by the Company, after taking into account the effects of obsolescence, technology, competition and other economic factors.  The Company has components of its website development that are operational and are being amortized on a straight-line basis over a three year life.


Impairment of Long-Lived Assets


Long-lived assets, such as property and equipment and intangible assets – domain names/website development costs are reviewed for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is



5




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)



measured by comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset.  


Income Taxes


Deferred tax assets (net of any valuation allowance) and liabilities resulting from temporary differences, net operating loss carry-forwards and tax credit carry-forwards are recorded using an asset-and-liability method.  Deferred taxes relating to temporary differences and loss carry-forwards are measured using the tax rate expected to be in effect when they are reversed or are realized.  Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be ultimately realized.  The Company has recorded a full valuation allowance against its net deferred tax asset due to the uncertainty of realizing the related future benefits.

 

The Company accounts for income taxes pursuant to Financial Accounting Standards Board guidance.  This guidance prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return.  For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities.  The Company’s adoption of these provisions specifically related to uncertain tax positions resulted in no cumulative effect adjustment.  The Company believes its income tax filing positions and deductions will be sustained upon examination and, accordingly, no reserves or related accruals for interest and penalties have been recorded at August 31, 2011 and February 28, 2011.  In accordance with the guidance, the Company has adopted a policy under which, if required to be recognized in the future, interest related to the underpayment of income taxes will be classified as a component of interest expense and any related penalties will be classified in operating expenses in the statements of operations.  The Company has three open years of tax returns subject to examination.


Stock-Based Compensation


The Company measures and recognizes compensation expense for all stock-based payment awards made to employees, directors and consultants on a straight-line basis over the respective vesting period of the awards.  The compensation expense for the Company's stock-based payments is based on estimated fair values at the time of the grant of the portion of stock-based payment awards that are ultimately expected to vest.


The Company estimates the fair value of stock-based payment awards on the date of grant using the Black-Scholes option pricing model. This option pricing model involves a number of assumptions, including the expected lives of stock options, the volatility of the public market price for the Company's common stock and interest rates.







6




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)




Recently Issued Accounting Pronouncements

There were no new accounting standards issued or effective during the six months ended August 31, 2011 that had or are expected to have a material impact on the Company’s results of operations, financial condition, or cash flows.

Note 3. Intangible Assets


Intangible assets, net are as follows:


 

August 31,            2011

February 28,     2011

Domain names

$        831,881

$      831,667

Website development costs

351,457

321,457

Less accumulated amortization

(71,427)

(34,810)

 

$     1,111,911

$   1,118,314


During the six months ended August 31, 2011, the Company capitalized $214 in additional domain name purchases.  Since the useful life of the domain names is deemed to be indefinite, no amortization has been recorded.


During the six months ended August 31, 2011, the Company incurred $130,782 of annual domain name renewal fees and recorded them as prepaid domain name renewal fees and expensed $43,160 and $85,688, respectively, on a straight line basis, to cost of revenues in the Company’s consolidated statement of operations for the three and six months ended August 31, 2011. At August 31, 2011, the Company had $83,025 of prepaid domain name renewal fees which will be amortized over future periods.


During the six months ended August 31, 2011, the Company capitalized $30,000 of website development costs and had a total recorded cost of $351,457 at August 31, 2011.  The Company has determined that $219,705 of the website development costs capitalized at August 31, 2011 pertain to components of the Company’s website development that is ready for its intended use and has an estimated useful life of three years.  During the three and six months ended August 31, 2011, the Company recorded $18,308 and $36,617, respectively, to cost of revenues for amortization expense pertaining to these website components.

 

Note 4. Deferred Officer Compensation


Richard Pomije, the CEO and Chairman of the Company, has elected to forego a portion of his salary at various times due to limited operating funds.  These amounts do not accrue interest and are due and payable as funds become available in the future.  During the six months ended August 31, 2011, the Company recorded $8,654 of additional deferred officer compensation and made a payment of $58,942 to Mr. Pomije.  The balance at August 31, 2011 was $ 0.




7




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)




Note 5. Stockholders’ Equity


Stock Transactions


On August 15, 2011, the Company issued 3,750 restricted common shares at $2.00 per share, valued at $7,500, to five directors of the Company for payment of director fees.


During the quarter ended August 31, 2011, the Company entered into stock purchase agreements and issued 630,005 units (each unit consisting of one share of restricted common stock and a two-year warrant to purchase one share of common stock at an exercise price of $4.00 per share) at a unit price of $1.50, for total cash proceeds of $945,009.  


On May 16, 2011, the Company issued 3,680 restricted common shares at $2.00 per share, valued at $7,360, to five directors of the Company for payment of director fees.


On April 27, 2011, the Company issued 1,000 free trading common shares at $2.11 per share, valued at $2,108, to Auctus Private Equity Fund, LLC in connection with a drawdown equity financing agreement.


During the quarter ended May 31, 2011, the Company entered into stock purchase agreements and issued 323,737 units (each unit consisting of one share of restricted common stock and a two-year warrant to purchase one share of common stock at an exercise price of $4.00 per share) at a unit price of $1.50, for total cash proceeds of $415,997.  The remaining balance due of $69,606 was received in June 2011, for a total of $485,603.


Stock Warrants


As of August 31, 2011, the Company has a total of 1,099,076 stock purchase warrants outstanding with an exercise price of $4.00.  The warrants expire two years from their date of issuance.  The weighted average remaining exercise period as of August 31, 2011 is 1.69 years.


