Crexendo, Inc. - FORM 10-Q

Attached files

file	filename
EX-32.2 - CERTIFICATE PURSUANT TO SECTION 18 U.S.C. PURSUANT TO SECTION 906 OF THE SARBANE - Crexendo, Inc.	cxdo_ex322.htm
EX-32.1 - CERTIFICATE PURSUANT TO SECTION 18 U.S.C. PURSUANT TO SECTION 906 OF THE SARBANE - Crexendo, Inc.	cxdo_ex321.htm
EX-31.2 - CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) CERTIFICATIONS SECTION 302 OF - Crexendo, Inc.	cxdo_ex312.htm
EX-31.1 - CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) CERTIFICATIONS SECTION 302 OF - Crexendo, Inc.	cxdo_ex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

———————

FORM 10-Q

———————

(Mark One)

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

For the quarterly period ended March 31, 2021

☐ TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from ________ to ________.

Commission file number 001-32277

———————

Crexendo, Inc.

(Exact name of registrant as specified in its charter)

———————

Nevada	87-0591719
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

1615 South 52nd Street, Tempe, AZ	85281
(Address of Principal Executive Offices)	(Zip Code)

(602) 714-8500

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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

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

Large accelerated filer	☐		Accelerated filer	☐
Non-accelerated filer	☐	(Do not check if a smaller reporting company)	Smaller reporting company	☑
			Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

The number of shares outstanding of the registrant’s common stock as of April 30, 2021 was 18,445,086.

INDEX

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements	3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3. Quantitative and Qualitative Disclosures about Market Risk	36
Item 4. Controls and Procedures	36

PART II – OTHER INFORMATION
Item 1. Legal Proceedings	37
Item 1A. Risk Factors	37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 6. Exhibits	37
Signatures	38

PART I - FINANCIAL INFORMATION

Item 1.

Financial Statements.

CREXENDO, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Unaudited, in thousands, except par value and share data)

	March 31, 2021	December 31, 2020
Assets
Current assets:
Cash and cash equivalents	$16,204	$17,579
Restricted cash	-	100
Trade receivables, net of allowance for doubtful accounts of $20
as of March 31, 2021 and $21 as of December 31, 2020	486	538
Contract assets	205	159
Inventories	419	504
Equipment financing receivables	298	286
Contract costs	442	421
Prepaid expenses	503	190
Income tax receivable	129	4
Other current assets	2	-
Total current assets	18,688	19,781

Long-term equipment financing receivables, net	880	906
Property and equipment, net	2,776	2,734
Deferred income tax assets, net	6,054	6,054
Operating lease right-of-use assets	135	1
Intangible assets, net	2,433	252
Goodwill	1,395	272
Contract costs, net of current portion	543	549
Other long-term assets	225	156
Total Assets	$33,129	$30,705

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$190	$56
Accrued expenses	1,998	1,628
Finance leases	43	29
Notes payable	72	71
Operating lease liabilities	44	1
Contigent consideration	746	-
Contract liabilities	1,034	778
Total current liabilities	4,127	2,563

Contract liabilities, net of current portion	352	450
Finance leases, net of current portion	50	55
Notes payable, net of current portion	1,854	1,873
Operating lease liabilities, net of current portion	75	-
Total liabilities	6,458	4,941

Stockholders' equity:
Preferred stock, par value $0.001 per share - authorized 5,000,000 shares; none issued	—	—
Common stock, par value $0.001 per share - authorized 25,000,000 shares, 18,424,602
shares issued and outstanding as of March 31, 2021 and 17,983,177 shares issued
and outstanding as of December 31, 2020	18	18
Additional paid-in capital	77,456	75,834
Accumulated deficit	(50,803)	(50,088)
Total stockholders' equity	26,671	25,764

Total Liabilities and Stockholders' Equity	$33,129	$30,705

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

CREXENDO, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(Unaudited, in thousands, except per share and share data)

	Three Months Ended March 31,
	2021	2020
Service revenue	$4,139	$3,488
Product revenue	368	379
Total revenue	4,507	3,867

Operating expenses:
Cost of service revenue	1,259	970
Cost of product revenue	225	220
Selling and marketing	1,241	1,038
General and administrative	2,254	1,188
Research and development	350	270
Total operating expenses	5,329	3,686

Income/(loss) from operations	(822)	181

Other income/(expense):
Interest income	-	1
Interest expense	(19)	(9)
Other income/(expense), net	2	(30)
Total other income/(expense), net	(17)	(38)

Income/(loss) before income tax	(839)	143

Income tax benefit/(provision)	124	(3)

Net income/(loss)	$(715)	$140

Earnings per common share:
Basic	$(0.04)	$0.01
Diluted	$(0.04)	$0.01

Weighted-average common shares outstanding:
Basic	18,189,783	14,905,599
Diluted	18,189,783	16,262,886

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

CREXENDO, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders' Equity

Three Months Ended March 31, 2021 and 2020

(Unaudited, in thousands, except share data)

	Common Stock		Additional		Total
	Shares	Amount	Paid-in Capital	Accumulated Deficit	Stockholders' Equity
Balance, January 1, 2021	17,983,177	$18	$75,834	$(50,088)	$25,764
Share-based compensation	-	-	282	-	282
Vesting of restricted stock units	14,367	-	-	-	-
Issuance of common stock for exercise of stock options	380,396	-	1,146	-	1,146
Taxes paid on the net settlement of stock options	-	-	(152)	-	(152)
Issuance of common stock in connection with a business acquisition	46,662	-	346	-	346
Net loss	-	-	-	(715)	(715)
Balance, March 31, 2021	18,424,602	$18	$77,456	$(50,803)	$26,671

	Common Stock		Additional		Total
	Shares	Amount	Paid-in Capital	Accumulated Deficit	Stockholders' Equity
Balance, January 1, 2020	14,884,755	$15	$62,400	$(58,028)	$4,387
Share-based compensation	-	-	105	-	105
Vesting of restricted stock units	7,498	-	-	-	-
Issuance of common stock for exercise of stock options	49,200	-	84	-	84
Net income	-	-	-	140	140
Balance, March 31, 2020	14,941,453	$15	$62,589	$(57,888)	$4,716

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

CREXENDO, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited, in thousands)

	Three Months Ended March 31,
	2021	2020
CASH FLOWS FROM OPERATING ACTIVITIES
Net income/(loss)	$(715)	$140
Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
Depreciation and amortization	101	103
Share-based compensation	282	105
Changes in assets and liabilities:
Trade receivables	174	(54)
Contract assets	(46)	(6)
Equipment financing receivables	14	(102)
Inventories	97	153
Contract costs	(15)	(20)
Prepaid expenses	(309)	(323)
Income tax receivable	(125)	3
Other assets	(8)	(50)
Accounts payable and accrued expenses	291	(290)
Contract liabilities	11	53
Net cash used for operating activities	(248)	(288)

CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment	(29)	(528)
Business acquisition	(2,163)	-
Net cash used for investing activities	(2,192)	(528)

CASH FLOWS FROM FINANCING ACTIVITIES
Repayments made on finance leases	(11)	(8)
Repayments made on notes payable	(18)	(5)
Proceeds from exercise of options	1,146	84
Taxes paid on the net settlement of stock options	(152)	-
Net cash provided by financing activities	965	71

NET DECREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH	(1,475)	(745)

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT THE BEGINNING OF THE PERIOD	17,679	4,280

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT THE END OF THE PERIOD	$16,204	$3,535

Cash used during the year for:
Income taxes, net	$(1)	$-
Interest expense	$(19)	$(9)
Supplemental disclosure of non-cash investing and financing information:
Purchase of property and equipment with a note payable	$-	$2,000
Stock issued for the acquisition of Centric Telecom	$346	$-
Contingent consideration related to the acquisition of Centric Telecom	$746	$-

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

CREXENDO, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (unaudited)

Significant Accounting Policies

Description of Business – Crexendo, Inc. is incorporated in the state of Nevada. As used hereafter in the notes to consolidated financial statements, we refer to Crexendo, Inc. and its wholly owned subsidiaries, as “we,” “us,” or “our Company.” Crexendo is an award-winning premier provider of cloud communications, UCaaS, call center, collaboration services, and other cloud business services that are designed to provide enterprise-class cloud services to any size business at affordable monthly rates. The Company has two operating segments, which consist of Cloud Telecommunications and Web Services.

Basis of Presentation – The consolidated financial statements include the accounts and operations of Crexendo, Inc. and its wholly owned subsidiaries, which include Crexendo Business Solutions, Inc., Crexendo International, Inc., and Centric Telecom, Inc. All intercompany account balances and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“US GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These consolidated financial statements reflect the results of operations, financial position, changes in stockholders’ equity, and cash flows of our Company.

Cash and Cash Equivalents – We consider all highly liquid, short-term investments with maturities of three months or less at the time of purchase to be cash equivalents. As of March 31, 2021 and December 31, 2020, we had cash and cash equivalents in financial institutions in excess of federally insured limits in the amount of $15,565,000 and $17,175,000, respectively.

Restricted Cash – We classified $0 and $100,000 as restricted cash as of March 31, 2021 and December 31, 2020, respectively. During the three months ended March 31, 2021, our restricted cash requirement was waived and we released $100,000 into cash and cash equivalents. Cash was restricted for compensating balance requirements on purchasing card agreements. As of March 31, 2021 and December 31, 2020, we had restricted cash in financial institutions in excess of federally insured limits in the amount of $0 and $100,000, respectively.

The following table provides a reconciliation of cash and cash equivalents and restricted cash reported on the balance sheet to the cash, cash equivalents, and restricted cash shown in the condensed consolidated statement of cash flows (in thousands):

	March 31,	March 31,
	2021	2020
Cash and cash equivalents	$16,204	$3,435
Restricted cash	-	100
Total cash, cash equivalents, and restricted cash shown in the condensed
consolidated statement of cash flows	$16,204	$3,535

Trade Receivables – Trade receivables from our cloud telecommunications and web services segments are recorded at invoiced amounts.

Allowance for Doubtful Accounts – The allowance represents estimated losses resulting from customers’ failure to make required payments. The allowance estimate is based on historical collection experience, specific identification of probable bad debts based on collection efforts, aging of trade receivables, customer payment history, and other known factors, including current economic conditions. We believe that the allowance for doubtful accounts is adequate based on our assessment to date, however, actual collection results may differ materially from our expectations.

Contract Assets – Contract assets primarily relate to the Company’s rights to consideration for work completed but not billed as of the reporting date. The contract assets are transferred to receivables when the rights become unconditional.

