UNITED STATES 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
———————
 
FORM 10-K
 
☒
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2019:
 
Or
 
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
———————
 
Crexendo, Inc.
(Exact name of registrant as specified in its charter)
———————
 
Nevada
 
001-32277
 
87-0591719
(State or Other Jurisdiction of Incorporation or Organization)
 
(Commission File Number)
 
(I.R.S. Employer Identification No.)
 
1615 South 52nd Street, Tempe, AZ 85281
 (Address of Principal Executive Office) (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)
———————
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.001 per share
 
 OTCQX Marketplace
 
Securities registered pursuant to Section 12(g) of the Act: None
———————
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒
 
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 website, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒
 
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.
 
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 Act). Yes ☐ No ☒
 
The aggregate market value of the common stock held by non-affiliates of the registrant as of December 31, 2019 was approximately $16,979,147.
 
The number of shares of the registrant’s common stock outstanding as of February 28, 2020 was 14,899,751.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Proxy Statement for the Registrant’s 2020 Annual Meeting of Stockholders are incorporated by reference in Part III of this Annual Report on Form 10-K.  
 

 
 
 
TABLE OF CONTENTS
 
PART I
 
BUSINESS
1
RISK FACTORS
6
17
17
17
 
PART II
 
18
19
19
33
34
68
68
68
 
PART III
 
69
69
69
69
69
 
PART IV
 
70
 
 
 
 
PART I
 
Throughout this Annual Report, we refer to Crexendo, Inc., together with its subsidiaries, as “we,” “us,” “our Company,” “Crexendo®” or “the Company.” As used in this Annual Report, “Ride The Cloud™” is a registered trademark of our Company in the United States and other countries. All other product names are or may be trademarks of, and are used to identify the products and services of, their respective owners.
 
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS. THESE STATEMENTS RELATE TO FUTURE EVENTS OR OUR FUTURE FINANCIAL PERFORMANCE. IN SOME CASES, YOU CAN IDENTIFY FORWARD-LOOKING STATEMENTS BY TERMINOLOGY SUCH AS “MAY,” “WILL,” “SHOULD,” “EXPECT,” “PLAN,” “INTEND,” “ANTICIPATE,” “BELIEVE,” “ESTIMATE,” “PROJECT,” “PREDICT,” “POTENTIAL” OR “CONTINUE” (INCLUDING THE NEGATIVE OF SUCH TERMS), OR OTHER SIMILAR TERMINOLOGY. THESE STATEMENTS ARE ONLY ESTIMATIONS, AND ARE BASED UPON VARIOUS ASSUMPTIONS THAT MAY NOT BE REALIZED. ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY. IN EVALUATING THESE STATEMENTS, YOU SHOULD SPECIFICALLY CONSIDER VARIOUS FACTORS, INCLUDING, BUT NOT LIMITED TO, THE RISKS OUTLINED BELOW UNDER ITEM 1A. THESE FACTORS MAY CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY FORWARD-LOOKING STATEMENT.
 
ALTHOUGH WE BELIEVE THAT THE ESTIMATIONS REFLECTED IN THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. MOREOVER, NEITHER WE NOR ANY OTHER PERSON ASSUMES RESPONSIBILITY FOR THE ACCURACY AND COMPLETENESS OF THE FORWARD-LOOKING STATEMENTS. WE DO NOT INTEND TO UPDATE ANY OF THE FORWARD-LOOKING STATEMENTS AFTER THE DATE OF THIS ANNUAL REPORT TO CONFORM SUCH STATEMENTS TO ACTUAL RESULTS OR TO CHANGES IN OUR EXPECTATIONS, UNLESS REQUIRED BY LAW.
 
ITEM 1.  BUSINESS
 
OVERVIEW
 
Crexendo, Inc. 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, computer, or an application on a mobile device.
 
We generate recurring revenue from our cloud telecommunications and reselling broadband Internet services. Our cloud telecommunications contracts typically have a thirty-six to sixty month term. 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.
 
Web Services – We generate recurring revenue from website hosting and other professional services.
 
 
1
 
 
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 communication solutions for businesses using IP or cloud technology over any high-speed Internet connection. These services are rendered through a variety of devices and 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.
 
 
2
 
 
SEGMENT INFORMATION
 
The Company has two operating segments, which consist of Cloud Telecommunications and Web Services. Segment revenue and income/(loss) before income tax provision was as follows (in thousands):
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
Revenue:
 
 
 
 
 
 
Cloud Telecommunications
 $13,780 
 $11,083 
Web Services
  656 
  825 
Consolidated revenue
 $14,436 
 $11,908 
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
Income/(loss) before income tax provision:
 
 
 
 
 
 
Cloud Telecommunications
 $862 
 $(608)
Web Services
  283 
  400 
Income/(loss) before income tax
 $1,145 
 $(208)
 
TECHNOLOGY
 
We believe our proprietary implementation of standard Web, IP, Cloud, Mobile and Internet technologies represent a key component of our business model. We believe these technologies and how we deliver them to our customers distinguish our services and products from the services and products offered by our competitors. Our technology infrastructure and virtual network operation center, all of which is built and managed on industry standard computers, storage, network, data and platforms offers us greater efficiencies while maintaining scalability and redundancy. The synergies between Web and Telecommunication protocols such as TCP/IP, HTTP, XML, SIP and innovations in computing, load balancing, redundancy and high availability of Web and Telecommunications technologies offers us a unique advantage in delivering these services to our customers seamlessly from our data center.
 
Our Cloud Telecommunications technology is continuously being enhanced with additional features and software functionality. Our current functionality includes:
 
●
High-end desktop telephony devices such as Gigabit, PoE, 6 Line Color Phone with 10 programmable buttons and lower end Monochrome 2 Line wall mountable device;
●
Basic Business Telephony Features such as those offered in a traditional private branch exchange (“PBX”) systems like extension dialing, Direct Inward Dialing (DID), Hold/Resume, Music-On-Hold, Call Transfer (Attended and Unattended), Conferencing, Local, Long Distance, Toll-Free and International Dialing, Voicemail, Auto-Attendant and traditional faxing;
●
Advanced telephony features such as Call Park, Call Pickup, Paging (through the phones), Overhead paging, Call Recording;
●
Call Center Functionality such as Agent Log In/Log Out, Whisper, Barge and Call center reporting;
●
Unified Communications features like Simultaneous Ring, Sequential Ring, Status based Routing (Find-Me-Follow-Me), 10-party instant conference, and Mobile application (CrexMo);
●
Crexendo Mobile Application (CrexMo), which allows users to place and receive extension calls using Crexendo’s network, transfer and conference other users right from their mobile device as if they were in the office. It also provided users instant access to visual voicemail and call logs;
●
End User Portal and Unified Messaging with Voicemail, Call Recording and eFax inbox.
●
Collaboration products like group chat, SMS/MMS, document sharing, video and web conferencing
 
Our website software platform is feature rich and battle tested to provide an innovative website-building environment. We continue to maintain our Web platform to make it an always available and reliable experience for our web customers and for their website visitors.
 
 
3
 
 
RESEARCH AND DEVELOPMENT
 
We invested $853,000 and $801,000 for the years ended December 31, 2019 and 2018, respectively, in the research and development of our technologies and data center. The majority of these expenditures were for enhancements to our cloud telecommunications products and services and website development software.
 
COMPETITION
 
The market for cloud business communications services is large and increasingly competitive. We expect competition to continue to increase in the future. Some of these competitors include:
 
●
traditional on-premise, hardware business communications providers such as Alcatel-Lucent, Avaya Inc., Cisco Systems, Inc., Mitel, NEC, and Siemens Enterprise Networks, LLC, any of which may now or in the future also host their solutions through the cloud;
●
software providers such as Microsoft Corporation (Microsoft Teams (formerly Skype for Business)) and BroadSoft, Inc. (acquired by Cisco Systems, Inc.) that generally license their software and may now or in the future also host their solutions through the cloud, and their resellers including major carriers and cable companies;
●
established communications providers that resell on-premise hardware, software, and hosted solutions, such as AT&T, Verizon Communications Inc., CenturyLink, Cox, Charter and Comcast Corporation in the United States, TELUS and others in Canada, and BT, Vodafone, and others in the U.K., all of whom have significantly greater resources than us and do now or may in the future also develop and/or host their own or other solutions through the cloud;
●
other cloud companies such as 8x8, Inc., RingCentral, Inc., Amazon.com, Inc., DialPad, Inc., Fusion, Fuze (formerly Thinking Phone Networks), StarBlue (merger of Star2Star and BlueFace), Intermedia.net, Inc., J2 Global, Inc., Jive Communications, Inc. (acquired by LogMeIn, Inc.), Microsoft Corporation (Microsoft Teams (formerly Skype for Business)), Mitel, Nextiva, Inc., Slack Technologies, Inc., Vonage Holdings Corp., and West Corporation;
●
other large internet companies such as Alphabet Inc., Facebook, Inc., Oracle Corporation, Zoom,  and Salesforce.com, Inc., any of which might launch its own cloud-based business communication services or acquire other cloud-based business communications companies in the future; and
●
established contact center providers such as Amazon.com, Inc., Aspect Software, Inc., Avaya Inc., Five9, Inc., Genesys Telecommunications Laboratories, Inc., and NewVoiceMedia.
 
Additionally, should we determine to pursue acquisition opportunities, we may compete with other companies with similar growth strategies. Some of these competitors may be larger and have greater financial resources than we do. Competition for these acquisition targets could also result in increased prices of acquisition targets and a diminished pool of companies available for acquisition.
 
There are relatively low barriers to entry into our business. Our proprietary technology does not preclude or inhibit competitors from entering our markets. In particular, we anticipate new entrants will attempt to develop competing products and services or new forums for conducting e-commerce and telecommunications services which could be deemed competition. Additionally, if telecommunications service providers with more resources and name recognition were to enter our markets, they may redefine our industry and make it difficult for us to compete.
 