Other


In February 2010, the Company entered into an agreement with an investment banker to promote and sell shares of common stock to accredited and institutional investors.  In conjunction with the potential sale of shares of common stock, the investment banker will receive a 10% commission, be reimbursed for expenses and granted a five-year warrant of the Company's common stock equal to 10% of the shares of common stock sold.  In February 2010, the Company paid the investment banker an advance of $20,000 consisting of $15,000 as a retainer to be applied against any potential commission earned and $5,000 as an advance on expenses.  On November 12, 2010, the Company had not received any proceeds from the sale of common stock related to this agreement and thus ended its agreement with the investment banker and signed a drawdown equity financing agreement (“Drawdown Agreement”) with an institutional investor on December 3, 2010.  




8




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)



The Drawdown Agreement was entered into with Auctus Private Equity Fund, LLC (“Auctus”).  In connection with the Drawdown Agreement, in April 2011, the Company registered 3,000,000 shares of common stock with the SEC under the Securities Act of 1933 and at its discretion, has the right to sell up to the registered shares of common stock to Auctus over a thirty six month period for maximum aggregated consideration of up to $10,000,000, subject to the following terms and conditions.


·

The maximum advance amount available to the Company is limited to the greater of $150,000 or 200% of the average daily volume based on the 10 days preceding the Company’s notice requesting a draw.

·

Auctus’ purchase price per common share will be 94% of the lowest closing volume weighted average price (“VWAP”) of the Company’s common stock during the five trading days immediately following the Company’s delivery of notice to Auctus.

·

At its option, the Company can establish a floor price under which Auctus may not sell the shares.  The floor price shall be 75% of the closing VWAP for the 10 days prior to the notice requesting a draw.  Auctus must cease selling any shares purchased in connection with the Drawdown Agreement if the price falls below the established floor price.  The Company, at its discretion, may waive the floor price and allow Auctus to sell its shares below the floor price.

·

In no event can the number of shares owned by Auctus exceed 4.99% of the then outstanding shares of the Company’s common stock.  As of August 31, 2011, this would translate into maximum ownership by Auctus of approximately 1,447,000 shares of the Company’s common stock.


In April 2011, the Company issued a drawdown notice to Auctus for $50,000.  Auctus honored $2,108 on April 27, 2011 of the notice, but has refused to honor the balance.  The Company considers Auctus to be in breach of the Drawdown Agreement.


Note 6. Stock Options


The Company has one stock option plan called The 2006 Employee Stock and Option Plan. As of August 31, 2011, an aggregate of 5,000,000 shares of common stock may be granted under this plan determined by the Board of Directors. The stock options may be granted to directors, officers, employees, consultants and advisors of the Company.  Options granted under this plan are non-qualified stock options and have exercise prices and vesting terms established by the Board of Directors at the time of each grant.  Vesting terms of the outstanding options range from immediate to two years from the grant date anniversary.  The terms of the options are five years from the date of grant.


The Company’s consolidated financial statements as of and for the six months ended August 31, 2011 and 2010, reflect the impact of their stock-based compensation.  For the three months ended August 31, 2011, the Company granted no stock options. Total stock compensation expense for all option grants was $78,110 and $93,049 for the three months ended August 31, 2011 and 2010, respectively.  For the six months ended August 31, 2011 and 2010, the Company has recorded $148,566 and $126,040 in stock compensation expense, respectively. This expense is included in selling, general and administrative expense. As of August 31, 2011, the Company has not recorded any tax benefit from this non-cash expense due to the Company having a full valuation allowance against its deferred tax assets. The



9




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)



compensation expense impacted the three and six months ended August 31, 2011 basic (loss) per common share by $(0.003) and $(0.005), respectively. There remains $165,370 of total unrecognized compensation expense, which is expected to be recognized over future periods through November 30, 2012.


The following table summarizes information about the Company’s stock options:

  

                 

 

Number of Options

Weighted Average Exercise Price

Weighted Average Remaining Contract Life (years)

Aggregate Intrinsic Value (1)

Outstanding - February 28, 2011              

4,155,000

$  1.862

-

-

Granted

-

-

-

-

Canceled or expired

(60,000)

(1.750)

-

-

Exercised

-

-

-

-

Outstanding – August 31, 2011              

4,095,000

$  1.861

1.01

-         

Exercisable at August 31, 2011                           

3,728,500

$  1.873

0.71

-


(1)

The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price.


Note 7. Related Party Transactions


The Company entered into a five year lease with Jeff Mills, a director/stockholder of the Company, for approximately 2,650 square feet of space used for offices and operations equipment storage at 11974 Portland Avenue, Burnsville, Minnesota.  The lease commenced on December 16, 2006 at a monthly rent of $2,650 for the five year term of the lease and contains an option to renew for an additional term of one year at a monthly rent of $3,650.  The Company’s lease payments made to the director for the three months ended August 31, 2011 and 2010 totaled $7,950 each period.  For the six months ended August 31, 2011 and 2010, the Company recorded $15,900 in lease payments to the director for each period.


Minimum lease payments at August 31, 2011 are as follows:

 

 

FY 2012-remainder

    $   9,275


Loan from Director/Stockholder


As of August 31, 2011, the Company had an outstanding working capital loan of $37,088 from Jeff Mills, a director/stockholder of the Company.  The loan is due on demand and bears annual interest at 7.0%.  The Company made a principal payment of $100,000 and received no additional draws during the six months ended August 31, 2011.  Interest expense incurred on this loan for the three and six months ended August 31, 2011 and 2010 was $1,000 and $3,628 and $1,544 and $3,792, respectively.