Contract Costs – Contract costs primarily relate to incremental commission costs paid to sales representatives and sales leadership as a result of obtaining telecommunications contracts which are recoverable. The Company capitalized contract costs in the amount of $985,000 and $970,000 at March 31, 2021 and December 31, 2020, respectively. Capitalized commission costs are amortized based on the transfer of goods or services to which the assets relate which typically range from thirty-six to sixty months, and are included in selling and marketing expenses. During the three months ended March 31, 2021 and 2020, the Company amortized $122,000 and $111,000 respectively, and there was no impairment loss in relation to the costs capitalized.

Inventory – Finished goods telecommunications equipment inventory is stated at the lower of cost or net realizable value (first-in, first-out method). In accordance with applicable accounting guidance, we regularly evaluate whether inventory is stated at the lower of cost or net realizable value. If net realizable value is less than cost, the write-down is recognized as a loss in earnings in the period in which the excess occurs.

Property and Equipment – Depreciation and amortization expense is computed using the straight-line method in amounts sufficient to allocate the cost of depreciable assets over their estimated useful lives ranging from two to thirty-nine years. The cost of leasehold improvements is amortized using the straight-line method over the shorter of the estimated useful life of the asset or the term of the related lease. Land is not depreciable. Depreciable lives by asset group are as follows:

Building	39 years
Land	Not depreciated
Computer and office equipment	2 to 5 years
Computer software	3 years
Internal-use software	3 years
Furniture and fixtures	4 years
Vehicles	5 years
Leasehold improvements	2 to 5 years

Maintenance and repairs are expensed as incurred. The cost and accumulated depreciation of property and equipment sold or otherwise retired are removed from the accounts and any related gain or loss on disposition is reflected in the statement of operations.

Asset Acquisitions – Periodically we acquire customer relationships that we account for as an asset acquisition and record a corresponding intangible asset that is amortized over its estimated useful life. Any excess of the fair value of the purchase price over the fair value of the identifiable assets and liabilities is allocated on a relative fair value basis. No goodwill is recorded in an asset acquisition. If the fair value of the assets acquired exceeds the initial consideration paid as of the date of acquisition but includes a contingent consideration arrangement and ASC 450 and ASC 815 do not apply to contingent consideration, we analogize to the guidance in ASC 323 on recognizing contingent consideration in the acquisition of an equity method investment. The Company recognizes a liability equal to the lesser of, the maximum amount of contingent consideration or the excess of the fair value of the net assets acquired over the initial cost measurement. In accordance with the requirements of ASC 323 for equity method investments, the Company recognizes any excess of the contingent consideration issued or issuable, over the amount that was initially recognized as a liability, as an additional cost of the asset acquisition. If the amount initially recognized as a liability exceeds the contingent consideration issued or issuable, the entity recognizes that amount as a reduction of the cost of the asset acquisition. In 2019, the Company acquired customer relationships for an estimated aggregate purchase price of $351,000. During the year ended December 31, 2020, the Company determined that the contingent consideration payable was $121,000 less than initially recorded and recognized a reduction in the cost of the asset acquired.

Business Acquisitions - We account for business combinations using the acquisition method of accounting. The acquisition method of accounting requires that the purchase price, including the fair value of contingent consideration, of the acquisition be allocated to the assets acquired and liabilities assumed using the fair values determined by management as of the acquisition date. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of assets acquired and the liabilities assumed. While the Company uses its best estimates and assumptions as part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the acquisition date, the Company’s estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company records adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill to the extent the Company identifies adjustments to the preliminary purchase price allocation. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the consolidated statements of operations. We include the results of all acquisitions in our consolidated financial statements from the date of acquisition. Acquisition related transaction costs, such as banking, legal, accounting and other costs incurred in connection with an acquisition, are expensed as incurred in general and administrative expenses.

Goodwill – Goodwill is tested for impairment using a fair-value-based approach on an annual basis (December 31) and between annual tests if indicators of potential impairment exist.

Intangible Assets – Our intangible assets consist of customer relationships. The intangible assets are amortized following the patterns in which the economic benefits are consumed. We periodically review the estimated useful lives of our intangible assets and review these assets for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. The determination of impairment is based on estimates of future undiscounted cash flows. If an intangible asset is considered to be impaired, the amount of the impairment will be equal to the excess of the carrying value over the fair value of the asset.

Contract Liabilities – Our contract liabilities consist primarily of advance consideration received from customers for telecommunications contracts. The product and monthly service revenue is recognized on completion of the implementation and the remaining activation fees are reclassified as deferred revenue.

Use of Estimates – In preparing the consolidated financial statements, management makes assumptions, estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of net sales and expenses during the reported periods. Specific estimates and judgments include valuation of goodwill and intangible assets in connection with business acquisitions and asset acquisitions, allowances for doubtful accounts, uncertainties related to certain income tax benefits, valuation of deferred income tax assets, valuations of share-based payments, annual incentive bonuses accrual, recoverability of long-lived assets and product warranty liabilities. Management’s estimates are based on historical experience and on our expectations that are believed to be reasonable. The combination of these factors forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from our current estimates and those differences may be material.

Contingencies – The Company accrues for claims and contingencies when losses become probable and reasonably estimable. As of the end of each applicable reporting period, the Company reviews each of its matters and, where it is probable that a liability has been or will be incurred, it accrues for all probable and reasonably estimable losses. Where the Company can reasonably estimate a range of losses it may incur regarding such a matter, it records an accrual for the amount within the range that constitutes its best estimate. If the Company can reasonably estimate a range but no amount within the range appears to be a better estimate than any other, it uses the amount that is the low end of such range.

Product and Service Revenue Recognition – Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services and excludes any amounts collected on behalf of third parties. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. We recognize revenue for delivered elements only when we determine there are no uncertainties regarding customer acceptance. Changes in the allocation of the sales price between delivered and undelivered elements can impact the timing of revenue recognized but does not change the total revenue recognized on any agreement. Revenue is recognized net of any taxes collected from customers, which are subsequently remitted to governmental authorities. For more detailed information about revenue, see Note 2.

Cost of Service Revenue – Cost of service includes Cloud Telecommunications and Web Services cost of service revenue. Cloud Telecommunications cost of service revenue primarily consists of fees we pay to third-party telecommunications and broadband Internet providers, costs of other third-party services we resell, personnel and travel expenses related to system implementation, and customer service. Web Services cost of service revenue consists primarily of customer service costs and outsourcing fees related to fulfillment of our professional web management services.

Cost of Product Revenue – Cost of product revenue primarily consists of the costs associated with the purchase of desktop devices and other third-party equipment we purchase for resale.

Product Warranty – We provide for the estimated cost of product warranties at the time we recognize revenue. We evaluate our warranty obligations on a product group basis. Our standard product warranty terms generally include post-sales support and repairs or replacement of a product at no additional charge for a specified period of time. We base our estimated warranty obligation upon warranty terms, ongoing product failure rates, and current period product shipments. If actual product failure rates, repair rates or any other post-sales support costs were to differ from our estimates, we would be required to make revisions to the estimated warranty liability. Warranty terms generally last for the duration that the customer has service.

Contingent Consideration – Contingent consideration represents deferred business acquisition and asset acquisition consideration to be paid out at some point in the future, typically over a one-year period or less from the acquisition date. Contingent consideration is recorded at the asset acquisition date fair value. Contingent consideration recorded in connection with a business acquisition is reported at fair value each reporting period until the contingency is resolved. Any changes in fair value are recognized in earnings. Contingent consideration recorded in connection with an asset acquisition is not derecognized until the related contingency is resolved and the consideration is paid or becomes payable. If the amount initially recorded as contingent consideration exceeds the amount paid or payable, the Company recognizes that excess amount as a reduction in the cost of the related intangible assets.

Public Offering – On September 28, 2020, the Company completed a public offering in which it issued and sold 1,750,000 shares of common stock at a price to the public of $5.50 per share. The shares sold and issued in the public offering resulted in an aggregate gross offering price of $9,625,000. The Company received net proceeds of $8,623,000 after deducting underwriting discounts and commissions of $674,000 and offering expenses of $328,000.

On October 21, 2020, the underwriters of the Company’s public offering exercised their option to purchase additional shares of the Company’s common stock to cover sales by the underwriters of a greater number of shares than the total set forth in the filed prospectus for the public offering. The underwriters purchased an additional 420,000 shares of common stock from the Company. The gross proceeds to the Company of the issuance were $2,310,000, and the Company received net proceeds of $2,148,000 after deducting underwriting discounts and commissions.

Research and Development – Research and development costs are expensed as incurred. Costs related to internally developed software are expensed as research and development expense until technological feasibility has been achieved, after which the costs are capitalized.

Fair Value Measurements – The fair value of our financial assets and liabilities was determined based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

Level 1 — Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.

Level 2 — Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:

· Quoted prices for similar assets or liabilities in active markets;

· Quoted prices for identical or similar assets in non-active markets;

· Inputs other than quoted prices that are observable for the asset or liability; and

· Inputs that are derived principally from or corroborated by other observable market data.

Level 3 — Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

Lease Obligations – We determine if an agreement is a lease at inception. We evaluate the lease terms to determine whether the lease will be accounted for as an operating or finance lease. Operating leases are included in operating lease right-of-use (“ROU”) assets, operating lease liabilities, current portion, and operating lease liabilities, net of current portion in our consolidated balance sheets.

ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

A lease that transfers substantially all of the benefits and risks incidental to ownership of property are accounted for as finance leases. At the inception of a finance lease, an asset and finance lease obligation is recorded at an amount equal to the lesser of the present value of the minimum lease payments and the property’s fair market value. Finance lease obligations are classified as either current or long-term based on the due dates of future minimum lease payments, net of interest.

Notes Payable – We record notes payable net of any discounts or premiums. Discounts and premiums are amortized as interest expense or income over the life of the note in such a way as to result in a constant rate of interest when applied to the amount outstanding at the beginning of any given period.

Income Taxes – We recognize a liability or asset for the deferred tax consequences of all temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years when the reported amounts of the assets and liabilities are recovered or settled. Accruals for uncertain tax positions are provided for in accordance with accounting guidance. Accordingly, we may recognize the tax benefits from an uncertain tax position only if it is more-likely-than-not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting guidance is also provided on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in the financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our financial position, results of operations, and cash flows. In assessing the need for a valuation allowance, we evaluate all significant available positive and negative evidence, including historical operating results, estimates of future taxable income and the existence of prudent and feasible tax planning strategies. At December 31, 2020 we determined that we would be able to realize our deferred income tax assets in the future and released $7,487,000 of the valuation allowance.

Interest and penalties associated with income taxes are classified as income tax expense in the consolidated statements of operations.

Stock-Based Compensation – For equity-classified awards, compensation expense is recognized over the requisite service period based on the computed fair value on the grant date of the award. Equity classified awards include the issuance of stock options and restricted stock units (“RSUs”).