Expected technology advances associated with the Cloud, increasing use of the Cloud, and new software products are welcome advancements that we believe will broaden the Cloud’s viability. We anticipate that we can compete successfully by relying on our infrastructure, marketing strategies and techniques, systems and procedures, and by adding additional products and services in the future. We believe we can continue the operation of our business by periodic review and revision to our product offerings and marketing approach.
 
INTELLECTUAL PROPERTY
 
Our success depends in part on using and protecting our proprietary technology and other intellectual property. Furthermore, we must conduct our operations without infringing on the proprietary rights of third parties. We also rely upon trade secrets and the know-how and expertise of our key employees. To protect our proprietary technology and other intellectual property, we rely on a combination of the protections provided by applicable copyright, trademark and trade secret laws, as well as confidentiality procedures and licensing arrangements. Although we believe we have taken appropriate steps to protect our intellectual property rights, including requiring employees and third parties who are granted access to our intellectual property to enter into confidentiality agreements, these measures may not be sufficient to protect our rights against third parties. Others may independently develop or otherwise acquire unpatented technologies or products similar or superior to ours.
 
We license from third parties certain software and Internet tools which we include in our services and products. If any of these licenses were terminated, we could be required to seek licenses for similar software and Internet tools from other third parties or develop these tools internally. We may not be able to obtain such licenses or develop such tools in a timely fashion, on acceptable terms, or at all.
 
Companies participating in the software, Internet technology, and telecommunication industries are frequently involved in disputes relating to intellectual property. We may be required to defend our intellectual property rights against infringement, duplication, discovery and misappropriation by third parties or to defend against third-party claims of infringement. Likewise, disputes may arise in the future with respect to ownership of technology developed by employees who were previously employed by other companies. Any such litigation or disputes could be costly and divert our attention from our business. An adverse determination could subject us to significant liabilities to third parties, require us to seek licenses from, or pay royalties to, third parties, or require us to develop appropriate alternative technology. Some or all of these licenses may not be available to us on acceptable terms, or at all. In addition, we may be unable to develop alternate technology at an acceptable price, or at all. Any of these events could have a material adverse effect on our business prospects, financial position, or results of operations.
 
 
4
 
 
EMPLOYEES
 
As of December 31, 2019, we had 56 employees; 55 full-time and 1 part-time, including 3 executives, 16 sales representatives and sales management, 9 engineers and IT support, 20 in operations and customer support, 8 in accounting, finance, and legal.
 
CORPORATE INFORMATION
 
Crexendo, Inc. was incorporated as a Nevada corporation under the name “Netgateway, Inc.” on April 13, 1995. In November 1999, we were reincorporated under the laws of Delaware. In July 2002, we changed our corporate name to “iMergent, Inc.” In May 2011, our stockholders approved an amendment to our Certificate of Incorporation to change our name from "iMergent, Inc." to "Crexendo, Inc." The name change was effective May 18, 2011. Our ticker symbol "IIG" on the New York Stock Exchange was changed to “EXE” on May 18, 2011. We changed the name to better reflect the scope and direction of our business activities of assisting and providing web-based technology solutions to any size business who are seeking to take advantage of the benefits of conducting business on the cloud. On January 13, 2015, the Company moved to the OTCQX Marketplace and our ticker symbol was changed to “CXDO”. In November 2016, we were reincorporated as a Nevada corporation.
 
Our principal executive offices are located at 1615 S. 52nd Street, Tempe, AZ 85281. The telephone number of our principal executive offices is (602) 714-8500, and our main corporate website is www.crexendo.com. Information contained on, or that can be accessed through, our website, does not constitute part of this Annual Report on Form 10-K and inclusion of our website address in this Annual Report on Form 10-K is an inactive textual reference only.
 
We make available our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended, free of charge on our website, www.crexendo.com/company/investors as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission, or the “SEC”. In addition, the SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.
 
The Company announces material information to the public about the Company, its products and services and other matters through a variety of means, including the Company’s website (www.crexendo.com), the investor relations section of its website (www.crexendo.com/company/investors), press releases, filings with the SEC, and public conference calls, in order to achieve broad, non-exclusionary distribution of information to the public. The Company encourages investors and others to review the information it makes public in these locations, as such information could be deemed to be material information. Please note that this list may be updated from time to time.
 
GOVERNMENTAL REGULATION
 
As a provider of Internet communications services, we are subject to regulation in the U.S. by the FCC. Some of these regulatory obligations include contributing to the Federal Universal Service Fund, Telecommunications Relay Service Fund and federal programs related to number administration; providing access to E-911 services; protecting customer information; and porting phone numbers upon a valid customer request. We are also required to pay state and local 911 fees and contribute to state universal service funds in those states that assess Internet voice communications services. We are a competitive local exchange carrier (CLEC) in forty-seven states. We are subject to the same FCC regulations applicable to telecommunications companies, as well as regulation by the public utility commission in these states. Specific regulations vary on a state-by-state basis, but generally include the requirement to register or seek certification to provide its services, to file and update tariffs setting forth the terms, conditions and prices for our intrastate services and to comply with various reporting, record-keeping, surcharge collection, and consumer protection requirements.
 
We are subject to regulations generally applicable to all businesses. We are also subject to an increasing number of laws and regulations directly applicable to telecommunication, internet access and commerce. The adoption of any such additional laws or regulations may decrease the rate of growth of the Internet, which could in turn decrease the demand for our products and services. Such laws may also increase our costs of doing business or otherwise have an adverse effect on our business prospects, financial position or results of operations. Moreover, the applicability to the Internet of existing laws governing issues such as property ownership, libel, and personal privacy is uncertain. Future federal or state legislation or regulation could have a material adverse effect on our business prospects, financial condition and results of operations.
 
 
5
 
 
ITEM 1A.  RISK FACTORS.
 
Our quarterly and annual results of operations have fluctuated in the past and may continue to do so in the future. As a result, we may fail to meet or to exceed the expectations of research analysts or investors, which could cause our stock price to fluctuate.
 
Our quarterly and annual results of operations have varied historically from period to period, and we expect that they will continue to fluctuate due to a variety of factors, some of which are outside of our control, including:
 
● 
our ability to retain existing customers and resellers, expand our existing customers’ user base, and attract new customers;
● 
our ability to introduce new solutions; 
● 
the actions of our competitors, including pricing changes or the introduction of new solutions; 
● 
our ability to effectively manage our growth; 
● 
our ability to successfully penetrate the market for larger businesses; 
● 
the mix of annual and multi-year subscriptions at any given time; 
● 
the timing, cost, and effectiveness of our advertising and marketing efforts; 
● 
the timing, operating cost, and capital expenditures related to the operation, maintenance and expansion of our business;
● 
service outages or information security breaches and any related impact on our reputation; 
● 
our ability to accurately forecast revenues and appropriately plan our expenses; 
● 
our ability to realize our deferred tax assets; 
● 
costs associated with defending and resolving intellectual property infringement and other claims; 
● 
changes in tax laws, regulations, or accounting rules; 
● 
the timing and cost of developing or acquiring technologies, services or businesses, and our ability to successfully manage any such acquisitions; 
● 
adverse weather conditions; 
● 
the impact of worldwide economic, political, industry, and market conditions; and, 
● 
our ability to maintain compliance with all regulatory requirements. 
 
Any one of the factors above, or the cumulative effect of some or all of the factors referred to above, may result in significant fluctuations in our quarterly and annual results of operations. This variability and unpredictability could result in our failure to meet the expectations of securities analysts or investors for any period, which could cause our stock price to decline. In addition, a significant percentage of our operating expenses is fixed in nature and is based on forecasted revenues trends. Accordingly, in the event of revenue shortfalls, we may not be able to mitigate the negative impact on net income/(loss) and margins in the short term. If we fail to meet or exceed the expectations of research analysts or investors, the market price of our shares could fall substantially, and we could face costly lawsuits, including securities class-action suits.
 
We have incurred operating losses in prior periods.
 
We sustained operating losses in prior years and cannot guarantee ongoing profitability. Our ability to obtain positive cash flows from operating activities will depend on many factors including, but not limited to, our ability to acquire new customers and retaining and selling additional services to our existing customers. Our future success depends on our ability to significantly increase revenue generated from sales of our solutions to business customers. To increase our revenue, we must add new customers and encourage existing customers to continue their subscriptions at rates that are profitable for us. For customer demand and adoption of our solutions to grow, the quality, cost and feature benefits of these services must compare favorably to those of competing services. As our target markets mature, or as competitors introduce lower cost and/or more differentiated products or services that compete or are perceived to compete with ours, we may be unable to renew or extend our agreements with existing customers or attract new customers, or new business from existing customers, on favorable terms, or at all, which could have an adverse effect on our revenue and growth.
 
 
6
 
 
Fluctuations in our operating results may affect our stock price and ability to raise capital.
 
Our operating results for any given quarter or fiscal year should not be relied upon as an indication of future performance. Our future results will fluctuate, and those results may fall below the expectations of investors and may cause the trading price of our common stock to fall or fluctuate greatly. This may impair our ability to raise capital, should we seek to do so. Our quarterly results may fluctuate based on, including but not limited to our sales results, marketing, management, our ability to compete, pricing, and other risk factors contained in this section.
 
Our Chief Executive Officer owns a significant amount of our common stock and could exercise substantial corporate control. There may be limited ability to sell the company absent the consent of the CEO.
 
Steven G. Mihaylo, Chief Executive Officer (“CEO”) of Crexendo, Inc., owns 69% of the outstanding shares of our common stock based on the number of shares outstanding as of December 31, 2019. As a result, Mr. Mihaylo would have the ability to determine the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, amalgamation, consolidation or sale of all or substantially all of our assets. Mr. Mihaylo may have the ability to control the management and affairs of our Company. As a “control company” it may not be required that the company maintains an independent board. As a director and officer, Mr. Mihaylo owes a fiduciary duty to our stockholders. As a stockholder, Mr. Mihaylo is entitled to vote his shares, in his own interests, which may not always be in the interests of our stockholders generally. Accordingly, even though certain transactions may be in the best interests of other stockholders, this concentration of ownership may harm the market price of our common stock by, among other things, delaying, deferring or preventing a change in control of our Company, impeding a merger, amalgamation, consolidation, takeover or other business combination involving our Company, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our Company.
 