10




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)



Note 8. Commitments and Contingencies


The Company is exposed to asserted and unasserted claims encountered in the normal course of business. In the opinion of management, the resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations.

On December 8, 2010, the Company entered into a five year strategic partnership agreement with the National Interscholastic Athletic Administrators Association (“NIAAA”).  The NIAAA and DigitalTown will work together to establish a national, standardized system for recording schedules, scores, rosters and statistics for interscholastic sports teams and individual students.  Pursuant to the agreement, the Company has committed to pay the expenses related to this strategic partnership; however any expenses in excess of $5,000 must be preapproved by the Company.  The Company has committed to deposit $50,000 for such expenses for the first fiscal year of the contract which the Company has paid as of August 31, 2011, and an additional $50,000 for the second year.  In addition, the Company has committed to donate 25% up to $3,000,000 of the annual net sponsorship revenue in the scheduling and stats areas of its websites to yet to be named program funds that promote youth activities and the NIAAA.  Lastly, the Company has committed to a minimal revenue share of $100,000 per year with the future launch of its beta 3 software.  As of August 31, 2011, the Company has not yet launched its beta 3 software nor has it generated any net sponsorship revenue.

On August 22, 2011, the Company entered into a nine month agreement with Enable Consulting, LLC to complete the design and development of the Company’s sales center application.  The Company has committed to $66,000 for the development and support of this software application through May 2012.

Note 9. Common Stock Subscriptions Receivable


As of August 31, 2011, the Company has the following related party stock subscription agreements outstanding all of which is due from a related party:


2005 Agreements


Material terms of the subscription agreements received by the Company on December 30, 2005 for 4,733,333 restricted common shares at $0.75 per share (total value of $3,550,000) are as follows:


·

Payment is due in full in 60 months.

·

At 24 months, the Company can demand at its option, monthly 1/36 payments on the subscription agreement.

·

The Company has the option to charge simple annual interest of up to 4%.

·

The Company will provide downside protection of up to 30% of the stock price upon conversion.


The outstanding balance owed on the 2005 subscription agreements at August 31, 2011 is $24,654.  The Company recognizes that this receivable is now past due and deems it to be fully collectable.





11




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)



2007 Agreements


On October 5, 2007, the Company received subscriptions for 1,300,000 restricted common shares at $2.50 per share (total value of $3,250,000).  Significant terms of the original subscription agreement are as follows:


·

The price per share of $2.50 was based on the closing price on October 4, 2007.

·

At 24 months, 1/36 payments are due monthly.

·

The Company, at its option, may call up to 1/12 of the gross receivable per month if the preceding 30 day average trading price is at or above $7.00 a share with minimum trading volume of 5,000 shares per day.

·

If the purchaser sells these common shares, the purchaser shall be entitled to an amount equal to 200% of the original purchase price of each share and the Company shall be entitled to 50% of any additional net sales proceeds from the stock sale.


On February 25, 2010, due to the recent economic downturn and the market value decline of the Company’s stock, which was trading below $2.50 per share, the Company amended the pricing terms of the subscription agreements received by the Company on October 5, 2007.  The amendment changed the following significant terms of the subscription agreement:


The parties agree that the Initial Pricing terms in the Confidential Binding Term Sheet dated October 5, 2007 of the Agreement will be amended to state as follows:


1.

The Subscriber offers to purchase shares of the Company for $0.75 per share.  After the price adjustment, the revised total value of this subscription agreement is $975,000.


The following other provisions of the Initial Pricing and Final Pricing terms in the Confidential Binding Term Sheet dated October 5, 2007 of the Agreement will be deleted, and are not enforceable by either party:


·

Beginning October 5, 2009, 1/36 payments are due each month thereafter on the 5th of every month.

·

The Company at its option may call up to 1/12 of the (gross) receivable note per month if the preceding 30 day average trading price is at or above $7.00 a share.  Minimum trading volume must be 5,000 shares a day.

·

As total consideration for the purchase and sale of the Company’s stock, purchaser shall ultimately pay to the Company the following amount (the “Purchase Price”):

A.

Purchaser shall first be entitled to an amount equal to 200% of the face amount of each share.

B.

After the purchaser receives the amount in A above, the Company shall be entitled to 50% of any additional net sales proceeds of the stock.  Net sales proceeds shall mean the gross proceeds received from the sale of the stock, less reasonable brokerage commissions.

C.

Final adjusted net sales proceeds will be wired to the Company within 7 days from the final settlement of the sale of stock sold.



12




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)




The outstanding balance owed on the revised 2007 subscription agreements at August 31, 2011 is $975,000.


2010 Agreement


Material terms of the subscription agreement received by the Company on June 22, 2010, for 400,000 restricted common shares at $0.75 per share (total value of $300,000) are as follows:


·

Payment is due in full in 60 months.

·

At 24 months, the Company can demand at its option, monthly 1/36 payments on the subscription agreement.

·

The Company has the option to charge simple annual interest of up to 4%.

·

The Company will provide downside protection of up to 30% of the stock price upon conversion.


The outstanding balance owed on the 2010 subscription agreement at August 31, 2011 is $300,000.


Summary


For the six months ended August 31, 2011, the Company received stock subscription payments of $123,000 and as of August 31, 2011, the Company had related party stock subscriptions receivable aggregating $1,299,654 for the 2005, 2007, and 2010 agreements.  