Comprehensive Income/(Loss) – There were no other components of comprehensive income/(loss) other than net income/(loss) for the three months ended March 31, 2021 and 2020.

Operating Segments – Accounting guidance establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires enterprises to report selected information about operating segments in financial reports issued to stockholders. The Company has two operating segments, which consist of Cloud Telecommunications and Web Services. Research and development expenses are allocated to Cloud Telecommunications and Web Services segments based on the level of effort, measured primarily by wages and benefits attributed to our engineering department. Indirect sales and marketing expenses are allocated to the Cloud Telecommunications and Web Services segments based on level of effort, measured by month-to-date contract bookings. General and administrative expenses are allocated to both segments based on revenue recognized for each segment. Accounting guidance also establishes standards for related disclosure about products and services, geographic areas and major customers. We generate over 99% of our total revenue from customers within North America (United States and Canada) and less than 1% of our total revenues from customers in other parts of the world.

Significant Customers – No customer accounted for 10% or more of our total revenue for the three months ended March 31, 2021 and 2020. No customer accounted for 10% or more of our total trade accounts receivable as of March 31, 2021 and one telecommunications services customer accounted for 11% of total trade accounts receivable as of December 31, 2020.

Recently Adopted Accounting Pronouncements – In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12 to simplify the accounting in ASC 740, Income Taxes. This guidance removes certain exceptions related to the approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences. This guidance also clarifies and simplifies other areas of ASC 740. Certain amendments in this update must be applied on a prospective basis, certain amendments must be applied on a retrospective basis, and certain amendments must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings/(deficit) in the period of adoption. The Company adopted ASU 2019-12 effective January 1, 2021. The adoption of this guidance did not have a material impact on our consolidated financial statements and related disclosures.

In August 2018, the FASB issued ASU 2018-13, which removes, modifies and adds to the disclosure requirements on fair value measurements in Topic 820. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this updated guidance and delay adoption of the additional disclosures until their effective date. We adopted this guidance effective January 1, 2020. The adoption of this guidance did not have a material impact on our consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminates Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The Company adopted ASU 2017-04 effective January 1, 2020. The adoption of this ASU did not have an impact on our condensed consolidated financial statements.

Recently Issued Accounting Pronouncements – In June 2016, the FASB issued ASU 2016-13, which requires measurement and recognition of expected credit losses for financial assets held. Following the effective date philosophy for all other entities in ASU 2019-10, which includes smaller reporting companies (SRCs), this guidance is effective for fiscal years beginning after December 15, 2022 including interim periods within those fiscal years. The standard is to be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. We do not plan to early adopt this ASU. We are in the process of evaluating the potential impact of adopting this new accounting standard on our consolidated financial statements and related disclosures.

In August 2020, the FASB issued ASU 2020-06, which simplifies the accounting for convertible instruments. ASU 2020-06 eliminates certain models that require separate accounting for embedded conversion features, in certain cases. Additionally, among other changes, the guidance eliminates certain of the conditions for equity classification for contracts in an entity’s own equity. ASU 2020-06 also requires entities to use the if-converted method for all convertible instruments in the diluted earnings per share calculation and include the effect of share settlement for instruments that may be settled in cash or shares, except for certain liability-classified share-based payment awards. ASU 2020-06 is effective for our fiscal year beginning after December 15, 2021, including interim periods within this fiscal year. This guidance can be applied using either a modified or full retrospective approach. The Company is currently evaluating the impact this ASU will have on the financial statements and related disclosures, as well as the timing of adoption.

Revenue

Revenue is measured based on a consideration specified in a contract with a customer, and excludes any sales incentives and amounts collected on behalf of third parties. The Company recognizes revenue when it satisfies a performance obligation by transferring control over a product or service to a customer. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer, are excluded from revenue. The following is a description of principal activities – separated by reportable segments – from which the Company generates its revenue. For more detailed information about reportable segments, see Note 15.

Cloud Telecommunications Segment

Products and services may be sold separately or in bundled packages. The typical length of a contract for service is thirty-six to sixty months. Customers are billed for these services on a monthly basis. For bundled packages, the Company accounts for individual products and services separately if they are distinct – i.e. if a product or service is separately identifiable from other items in the bundled package and if a customer can benefit from it on its own or with other resources that are readily available to the customer. The consideration (including any discounts) is allocated between separate products and services in a bundle based on their relative stand-alone selling prices. The stand-alone selling prices are determined based on the prices at which the Company separately sells the desktop devices and telecommunication services. For items that are not sold separately (e.g. additional features) the Company estimates stand-alone selling prices using the adjusted market assessment approach. When we provide a free trial period, we do not begin to recognize recurring revenue until the trial period has ended and the customer has been billed for the services.

Desktop Devices – Revenue generated from the sale of telecommunications equipment (desktop devices) is recognized when the customer takes possession of the devices and the cloud telecommunications services begin. The Company typically bills and collects the fees for the equipment upon entering into a contract with a customer. Cash receipts are recorded as a contract liability until implementation is complete and the services begin.

Equipment Financing Revenue – Fees generated from renting our cloud telecommunication equipment (IP or cloud telephone desktop devices) through leasing contracts are recognized as revenue based on whether the lease qualifies as an operating lease or sales-type lease. The two primary accounting provisions which we use to classify transactions as sales-type or operating leases are: 1) lease term to determine if it is equal to or greater than 75% of the economic life of the equipment and 2) the present value of the minimum lease payments to determine if they are equal to or greater than 90% of the fair market value of the equipment at the inception of the lease. The economic life of most of our products is estimated to be three years, since this represents the most frequent contractual lease term for our products, and there is no residual value for used equipment. Residual values, if any, are established at the lease inception using estimates of fair value at the end of the lease term. The vast majority of our leases that qualify as sales-type leases are non-cancelable and include cancellation penalties approximately equal to the full value of the lease receivables. Leases that do not meet the criteria for sales-type lease accounting are accounted for as operating leases. Revenue from sales-type leases is recognized upon installation and the interest portion is deferred and recognized as earned. Revenue from operating leases in recognized ratably over the applicable service period.

Cloud Telecommunications Services – Cloud telecommunication services include voice, data, collaboration software, broadband Internet access, interest generated from equipment financing revenue, and support for premise based PBX phone systems. The Company recognizes revenue as services are provided in service revenue. Fees generated from reselling broadband Internet access are recognized as revenue net of the costs charged by the third-party service providers. Cloud telecommunications services are billed and paid on a monthly basis. Our telecommunications services contracts typically have a term of thirty-six to sixty months.

Fees, Commissions, and Other, Recognized over Time – Includes contracted and non-contracted items such as:

●

Contracted activation and flash fees – The Company generally allocates a portion of the activation fees to the desktop devices, which is recognized at the time of the installation or customer acceptance, and a portion to the service, which is recognized over the contract term using the straight-line method.

●

Non-contracted carrier cost recovery fee – This fee recovers the various costs and expenses that the Company incurs in connection with complying with legal, regulatory, and other requirements, including without limitation federal, state, and local reporting and filing requirements. This fee is assessed as a set percentage of our monthly billing and is recognized monthly.

●

Non-contracted administrative fees – Administrative fees are recognized as revenue on a monthly basis.

One-Time Fees, Commissions, and Other – Includes contracted and non-contracted items such as:

●

Contracted professional service revenue – Professional service revenue includes professional installation services, custom integration, and other professional services. The Company typically bills and collects professional service revenue upon entering into a contract with a customer. Professional service revenue is recognized as revenue when the performance obligations are completed.

●

Non-contracted cancellation fees – These cancellation fees relate to remaining contractual term buyout payments in connection with early cancellation and are billed and recognized as revenue upon receipt.

●

Other non-contracted fees – These fees include disconnect fees, shipping fees, restocking fees, and porting fees. Other non-contracted fees are recognized as revenue upon receipt of payment.

Web Services Segment

Website Hosting Service – Fees generated from hosting customer websites are recognized as revenue as the services are provided in service revenue. Website hosting services are billed and collected on a monthly basis.

Professional Website Management Service and Other – Fees generated from reselling professional website management services are recognized as revenue net of the costs charged by the third-party service providers. Professional website management services are billed and paid on a monthly basis.

Disaggregation of Revenue

In the following table, revenue is disaggregated by primary major product line, and timing of revenue recognition. The table also includes a reconciliation of the disaggregated revenue with the reportable segments.

Three Months Ended March 31, 2021	Cloud		Total
(In thousands)	Telecommunications	Web Services	Reportable
	Segment	Segment	Segments
Major products/services lines
Desktop devices	$368	$-	$368
Equipment financing revenue	68	-	68
Telecommunications services	3,592	-	3,592
Fees, commissions, and other, recognized over time	289	-	289
One time fees, commissions and other	74	-	74
Website hosting services	-	106	106
Website management services and other	-	10	10
	$4,391	$116	$4,507
Timing of revenue recognition
Products, services, and fees recognized at a point in time	$341	$-	$341
Products, services, and fees transferred over time	4,050	116	4,166
	$4,391	$116	$4,507

Three Months Ended March 31, 2020	Cloud		Total
(In thousands)	Telecommunications	Web Services	Reportable
	Segment	Segment	Segments
Major products/services lines
Desktop devices	$379	$-	$379
Equipment financing revenue	45	-	45
Telecommunications services	3,025	-	3,025
Fees, commissions, and other, recognized over time	233	-	233
One time fees, commissions and other	29	-	29
Website hosting services	-	133	133
Website management services and other	-	23	23
	$3,711	$156	$3,867
Timing of revenue recognition
Products and fees recognized at a point in time	$408	$-	$408
Services and fees transferred over time	3,303	156	3,459
	$3,711	$156	$3,867

Contract balances

The following table provides information about receivables, contract assets, and contract liabilities from contracts with customers.