In addition, sales or other dispositions of our shares by Mr. Mihaylo may depress our stock price. Sales of a significant number of shares of our common stock in the public market could harm the market price of our common stock. As additional shares of our common stock become available for resale in the public market, the supply of our common stock will increase, which could result in a decrease in the market price of our common stock.
 
Some of the provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders by providing them with the opportunity to sell their shares at a premium to the then market price. Our bylaws contain provisions regulating the introduction of business at annual stockholders’ meetings by anyone other than the board of directors. These provisions may have the effect of making it more difficult, delaying, discouraging, preventing or rendering costlier an acquisition or a change in control of our Company.
 
Our securities have been thinly traded. An active trading market in our equity securities may cease to exist, which would adversely affect the market price and liquidity of our common stock, in addition our stock price has been subject to fluctuating prices.
 
Our common stock is traded exclusively in the over-the-counter market. We cannot predict the actions of market makers, investors or other market participants, and can offer no assurances that the market for our securities will be stable. If there is no active trading market in our equity securities, the market price and liquidity of the securities will be adversely affected. The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market or the perception that these sales could occur. These sales also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. As of February 28, 2020, we had outstanding 14,899,751 shares of common stock.
 
Additional dilution will result if outstanding options to acquire shares of our common stock are exercised. In addition, in the event future financings are required they could be convertible into or exchangeable for our equity securities, investors may experience additional dilution.
 
Our stock price may be affected by future sales of our common stock or equity-linked securities in the public market.
 
Such sales or offerings could lower the market price for our common stock. In the future, we may sell additional shares of our common stock or equity-linked securities to raise capital. In addition, a substantial number of shares of our common stock could be registered and issued. Furthermore, there are substantial amounts of vested stock options which are “in the money” which could be exercised and sold in public markets. The Company continues to expect to issue stock options as part of compensation. There may be further effect on our stock price upon the vesting and settlement of restricted stock units and performance units. We cannot predict the size of future issuances or the effect, if any, that they may have on the market price for our common stock. The issuance and sale of substantial amounts of common stock or equity-linked securities, or the perception that such issuances and sales may occur, could adversely affect the trading price of our common stock and impair our ability to raise capital through the sale of additional equity or equity-linked securities.
 
 
7
 
 
Lack of sufficient stockholder equity or continued losses from operations could subject us to fail to comply with the listing requirements of the OTCQX, if that occurred, the price of our common stock and our ability to access the capital markets could be negatively impacted, and our business will be harmed.
 
Our common stock is currently listed on OTCQX. We have had annual losses from continuing operations for the last four of five years (this current year has been profitable). There remains the possibility of future losses. While at current such losses would not impact our listing with OTCQX, requirements may change from time to time and it is possible we may not remain in compliance with the minimum condition of OTCQX listing standards. Delisting from the OTCQX could negatively affect the trading price of our stock and could also have other negative results, including the potential loss of confidence by suppliers and employees, the failure to attract the interest of institutional investors, and fewer business development opportunities.
 
We may face difficulties in attempting to uplist to a “major exchange” and there is no guarantee if the application is accepted, we will continue to meet the listing requirements.
 
While we believe that we meet the listing requirements of both the of the New York Stock Exchange and the Nasdaq Stock Market there is no guarantee if we attempt to uplist that our application will be accepted. Before a company can begin trading on either exchange, it must meet certain initial requirements or "listing standards." The various exchanges set their own standards for listing and continuing to trade a stock. The SEC does not set listing standards. To be listed initially, a company must meet minimum financial and non-financial standards. Among other things, the standards cover total market value, stock price, and the number of publicly traded shares and shareholders a company has. After a company's stock starts trading on an exchange, it usually is subject to other, less stringent requirements; if it fails to meet those, the stock can be delisted. As with listing requirements, the standards for delisting shares are not uniform; each exchange has its own requirements.
 
Our stock price, volatility and acceptance of our securities may be influenced by the research and reports that securities or industry analysts may publish about us or our business.
 
The Company cannot guarantee if there will be research reports written on the Company. The Stock price may be affected by the ability to get coverage and/or sufficient coverage. If coverage is initiated and/or if one or more of current or future analysts who cover us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts after issuing coverage ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline. Furthermore, such analysts publish their own projections regarding our actual results. These projections may vary widely from one another and may not accurately predict the results we actually achieve. Our stock price may decline if we fail to meet analysts’ projections.
 
We may undertake acquisitions, mergers or change to our capital structure to expand our business, which may pose risks to our business and dilute the ownership of our existing stockholders.
 
As part of a potential growth strategy, we may attempt to acquire or merge with certain businesses. Whether we realize benefits from any such transactions will depend in part upon the integration of the acquired businesses, the performance of the acquired products, services and capacities of the technologies acquired, as well as the personnel hired in connection therewith. Accordingly, our results of operations could be adversely affected from transaction-related charges, amortization of intangible assets, and charges for impairment of long-term assets. While we believe that we have established appropriate and adequate procedures and processes to mitigate these risks, there can be no assurance that any potential transaction will be successful.
 
In addition, the financing of any acquisition may require us to raise additional funds through public or private sources. Additional funds may not be available on terms that are favorable to us and, in the case of equity financings, may result in dilution to our stockholders. Future acquisitions by us could also result in large and immediate write-offs or assumptions of debt and contingent liabilities, any of which may have a material adverse effect on our consolidated financial position, results of operations, and cash flows.
 
Our ability to use our net operating loss carry-forwards may be reduced in the event of an ownership change, and could adversely affect our financial results.
 
As of December 31, 2019, we had net operating loss (“NOL”) carry-forwards of approximately $18,520,000. Section 382 of the Internal Revenue Code, as amended (the “Code”) imposes limitations on a corporation’s ability to utilize its NOL carry-forwards. In general terms, an ownership change results from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50% over a three-year period. Any limited amounts may be carried over into later years, and the amount of the limitation may, under certain circumstances, be increased by the “recognized built-in gains” that occur during the five-year period after the ownership change (the recognition period). Future changes in ownership of more than 50% may also limit the use of these remaining NOL carry-forwards. Our earnings, if any, and cash resources would be materially and adversely affected if we cannot receive the full benefit of the remaining NOL carry-forwards. An ownership change could occur as a result of circumstances that are not within our control.
 
 
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The telecommunications industry is highly competitive. We face intense competition from traditional telephone companies, wireless companies, cable companies and alternative voice communication providers and other VoIP companies.
 
Our Cloud telecommunications services compete with other voice over internet protocol (VoIP) providers. In addition, we also compete with traditional telephone service providers which provide telephone service based on the public switched telephone network (PSTN). Our VoIP offering is not fully compatible with such customers. Some of these traditional providers have also added VoIP services. There is also competition from cable providers, which have added VoIP service offerings in bundled packages to their existing cable customers. The telecommunications industry is highly competitive. We face intense competition from traditional telephone companies, wireless companies, cable companies, and alternative voice communication providers.
 
Most traditional wire line and wireless telephone service providers, cable companies, and some VoIP providers are substantially larger and better capitalized than we are and have the advantage of a large existing customer base. Because most of our target customers are already purchasing communications services from one or more of these providers, our success is dependent upon our ability to attract target customers away from their existing providers. Our competitors’ financial resources may allow them to offer services at prices below cost or even for free in order to maintain and gain market share or otherwise improve their competitive positions.
 
The markets for our products and services are continuing to evolve and are increasingly competitive. Demand and market acceptance for recently introduced and proposed new products and services and sales of such products and services are subject to a high level of uncertainty and risk. Our business may suffer if the market develops in an unexpected manner, develops more slowly than in the past or becomes saturated with competitors, if any new products and services do not sustain market acceptance. A number of very large, well-capitalized, high profile companies serve the e-commerce, VoIP and Cloud technology markets. If any of these companies entered our markets in a focused and concentrated fashion, we could lose customers, particularly more sophisticated and financially stable customers.
 
Our VoIP or cloud telecommunications service competes against established well financed alternative voice communication providers, (such as 8x8 and Ring Central) who may provide comparable services at comparable or lower pricing.
 
Pricing in the telecommunications industry is very fluid and competitive. Price is often a substantial motivation factor in a customer’s decision to switch to our telephony products and services. Our competitors may reduce their rates which may require us to reduce our rates, which would affect our margins and revenues, or otherwise make our pricing non-competitive. We may be at a disadvantage compared with those competitors who have substantially greater resources than us or may otherwise be better positioned to withstand an extended period of downward pricing pressure.
 
Many of our current and potential competitors have longer operating histories, significantly greater resources and brand awareness, and a larger base of customers than we have. As a result, these competitors may have greater credibility with our existing and potential customers. Our competitors may also offer bundled service arrangements that present a more differentiated or better integrated product to customers. Announcements, or expectations, as to the introduction of new products and technologies by our competitors or us could cause customers to defer purchases of our existing products, which also could have a material adverse effect on our business, financial condition or operating results.
 
Changes to rates by our suppliers, competitors and increasing regulatory charges may require us to raise prices which could impact results.
 
Pricing in the telecommunications industry is very fluid and competitive. Price is often a substantial motivating factor in a customer’s decision to switch to our cloud telecommunications products and services. Our competitors may reduce their rates which may require us to reduce our rates, which would affect our margins and revenues, or otherwise make our pricing non-competitive. Our upstream carriers, suppliers and vendors may increase their rates thus directly impacting our cost of sales, which would affect our margins. Interconnected VoIP traffic may be subject to increased charges. Should this occur, the rates paid to our underlying carriers may increase which could reduce our profitability. Changes in our underlying costs of sales may increase rates we charge our customers which could make us less competitive and impact our sales and retention of existing customers.
 