The following tables summarize information about the stock subscription receivable:


Receivable balance at February 29, 2008

    $        5,030,795

     Cash collected

(523,832)

Receivable balance at February 28, 2009

    4,506,963

     Cash collected

(337,500)

     2007 subscription agreement pricing revised (1)

(2,275,000)

Receivable balance at February 28, 2010

       1,894,463

     New subscription agreement (2)

300,000

     Cash collected

(771,809)

Receivable balance at February 28, 2011

   1,422,654

     Cash collected

(123,000)

Receivable balance at August 31, 2011

$        1,299,654

 

 

 

 

Summary of outstanding subscriptions:

 

2005 subscriptions

$            24,654

2007 subscriptions

975,000

2010 subscriptions

300,000

 

$       1,299,654

 

 



13




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)





(1)

Amendment to the terms of the subscription agreements received by the Company on October 5, 2007 for 1,300,000 restricted common shares reducing the price paid per share from $2.50 to $0.75.

(2)

New subscription agreement received on June 22, 2010.


The Company has not exercised its rights, per the 2005 subscription agreements, to demand monthly 1/36 payments or to charge up to 4% interest on the subscription amounts outstanding and they have provided no “downside protection” to the subscribers.  The “downside protection” in the terms for the 2005 subscription agreements requires the Company to reimburse the subscription holder up to 30% of the $.75 purchase price, or $.225, if the market price of the stock is below $.75 when converted. The protection may be provided in additional shares if necessary.  For the six month period ended August 31, 2011, there was no downside protection provided because the stock price did not go below $.75 when converted.  The subscription agreements do not define the term “when converted.”  The Company has taken the position that if at the time that a purchaser makes a payment in full for the shares under a subscription agreement and the closing price of the shares of the Company’s stock is less than $.75, the shareholder would be entitled to up to 30% additional shares, depending on the trading share price.  Once the subscription shares have been paid for in their entirety, the downside protection ceases.


Note 10. Earnings (Loss) Per Share


The Company computes earnings per share using two different methods, basic and diluted, and presents per share data for all periods in which statements of operations are presented. Basic earnings per share are computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted earnings per share are computed by dividing net income (loss) by the weighted average number of common stock and common stock equivalents outstanding.


The following tables provide a reconciliation of the numerators and denominators used in calculating basic and diluted earnings (loss) per share for the three and six month periods ended August 31, 2011 and 2010:

 

Three months ended

  

August 31,

 

2011

 

2010

Basic earnings (loss) per share calculation:

 

 

 

Net loss to common shareholders

$             (347,335)

 

$         (273,325)

Weighted average of common shares outstanding

28,820,142

 

27,810,431

Basic net loss per share

$                   (0.01)

 

$               (0.01)

  

 

 

 

Diluted earnings (loss) per share calculation:

 

 

 

Net loss to common shareholders

$             (347,335)

 

$        (273,325)

Weighted average of common shares outstanding

28,820,142

 

27,810,431

Stock options (1)

-

 

-

Warrants (2)

-

 

-

Diluted weighted average common shares outstanding

28,820,142

 

27,810,431

  

 

 

 

Diluted net loss per share

$                   (0.01)

 

$               (0.01)



14




DigitalTown, Inc.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (unaudited)





 

Six months ended

  

August 31,

 

2011

 

2010

Basic earnings (loss) per share calculation:

 

 

 

Net loss to common shareholders

$             (642,468)

 

$         (516,540)

Weighted average of common shares outstanding

28,441,830

 

27,645,077

Basic net loss per share

$                   (0.02)

 

$               (0.02)

  

 

 

 

Diluted earnings (loss) per share calculation:

 

 

 

Net loss to common shareholders

$             (642,468)

 

$        (516,540)

Weighted average of common shares outstanding

28,441,830

 

27,645,077

Stock options (1)

-

 

-

Warrants (2)

-

 

-

Diluted weighted average common shares outstanding

28,441,830

 

27,645,077

  

 

 

 

Diluted net loss per share

$                   (0.02)

 

$               (0.02)


 (1)    

At August 31, 2011 and 2010, there were outstanding stock options equivalent of 4,095,000 and 4,053,000 common shares, respectively.  The stock options are anti-dilutive at August 31, 2011 and 2010 and therefore have been excluded from diluted earnings (loss) per share.

 

 

(2)       

At August 31, 2011 and 2010, there were outstanding warrants equivalent to 1,099,076 and 229,668 common shares, respectively.   The warrants are anti-dilutive at August 31, 2011 and 2010 and therefore have been excluded from diluted earnings (loss) per share.

Note 11. Supplemental Disclosure of Cash Flow Information


 

Six months ended

 

August 31,

 

2011

2010

Non-cash flow information:

 

 

    Cash paid for interest

$          3,628

$        3,792

    Intangible assets – website development costs in accounts payable

$        30,000           

$                -

          

 

 


Note 12. Subsequent Events


The Company entered into stock purchase agreements and issued 16,668 units (each unit consisting of one share of common stock and a two-year warrant to purchase one share of common stock at an exercise price of $4.00 per share) at a unit price of $1.50, for total cash proceeds of $25,002 during the period from September 1, 2011 to October 13, 2010.


In September 2011, the Company repaid $37,088 of the loan from director/stockholder.



15






ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


The following is a discussion of the financial condition of the Company as of August 31, 2011, and its results of operations for the six months ended August 31, 2011 and 2010, which should be read in conjunction with, and is qualified in its entirety by, the financial statements and notes thereto included elsewhere in this report and the audited consolidated financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended February 28, 2011


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION


This Form 10-Q for the quarter ended August 31, 2011, contains forward-looking statements.  Forward-looking statements may be identified by the use of forward-looking terminology, such as “may,” “shall,” “could,” “expect,” “estimate,” “anticipate,” “predict,” “probable,” “should,” “continue,” or similar terms, variations of those terms or the negative of those terms.  The forward-looking statements specified in the following information have been compiled by our management and are considered by management to be reasonable.  Our future operating results, however, are impossible to predict and no representation, guaranty, or warranty is to be inferred from those forward-looking statements.