	March 31,	December 31,
(In thousands)	2021	2020
Receivables, which are included in trade receivables, net of allowance
for doubtful accounts	$486	$538
Contract assets	205	159
Contract liabilities	1,386	1,228

Significant changes in the contract assets and the contract liabilities balances during the period are as follows:

	Three Months Ended		For the Year Ended
(In thousands)	March 31, 2021		December 31, 2020
	Contract Assets	Contract Liabilities	Contract Assets	Contract Liabilities
Revenue recognized that was included in the contract liability balance at the beginning of the period	$-	$(788)	$-	$(976)
Increase due to cash received, excluding amounts recognized as revenue during the period	-	946	-	990
Transferred to receivables from contract assets recognized at the beginning of the period	(15)	-	(21)	-
Increase due to additional unamortized discounts	61	-	158	-

Transaction price allocated to the remaining performance obligations

The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied) at the end of the reporting period (in thousands):

	2021	2022	2023	2024	2025	2026	Total
Desktop devices	$307	-	-	-	-	-	$307
Telecommunications service	$8,420	8,214	5,768	3,665	1,331	61	$27,459
All consideration from contracts with customers is included in the amounts presented above

Earnings Per Common Share

Basic net income/(loss) per common share is computed by dividing the net income for the period by the weighted-average number of common shares outstanding during the period. Diluted net income per common share is computed giving effect to all dilutive common stock equivalents, consisting of common stock options. Diluted net loss per common share for the three months ended March 31, 2021 is the same as basic net loss per common share because the common share equivalents were anti-dilutive due to the net loss. The following table sets forth the computation of basic and diluted net income per common share:

	Three Months Ended March 31,
	2021	2020
Net income/(loss) (in thousands) (A)	$(715)	$140

Weighted-average share reconciliation:
Weighted-average basic shares outstanding (B)	18,189,783	14,904,599
Dilutive effect of stock-based awards	-	1,358,287
Diluted weighted-average outstanding shares of common stock (C)	18,189,783	16,262,886

Earnings per common share:
Basic (A/B)	$(0.04)	$0.01
Diluted (A/C)	$(0.04)	$0.01

For the three months ended March 31, 2021 and 2020, the following potentially dilutive common stock, including awards granted under our equity incentive compensation plans, were excluded from the computation of diluted net income per share because including them would be anti-dilutive.

	Three Months Ended March 31,
	2021	2020
Stock options	488,104	1,662,311

Acquisitions

Centric Telecom, Inc. Business Acquisition

On January 14, 2021, the Company acquired 100% of the issued and outstanding shares of Centric Telecom, Inc., a provider of telecommunications products, services, and solutions in Northern Virginia. The aggregate purchase price of $3,255,000 consisted of $2,163,000 of cash paid at closing, 46,662 shares of our common stock with an estimated fair value of $346,000 issued at closing, and $746,000 of estimated contingent consideration to be paid out based on annualized revenue recognized during the nine month earn-out period. The fair value of the common stock issued as consideration was determined based on the closing market price of the Company’s common stock on the date of the acquisition of $7.42. The aggregate purchase price is subject to customary upward or downward adjustments for Centric Telecom’s net working capital.

The acquisition was accounted for under the acquisition method of accounting, with the Company identified as the acquirer. The Company’s unaudited condensed consolidated financial statements include the results of operations of Centric Telecom from the date of acquisition. The historical results of operations of Centric Telecom were not significant to the Company’s unaudited condensed consolidated results of operations for the periods presented. Under the acquisition method of accounting, the aggregate amount of consideration paid by the Company was allocated to Centric Telecom’s net tangible assets and intangible assets based on their estimated fair value on the acquisition date. The preliminary purchase price allocation, as set forth in the table below, reflects various preliminary fair value estimates and analysis prepared by the Company. The preliminary purchase price allocation is subject to revision as a more detailed analysis is completed by a third party valuation specialist and additional information on the fair values of Centric’s assets and liabilities becomes available. Any change in the fair value of the net assets of Centric Telecom will change the amount of the purchase price allocable to goodwill. Final purchase accounting adjustments may differ materially from preliminary purchase price allocation presented here. The primary areas of the purchase price allocation that are not yet finalized relate to the valuation of the intangible assets acquired, fair value of right to use assets and associated operating lease liabilities assumed, and net working capital adjustments. We anticipate finalizing our purchase price allocation during 2021. The following table presents the preliminary allocation of the assets acquired and liabilities assumed as of January 14, 2021 (in thousands):

Consideration (including estimated unpaid contingent consideration)
Cash	$2,163
Common stock	346
Contingent consideration	746
	$3,255
Assets
Cash	$7
Accounts receivables	122
Prepaid expenses	4
Inventory	12
Other assets	12
Property and equipment	57
Right to use assets	134
Intangible assets acquired	2,238
Other long-term assets	44
Total assets acquired	2,630

Liabilities
Accounts Payable	26
Accrued Expenses	187
Contract Liability	147
Operating Lease Liability	118
Direct Financing Liability	20
Total liabilities assumed	498

Net identifiable assets acquired	2,132
Goodwill	1,123
Total purchase price	$3,255

The intangible assets acquired consist of customer relationships. The fair value of the customer relationships was determined utilizing variations of the income approach where the expected future cash flows resulting from the acquired identifiable intangible assets were reduced by operating costs and charges for contributory assets and then discounted to present value at the weighted average cost of capital. The key assumptions used in valuing the customer relationships acquired is a weighted average cost of capital of 17.4% and a tax rate of 22.5%. The amortizable intangible assets have an average useful life of eight years. The purchase price exceeded the estimated fair value of the tangible and identifiable intangible assets and liabilities acquired and, as a result of the allocation, the Company recorded goodwill of $1,123,000, which is not deductible for tax purposes. The goodwill recognized is primarily attributable to contributions of the entity's assembled workforce of the acquired business.

NetSapiens, Inc. Merger Agreement

During the three months ended March 31, 2021, the Company entered into a Merger Agreement to acquire NetSapiens, Inc. for approximately $50 million, consisting of (1) $10 million in cash, and (2) approximately $40 million in the form of shares of the Company’s common stock or Company options. The merger consideration is subject to customary upward or downward adjustments for NetSapiens’ net working capital and closing cash. When taking into account the anticipated adjustments for net working capital and closing cash, the Company expects to issue approximately 3,114,690 shares of the Company’s common stock valued at $6.19 per share for common stock consideration of approximately $19.3 million and approximately 4,438,321 options with an aggregate value of $21.8 million, net of the aggregate exercise price of $5.6 million, at the closing. The completion of the Merger is subject to the satisfaction or waiver of certain conditions, including: (i) the adoption of the Merger Agreement by the affirmative vote of the holders of a majority of all outstanding shares of NetSapiens entitled to vote; (ii) the approval of the issuance of the Merger Shares and the other matters requiring stockholder approval for the consummation of the Transactions by the affirmative vote of the holders of a majority of all outstanding shares of the Company entitled to vote thereon; and (iii) the absence of governmental restraints or prohibitions preventing the consummation of the Mergers.

DoubleHorn, LLC Asset Acquisition

On December 31, 2019, the Company acquired certain assets from DoubleHorn, LLC. The aggregate purchase price of approximately $351,000 consisted of $176,000 of cash payable at closing and $175,000 of contingent consideration it estimates will be paid during the six month earn-out period. The Company concluded that the DoubleHorn acquisition met the definition of an asset acquisition under ASU 2017-01, "Clarifying the Definition of a Business", and the cost was allocated to the individual assets acquired and liabilities assumed based on their relative fair values. The customer relationships intangible asset will be amortized over a six year estimated useful life following the pattern of the economic benefits.

During the year ended December 31, 2020, $54,000 of contingent consideration was paid in cash and the Company determined that the contingent consideration payable was $121,000 less than initially recorded and recognized a reduction in the cost of the asset acquired. The following table presents the cost of the acquisition and the allocation to assets acquired based upon their relative fair value:

Consideration:
Cash	$230
Total consideration	$230

Recognized amounts of identifiable assets acquired and liabilities assumed:
Customer relationships	$230
Net assets acquired	$230

Trade Receivables, net

Our trade receivables balance consists of traditional trade receivables. Below is an analysis of our trade receivables as shown on our balance sheet (in thousands):

	March 31,	December 31,
	2021	2020
Gross trade receivables	$506	$559
Less: allowance for doubtful accounts	(20)	(21)
Trade receivables, net	$486	$538

Current trade receivables, net	$486	$538
Long-term trade receivables, net	-	-
Trade receivables, net	$486	$538

Prepaid Expenses

Prepaid expenses consisted of the following (in thousands):

	March 31,	December 31,
	2021	2020
Prepaid corporate insurance	$32	$53
Prepaid software services and support	220	20
Prepaid employee insurance premiums	71	71
Prepaid tax deposit	45	-
Prepaid Nasdaq listing fee	44	-
Other prepaid expenses	91	46
Total prepaid expenses	$503	$190

Property and Equipment

Property and equipment consisted of the following (in thousands):

	March 31,	December 31,
	2021	2020
Building	$2,000	$2,000
Land	500	500
Computer and office equipment	1,480	1,407
Computer software	547	526
Internal-use software	14	14
Furniture and fixtures	75	29
Vehicles	95	-
Leasehold improvements	25	-
Less: accumulated depreciation	(1,960)	(1,742)
Total property and equipment, net	$2,776	$2,734

Depreciation and amortization expense is included in general and administrative expenses and totaled $44,000 and $73,000 for the three months ended March 31, 2021 and 2020, respectively.

Intangible Assets and Goodwill

Acquired intangible assets subject to amortization consist of the following (in thousands):

	March 31, 2021			December 31, 2020
	Gross Carrying Amount	Accumulated Amortization	Net Carrying Amount	Gross Carrying Amount	Accumulated Amortization	Net Carrying Amount
Customer relationships	$3,409	$(976)	$2,433	$1,171	$(919)	$252
Total acquired intangible assets	$3,409	$(976)	$2,433	$1,171	$(919)	$252

As of March 31, 2021, the weighted average remaining useful life for customer relationships was 7.5 years.

Amortization expense is included in general and administrative expenses and totaled $57,000 and $30,000 for the three months ended March 31, 2021 and 2020, respectively. During the three months ended March 31, 2021, the Company acquired $2,238,000 in intangible assets in connection with the Centric Telecom business acquisition. During the year ended December 31, 2020, we reduced customer relationships by $121,000 due to an adjustment to the total consideration payable under the DoubleHorn customer relationships asset purchase agreement.

As of March 31, 2021, annual amortization of definite lived intangible assets, based on existing intangible assets and current useful lives, is estimated to be the following (in thousands):

Year ending December 31,
2021 remaining	$188
2022	225
2023	390
2024	361
2025 and thereafter	1,269
Total	$2,433

The following table provides a summary of changes in the carrying amounts of goodwill (in thousands):

	Goodwill
Balance at December 31, 2020	272
Business acquisition	1,123
Balance at March 31, 2021	$1,395

Accrued Expenses

Accrued expenses consisted of the following (in thousands):

	March 31,	December 31,
	2021	2020
Accrued wages and benefits	$440	$513
Accrued accounts payable	691	505
Accrued sales and telecommunication taxes	684	438
Product warranty liability	31	33
Other accrued expenses	152	139
Total accrued expenses	$1,998	$1,628

The changes in aggregate product warranty liabilities for the year ended December 31, 2020 and three months ended March 31, 2021 were as follows (in thousands):

	Warranty Liabilities
Balance at January 1, 2020	$37
Accrual for warranties	33
Adjustments related to pre-existing warranties	(10)
Warranty settlements	(27)
Balance at December 31, 2020	33
Accrual for warranties	5
Warranty settlements	(7)
Balance at March 31, 2021	$31

Product warranty expense is included in cost of product revenue expense and totaled $5,000 and $8,000 for the three months ended March 31, 2021 and 2020, respectively.