We have targeted sales to mid-market and larger enterprise customers. Not properly managing these customers could negatively affect our business, margins, cash flow and operations.
 
Selling to larger enterprise customers contains inherent risks and uncertainties. Our sales cycle has become more time-consuming and expensive. The delays associated with closing and installing larger customers may impact results on a quarter to quarter basis. There may be additional pricing pressure in this market which may affect margins and profitability. Revenue recognition may be delayed for some complex transactions, all of which could harm our business and operating results. The loss of a large customer may have a material negative impact on quarterly or annual results.
 
Multi-location users require additional and expensive customer service which may require additional expense and impact margins on enterprise sales. Enterprise customers may demand more features, integration services and customization which require additional engineering and operational time which could impact margins on an enterprise sale. Multi-location enterprise customer sales may have different requirement in different locations which may be difficult to fulfill or satisfy various interests which could result in cancellations.
 
Enterprise customers might demand we provide service locations internationally where we may encounter technical, logistical, infrastructure and regulatory limitations on our ability to implement or deliver our services. Our inability to provide service in certain international locations may result in a cancellation of the entire contract. Further with larger enterprise customer sales, the risk of customers transporting desktop devices internationally without our knowledge may increase.
 
 
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Sales to small and medium-sized businesses face risks as they may have fewer financial resources to weather an economic downturn.
 
A substantial percentage of our revenues come from small and medium-sized businesses. These customers may be more adversely affected by economic downturns than larger, more established businesses. The majority of our customers pay for our subscriptions with credit and debit cards. Weakness in certain segments of the credit markets and in the U.S. and global economies may result in increased numbers of rejected credit and debit card payments, which could negatively affect our business. If small and medium-sized businesses experience financial hardship as a result of a weak economy, industry consolidation, or any other reason, the overall demand for our subscriptions could be materially and adversely affected.
 
We must acquire new customers on an ongoing basis to maintain and increase our customers and revenues.
 
We will have to acquire new customers in order to increase revenues. We incur significant costs to acquire new customers, and those costs are an important factor in determining our profitability. Therefore, if we are unsuccessful in retaining customers or are required to spend significant amounts to acquire new customers beyond those budgeted, our revenue could decrease, which could prevent us from reaching profitability and have our net loss increase. Marketing expenditures are an ongoing requirement and will become a larger ongoing requirement of our business.
 
If we do not successfully expand our sales including our partner channel program and direct sales, we may be unable to increase our sales and that may affect our stock price.
 
We sell our products primarily through direct sales and our partner channel, and we must substantially expand the number of partners and producing direct sales personnel to increase organic revenue substantially. If we are unable to expand our partner channel network and hire and retain qualified sales personnel, our ability to increase our organic revenue and grow our business could be compromised. The challenge of attracting, training, and retaining qualified candidates, may make it difficult to grow revenue.  Our direct sales are driven largely by inside sales who sell our services and products to customers. Our future growth depends on our ability to develop and maintain a successful direct sales organization that identifies and closes a significant portion of sales. If we or the agents fail to do so, we may be unable to meet our revenue growth targets. Our partner sales are generated through indirect channel sales. These channels consist of master agents’ independent agents (including master agents), value-added resellers, and service providers. We contract directly with the end customer. We may or may not have active involvement in the sale or may use these channel partners to identify, qualify and manage prospects throughout the sales cycle. These channels may generate an increasing portion of our revenue in the future. Our continued success requires continuing to develop and maintain successful relationships with these partners. If we fail to properly select and manage our partners, or they are not successful in their sales efforts, we may be unable to meet our revenue growth targets.
 
We face risks in our sales to certain market segments including, but not limited to, sales subject to HIPPA Regulations.
 
We have sold and will continue to attempt to sell to certain customer segments which may have requirements for additional privacy or security. In addition sales may be made to customers that are subject to additional security requirements and or HIPPA requirements. Selling into segments with additional requirements increases potential liability which in some instances may be unlimited. While the Company believes it meets or exceeds all requirements for sales into such segments, there is no assurance that the Company systems fully comply with all requirements. Our customers can use our services to store contact and other personal or identifying information, and to process, transmit, receive, store and retrieve a variety of communications and messages, including information about their own customers and other contacts. In addition, customers may use our services to store protected health information, or PHI, that is protected under the Health Insurance Portability and Accountability Act, or HIPAA. Noncompliance with laws and regulations relating to privacy and HIPAA may lead to significant fines, penalties or civil liability.
 
 
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Our collection, processing, storage, use, and transmission of personal data could give rise to liabilities as a result of governmental regulation, conflicting legal requirements, differing views on data privacy, or security breaches.
 
We collect, process, store, use, and transmit personal data on a daily basis. Personal data is increasingly subject to legal and regulatory protections around the world, which vary widely in approach and which possibly conflict with one another. In recent years, for example, U.S. legislators and regulatory agencies, such as the Federal Trade Commission, as well as U.S. states have increased their focus on protecting personal data by law and regulation and have increased enforcement actions for violations of privacy and data protection requirements. California recently enacted legislation, the California Consumer Privacy Act (“CCPA”) that will, among other things, require covered companies to provide new disclosures to California consumers, and afford such consumers new abilities to opt-out of certain sales of personal information, which became effective January 1, 2020. While we believe that we are not a covered entity under the law, the effects of the CCPA potentially are significant, however, and may require us to modify our data processing practices and policies and to incur substantial costs and expenses in an effort to comply. We may also from time to time be subject to, or face assertions that we are subject to, additional obligations relating to personal data by contract or due to assertions that self-regulatory obligations or industry standards apply to our practices.
 
The European Commission also approved and adopted the GDPR, its data protection law, which took effect beginning in May 2018. These data protection laws and regulations are intended to protect the privacy and security of personal data, including credit card information that is collected, processed, and transmitted in or from the relevant jurisdiction. While we do not currently provide services in Countries where compliance would be required and are therefore not required to be compliant, if we did provide those services or otherwise were required to become complaint, implementation of and compliance with these laws and regulations may be more costly or take longer than we anticipate, or could otherwise adversely affect our business operations, which could negatively impact our financial position or cash flows. We stopped hosting websites in GDPR-complaint Countries or Countries from which the bulk of business came from Countries subject to GDPR. We also took steps to block those Countries from accessing any other sites we host. Additionally, media coverage of data breaches has escalated, in part because of the increased number of enforcement actions, investigations, and lawsuits. As this focus and attention on privacy and data protection increases, we also risk exposure to potential liabilities and costs resulting from compliance with or any failure to comply with applicable legal requirements, conflicts among these legal requirements, or differences in approaches to privacy.
 
We could be liable for breaches of security on our website, fraudulent activities of our users, or the failure of third-party vendors to deliver credit card transaction processing services.
 
We engage in electronic billing and processing of our customers using secure transmission of sometimes confidential information over public networks. We have systems and processes in place that we deem more than sufficient and industry standard that are designed to protect consumer information and prevent fraudulent credit card transactions and other security breaches. Our failure to protect against fraud or breaches may subject us to costly breach notification and other mitigation obligations, class action lawsuits, investigations, fines, forfeitures, or penalties from governmental agencies that could adversely affect our operating results. We may be unable to prevent our customers from fraudulently receiving goods and services. Our liability could also increase if a large fraction of transactions using our services involve fraudulent or disputed credit card transactions. We may also experience losses due to subscriber fraud and theft of service. Subscribers have, in the past, obtained access to our service without paying for monthly service and international toll calls by unlawfully using fraudulently obtained codes. If our existing anti-fraud procedures are not adequate or effective, consumer fraud and theft of service could have a material adverse effect on our business, financial condition, and operating results.
 
We face risks in our strategy of designing and developing our own desktop telephones (“desktop devices”).
 
We continue to primarily sell Crexendo ® branded desktop devices, although, the Company also supports third party devices manufactured by Yealink, Cisco, and Polycom. Our desktop devices are being manufactured by third party vendors in China. The Crexendo branded desktop devices include firmware specifically designed for our cloud telecommunications services. If the phones are successfully manufactured there is no assurance of the acceptance of the desktop devices. Successful roll out is not guaranteed and is contingent on various factors including but not limited to; meeting certain industry standards, the availability of our vendors to meet agreed terms, supply from vendors being sufficient to meet demand, industry acceptance of the desktop devices, desktop devices meeting the needs of our customers, competitive pricing of the desktop devices, feature set of the desktop devices being up to competitive standards, regulatory approval as required of the desktop devices and competitor claims relating to the desktop devices. Our failure to be able to fully implement the sale of the Crexendo desktop devices or the inability to have desktop devices manufactured to meet our supply needs may cause us damage as well as require us to have to purchase desktop devices from other suppliers at a higher price which could affect sales and margins. Our desktop devices come preloaded with our firmware and are not currently intended to work with other competitors’ or vendors' services.
 
Our churn rate may increase in future periods due to customer cancellations or other factors, which may adversely impact our revenue or require us to spend more money to grow our customer base.
 
Our customers generally have initial service periods of between three and five year and may discontinue their subscriptions for our services after the expiration of their initial subscription period. In addition, our customers may renew for lower subscription amounts or for shorter contract lengths. We may not accurately predict cancellation rates for our customers. Our cancellation rates may increase or fluctuate because of a number of factors, including customer usage, pricing changes, number of applications used by our customers, customer satisfaction with our service, the acquisition of our customers by other companies and deteriorating general economic conditions. If our customers do not renew their subscriptions for our service or decrease the amount they spend with us, our revenue will decline, and our business will suffer.
 
Our rate of customer cancellations may increase in future periods due to many factors, some of which are beyond our control, such as the financial condition of our customers or the state of credit markets. In addition, a single, protracted service outage or a series of service disruptions, whether due to our services or those of our bandwidth carriers, may result in a sharp increase in customer cancellations.
 