Company Overview  


DigitalTown continues to develop its nationwide network of local on-line communities built around their domain names and the schools and communities they represent.  In August 2011, the Company entered into an agreement, with a consulting firm, to complete the design and development of their Sales Center Application.  Once the Sales Center Application is complete, the Company will have the capability to begin telemarketing advertising space to local businesses on specific websites that match the demographics of the local businesses’ customers.  The target date for completion of the Sales Center Application is November 2011.


The sites continue to feature 2011 and 2010 schedules, scores and Active Power Rankings for high school football.  The sites also feature 2010/2011 basketball and 2011 lacrosse schedules, scores and Active Power Rankings and will continue in the winter and spring to feature 2011/2012 basketball and 2012 lacrosse schedules, scores and Active Power Rankings.

On December 8, 2010, the Company entered into a five year strategic partnership agreement with the National Interscholastic Athletic Administrators Association (“NIAAA”).  The NIAAA and DigitalTown will work together to establish a national, standardized system for recording schedules, scores, rosters and statistics for interscholastic sports teams and individual students.  Pursuant to the agreement, the Company has committed to pay the expenses related to this strategic partnership; however any expenses in excess of $5,000 must be preapproved by the Company.  The Company has committed to deposit $50,000 for such expenses for the first fiscal year of the contract and an additional $50,000 for the second year.  In addition, the Company has committed to donate 25% up to $3,000,000 of the annual net sponsorship revenue in the scheduling and stats areas of its websites to yet to be named program funds that promote youth activities and the NIAAA.  Lastly, the Company has committed to a minimal revenue share of $100,000 per year with the future launch of its beta 3 software.  As of August 31, 2011, the Company has not launched its beta 3 software or generated any net sponsorship revenue.

On April 5, 2011, the Company’s registration statement, initially filed December 23, 2010, was declared effective by the SEC.  The effective registration statement allows the Company to sell 3,000,000 shares of



16






common stock to Auctus Private Equity Fund, LLC (“Auctus”) as part of the drawdown equity financing agreement the Company signed with Auctus on December 3, 2010. Per the agreement, the Company, at its discretion, has the right to sell up to $10,000,000 of common stock to Auctus over a 36 month period per the conditions set forth in the agreement.  The Company issued a drawdown notice to Auctus for $50,000.  Auctus honored $2,108 of the notice, but has refused to honor the balance.  The Company considers Auctus to be in breach of the drawdown agreement.


RESULTS OF OPERATIONS


THREE MONTHS ENDED AUGUST 31, 2011 and 2010


During the three months ended August 31, 2011, the Company recorded revenue of $5,105 and cost of revenue of $64,619 for a negative gross profit of $(59,514) compared to revenue of $5,077 and cost of revenue of $51,843 for a negative gross profit of $(46,766) for the same period in 2010.  For the two comparable periods, revenue consisted of commissions generated from advertising on our websites and cost of revenue consisted of amortization of prepaid annual domain name renewal fees of $43,160 for 2011 compared to $47,896 for 2010, server/bandwidth expense of $3,151 for 2011 and $2,001 for 2010 and amortization of website development fees were $18,308 for 2011 and $1,946 for 2010.

  

Selling, general and administrative expenses for the most current three months increased by $59,572 to $286,890 compared to a year ago.  Stock compensation expense, included in selling, general and administration expenses, was $78,110 for the three months ended August 31, 2011 compared to $93,049 for the three months ended August 31, 2010, a decrease of $14,939 when comparing the two periods.  Excluding non-cash stock compensation expense for the two comparable periods, selling, general, and administrative expenses were $208,780 for the three months ended August 31, 2011 compared to $134,269 for the three months ended August 31, 2010.  The increase of $74,511 was primarily due to a $62,185 increase in professional fees, primarily relating to the payment of $40,000 to the NIAAA for expenses related to the strategic partnership and expensing a $15,000 retainer paid to an investment banker in February 2010, a $5,352 increase in payroll expense and an increase of $3,171 in travel and entertainment expense.  The Company’s overall net loss for the current three months increased by $74,010 to $347,335.


SIX MONTHS ENDED AUGUST 31, 2011 and 2010


During the six months ended August 31, 2011, the Company recorded revenue of $10,525 and cost of revenue of $130,510 for a negative gross profit of $(119,985) compared to revenue of $9,147 and cost of revenue of $108,497 for a negative gross profit of $(99,350) for the same period in 2010.  For the two comparable periods, revenue consisted of commissions generated from advertising on our websites and cost of revenue consisted of amortization of prepaid annual domain name renewal fees of $85,688 for 2011 compared to $100,602 for 2010, server/bandwidth expense of $8,205 for 2011 and $4,002 for 2010 and amortization of website development fees were $36,617 for 2011 and $3,893 for 2010.  