10.

Notes Payable

Notes payable consists of a short and long-term financing arrangements:

	March 31,	December 31,
	2021	2020
Notes payable	$1,926	$1,944
Less: current notes payable	(72)	(71)
Notes payable, net of current portion	$1,854	$1,873

On January 27, 2020, we entered into a Fixed Rate Term Loan Agreement with Bank of America, N.A. to finance Two Million Dollars ($2,000,000) to purchase our corporate office building. The Loan Agreement has a term of seven (7) years with monthly payments of Eleven Thousand Eight Hundred Forty-One and 15/100 Dollars ($11,841.15), including interest at 3.67%, beginning on March 1, 2020, secured by the office building.

As of March 31, 2021, future principal payments are scheduled as follows (in thousands):

Year ending December 31,
2021 remaining	$53
2022	74
2023	76
2024	79
2025 and thereafter	1,644
Total	$1,926

11.

Fair Value Measurements

We have financial instruments as of March 31, 2021 and December 31, 2020 for which the fair value is summarized below (in thousands):

	March 31, 2021		December 31, 2020
	Carrying Value	Estimated Fair Value	Carrying Value	Estimated Fair Value
Assets:
Trade receivables, net	$486	$486	$538	$538
Equipment financing receivables	1,178	1,178	1,192	1,192
Liabilities:
Finance lease obligations	$93	$93	$84	$84
Notes payable	1,926	1,926	1,944	1,944
Business acquisition contigent consideration	746	746	-	-

Liabilities for which fair value is recognized in the balance sheet on a recurring basis are summarized below as of March 31, 2021 and December 31, 2020 (in thousands):

		Fair value measurement at reporting date
Description	As of March 31, 2021	Level 1	Level 2	Level 3

Liabilities:
Business acquisition contingent consideration	$746	$-	$-	$746

Description	As of December 31, 2020	Level 1	Level 2	Level 3

Liabilities:
Asset acquisition contingent consideration	$-	$-	$-	$-

The recurring Level 3 measurement of our business acquisition contingent consideration liability includes the following significant unobservable inputs at March 31, 2021 (in thousands):

Contingent consideration liability	Fair Value at March 31, 2021	Valuation technique	Unobservable inputs	Range
Revenue - based payments	$746	Discounted cash flow	Discount Rate	17.38%

			Probability of milestone payment	90%
			Projected year of payments	2021

Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. Future changes in fair value of the contingent financial milestone consideration, as a result of changes in significant inputs such as the discount rate and estimated probabilities of financial milestone achievements, could have a material effect on the statement of operations and balance sheet in the period of the change.

During the three months ended March 31, 2021, the Company recorded $746,000 of contingent consideration in connection with the Centric Telecom business acquisition, to be paid based on the completion of the earn-out period. During the year ended December 31, 2020, the Company reduced the contingent consideration to be paid based on the completion of the earn-out period by $121,000 and recognized a reduction in the cost of the assets acquired in the DoubleHorn Asset Acquisition. The progression of the Company’s Level 3 instruments fair valued on a recurring basis for the three months ended March 31, 2021 and the year ended December 31, 2020 are shown in the table below (in thousands):

	Asset and Business Acquisition Contingent Consideration
Balance at January 1, 2020	$175
Cash payments	(54)
Adjustment	(121)
Balance at December 31, 2020	$-
Additions	746
Cash payments	-
Adjustment	-
Balance at March 31, 2021	$746

12.

Income Taxes

Our effective tax rate for the three months ended March 31, 2021 and 2020 was (14.8%) and 2.1%, respectively, which resulted in an income tax benefit/(provision) of $124,000 and $(3,000), respectively.

As of each reporting date, management considers new evidence, both positive and negative, that could affect its view of the future realization of deferred tax assets. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in the periods in which those temporary differences become deductible. We reduce the carrying amounts of deferred tax assets by a valuation allowance if, based on the evidence available, it is more-likely-than-not that such assets will not be realized. In making the assessment under the more-likely-than-not standard, appropriate consideration must be given to all positive and negative evidence related to the realization of the deferred tax assets. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry-forward periods by jurisdiction, unitary versus stand-alone state tax filings, our experience with loss carryforwards expiring unutilized, and all tax planning alternatives that may be available. As of December 31, 2020, management reviewed the weight of all the positive and negative evidence available. Management reviewed positive evidence such as achievement of three years of cumulative pretax income in the U.S. federal tax jurisdiction, projections of future pretax income and the duration of statutory carry-forward periods. As of December 31, 2020 the Company has achieved three years of cumulative pretax income, the achievement of three years of cumulative pretax income is objectively verifiable positive evidence and is considered significant positive evidence. Management also evaluated projections of future pretax income and the duration of statutory carry-forward periods to determine if the NOL carryforwards could be utilized in whole or in part before they expire unutilized. Forecasts and projections of future income are inherently subjective and therefore generally are given less weight, based on the extent to which the assumptions can be objectively verified based on historical experience. Management utilized historical objectively verifiable revenue growth trends and operating expense trends as assumptions for projections of future pretax income and determined that the Company would generate sufficient pre-tax income in future periods to utilize all of our deferred tax assets. Although historical trends utilized in our projections are objectively verifiable we assigned less weight to this positive evidence given the subjective nature of assumptions in projections. The combination of three years of cumulative pretax income and projections of future pretax income was considered significant positive evidence. Management reviewed negative evidence related to experience of credits and loss carryforwards expiring unutilized, and determined that although negative evidence exists, it was not significant evidence, as the current loss carryforwards do not begin to expire until 2031 and therefore risk is minimal. After reviewing the weight of the positive and negative evidence, management determined that there is sufficient positive evidence to conclude that it is more likely than not that deferred taxes of $6,054,000 are realizable, and released the valuation allowance accordingly.

13.

Leases

Lessee Accounting

We determine if an agreement is a lease at inception. We lease office space, other assets, and office equipment under operating leases. We lease data center equipment, including maintenance contracts and vehicles under finance leases.

Operating leases are recorded as right-of-use (“ROU”) assets and lease liabilities on the balance sheet, excluding leases that are less than 12 months. ROU assets represent our right to use the leased asset for the lease term and lease liabilities represent our obligation to make lease payments. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our estimated incremental borrowing rate at the commencement date to determine the present value of lease payments. The operating lease ROU assets also include any lease payments made and exclude lease incentives. The Company’s lease agreements do not contain any variable lease payments, material residual value guarantees or any restrictive covenants. Our lease terms may include options, at our sole discretion, to extend or terminate the lease. At the adoption date of ASC Topic 842, the Company was reasonably certain that we would exercise our option to renew our corporate office building operating lease. Lease expense is recognized on a straight-line basis over the lease term.

We previously leased our corporate office building in Tempe, Arizona from a Company that is owned by the major shareholder and CEO of the Company. Amortization of the ROU assets and operating lease liabilities for the three months ended March 31, 2021 and 2020 was $0 and $50,000, respectively. Rental expense incurred on operating leases for the three months ended March 31, 2021 and 2020 was approximately $0 and $25,000, respectively.

We currently lease office space in McLean, Virginia under a non-cancelable operating lease agreement that expires in 2021. The operating lease contains customary escalation clauses. Rental expense for the three months ended March 31, 2021 and 2020 was approximately $17,000 and $0, respectively.

We currently lease other assets under multiple operating leases. The leases expire on various dates through 2023 and the interest rates range from 3.00% to 15.09%. The expense is included in cost of product expenses and totaled approximately $11,000 and $0 for the three months ended March 31, 2021 and 2020, respectively.

We have lease agreements with lease and non-lease components, and we account for the lease and non-lease components as a single lease component. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company leases equipment and support under a finance lease agreement which extends through 2023. The Company also leases three vehicles under financing agreements. One vehicle lease extends through 2021 and two vehicle leases extend through 2022. The outstanding balance for finance leases was $93,000 and $84,000 as of March 31, 2021 and December 31, 2020, respectively. The Company recorded assets classified as property and equipment under finance lease obligations of $203,000 and $129,000 as of March 31, 2021 and December 31, 2020, respectively. Related accumulated depreciation totaled $108,000 and $47,000 as of March 31, 2021 and 2020, respectively. The $25,000 support contract was classified as a prepaid expense and is being amortized over the service period of 3 years. Amortization expense is included in general and administrative expenses and totaled $0 and $2,000 for the three months ended March 31, 2021 and 2020, respectively. The interest rates on the finance lease obligations range from 3.99% to 6.7% and interest expense was $2,000 and $2,000 for the three months ended March 31, 2021 and 2020, respectively.

The maturity of operating leases and finance lease liabilities as of March 31, 2021 are as follows:

Year ending December 31,	Operating Leases	Finance Leases
2021 remaining	$40	$35
2022	11	43
2023	4	21
Total minimum lease payments	55	99
Less: amount representing interest	(1)	(6)
Present value of minimum lease payments	$54	$93

Lease term and discount rate	March 31, 2021
Weighted-average remaining lease term (years)
Operating leases	1.1
Finance leases	2.1
Weighted-average discount rate
Operating leases	3.6%
Finance leases	6.2%

	Three Months Ended March 31, 2021
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$29
Operating cash flows from finance leases	2
Financing cash flows from finance leases	11

Lessor Accounting

Lessor accounting remained substantially unchanged with the adoption of ASC Topic 842. Crexendo offers its customers lease financing for the lease of our cloud telecommunication equipment (IP or cloud telephone desktop devices). We account for these transactions as sales-type leases. The vast majority of our leases that qualify as sales-type leases are non-cancelable and include cancellation penalties approximately equal to the full value of the lease receivables. Leases that do not meet the criteria for sales-type lease accounting are accounted for as operating leases. Operating lease revenue is classified as product revenue and totaled $43,000 and $0 for the three months ended March 31, 2021 and 2020, respectively. Revenue from sales-type leases is recognized upon installation and the interest portion is deferred and recognized as earned. Revenue from operating leases is recognized ratably over the applicable service period.

Equipment finance receivables arising from the rental of our cloud telecommunications equipment through sales-type leases, were as follows (in thousands):

	March 31,	December 31,
	2021	2020
Gross financing receivables	$1,726	$1,774
Less: unearned income	(548)	(582)
Financing receivables, net	1,178	1,192
Less: current portion of finance receivables, net	(298)	(286)
Finance receivables due after one year	$880	$906

Future minimum lease payments as of March 31, 2021, consisted of the following:

Year ending December 31,	Lease Receivables
2021 remaining	$422
2022	512
2023	414
2024	269
2025 and thereafter	109
Gross equipment financing receivables	1,726
Less: unearned income	(548)
Equipment financing receivables, net	$1,178

14.