 
11
 
 
If we do not successfully expand our physical infrastructure and build diverse geo redundant locations, which require large investments, we may be unable to substantially increase our sales and retain customers.
 
Our ability to provide cloud telecommunications services is dependent upon on our physical and cloud based infrastructure. While most of our physical equipment required for providing these services is redundant in nature and offers high availability, certain types of failures or malfunctioning of critical hardware/software equipment, including but not limited to fire, water or other physical damage may impact our ability to deliver continuous service to our customers. Act of God or terrorism or vandalism or gross negligence of person(s) currently or formerly associated with the company may result in loss of revenue, profitability and retaining and acquiring new customers.
 
Our ability to recover from disasters, if and when they occur is paramount to offer continued service to our existing customers. In addition to our physical infrastructure, we have a cloud infrastructure deployment with AWS to provide continuous service to our customers in the event of a disaster or failure of our physical infrastructure. If our third-party service providers fail to maintain these facilities properly, or fail to respond quickly to problems, our customers may experience service interruptions. The failure of any of these third party service providers to properly maintain services may be subject to factors including but not limited to the following: (i) cause a loss of customers, (ii) adversely affect our reputation, (iii) cause negative publicity, (iv) negatively impact our ability to acquire customers, (v) negatively impact our revenue and profitability, (vi) potential law suits for not reaching E-911 services, and (vii) potential law suits for loss of business and loss of reputation.
 
We may not be able to scale our business efficiently or quickly enough to meet our customers' growing needs, in which case our operating results could be harmed.
 
As usage of our cloud telecommunications services by mid-market and larger distributed enterprises expands and as customers continue to integrate our services across their enterprises, we are required to devote additional resources to improving our application architecture, integrating our products and applications across our technology platform as well as expanding integration and performance. We will need to appropriately scale our internal business systems and our services organization, including customer support and services and regulatory compliance, to serve a growing customer base. Any failure of or delay in these efforts could cause to prevent acquisition of customers, impaired system performance and reduced customer satisfaction. These issues could result in decreased sales to new customers, lower renewal rates by existing customers, which could hurt our revenue growth and our reputation. We cannot be sure that the expansion and improvements to our infrastructure and systems will be fully or effectively implemented on a timely basis, if at all. These efforts may reduce revenue and our margins and adversely impact our financial results.
 
Our success depends in part upon our ability to provide customer service that effectively supports the needs of our customers.
 
Providing these services effectively requires that our customer support personnel have industry-specific technical knowledge and expertise, it may be difficult and costly for us to hire qualified personnel, particularly in the strong labor market in Phoenix, Arizona where we are headquartered. Our support personnel require extensive training on our products and services, which may make it difficult to scale up our support operations rapidly or effectively. The importance of high-quality customer support will increase as we expand our business and pursue new customers. If we do not help our customers quickly resolve post-implementation issues and provide effective ongoing support, our ability to sell additional features and services to existing customers will suffer and our reputation may be harmed.
 
Our future success could depend on our ability to effectively implement and support the services we sell to mid-market and larger enterprises.
 
We have a limited history of selling our services to larger businesses and may experience challenges in configuring and providing ongoing support for the solutions we sell to large customers. Larger customers' networks are often more complex than those of smaller customers, and the configuration of our services for these customers usually requires customer assistance. There is no guarantee that the customer will make available to us the necessary personnel and other resources for a successful configuration of services. Lack of assistance from the customer or lack of local resources may prevent us from properly configuring our services for the customer, which can in turn adversely impact the quality of services that we deliver over our customers' networks, and/or may result in delays in the implementation of our services and impact the quality and ability to continue to provide the services. This could also create a public perception that we are unable to deliver high quality of service to our customers, which could harm our reputation. In addition to the foregoing larger customers tend to require higher levels of customer service and individual attention, which may increase our costs for implementing and delivering services.
 
Our success depends in part upon the capacity, reliability, and performance of our network infrastructure, including the capacity provided by our Internet bandwidth suppliers.
 
We depend on these companies to provide uninterrupted and error-free service. Some of these providers are also our competitors. We do not have control over these providers. We may be subject to interruptions or delays in network service. If we fail to maintain reliable bandwidth or performance that could significantly reduce customer demand for our services and damage our business.
 
 
12
 
 
Our success depends in part upon the capacity, reliability, and performance of our telecom carriers, and their network infrastructure, including the capacity provided by our Tier 1 and non-Tier 1 Telecom suppliers for Telecom Origination and Termination Services.
 
We depend on these companies to provide uninterrupted and error-free service telecom services, sourcing of DIDs, porting of numbers and delivering telephone calls from and to endpoints and devices on our network. Some of these providers are also our competitors. We do not have control over these providers. We may be subject to interruptions or delays in their service. If we fail to maintain reliable connectivity or performance with our upstream carriers it could then significantly reduce customer demand for our services and damage our business.
 
Our ability to provide telecommunications services is dependent upon third-party facilities and equipment, the failure of which could cause delays or interruptions of our service and impact our revenue and profitability.
 
Our ability to provide quality and reliable cloud telecommunications service is in part dependent upon the proper functioning of facilities and equipment owned and operated by third parties and is, therefore, beyond our control. Our cloud telecommunications service (and to a lesser extend our e-commerce services) requires our customers to have an operative broadband Internet connection and an electrical power supply, which are provided by the customer’s Internet service provider and electric utility company and not by us. The quality of some broadband Internet connections may be too poor for customers to use our services properly. In addition, if there is any interruption to a customer’s broadband Internet service or electrical power supply, that customer will be unable to make or receive calls, including emergency calls (our E-911 service), using our service. We outsource several of our network functions to third-party providers. If our third-party service providers fail to maintain these facilities properly, or fail to respond quickly to problems, our customers may experience service interruptions. The failure of any of these third party service providers to properly maintain services may be subject to factors including but not limited to the following: (i) cause a loss of customers, (ii) adversely affect our reputation, (iii) cause negative publicity, (iv) negatively impact our ability to acquire customers, (v) negatively impact our revenue and profitability, (vi) potential law suits for not reaching E-911 services, and (vii) potential law suits for loss of business and loss of reputation.
 
We rely on third parties to provide a portion of our customer service responses, initiate local number portability for our customers, deliver calls to and from PSTN and other public telephone VoIP/Wireless service providers and provide aspects of our E-911 service.
 
We offer our cloud telecommunications customers support 24 hours a day, seven days a week. We may rely on third parties (sometimes outside of the U.S) to respond to customer inquiries. These third-party providers generally represent us without identifying themselves as independent parties. The ability of third-party providers to provide these representatives may be disrupted due to issues outside our control.
 
We also maintain an agreement with an E-911 provider to assist us in routing emergency calls directly to an emergency service dispatcher at the PSAP in the area of the customer’s registered location and terminating E-911 calls. We also contract with a provider for the national call center that operates 24 hours a day, seven days a week to receive certain emergency calls and with several companies that maintain PSAP databases for the purpose of deploying and operating E-911 services. The dispatcher will have automatic access to the customer's telephone number and registered location information. If a customer moves their Crexendo service to a new location, the customer's registered location information must be updated and verified by the customer. Until that takes place, the customer will have to verbally advise the emergency dispatcher of his or her actual location at the time of an emergency 9-1-1 call. This can lead to delays in the delivery of emergency services
 
Interruptions in service from these vendors could also cause failures in our customers’ access to E-911 services and expose us to liability.
 
We also have agreements with companies that initiate our local number portability, which allow new customers to retain their existing telephone numbers when subscribing to our services. We will need to work with these companies to properly port numbers. The failure to port numbers may subject us to loss of customers or regulatory review.
 
If any of these third parties do not provide reliable, high-quality service, our reputation and our business will be harmed. In addition, industry consolidation among providers of services to us may impact our ability to obtain these services or increase our expense for these services.
 
Our dependence on outside contractors and third-party agents for fulfillment of certain items and critical manufacturing services could result in product or delivery delays and/or damage our customer relations.
 
We outsource the manufacturing of certain products we sell and products we provide. We submit purchase orders to agents or the companies that manufacture the products. We describe, among other things, the type and quantities of products or components to be supplied or manufactured and the delivery date and other terms applicable to the products or components. Our suppliers or manufacturers potentially may not accept any purchase order that we submit. Our reliance on outside parties involves a number of potential risks, including: (i) the absence of adequate capacity, (ii) the unavailability of, or interruptions in access to, production or manufacturing processes, (iii) reduced control over delivery schedules, (iv) errors in the product, and (v) claims of third party intellectual infringement or defective merchandise. If delays, problems or defects were to occur, it could adversely affect our business, cause claims for damages to be filed against us, and negatively impact our consolidated operations and cash flows.
 
 
13
 
 
Errors in our technology or technological issues outside our control could cause delays or interruptions to our customers.
 
Our services (including cloud telecommunications and e-commerce) may be disrupted by problems with our technology and systems such as malfunctions in our software or facilities. In addition there may be service interruptions for reasons outside our control. Our customers and potential customers subscribing to our services have experienced interruptions in the past and may experience interruptions in the future as a result of these types of problems. Interruptions could cause us to lose customers and offer customer credits, which could adversely affect our revenue and profitability. Network and Telecommunication interruptions may also impair our ability to sign-up new customers. In addition since our systems and our customers’ ability to use our services are Internet-dependent, our services may be subject to “cyber-attacks” from the Internet, which could have a significant impact on our systems and services. Our customers’ ability to use our services is dependent on third-party internet providers which may suffer service disruptions. If service interruptions adversely affect the perceived reliability of our service, we may have difficulty attracting and retaining customers and our growth may suffer.
 
Our operations could be hurt by a natural disaster, network security breach, or other catastrophic event.
 