Selling, general and administrative expenses for the most current six months increased by $95,627 to $518,931 compared to a year ago.  Stock compensation expense, included in selling, general and administration expenses was $148,566 for the six months ended August 31, 2011 compared to $126,040 for the six months ended August 31, 2010, an increase of $22,526 when comparing the two periods.  Excluding non-cash stock compensation expense for the two comparable periods, selling, general, and administrative expenses were $370,365 for the six months ended August 31, 2011, compared to $297,264 for the six months ended August 31, 2010.  The increase of $73,101 was primarily due to a $69,014



17






increase in professional fees relating to the payment of $40,000 to the NIAAA for expenses related to the strategic partnership and expensing a $15,000 retainer paid to an investment banker in February 2010,  The Company’s overall net loss for the current six months increased by $125,928 to $642,468 from the same period one-year ago.


LIQUIDITY AND CAPITAL RESOURCES


SIX MONTHS ENDED AUGUST 31, 2011


The Company’s cash position at August 31, 2011, was $817,289, an increase of $713,979 from $103,310 at February 28, 2011.  During the six months ended August 31, 2011, net cash used in operating activities was $730,308.  When comparing the six months ended August 31, 2011 and 2010, the increase in cash used in operating activities of $436,991 for the six months ended August 31, 2011 is due primarily from cash being expended to decrease accounts payable and deferred officers compensation by $296,925 and $53,853, respectively, and expend an additional $15,097 in domain renewal fees.


Net cash used in investing activities for the six months ended August 31, 2011 was $11,433 of which $11,219 was used for the purchase of property and equipment and $214 for the purchase of additional domain names as compared to net cash used of $121,572, of which $95,787 was used for website development costs, $20,001 for the purchase of property and equipment and $5,784 for the purchase of additional domain names for the comparable 2010 period.  


Net cash provided by financing activities for the six months ended August 31, 2011 was $1,455,720 which consisted of proceeds from issuance of stock of $1,432,720 and payments received on stockholder subscription receivables of $123,000 less a $100,000 payment made on the loan from director/stockholder. For the comparable period ended August 31, 2010, the Company received net cash provided by financing activities of $390,384 which consisted of payments received on stockholder subscription receivables of $431,450 and proceeds from the issuance of common stock of $10,000 less principal payments made on the loan from director/stockholder of $51,066.


Monthly cash operating expenses for the six months ended August 31, 2011, were approximately $122,000 per month, which included payments of $130,782 of the projected yearly cost of $174,000 for annual domain name renewals.  Based on current projections, the Company’s monthly cash operating expenses going forward for the remainder of the fiscal year should be approximately $107,000 per month, which includes the remaining projected cost of the renewal of the existing domain names totaling approximately $43,000.   In addition to the normal monthly operating expenses, the Company’s committed cash requirements for the six months ending February 28, 2012 include $126,475 for website development services. Further, the Company in September 2011, paid the outstanding balance of a promissory note with Jeff Mills, a director and stockholder of the Company, in the amount of $37,088.  From September 1, 2011 to October 13, 2011 the Company has received cash proceeds of $25,002 from issuance of common stock.  The Company anticipates that its existing cash reserves plus proceeds from the collection of its remaining stock subscriptions receivable or sale of additional shares of common stock will fund its operations.


As of August 31, 2011, the Company has the following stock subscription agreements outstanding of all of which is due from a related party:






18






2005 Agreements


Material terms of the subscription agreements received by the Company on December 30, 2005 for 4,733,333 restricted common shares at $0.75 per share (total value of $3,550,000) are as follows:


·

Payment is due in full in 60 months.

·

At 24 months, the Company can demand at its option, monthly 1/36 payments on the subscription agreement.

·

The Company has the option to charge simple annual interest of up to 4%.

·

The Company will provide downside protection of up to 30% of the stock price upon conversion.


The outstanding balance owed on the 2005 subscription agreements at August 31, 2011 is $24,654.  The Company recognizes that this receivable is now past due and deems it to be fully collectable.


2007 Agreements


On October 5, 2007, the Company received subscriptions for 1,300,000 restricted common shares at $2.50 per share (total value of $3,250,000).  Significant terms of the original subscription agreement are as follows:


·

The price per share of $2.50 was based on the closing price on October 4, 2007.

·

At 24 months, 1/36 payments are due monthly.

·

The Company, at its option, may call up to 1/12 of the gross receivable per month if the preceding 30 day average trading price is at or above $7.00 a share with minimum trading volume of 5,000 shares per day.

·

If the purchaser sells these common shares, the purchaser shall be entitled to an amount equal to 200% of the original purchase price of each share and the Company shall be entitled to 50% of any additional net sales proceeds from the stock sale.


On February 25, 2010, due to the recent economic downturn and the market value decline of the Company’s stock, which was trading below $2.50 per share, the Company amended the pricing terms of the subscription agreements received by the Company on October 5, 2007.  The amendment changed the following significant terms of the subscription agreement:


The parties agree that the Initial Pricing terms in the Confidential Binding Term Sheet dated October 5, 2007 of the Agreement will be amended to state as follows:


1.

The Subscriber offers to purchase shares of the Company for $0.75 per share.  After the price adjustment, the revised total value of this subscription agreement is $975,000.


The following other provisions of the Initial Pricing and Final Pricing terms in the Confidential Binding Term Sheet dated October 5, 2007 of the Agreement will be deleted, and are not enforceable by either party:


·

Beginning October 5, 2009, 1/36 payments are due each month thereafter on the 5th of every month.



19






·

The Company at its option may call up to 1/12 of the (gross) receivable note per month if the preceding 30 day average trading price is at or above $7.00 a share.  Minimum trading volume must be 5,000 shares a day.

·

As total consideration for the purchase and sale of the Company’s stock, purchaser shall ultimately pay to the Company the following amount (the “Purchase Price”):

A.

Purchaser shall first be entitled to an amount equal to 200% of the face amount of each share.

B.