Commitments and Contingencies

Legal Proceedings

In the ordinary course of business, the Company may be involved in a variety of claims, lawsuits, investigations, and other proceedings, including patent infringement claims, employment litigation, regulatory compliance matters, and contractual disputes, that can arise in the normal course of the Company's operations. The Company recognizes a provision when management believes information available prior to the issuance of the financial statements indicates it is probable a loss has been incurred as of the date of the financial statements and the amount of loss can be reasonably estimated. The Company adjusts the amount of the provision to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. As of March 31, 2021, the Company does not have a recorded liability for estimated losses. Legal costs are expensed as incurred.

15.

Segments

Management has chosen to organize the Company around differences based on its products and services. Cloud Telecommunications segment generates revenue from selling cloud telecommunication products and services and broadband Internet services. Web Services segment generates revenue from website hosting and other professional services. The Company has two operating segments, which consist of Cloud Telecommunications and Web Services. Segment revenue and income before income tax provision are as follows (in thousands):

	Three Months Ended March 31,
	2021	2020
Revenue:
Cloud telecommunications	$4,391	$3,711
Web services	116	156
Consolidated revenue	4,507	3,867

Income/(Loss) from operations:
Cloud telecommunications	(817)	129
Web services	(5)	52
Total operating income/(loss)	(822)	181
Other income/(expense), net:
Cloud telecommunications	(17)	(6)
Web services	-	(32)
Total other income/(expense), net	(17)	(38)
Income/(Loss) before income tax provision:
Cloud telecommunications	(834)	123
Web services	(5)	20
Income/(Loss) before income tax provision	$(839)	$143

Depreciation and amortization was $99,000 and $99,000 for the Cloud Telecommunications segment for the three months ended March 31, 2021 and 2020, respectively. Depreciation and amortization was $2,000 and $4,000 for the Web Services segment for the three months ended March 31, 2021 and 2020, respectively.

Interest income was $0 and $1,000 for the Web Services segment for the three months ended March 31, 2021 and 2020, respectively.

Interest expense was $19,000 and $9,000 for the Cloud Telecommunications segment for the three months ended March 31, 2021 and 2020, respectively. Interest expense was $0 and $0 for the Web Services segment for the three months ended March 31, 2021 and 2020.

Item 2.

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

This section and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and our Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A, “Risk Factors,” which are incorporated herein by reference. The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 Form 10-K”) filed with the SEC and the Condensed Consolidated Financial Statements and notes thereto included in the 2020 Form 10-Qs and elsewhere in this Form 10-Q. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.

OVERVIEW

Crexendo is an award-winning premier provider of cloud communications, UCaaS (Unified Communications as a Service), call center, collaboration services, and other cloud business services that are designed to provide enterprise-class cloud services to any size business at affordable monthly rates. The Company has two operating segments, which consist of Cloud Telecommunications and Web Services.

Cloud Telecommunications – Our cloud telecommunications services transmit calls using IP or cloud technology, which converts voice signals into digital data packets for transmission over the Internet or cloud. Each of our calling plans provides a number of basic features typically offered by traditional telephone service providers, plus a wide range of enhanced features that we believe offer an attractive value proposition to our customers. This platform enables a user, via a single “identity” or telephone number, to access and utilize services and features regardless of how the user is connected to the Internet or cloud, whether it’s from a desktop device or an application on a mobile device.

We generate recurring revenue from our cloud telecommunications and broadband Internet services. Our cloud telecommunications contracts typically have a thirty-six to sixty month term. We may also charge activation and flash fees and the Company generally allocates a portion of the activation fees to the desktop devices, which is recognized at the time of the installation or customer acceptance, and a portion to the service, which is recognized over the contract term using the straight-line method. We also charge other various contracted and non-contracted fees.

We generate product revenue and equipment financing revenue from the sale and lease of our cloud telecommunications equipment. Revenues from the sale of equipment, including those from sales-type leases, are recognized at the time of sale or at the inception of the lease, as appropriate.

Our Cloud Telecommunications service revenue increased 21% or $691,000 to $4,023,000 for the three months ended March 31, 2021 as compared to $3,332,000 for the three months ended March 31, 2020. Our Cloud Telecommunications product revenue decreased 3% or $11,000 to $368,000 for the three months ended March 31, 2021 as compared to $379,000 for the three months ended March 31, 2020. As of March 31, 2021 and 2020, our backlog was $27,766,000 and $26,583,000, respectively.

Web Services – We generate recurring revenue from website hosting and other professional services.

Our Web Services revenue decreased 26% or $40,000 to $116,000 for the three months ended March 31, 2021 as compared to $156,000 for the three months ended March 31, 2020.

OUR SERVICES AND PRODUCTS

Our goal is to provide a broad range of cloud-based products and services that nearly eliminate the cost of a businesses’ technology infrastructure and enable businesses of any size to more efficiently run their business. By providing a variety of comprehensive and scalable solutions, we are able to cater to businesses of all sizes on a monthly subscription basis without the need for expensive capital investments, regardless of where their business is in its lifecycle. Our products and services can be categorized in the following offerings:

Cloud Telecommunications – Our cloud telecommunications service offering includes hardware, software, and unified ng IP or cloud technology over any high-speed Internet connection. These services are rendered through a variety of devices and communication solutions for businesses using user interfaces such as a Crexendo branded desktop phones and/or mobile and desktop applications. Some examples of mobile devices are Android cell phones, iPhones, iPads or Android tablets. These services enable our customers to seamlessly communicate with others through phone calls that originate/terminate on our network or PSTN networks. Our cloud telecommunications services are powered by our proprietary implementation of standards based Web and VoIP cloud technologies. Our services use our highly scalable complex infrastructure that we build and manage based on industry standard best practices to achieve greater efficiencies, better quality of service (QoS) and customer satisfaction. Our infrastructure comprises of compute, storage, network technologies, 3rd party products and vendor relationships. We also develop end user portals for account management, license management, billing and customer support and adopt other cloud technologies through our partnerships.

Crexendo’s cloud telecommunication service offers a wide variety of essential and advanced features for businesses of all sizes. Many of these features included in the service offering are:

●

Business Productivity Features such as dial-by extension and name, transfer, conference, call recording, Unlimited calling to anywhere in the US and Canada, International calling, Toll free (Inbound and Outbound)

●

Individual Productivity Features such as Caller ID, Call Waiting, Last Call Return, Call Recording, Music/Message-On-Hold, Voicemail, Unified Messaging, Hot-Desking

●

Group Productivity Features such as Call Park, Call Pickup, Interactive Voice Response (IVR), Individual and Universal Paging, Corporate Directory, Multi-Party Conferencing, Group Mailboxes, Web and mobile devices based collaboration applications

●

Call Center Features such as Automated Call Distribution (ACD), Call Monitor, Whisper and Barge, Automatic Call Recording, One way call recording, Analytics

●

Advanced Unified Communication Features such as Find-Me-Follow-Me, Sequential Ring and Simultaneous Ring, Voicemail transcription

●

Mobile Features such as extension dialing, transfer and conference and seamless hand-off from WiFi to/from 3G and 4G, LTE, as well as other data services. These features are also available on CrexMo, an intelligent mobile application for iPhones and Android smartphones, as well as iPads and Android tablets

●

Traditional PBX Features such as Busy Lamp Fields, System Hold. 16-48 Port density Analog Devices

●

Expanded Desktop Device Selection such as Entry Level Phone, Executive Desktop, DECT Phone for roaming users

●

Advanced Faxing solution such as Cloud Fax (cFax) allowing customers to send and receive Faxes from their Email Clients, Mobile Phones and Desktops without having to use a Fax Machine simply by attaching a file

●

Web based online portal to administer, manage and provision the system.

●

Asynchronous communication tools like SMS/MMS, chat and document sharing to keep in pace with emerging communication trends.

Many of these services are included in our basic offering to our customers for a monthly recurring fee and do not require a capital expense. Some of the advanced features such as Automatic Call Recording and Call Center Features require additional monthly fees. Crexendo continues to invest and develop its technology and CPaaS offerings to make them more competitive and profitable.

Website Services – Our website services segment allows businesses to host their websites in our data center for a recurring monthly fee.

RESULTS OF OPERATIONS

The following discussion of financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and notes thereto and other financial information included elsewhere in this Form 10-Q.

Results of Consolidated Operations (in thousands, except for per share amounts):

	Three Months Ended March 31,
	2021	2020
Service revenue	$4,139	$3,488
Product revenue	368	379
Total revenue	$4,507	$3,867
Income/(loss) before income taxes	(839)	143
Income tax benefit/(provision)	124	(3)
Net income/(loss)	(715)	140
Basic earnings per share	$(0.04)	$0.01
Diluted earnings per share	$(0.04)	$0.01

Three months ended March 31, 2021 compared to three months ended March 31, 2020

Service revenue

Service revenue consists primarily of fees collected for cloud telecommunications services, professional services, interest from sales-type leases, reselling broadband Internet services, administrative fees, website hosting, and web management services. Service revenue increased 19% or $651,000, to $4,139,000 for the three months ended March 31, 2021 as compared to $3,488,000 for the three months ended March 31, 2020. Cloud Telecommunications service revenue increased 21% or $691,000, to $4,023,000 for the three months ended March 31, 2021 as compared to $3,332,000 for the three months ended March 31, 2020. Web service revenue decreased 26% or $40,000, to $116,000 for the three months ended March 31, 2021 as compared to $156,000 for the three months ended March 31, 2020.

Product Revenue

Product revenue consists primarily of fees collected from the sale and lease of desktop phone devices and third-party equipment. Product revenue decreased 3% or $11,000, to $368,000 for the three months ended March 31, 2021 as compared to $379,000 for the three months ended March 31, 2020. Product revenue fluctuates from one period to the next based on timing of installations. Our typical customer installation is complete within 30-60 days. However, larger enterprise customers can take multiple months, depending on size and the number of locations. Product revenue is recognized when products have been installed and services commence. Additionally, product revenue can fluctuate due to the allocation of discounts or sales promotions across the performance obligations.

Income/(Loss) Before Income Taxes

Income before income taxes decreased 687% or $982,000, to a loss before income taxes of $(839,000) for the three months ended March 31, 2021 as compared to income before income taxes of $143,000 for the three months ended March 31, 2020. The decrease in income before income tax is primarily due to an increase in operating expenses of $1,643,000, offset by an increase in revenue of $640,000 and a decrease in interest expense and other expense of $21,000. The increase in operating expenses is primarily related to increases in salaries and benefits, stock compensation expense and acquisition related expenses. During the three months ended March 31, 2021 the Company recognized $684,000 in one-time acquisition related expenses associated with the NetSapiens and Centric Telecom business acquisitions.