We maintain a fully redundant physical infrastructure in our data center in Tempe, Arizona and a cloud infrastructure deployment with AWS for disaster recovery. This system does not guarantee continued reliability if a catastrophic event occurs. Despite implementation of network security measures, our servers may be vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with our computer systems including, but not limited to, denial of service attacks. In addition, if there is a breach or alleged breach of security or privacy involving our services including but not limited to data loss, or if any third party undertakes illegal or harmful actions using our communications or e-commerce services, our business and reputation could suffer substantial adverse publicity and impairment. We have experienced interruptions in service in the past. While we do not believe that we have lost customers as a consequence, the harm to our reputation is difficult to assess. We have taken and continue to take steps to improve our infrastructure to prevent service interruptions.
 
Failure in our data center or services could lead to significant costs and disruptions.
 
All data centers, including ours, are subject to various points of failure. Problems with cooling equipment, generators, uninterruptible power supply, routers, switches, or other equipment, whether or not within our control, could result in service interruptions for our customers as well as equipment damage. Any failure or downtime could affect a significant percentage of our customers. The total destruction or severe impairment of our data center facilities could result in significant downtime of our services and the loss of customer data.
 
Internet security issues and growing Cyber threats pose risks to the development of e-commerce and our business.
 
Security and privacy concerns may inhibit the growth of the Internet and other online services generally, especially as a means of conducting commercial transactions.
 
We could experience security breaches in the transmission and analysis of confidential and proprietary information of the consumer, the merchant, or both, as well as our own confidential and proprietary information.
 
Anyone able to circumvent security measures could misappropriate proprietary information or cause interruptions in our operations, as well as the operations of the merchant. We may be required to expend significant capital and other resources to protect against security breaches or to minimize problems caused by security breaches. To the extent that we experience breaches in the security of proprietary information which we store and transmit, our reputation could be damaged and we could be exposed to a risk of loss or litigation. 
 
We collect personal and credit card information from our customers and employees could misuse this information.
 
The PCI Data Security Standard (“PCI DSS”) is a specific set of comprehensive security standards required by credit card brands for enhancing payment account data security, including but not limited to requirements for security management, policies, procedures, network architecture, and software design. We maintain credit card and other personal information in our systems. Due to the sensitive nature of retaining such information we have implemented policies and procedures to preserve and protect our data and our customers’ data against loss, misuse, corruption, misappropriation caused by systems failures, unauthorized access, or misuse. Notwithstanding these policies, we could be subject to liability claims by individuals and customers whose data resides in our databases for the misuse of that information. While the Company believes its systems meet or exceed industry standards, the Company does not believe it is required to meet PCI level 1 compliance and has not certified under that level. Failure to meet PCI compliance levels could negatively impact the Company’s ability to collect and store credit card information which could cause substantial disruption to our business. Notwithstanding the results of this assessment there can be no assurance that payment card brands will not request further compliance assessments or set forth additional requirements to maintain access to credit card processing services, which could incur substantial additional costs and could have a material adverse effect on our business.
 
 
14
 
 
We depend upon industry standard protocols, best practices, solutions, third-party software, technology, tools including but not limited to Open Source software.
 
We rely on non-proprietary third party licensing and software some of which may be Open Source and protected under various licensing agreements. We may be subject to additional royalties, license or trademark infringement costs or other unknown costs when one or more of these third-party technologies are affected or need to be replaced due to end-of-support or end-of-sale of such third parties.
 
We may incur substantial expenses in defending against third-party patent and trademark infringement claims regardless of their merit.
 
From time to time, parties may assert patent infringement claims against us in the form of letters, lawsuits, and other forms of communication. Third parties may also assert claims against us alleging infringement of copyrights, trademark rights, trade secret rights or other proprietary rights or alleging unfair competition. If there is a determination that we have infringed third-party proprietary rights, we could incur substantial monetary liability and be prevented from using the rights in the future.
 
We depend on our senior management and other key personnel, and a loss of these individuals could adversely impact our ability to execute our business plan and grow our business.
 
We depend on the continued services of our key personnel, including our Officers and certain engineers. Each of these individuals has acquired specialized knowledge and skills with respect to our operations. The loss of one or more of these key personnel could negatively impact our performance. In addition, we expect to hire additional personnel as we continue to execute our strategic plan, particularly if we are successful in expanding our operations. Competition for the limited number of qualified personnel in our industry is intense. At times, we have experienced difficulties in hiring personnel with the necessary training or experience.
 
Our public filings are subject to review by the SEC.
 
Our SEC filings are reviewed by the SEC from time to time and any significant changes required as a result of any such review may result in material liability to us and have a material adverse impact on the trading price of our common stock.
 
Examinations by relevant tax authorities may result in material changes in related tax reserves for tax positions taken in previously filed tax returns or may impact the valuation of certain deferred income tax assets, such as net operating loss carry-forwards.
 
Based on the outcome of examinations by relevant tax authorities, or as a result of the expiration of statutes of limitations for specific jurisdictions, it is reasonably possible that the related tax reserves for tax positions taken regarding previously filed tax returns will materially change from those recorded in our financial statements. In addition, the outcome of examinations may impact the valuation of certain deferred income tax assets (such as net operating loss carry-forwards) in future periods. It is not possible to estimate the impact of the amount of such changes, if any, to previously recorded uncertain tax positions.
 
Changes in our business model and sales strategies may adversely impact revenue.
 
When the Company shifted away from a seminar sales model, our web services revenue was adversely impacted. Our website hosting revenue has continued to decline since we no longer sell our website development software through a seminar sales model. The Company is not actively marketing its website development software or website hosting services. Our web services segment revenue may continue to decline over time as more competitors enter the website building and hosting industry.
 
From time to time we had been the subject of governmental inquiries and investigations related to our discontinued seminar sales model and business practices that could require us to pay refunds, damages or fines, which could negatively impact our financial results or ability to conduct business. We have received customer complaints and civil actions.
 
From time to time, we received inquiries from federal, national, state, city and local government officials in the various jurisdictions in which we operated. These inquiries had historically been related to our discontinued seminar sales practices. There is still the potential of review of past sales and sales of our current web and telecom services. We respond to these inquiries and have generally been successful in addressing the concerns of these persons and entities, without a formal complaint or charge being made, although there is often no formal closing of the inquiry or investigation. The ultimate resolution of these or other inquiries or investigations may have a material adverse effect on our business or operations, or a formal complaint could be initiated. During the ordinary course of business, we also receive a number of complaints and inquiries from customers, governmental and private entities. In some cases, these complaints and inquiries from agencies and customers have ended up in civil court. We may continue to receive customer and agency claims and actions.
 
 
15
 
 
Changes in laws and regulations and the interpretation and enforcement of such laws and regulations could adversely impact our financial results or ability to conduct business.
 
We are subject to a variety of federal and state laws and regulations as well as oversight from a variety of governmental agencies and public service commissions. The laws governing our business may change in ways that harm our business. Federal or state governmental agencies administering and enforcing such laws may also choose to interpret and apply them in ways that harm our business. These interpretations are also subject to change. Regulatory action could materially impair or force us to change our business model and may adversely affect our revenue, increase our compliance costs, and reduce our profitability. In addition, governmental agencies such as the SEC, Internal Revenue Service (IRS), Federal Trade Commission (FTC), Federal Communication Commission (FCC) and state taxing authorities may conclude that we have violated federal laws, state laws or other rules and regulations, and we could be subject to fines, penalties or other actions that could adversely impact our financial results or our ability to conduct business.
 
The FCC net neutrality rules have changed. There may be a negative effect to our business going forward as a consequence of those changes.
 
On January 4, 2018, the Federal Communications Commission, or FCC, released an order that largely repeals rules that the FCC had in place which prevented broadband internet access providers from degrading or otherwise disrupting a broad range of services provisioned over consumers' and enterprises' broadband internet access lines. There are efforts in Congress to prevent the Order from becoming effective and a number of state attorneys general have filed an appeal of the FCC's January 4, 2018 order. Many of the largest providers of broadband services, like cable companies and traditional telephone companies, have publicly stated that they will not degrade or disrupt their customers' use of applications and services, like ours. However there is not guarantee that they will continue to do such. If such providers were to degrade, impair, or block our services, it would negatively impact our ability to provide services to our customers, likely result in lost revenue and profits, and we would incur legal fees in attempting to restore our customers' access to our services. Broadband internet access providers may also attempt to charge us or our customers additional fees to access services like ours that may result in the loss of customers and revenue, decreased profitability, or increased costs to our offerings that may make our services less competitive. Following the adoption of the January 4, 2018 Order, a number of states have passed laws establishing rules similar to those that existed prior to the effective date of the January 4, 2018 Order. States have adopted a variety of approaches in attempting to preserve the rules in place prior to the FCC Order. We however cannot rely on those laws as there is legal uncertainty as to whether states that have passed such laws have the authority to do so if such laws as they could be interpreted to conflict with the January 4, 2018 Order. The U.S. Department of Justice has taken the position that local authorities do not have the authority to contradict the FTC order. We cannot predict the ultimate outcome of these disputes.
 
Internet access providers may limit our access which could have a negative effect on our business.
 
Our service require internet access and internet backbone providers may be able to block, degrade or charge for access to, or the bandwidth use of certain of our products and services which could have a negative effect on our services and could lead to additional expenses and the loss of users. Our products and services depend on the ability of our users to access the Internet, and many of our services require significant bandwidth to work effectively. Further, customers who access our mobile application Crexmo© (or future application) through their smartphones must have a high-speed connection, to use our services. This access is provided by companies that have significant and increasing market power in the broadband and Internet access marketplace some of these providers offer products and services that directly compete with our own offerings, which give them a significant competitive advantage.
 
Our Telecommunications services are required to comply with industry standards, FCC regulations, privacy laws as well as certain State and local jurisdiction specific regulations failure to comply with those may subject us to penalties and may also require us to modify existing products and/or service.
 