After the purchaser receives the amount in A above, the Company shall be entitled to 50% of any additional net sales proceeds of the stock.  Net sales proceeds shall mean the gross proceeds received from the sale of the stock, less reasonable brokerage commissions.

C.

Final adjusted net sales proceeds will be wired to the Company within 7 days from the final settlement of the sale of stock sold.


The outstanding balance owed on the revised 2007 subscription agreements at August 31, 2011 is $975,000.


2010 Agreement


Material terms of the subscription agreement received by the Company on June 22, 2010, for 400,000 restricted common shares at $0.75 per share (total value of $300,000) are as follows:


·

Payment is due in full in 60 months.

·

At 24 months, the Company can demand at its option, monthly 1/36 payments on the subscription agreement.

·

The Company has the option to charge simple annual interest of up to 4%.

·

The Company will provide downside protection of up to 30% of the stock price upon conversion.


The outstanding balance owed on the 2010 subscription agreement at August 31, 2011 is $300,000.


Summary


For the six months ended August 31, 2011, the Company received stock subscription payments of $123,000 and as of August 31, 2011, the Company had related party stock subscriptions receivable aggregating $1,299,654 for the 2005, 2007, and 2010 agreements.  


The following table summarizes the stock subscription receivable, by quarter, at August 31, 2011:


Quarter Ended

Total Balance Due

Total Amount Collected

New Subscription Agreements

 

Participatory Rights in the Proceeds of the Resales Collected

Amount of Downside Protection Provided

February 28, 2010

1,894,463

 

 

 

 

-

May 31, 2010

1,535,513

358,950

 

 

 

 

August 31, 2010

1,763,013

72,500

$ 300,000

(1)

 

 

November 30, 2010

1,680,388

   82,625

 

 

 

 

February 28, 2011

1,422,654

257,734

 

 

 

 

May 31, 2011

1,369,260

123,000

 

 

 

 

August 31, 2011

1,299,654

-

 

 

 

 




20






(1)

New subscription agreement received on June 22, 2010.


The Company has not exercised its rights, per the 2005 subscription agreements, to demand monthly 1/36 payments or to charge up to 4% interest on the subscription amounts outstanding and they have provided no “downside protection” to the subscribers.  The “downside protection” in the terms for the 2005 subscription agreements requires the Company to reimburse the subscription holder up to 30% of the $.75 purchase price, or $.225, if the market price of the stock is below $.75 when converted. The protection may be provided in additional shares if necessary.  For the six month period ended August 31, 2011, there was no downside protection provided because the stock price did not go below $.75 when converted.  The subscription agreements do not define the term “when converted.”  The Company has taken the position that if at the time that a purchaser makes a payment in full for the shares under a subscription agreement and the closing price of the shares of the Company’s stock is less than $.75, the shareholder would be entitled to up to 30% additional shares, depending on the trading share price.  Once the subscription shares have been paid for in their entirety, the downside protection ceases.


In summary, we believe our current cash reserves, the amounts we expect to collect on our outstanding stock subscription receivables and proceeds from the sale of our common stock should be sufficient to enable us to operate for the next 12 months. In the event that we are unable to collect in the future our stock subscriptions receivable or obtain capital from new issuances of common stock, as needed, we would be forced to reduce operating expenses and/or cease operations altogether.


Critical Accounting Policies


The discussion and analysis of DigitalTown, Inc.’s financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and related disclosure of contingent assets and liabilities. Management reviews its estimates on an ongoing basis. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. While DigitalTown Inc.’s significant accounting policies are described in more detail in Note 2 to its financial statements, management believes the following accounting policies to be critical to the judgments and estimates used in the preparation of its financial statements:


Intangible Assets – Domain Names/Website Development Costs


Domain name costs are accounted for in accordance with the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC 350-50) guidance pertaining to Intangibles-Goodwill and Other, Website Development Costs.  Certain modules and components of the Company’s overall website development are ready for their intended use and the Company’s resulting websites are currently operational. Accordingly, the annual domain name renewal fees are currently being amortized over one year and the purchase of any new domain names are capitalized.  Previously, during the infrastructure development stage of its websites, the Company capitalized the purchase of new domain names and the annual domain name renewal fees. Since the ownership of each domain name can be renewed for a nominal renewal fee each year prior to their expiration date, the useful lives of the domain names are deemed to be indefinite and no amortization of the capitalized costs for the domain names will be recorded.  




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Website development costs are accounted for in accordance with the FASB Accounting Standards Codification (ASC 350-40) guidance pertaining to Intangibles-Goodwill and Other, Internal-Use Software which requires that all internal and external costs incurred to develop the internal-use software necessary to operate the websites be capitalized.  The guidance further states, amortization should begin when an individual module or component of the overall internal-use software is ready for its intended use.  The cost of such module or component will be amortized on a straight-line basis over its estimated useful life, as determined by the Company, after taking into account the effects of obsolescence, technology, competition and other economic factors.  The Company has components of its website development that are operational and are being amortized on a straight-line basis over a three year life.


            Impairment of Long-Lived Assets


Long-lived assets, such as property and equipment and intangible assets – domain names/website development costs are reviewed for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset.  


Stock-Based Compensation


The Company measures and recognizes compensation expense for all stock-based payment awards made to employees and directors on a straight-line basis over the respective vesting period of the awards.  The compensation expense for the Company's stock-based payments is based on estimated fair values at the time of the grant of the portion of stock-based payment awards that are ultimately expected to vest.