Income Tax Benefit/(Provision)

We had an income tax benefit of $124,000 for the three months ended March 31, 2021 compared to an income tax provision of ($3,000) for the three months ended March 31, 2020. We had pre-tax income/(loss) for the three months ended March 31, 2021 and 2020 of $(839,000) and $143,000, respectively.

USE OF NON-GAAP FINANCIAL MEASURES

To evaluate our business, we consider and use non-generally accepted accounting principles (“Non-GAAP”) net income and Adjusted EBITDA as a supplemental measure of operating performance. These measures include the same adjustments that management takes into account when it reviews and assesses operating performance on a period-to-period basis. We consider Non-GAAP net income to be an important indicator of overall business performance because it allows us to evaluate results without the effects of share-based compensation, acquisition related expenses and amortization of intangibles. We define EBITDA as U.S. GAAP net income/(loss) before interest income, interest expense, other income and expense, provision for income taxes, and depreciation and amortization. We believe EBITDA provides a useful metric to investors to compare us with other companies within our industry and across industries. We define Adjusted EBITDA as EBITDA adjusted for acquisition related expenses and share-based compensation. We use Adjusted EBITDA as a supplemental measure to review and assess operating performance. We also believe use of Adjusted EBITDA facilitates investors’ use of operating performance comparisons from period to period, as well as across companies.

In our May 11, 2021 earnings press release, as furnished on Form 8-K, we included Non-GAAP net income, EBITDA and Adjusted EBITDA. The terms Non-GAAP net income, EBITDA, and Adjusted EBITDA are not defined under U.S. GAAP, and are not measures of operating income, operating performance or liquidity presented in analytical tools, and when assessing our operating performance, Non-GAAP net income, EBITDA, and Adjusted EBITDA should not be considered in isolation, or as a substitute for net income/(loss) or other consolidated income statement data prepared in accordance with U.S. GAAP. Some of these limitations include, but are not limited to:

●

EBITDA and Adjusted EBITDA do not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;

●

they do not reflect changes in, or cash requirements for, our working capital needs;

●

they do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt that we may incur;

●

they do not reflect income taxes or the cash requirements for any tax payments;

●

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will be replaced sometime in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements;

●

while share-based compensation is a component of operating expense, the impact on our financial statements compared to other companies can vary significantly due to such factors as the assumed life of the options and the assumed volatility of our common stock; and

●

other companies may calculate EBITDA and Adjusted EBITDA differently than we do, limiting their usefulness as comparative measures.

We compensate for these limitations by relying primarily on our U.S. GAAP results and using Non-GAAP net income, EBITDA, and Adjusted EBITDA only as supplemental support for management’s analysis of business performance. Non-GAAP net income, EBITDA and Adjusted EBITDA are calculated as follows for the periods presented.

RECONCILIATION OF NON-GAAP FINANCIAL MEASURES

In accordance with the requirements of Regulation G issued by the SEC, we are presenting the most directly comparable U.S. GAAP financial measures and reconciling the unaudited Non-GAAP financial metrics to the comparable U.S. GAAP measures.

Reconciliation of U.S. GAAP Net Income/(Loss) to Non-GAAP Net Income

(Unaudited, in thousands, except for per share and share data)

	Three Months Ended March 31,
	2021	2020
U.S. GAAP net income/(loss)	$(715)	$140
Share-based compensation	282	105
Acquisition related expenses	684	-
Amortization of intangible assets	57	30
Non-GAAP net income	$308	$275

Non-GAAP earnings per common share:
Basic	$0.02	$0.02
Diluted	$0.02	$0.02

Weighted-average common shares outstanding:
Basic	18,189,783	14,904,599
Diluted	19,484,148	16,262,886

Reconciliation of U.S. GAAP Net Income/(Loss) to EBITDA to Adjusted EBITDA

(Unaudited, in thousands)

	Three Months Ended March 31,
	2021	2020
U.S. GAAP net income/(loss)	$(715)	$140
Depreciation and amortization	101	103
Interest expense	19	9
Interest and other expense/(income)	(2)	29
Income tax provision/(benefit)	(124)	3
EBITDA	(721)	284
Acquisition related expenses	684	-
Share-based compensation	282	105
Adjusted EBITDA	$245	$389

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. Please see Note 1 of Part I, Item 1 of this quarterly report on Form 10-Q for a summary of significant accounting policies. In addition, the estimates, assumptions and judgments involved in our accounting policies described in critical accounting policies and estimates are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020.

Segment Operating Results

The Company has two operating segments, which consist of Cloud Telecommunications and Web Services. The information below is organized in accordance with our two reportable segments. Segment operating income is equal to segment net revenue less segment cost of service revenue, cost of product revenue, sales and marketing, research and development, and general and administrative expenses.

Operating Results of our Cloud Telecommunications Segment (in thousands):

	Three Months Ended March 31,
Cloud Telecommunications	2021	2020
Service revenue	$4,023	$3,332
Product revenue	368	379
Total revenue	$4,391	$3,711
Operating expenses:
Cost of service revenue	$1,240	$945
Cost of product revenue	225	220
Research and development	341	262
Selling and marketing	1,241	1,038
General and administrative	2,161	1,117
Total operating expenses	5,208	3,582
Operating income/(loss)	(817)	129
Other income/(expense)	(17)	(6)
Income before tax benefit/(provision)	$(834)	$123

Three months ended March 31, 2021 compared to three months ended March 31, 2020

Service Revenue

Cloud Telecommunications service revenue consists primarily of fees collected for cloud telecommunications services, professional services, interest from sales-type leases, administrative fees, and reselling broadband Internet services. Service revenue increased 21% or $691,000, to $4,023,000 for the three months ended March 31, 2021 as compared to $3,332,000 for the three months ended March 31, 2020. The increase in service revenue is due to an increase in contracted service revenue and usage charges of $567,000, an increase in fees, commissions, and other, recognized over time of $56,000, an increase in one time fees, commissions and other of $45,000, and an increase in sales-type lease interest of $23,000. A substantial portion of Cloud Telecommunications service revenue is generated through thirty-six to sixty month service contracts.

Product Revenue

Product revenue consists primarily of fees collected from the sale of desktop phone devices and third-party equipment. Product revenue decreased 3% or $11,000, to $368,000 for the three months ended March 31, 2021 as compared to $379,000 for the three months ended March 31, 2020. Product revenue fluctuates from one period to the next based on timing of installations. Our typical customer installation is complete within 30-60 days. However, larger enterprise customers can take multiple months, depending on size and the number of locations. Product revenue is recognized when products have been installed and services commence. Additionally, product revenue can fluctuate due to the allocation of discounts or sales promotions across the performance obligations.

Backlog

Backlog represents the total contract value of all contracts signed, less revenue recognized from those contracts as of March 31, 2021 and 2020. Backlog increased 4% or $1,183,000 to $27,766,000 as of March 31, 2021 as compared to $26,583,000 as of March 31, 2020. Below is a table which displays the Cloud Telecommunications segment revenue backlog as of January 1, 2021 and 2020, and March 31, 2021 and 2020, which we expect to recognize as revenue within the next thirty-six to sixty months (in thousands):

Cloud Telecommunications backlog as of January 1, 2021	$28,551
Cloud Telecommunications backlog as of March 31, 2021	$27,766

Cloud Telecommunications backlog as of January 1, 2020	$26,110
Cloud Telecommunications backlog as of March 31, 2020	$26,583

Cost of Service Revenue

Cost of service revenue consists primarily of fees we pay to third-party telecommunications carriers, broadband Internet providers, software providers, costs related to installations, credit card processing fees, shipping charges, customer support salaries and benefits, and share-based compensation. Cost of service revenue increased 31% or $295,000, to $1,240,000 for the three months ended March 31, 2021 as compared to $945,000 for the three months ended March 31, 2020. The increase in cost of service revenue was primarily due to an increase in salaries, wages and benefits of $194,000 as a result of an increase in customer support and implementation specialist headcount directly related to the increase in service revenue. Bandwidth costs increased $75,000 directly related to the increase in service revenue. Professional installation service costs increased $16,000. As a result of the growth in monthly recurring revenue, credit card processing fees increased $14,000. These increases were offset by a decrease in other cost of service revenue of $4,000.

Cost of Product Revenue

Cost of product revenue consists of the costs associated with desktop phone devices and third-party equipment. Cost of product revenue increased 2% or $5,000, to $225,000 for the three months ended March 31, 2021 as compared to $220,000 for the three months ended March 31, 2020.

Research and Development

Research and development expenses primarily consist of salaries and benefits, share-based compensation, and outsourced engineering services related to the development of new cloud telecommunications features and products. Research and development expenses increased 30% or $79,000, to $341,000 for the three months ended March 31, 2021 as compared to $262,000 for the three months ended March 31, 2020. There was an increase in salaries, wages and benefits of $57,000 as a result of an increase in headcount as we continue to invest in our solution. We also incurred increased development costs for maintenance on our customer user interface, our Android and iPhone mobile phone applications, product testing, and Java development of $22,000.

Selling and Marketing

Selling and marketing expenses consist primarily of direct and channel sales representative salaries and benefits, share-based compensation, partner channel commissions, amortization of costs to acquire contracts, travel expenses, lead generation services, trade shows, internal and third-party marketing costs, the production of marketing materials, and sales support software. Selling and marketing expenses increased 20% or $203,000, to $1,241,000 for the three months ended March 31, 2021 as compared to $1,038,000 for the three months ended March 31, 2020. There was an increase in increase in salaries, wages and benefits of $189,000 related to an increase in headcount of sales reps and the addition of our chief revenue officer. There was also an increase in commission expense of $68,000 directly related to an increase in revenue. These increases were offset by a decrease in travel and trade show related expenses of $35,000, a decrease in sales lead generation cost of $8,000, and a decrease in other sales and marketing expense of $11,000.