The acceptance of telecommunications services is dependent upon our meeting certain industry standards. We are required to comply with certain rules and regulations of the FCC regarding safety standards. Standards are continuously being modified and replaced. As standards evolve, we may be required to modify our existing products or develop and support new versions of our products. We must comply with certain federal, state, and local requirements regarding how we interact with our customers, including marketing practices, consumer protection, privacy, and billing issues, the provision of 9-1-1 emergency service and the quality of service we provide to our customers. The failure of our products and services to comply, or delays in compliance, with various existing and evolving standards could delay future offerings and impact our sales, margins, and profitability. Changes to the Universal Service Funds by the FCC or various States may require us to increase our costs which could negatively affect revenue and margins.
 
We are subject to Federal laws and FCC regulations that require us to protect customer information. While we have protections in place to protect customer information there is no assurance that our systems will not be subject to failure or intentional fraudulent attack. The failure to protect required information could subject us to penalties and diminish the confidence our customers have in our systems which could negatively affect results. While we try to comply with all applicable data protection laws, regulations, standards, and codes of conduct, as well as our own posted privacy policies and contractual commitments to the extent possible, any failure by us to protect our users’ privacy and data, including as a result of our systems being compromised by hacking or other malicious or surreptitious activity, could result in a loss of user confidence in our services and ultimately in a loss of users, which could materially and adversely affect our business as well as subject us to law suits, civil fines and criminal penalties.
 
Governmental entities, class action lawyers and consumer advocates are reviewing the data collection and use by companies that must maintain such data. Our own requirements as well as regulatory codes of conduct, enforcement actions by regulatory agencies, and lawsuits by other parties could impose additional compliance costs on us as well as subject us to unknown potential liabilities. These evolving laws, rules and practices may also curtail our current business activities which may delay or affect our ability to become profitable as well as affect customers and other business opportunities.
 
We are also subject to the privacy and data protection-related obligations in our contracts with our customers and other third parties. Any failure, or perceived failure, to comply with federal, state, or international laws, or to comply with our contractual obligations related to privacy, could result in proceedings or actions against us which could result in significant liability to us as well as harm to our reputation. Additionally, third parties with whom we contract may violate or appear to violate laws or regulations which could subject us to the same risks.
 
There is considerable uncertainty with respect to the state of law governing data transfers between the European Union ("EU"), and other countries with similar data protection laws, and it remains unclear what the final resolution will be for cross-border data transfers of personal information. There may be risks associated with data transfer and customers who use International Locations.
 
 
16
 
 
States are adding regulation for VoIP providers which could increase our costs and change certain aspects of our service.
 
Certain states take the position that offerings by VoIP providers are intrastate and therefore subject to state regulation. We have registered as a CLEC in most states, however our rates are not regulated in the same manner as traditional telephone service providers. Some states are also requiring that we register as a seller of VoIP services even though we have registered as a CLEC. Some states argue that if the beginning and desktop devices of communications are known, and if some of these communications occur entirely within the boundaries of a state, the state can regulate that offering and may therefore add additional taxes or surcharges or regulate rates in a similar matter to traditional telephone service providers. We believe that the FCC has pre-empted states from regulating VoIP providers in the same manner as providers of traditional telecommunications services. We cannot predict how this issue will be resolved or its impact on our business at this time.
 
Our ability to offer services outside the U.S. is subject to different regulations which may be unknown and uncertain.
 
Regulatory treatment of VoIP providers outside the United States varies from country to country, and local jurisdictions. Many times, the laws are vague, unclear and regulations are not enforced uniformly. We are licensed as a VoIP seller in Canada, and are considering expanding to other Countries. We also cannot control if our customers take their devices out of the United States and use them abroad. Our resellers may sell to customers who maintain facilities outside the United States. The failure by us or our customers and resellers to comply with laws and regulations could reduce our revenue and profitability. As we expand to additional Countries there may be additional regulations that we are required to comply with, the failure to comply or properly assess regulations may subject us to penalties, fines and other actions which could materially affect our business.
 
ITEM 2.  PROPERTIES
 
Our corporate office consists of approximately 22,000 square feet of office space in Tempe, Arizona owned by our CEO. In January 2020, the Company purchased our corporate office building, see Note 22 of Item 8 included herein this annual report. Our corporate office is located at 1615 South 52nd Street, Tempe, Arizona 85281. We maintain property insurance on the corporate office building as required by the lease and tenant fire and casualty insurance on our assets located in these buildings in an amount that we deem adequate.
 
ITEM 3.  LEGAL PROCEEDINGS
 
From time to time we receive inquiries from federal, state, city and local government officials as well as the FCC and taxing authorities in the various jurisdictions in which we operate. These inquiries and investigations related primarily to our discontinued seminar operations and concern compliance with various city, county, state, and/or federal regulations involving sales, representations made, customer service, refund policies, services and marketing practices. We respond to these inquiries and have generally been successful in addressing the concerns of these persons and entities, without a formal complaint or charge being made, although there is often no formal closing of the inquiry or investigation. There can be no assurance that the ultimate resolution of these or other inquiries and investigations will not have a material adverse effect on our business or operations, or that a formal complaint will not be initiated. We also receive complaints and inquiries in the ordinary course of our business from both customers and governmental and non-governmental bodies on behalf of customers, and in some cases these customer complaints have risen to the level of litigation. There can be no assurance that the ultimate resolution of these matters will not have a material adverse effect on our business or results of operations.
 
ITEM 4.  MINE SAFETY DISCLOSURES
 
The disclosure required by this item is not applicable
 
 
17
 
 
PART II
 
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
MARKET INFORMATION
 
 
Our common stock began trading on the NYSE - MKT on August 16, 2004 under the symbol “IIG.” In May 2011, our stockholders approved an amendment to our Certificate of Incorporation to change our name from "iMergent, Inc." to "Crexendo, Inc." The name change was effective May 18, 2011. Our ticker symbol "IIG" on the New York Stock Exchange was changed to “EXE” on May 18, 2011. On January 13, 2015, the Company moved to the OTCQX Marketplace and our ticker symbol was changed to “CXDO”. The following table sets forth the range of high and low sales prices as reported on the OTCQX Marketplace for the periods indicated.
 
 
 
High
 
 
Low
 
Year Ended December 31, 2019
 
   
 
 
   
 
   October to December 2019
 $4.70 
 $3.05 
   July to September 2019
  3.54 
  3.00 
   April to June 2019
  4.00 
  2.60 
  January to March 2019
  3.00 
  1.76 
Year Ended December 31, 2018
    
    
   October to December 2018
 $3.00 
 $1.54 
   July to September 2018
  2.70 
  1.50 
   April to June 2018
  2.90 
  2.31 
  January to March 2018
  3.49 
  2.00 
 
SECURITY HOLDERS
 
There were approximately 1,122 holders of record of our shares of common stock as of December 31, 2019. The number of holders does not include individual participants in security positions listings.
 
DIVIDENDS
 
There were no dividends declared for the years ended December 31, 2019 and 2018.
 
ISSUER PURCHASES OF EQUITY SEQURITIES
 
None
 
RECENT SALES OF UNREGISTERED SECURITIES
 
None
 
 
18
 
 
ITEM 6.   SELECTED FINANCIAL DATA
 
Not required.
 
ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
SAFE HARBOR
 
In addition to historical information, this Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties, including the risk factors set forth in Item 1A. above and the risk factors set forth in this Annual Report. Generally, the words “anticipate”, “expect”, “intend”, “believe” and similar expressions identify forward-looking statements. The forward-looking statements made in this Annual Report are made as of the filing date of this Annual Report with the SEC, and future events or circumstances could cause results that differ significantly from the forward-looking statements included here. Accordingly, we caution readers not to place undue reliance on these statements. We expressly disclaim any obligation to update or alter our forward-looking statements, whether, as a result of new information, future events or otherwise after the date of this document.
 
OVERVIEW
 
Crexendo, Inc. 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, computer, 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 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 25% or $2,453,000 to $12,089,000 for the year ended December 31, 2019 as compared to $9,636,000 for the year ended December 31, 2018. Our Cloud Telecommunications product revenue increased 17% or $244,000 to $1,691,000 for the year ended December 31, 2019 as compared to $1,447,000 for the year ended December 31, 2018. As of December 31, 2019 and 2018, our backlog was $26,110,000 and $23,029,000, respectively.
 
Web Services – We generate recurring revenue from website hosting and other professional services.
 
Our Web Services revenue decreased 20% or $169,000 to $656,000 for the year ended December 31, 2019 as compared to $825,000 for the year ended December 31, 2018.
 
Results of Consolidated Operations
 
The following discussion of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto and other financial information included herein this Annual Report.
 
 
19
 
 
Results of Consolidated Operations (in thousands, except for per share amounts)
 
 
 
Year Ended December 31,
 
Consolidated
 
2019
 
 
2018
 
Service revenue
 $12,745 
 $10,461 
Product revenue
  1,691 
  1,447 
Total revenue
  14,436 
  11,908 
Income/(loss) before income taxes
  1,145 
  (208)
Income tax provision
  (6)
  (15)
Net income/(loss)
  1,139 
  (223)
Basic earnings/(loss) per common share
 $0.08 
 $(0.02)
Diluted earnings/(loss) per common share
 $0.07 
 $(0.02)
 
 
 
For the three months ended
 
Consolidated
 
March 31,
2019
 
 
June 30,
2019
 
 
September 30,
2019
 
 
December 31,
2019
 
Service revenue
 $3,008 
 $3,147 
 $3,259 
 $3,331 
Product revenue
  484 
  467 
  343 
  397 
Total revenue
  3,492 
  3,614 
  3,602 
  3,728 
Income before income taxes
  242 
  342 
  334 
  227 
Income tax benefit/(provision)
  (3)
  (4)
  - 
  1 
Net income
  239 
  338 
  334 
  228 
 
    
    
    
    
Basic earnings per common share (1)
 $0.02 
 $0.02 
 $0.02 
 $0.02 
Diluted earnings per common share (1)
 $0.02 
 $0.02 
 $0.02 
 $0.01 
 
 
 
For the three months ended
 
Consolidated
 
March 31,
2018
 
 
June 30,
2018
 
 
September 30,
2018
 
 
December 31,
2018
 
Service revenue
 $2,442 
 $2,540 
 $2,712 
 $2,767 
Product revenue
  366 
  437 
  314 
  330 
Total revenue
  2,808 
  2,977 
  3,026 
  3,097 
Income/(loss) before income taxes
  (59)
  50 
  (191)
  (8)
Income tax provision
  (4)
  (3)
  (8)
  - 
Net income/(loss)
  (63)
  47 
  (199)
  (8)
 
    
    
    
    
Basic earnings/(loss) per common share (1)
 $(0.00)
 $0.00 
 $(0.01)
 $(0.00)
Diluted earnings/(loss) per common share (1)
 $(0.00)
 $0.00 
 $(0.01)
 $(0.00)
 
———————
 
 (1) 
Earnings (loss) per common share is computed independently for each of the quarters presented. Therefore, the sums of quarterly earnings (loss) per common share amounts do not necessarily equal the total for the twelve month periods presented.
 