The Company estimates the fair value of stock-based payment awards on the date of grant using the Black-Scholes option pricing model. This option pricing model involves a number of assumptions, including the expected lives of stock options, the volatility of the public market price for the Company's common stock and interest rates.


Recently issued accounting pronouncements:

There were no new accounting standards issued or effective during the three months ended August 31, 2011 that had or are expected to have a material impact on the Company’s results of operations, financial condition, or cash flows.


FORWARD-LOOKING INFORMATION


Any statements contained herein related to future events are forward-looking statements.  Readers are cautioned not to place undue reliance on forward-looking statements.  DigitalTown, Inc. undertakes no obligation to update any such statements to reflect actual events.




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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.


The Company has not entered into, and does not expect to enter into, financial instruments for trading or hedging purposes.  The Company does not currently anticipate entering into interest rate swap and/or similar instruments.  Our primary market risk exposure with regard to financial instruments is to changes in interest rates, which would only impact interest income earned on such instruments.  As of August 31, 2011, the Company does not have any material currency exchange or interest rate risk exposure.


ITEM 4. CONTROLS AND PROCEDURES


(a) Evaluation of Disclosure Controls and Procedures.


Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness, as of August 31, 2011, of our disclosure controls and procedures, as defined in Rules 13(a)-13(e) and 15(d)-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act. The purpose of this evaluation was to determine whether as of the evaluation date our disclosure controls and procedures were effective to provide reasonable assurance that the information we are required to disclose in our filings with the Securities and Exchange Commission, or SEC, under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. Based on their evaluation, our management has concluded, as previously discussed in Item 9A(T) of our Form 10-K for the fiscal year ended February 28, 2011, that material weaknesses continue to exist in our internal control over financial reporting as of August 31, 2011, and as a result our disclosures controls and procedures were not effective.  Notwithstanding the material weaknesses that continue to exist as of August 31, 2011, our chief executive officer and chief financial officer have concluded that the financial statements included in this Quarterly Report on Form 10-Q present fairly, in all material aspects, the financial position, results of operations and cash flows of the Company in conformity with accounting principles generally accepted in the United States of America (“GAAP”).


 (b) Changes in Internal Controls over Financial Reporting.


Management continues to evaluate the Company’s internal controls over financial reporting to insure that the design and implementation of corrective procedures are adequate to remediate the previously identified material weaknesses.   Management also continues to analyze the cost effectiveness of adding additional corrective procedures to remediate their existing material weaknesses.


During the fiscal quarter ended August 31, 2011, there was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II


ITEM 1.  LEGAL PROCEEDINGS


DigitalTown, Inc. is, from time to time, a party to litigation arising in the normal course of its business.  The Company believes that none of these actions will have a material adverse effect on its financial condition or results of operations.


ITEM 1A.  RISK FACTORS


The most significant risk factors applicable to the Company are described in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended February 28, 2011.  There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K.


ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS


On August 15, 2011, the Company issued 3,750 restricted common shares at $2.00 per share, valued at $7,500, to five directors of the Company for payment of director fees.


During the quarter ended August 31, 2011, the Company entered into stock purchase agreements and issued 630,005 units (each unit consisting of one share of restricted common stock and a two-year warrant to purchase one share of common stock at an exercise price of $4.00 per share) at a unit price of $1.50, for total cash proceeds of $945,009.  These shares are unregistered with no underwriter used for the sale of the common stock.  The shares of stock were sold pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933 and/or Rule 506 of Regulation D promulgated thereunder.


On May 16, 2011, the Company issued 3,680 restricted common shares at $2.00 per share, valued at $7,360, to five directors of the Company for payment of director fees.


During the quarter ended May 31, 2011, the Company entered into stock purchase agreements and issued 323,737 units (each unit consisting of one share of restricted common stock and a two-year warrant to purchase one share of common stock at an exercise price of $4.00 per share) at a unit price of $1.50, for total cash proceeds of $415,997.  The remaining balance due of $69,606 was received in June 2011. These shares are unregistered with no underwriter used for the sale of the common stock.  The shares of stock were sold pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933 and/or Rule 506 of Regulation D promulgated thereunder.


ITEM 3.  DEFAULTS UPON SENIOR SECURITIES


None.


ITEM 4.  (REMOVED AND RESERVED)


ITEM 5.  OTHER INFORMATION


(a)

All information required to be disclosed on a report on Form 8-K during the period ended August 31, 2011, has previously been reported.

(b)

There have been no material changes to the procedures by which security holders may recommend nominees to the registrant’s board of directors.



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ITEM 6.  EXHIBITS

 

3.1

 

Articles of Incorporation, as amended *

Previously Filed

3.2

 

Bylaws*

Previously Filed

31

 

Certifications of Chief Executive Officer and Chief Financial Officer under Rule 13a-14(a)/15d-14(a)

Included

32

 

Certifications under Section 1350

Included

101.INS**

 

XBRL Instance

Included

101.SCH**

 

XBRL Taxonomy Extension Schema

Included

101.CAL**

 

XBRL Taxonomy Extension Calculation

Included

101.DEF**

 

XBRL Taxonomy Extension Definition

Included

101.LAB**

 

XBRL Taxonomy Extension Labels

Included

101.PRE**

 

XBRL Taxonomy Extension Presentation

Included

 *Incorporated by reference to exhibit filed as a part of Registration Statement on Form 10-SB (Commission File No. 000-27225).

** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 



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SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


DigitalTown, Inc.


Dated: October 13, 2011


/s/ Richard A. Pomije

Richard A. Pomije, CEO


/s/ Paul R. Gramstad

Paul R. Gramstad, CFO







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