General and Administrative

General and administrative expenses consist of salaries, benefits and stock compensation for executives, administrative personnel, legal, rent, equipment, accounting and other professional services, investor relations, depreciation, amortization of intangibles, and other administrative corporate expenses. General and administrative expenses increased 93% or $1,044,000, to $2,161,000 for the three months ended March 31, 2021 as compared to $1,117,000 for the three months ended March 31, 2020. Consolidated general and administrative expenses increased 90% or $1,066,000, to $2,254,000 for the three months ended March 31, 2021 as compared to $1,188,000 for the three months ended March 31, 2020. As Web Services segment revenue has decreased and Cloud Telecommunications segment revenue has increased, a higher percentage of general and administrative costs are being allocated to the Cloud Telecommunications segment. Therefore, we will discuss changes in our consolidated general and administrative expenses. The increase in consolidated general and administrative expenses is primarily due to an increase in acquisition related legal, accounting, discretionary bonuses, and other consultation and professional services of $684,000. There was an increase in administrative salaries, wages and benefits of $286,000 as a result of an increase in headcount and increased salaries. We invested $72,000 in contractor costs, data center equipment and office equipment for maintenance and improvements in our data center and towards our disaster recovery failover solution. There was an increase in intangible amortization of $27,000 from the Centric Telecom business acquisition. The increases were offset by a decrease in other general and administrative expense of $3,000, which includes our Nasdaq listing fee, telecommunications fees, depreciation, rent, legal fees and other general and administrative expenses.

Other Income/(Expense)

Other income/(expense) primarily relates to the allocated portions of interest expense offset by credit card cash back rewards. Other expenses increased 183%, or $11,000, to $17,000 for the three months ended March 31, 2021 as compared to $6,000 of net other expense for the three months ended March 31, 2020. The increase in other expenses is related to our increase in interest expense of $10,000 for interest paid on finance agreements and a decrease in credit card cash back rewards of $1,000.

Operating Results of Web Services segment (in thousands):

	Three Months Ended March 31,
Web Services	2021	2020
Service revenue	$116	$156
Operating expenses:
Cost of service revenue	19	25
Research and development	9	8
General and administrative	93	71
Total operating expenses	121	104
Operating income/(loss)	(5)	52
Other income/(expense)	-	(32)
Income/(loss) before tax benefit/(provision)	$(5)	$20

Three months ended March 31, 2021 compared to three months ended March 31, 2020

Service Revenue

Service revenue is generated primarily through website hosting and professional web management services. Web Services segment revenue decreased 26% or $40,000, to $116,000 for the three months ended March 31, 2021 as compared to $156,000 for the three months ended March 31, 2020. The decrease in service revenue is primarily due to a decrease in hosting revenue of $28,000 and a decrease in professional web management services of $12,000.

Cost of Service Revenue

Cost of service revenue consists primarily of bandwidth, web domain registration fees, customer service salaries and benefits, temporary labor cost, and credit card processing fees. Cost of service revenue decreased 24% or $6,000, to $19,000 for the three months ended March 31, 2021 as compared to $25,000 for the three months ended March 31, 2020. The decrease in cost of service revenue is primarily related to a decrease in customer service salaries, wages and benefits of $4,000, a decrease in web domain registration fees of $1,000, and a decrease in credit card fees of $1,000, directly related to the decrease in revenue.

Research and Development

Research and development expenses primarily consist of salaries and benefits, and related expenses which are attributable to the development of our website development software products. Research and development expenses increased 13% or $1,000, to $9,000 for the three months ended March 31, 2021 as compared to $8,000 for the three months ended March 31, 2020 due to fluctuations in salaries, wages and benefits.

General and Administrative

General and administrative expenses consist of salaries, benefits and stock compensation for executives, administrative personnel, legal, rent, equipment, accounting and other professional services, investor relations, depreciation, amortization of intangibles, and other administrative corporate expenses. General and administrative expenses increased 31% or $22,000, to $93,000 for the three months ended March 31, 2021 as compared to $71,000 for the three months ended March 31, 2020. Consolidated general and administrative expenses increased 90% or $1,066,000, to $2,254,000 for the three months ended March 31, 2021 as compared to $1,188,000 for the three months ended March 31, 2020. As Web Services segment revenue has decreased and Cloud Telecommunications segment revenue has increased, a higher percentage of general and administrative costs are being allocated to the Cloud Telecommunications segment. Therefore, we will discuss changes in our consolidated general and administrative expenses. The increase in consolidated general and administrative expenses is primarily due to an increase in acquisition related legal, accounting, discretionary bonuses, and other consultation and professional services of $684,000. There was an increase in administrative salaries, wages and benefits of $286,000 as a result of an increase in headcount and increased salaries. We invested $72,000 in contractor costs, data center equipment and office equipment for maintenance and improvements in our data center and towards our disaster recovery failover solution. There was an increase in intangible amortization of $27,000 from the Centric Telecom business acquisition. The increases were offset by a decrease in other general and administrative expense of $3,000, which includes our Nasdaq listing fee, telecommunications fees, depreciation, rent, legal fees and other general and administrative expenses.

Other Income/(Expense)

Other income/(expense) primarily relates to the allocated portions of interest expense offset by credit card cash back rewards. Net other income decreased 100% or $32,000, to $0 for the three months ended March 31, 2021 as compared to $32,000 of net other income for the three months ended March 31, 2020. The decrease in net other income is due to a decrease in net foreign exchange gains of $32,000.

Liquidity and Capital Resources

Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. We finance our operations primarily through product and service sales to our customers. As of March 31, 2021 and December 31, 2020, we had cash and cash equivalents of $16,204,000 and $17,579,000, respectively. Changes in cash and cash equivalents are dependent upon changes in, among other things, working capital items such as contract liabilities, contract costs, accounts payable, accounts receivable, prepaid expenses, and various accrued expenses, as well as purchases of property and equipment, asset acquisitions, and changes in our capital and financial structure due to debt repayments and issuances, stock option exercises, sales of equity investments and similar events. We believe that our operations along with existing liquidity sources will satisfy our cash requirements for at least the next 12 months.

During the year ended December 31, 2020, the Company completed a public offering in which it issued and sold 2,170,000 shares of common stock at a price to the public of $5.50 per share. The shares sold and issued in the public offering resulted in an aggregate gross offering price of $11,935,000 and net proceeds to the Company were $10,771,000 after deducting underwriting discounts and commissions. The Company intends to utilize the proceeds to fund acquisitions.

During the three months ended March 31, 2021, the Company acquired 100% of the issued and outstanding shares of Centric Telecom, Inc., a provider of telecommunications products, services, and solutions in Northern Virginia. The aggregate purchase price of $3,255,000 consisted of $2,163,000 of cash paid at closing, 46,662 shares of our common stock with an estimated fair value of $346,000 issued at closing, and $746,000 of estimated contingent consideration to be paid out based on annualized revenue recognized during the nine month earn-out period.

Operating Activities

Cash used in or provided by operating activities is driven by our net loss, the timing of customer collections, as well as the amount and timing of disbursements to our vendors, the amount of cash we invest in personnel, marketing, and infrastructure costs to support the anticipated growth of our business. Net cash used in operating activities was $248,000 for the three months ended March 31, 2021, compared to net cash used for operating activities of $288,000 the three months ended March 31, 2020, a decrease of $40,000.

The net cash used for operations was primarily driven by our net loss for the three months ended March 31, 2021 of $715,000, of which $684,000 is associated with acquisition related expenses for the Centric Telecom and NetSapiens business acquisitions. The net loss was offset by $174,000 improvement in our outstanding account receivable balance and $291,000 increase in accounts payable and accrued liabilities balances from December 31, 2020.

Investing Activities

Net cash used in investing activities was $2,192,000 for the three months ended March 31, 2021 compared to net cash used in investing activities of $528,000 for the three months ended March 31, 2020. During the three months ended March 31, 2021, the Company acquired 100% of the issued and outstanding shares of Centric Telecom, Inc., a provider of telecommunications products, services, and solutions in Northern Virginia. The aggregate purchase price of $3,255,000 consisted of $2,163,000 of cash paid at closing, 46,662 shares of our common stock with an estimated fair value of $346,000 issued at closing, and $746,000 of estimated contingent consideration to be paid out based on annualized revenue recognized during the nine month earn-out period. For the three months ended March 31, 2020, net cash used in investing activities related to cash used for capital expenditures, primarily for the cash portion of the purchase of the Company’s corporate office building. The remaining $2,000,000 of the purchase price was financed through a note payable with a bank.

Financing Activities

Net cash provided by financing activities was $965,000 for the three months ended March 31, 2021 compared to net cash provided by financing activities of $71,000 for the three months ended March 31, 2020. Net cash provided by financing activities in the three months ended March 31, 2021, primarily relates to cash received from the exercise of stock options of $1,146,000 offset by the payments of employee tax withholdings related to the net settlement of stock options of $152,000. Net cash provided by financing activities in the three months ended March 31, 2020, primarily relates to cash received from the exercise of stock options of $84,000.

Contractual Obligations and Commitments

Except as set forth in Notes 4, 10, and 13 in the accompanying notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, there were no significant changes in our commitments under contractual obligations, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020.

Off Balance Sheet Arrangements

As of, March 31, 2021, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

RELATED PARTY TRANSACTIONS

On January 27, 2020, the Company entered into an agreement to purchase our corporate office building located at 1615 S 52nd St, Tempe, AZ 85281 from a Company that is owned by the major shareholder and CEO of the Company for $2,500,000. The fair value of the building was established by an independent appraisal.

Impact of Recent Accounting Pronouncements

The information set forth under Note 1 to the condensed consolidated financial statements under the caption “Recent Accounting Pronouncements” is incorporated herein by reference.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Not required

Item 4.

Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Report, have concluded that, based on the evaluation of these controls and procedures, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended March 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

From time to time, we are involved in lawsuits, claims, investigations and proceedings that arise in the ordinary course of business. There are no matters pending or threatened that we expect to have a material adverse impact on our business, results of operations, financial condition or cash flows.

Item 1A.

Risk Factors

There are many risk factors that may affect our business and the results of our operations, many of which are beyond our control. Information on certain risks that we believe are material to our business is set forth in “Part I – Item 1A. Risk Factors” of the 2020 Form 10-K. Additional risk factors identified during the period are as follows:

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 6.

Exhibits

31.1		Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities and Exchange Act of 1934, as amended
31.2		Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities and Exchange Act of 1934, as amended
32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
101.INS*		XBRL INSTANCE DOCUMENT
101.SCH*		XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT
101.CAL*		XBRL TAXONOMY EXTENSION CALCULATION LINKBASE DOCUMENT
101.DEF*		XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT
101.LAB*		XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT
101.PRE*		XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE DOCUMENT

In accordance with Rule 406T of Regulation S-T, these XBRL (eXtensible Business Reporting Language) documents are 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 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.

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.

	Crexendo, Inc.


May 11, 2021	By:	/s/ Steven G. Mihaylo
		Steven G. Mihaylo Chief Executive Officer

May 11, 2021	By:	/s/ Ronald Vincent
		Ronald Vincent Chief Financial Officer

Crexendo, Inc. - FORM 10-Q - May 11, 2021

Attached files

Crexendo, Inc. Reports