 
20
 
 
Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
 
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 22% or $2,284,000, to $12,745,000 for the year ended December 31, 2019 as compared to $10,461,000 for the year ended December 31, 2018. Cloud Telecommunications service revenue increased 25% or $2,453,000, to $12,089,000 for the year ended December 31, 2019 as compared to $9,636,000 for the year ended December 31, 2018. Web service revenue decreased 20% or $169,000, to $656,000 for the year ended December 31, 2019 as compared to $825,000 for the year ended December 31, 2018.
 
Product Revenue
 
Product revenue consists primarily of fees collected for the sale of desktop phone devices and third-party equipment. Product revenue increased by 17% or $244,000, to $1,691,000 for the year ended December 31, 2019 as compared to $1,447,000 for the year ended December 31, 2018. 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.
 
Income/(Loss) Before Income Taxes
 
Income before income tax increased 650% or $1,353,000 to $1,145,000 for the year ended December 31, 2019 as compared to loss before income tax of ($208,000) for the year ended December 31, 2018. The increase in income before income tax is primarily due to an increase in revenue of $2,528,000 and an increase in other income of $12,000, offset by an increase in total operating expenses of $1,187,000.
 
Income Tax Provision
 
We had an income tax provision of $6,000 for the year ended December 31, 2019 compared to an income tax provision of $15,000 for the year ended December 31, 2018. We had pre-tax income for the year ended December 31, 2019 of $1,145,000 and a pre-tax loss of ($208,000) for the year ended December 31, 2018, and a full valuation allowance on all of our deferred tax assets for the years ended December 31, 2019 and 2018. The income tax provisions relate to state income taxes, as the Company has deferred tax assets to offset federal taxable income.
 
Use of Non-GAAP Financial Measures
 
To evaluate our business, we consider and use non-generally accepted accounting principles (Non-GAAP) net income/(loss) 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/(loss) to be an important indicator of overall business performance because it allows us to evaluate results without the effects of share-based compensation 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 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.
 
 
21
 
 
In our March 3, 2020 earnings press release, as furnished on Form 8-K, we included Non-GAAP net income/(loss), EBITDA and Adjusted EBITDA. The terms Non-GAAP net income/(loss), 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/(loss), 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/(loss), EBITDA, and Adjusted EBITDA only as supplemental support for management’s analysis of business performance. Non-GAAP net income/(loss), 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)
 
 
 
Three Months Ended December 31,
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
 
2019
 
 
2018
 
 
 
(In thousands)
 
 
(In thousands)
 
U.S. GAAP net income/(loss)
 $228 
 $(8)
 $1,139 
 $(223)
Share-based compensation
  106 
  94 
  399 
  438 
Amortization of intangible assets
  13 
  18 
  53 
  72 
Non-GAAP net income
 $347 
 $104 
 $1,591 
 $287 
 
    
    
    
    
Non-GAAP net income per common share:
    
    
    
    
Basic
 $0.02 
 $0.01 
 $0.11 
 $0.02 
Diluted
 $0.02 
 $0.01 
 $0.10 
 $0.02 
 
    
    
    
    
Weighted-average common shares outstanding:
    
    
    
    
Basic
  14,755,818 
  14,394,113 
  14,570,286 
  14,332,092 
Diluted
  15,929,874 
  14,902,330 
  15,559,863 
  15,095,262 
 
 
22
 
 
 Reconciliation of U.S. GAAP Net Income/(Loss) to EBITDA to Adjusted EBITDA
(Unaudited)
 
 
 
Three Months Ended December 31,
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
 
2019
 
 
2018
 
 
 
(In thousands)
 
 
(In thousands)
 
U.S. GAAP net income/(loss)
 $228 
 $(8)
 $1,139 
 $(223)
Depreciation and amortization
  25 
  26 
  94 
  92 
Interest expense
  3 
  4 
  12 
  12 
Interest and other expense/(income)
  (12)
  4 
  (22)
  (10)
Income tax provision/(benefit)
  (1)
  - 
  6 
  15 
EBITDA
  243 
  26 
  1,229 
  (114)
Share-based compensation
  106 
  94 
  399 
  438 
Adjusted EBITDA
 $349 
 $120 
 $1,628 
 $324 
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The following accounting policies are the most critical in understanding our consolidated financial position, results of operations or cash flows, and that may require management to make subjective or complex judgments about matters that are inherently uncertain.
 
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.
 
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 products and 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. Professional services revenue includes activation fees and any professional installation services. Installation services are recognized as revenue when the services are completed. 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. Our telecommunications services contracts typically have a term of thirty-six to sixty months. 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.
 
 
23
 
 
Goodwill
 
We have recorded goodwill as a result of past business acquisitions. Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. In each of our acquisitions, the objective of the acquisition was to expand our product offerings and customer base and to achieve synergies related to cross selling opportunities, all of which contributed to the recognition of goodwill. We test goodwill for impairment on an annual basis or more frequently if events or changes in circumstances indicate that goodwill might be impaired. The estimated fair value of the reporting unit is determined using our market capitalization as of our annual impairment assessment date or more frequently if circumstances indicate the goodwill might be impaired. Items that could reasonably be expected to negatively affect key assumptions used in estimating fair value include but are not limited to: sustained decline in our stock price due to a decline in our financial performance due to the loss of key customers, loss of key personnel, emergence of new technologies or new competitors; and decline in overall market or economic conditions leading to a decline in our stock price.
 
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.
 
Deferred Taxes
 
Our provision for income taxes is comprised of a current and a deferred portion. The current income tax provision is calculated as the estimated taxes payable or refundable on tax returns for the current year. The deferred income tax provision is calculated for the estimated future tax effects attributable to temporary differences and carryforwards using expected tax rates in effect during the years in which the differences are expected to reverse or the carryforwards are expected to be realized.
 
We currently have net deferred tax assets consisting of net operating loss carryforwards, tax credit carryforwards and deductible temporary differences. Management periodically weighs the positive and negative evidence to determine if it is more likely than not that some or all of the deferred tax assets will be realized. Forming a conclusion that a valuation allowance is not required is difficult when there is negative evidence such as cumulative losses in recent years. As a result of our recent cumulative losses, we have recorded a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes in the period of such realization.
 
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 Liabilities
 
Contingent liabilities require significant judgment in estimating potential payouts. Contingent considerations arising from business combinations and asset acquisitions require management to estimate future payouts based on forecasted results, which are highly sensitive to the estimates of discount rates and future revenues. These estimates can change significantly from period to period and are reviewed each reporting period to establish the fair value of the contingent liability.
 
Share-Based Compensation
 
We account for our share-based compensation awards using the fair-value method. The grant date fair value was determined using the Black-Scholes-Merton pricing model. The Black-Scholes-Merton valuation calculation requires us to make key assumptions such as future stock price volatility, expected terms, risk-free rates, and dividend yield. Our expected volatility is derived from our volatility rate as a publicly traded company. The expected term is based on our historical experience. The risk-free interest factor is based on the United States Treasury yield curve in effect at the time of the grant for zero coupon United States Treasury notes with maturities of approximately equal to each grant’s expected term. We have not paid cash dividends in the last three years and do not currently intend to pay cash dividends, and therefore, we have assumed a 0% dividend yield.
 
 
24
 
 
We develop an estimate of the number of share-based awards that will be forfeited due to employee turnover. We will continue to use judgment in evaluating the expected term, volatility, and forfeiture rate related to our own share-based awards on a prospective basis, and in incorporating these factors into the model. If our actual experience differs significantly from the assumptions used to compute our share-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little share-based compensation cost.
 
For additional information on use of estimates, see summary of Significant Accounting Policies in the notes to the Consolidated Financial Statements.
 
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/(loss) 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):
 
 
 
Year Ended December 31,
 
Cloud Telecommunications
 
2019
 
 
2018
 
Service revenue
 $12,089 
 $9,636 
Product revenue
  1,691 
  1,447 
Total revenue
  13,780 
  11,083 
Operating expenses:
    
    
Cost of service revenue
  3,354 
  2,973 
Cost of product revenue
  895 
  727 
Research and development
  821 
  776 
Selling and marketing
  3,862 
  3,403 
General and administrative
  3,984 
  3,817 
Total operating expenses
  12,916 
  11,696 
Operating income/(loss)
  864 
  (613)
Other income/(expense)
  (2)
  5 
Income/(loss) before tax provision
 $862 
 $(608)
 
 
25
 
 
Quarterly Financial Information
 
 
 
For the three months ended
 
Cloud Telecommunications
 
March 31,
2019
 
 
June 30,
2019
 
 
September 30,
2019
 
 
December 31,
2019 
 
Service revenue
 $2,830 
 $2,982 
 $3,100 
 $3,177 
Product revenue
  484 
  467 
  343 
  397 
Total revenue
  3,314 
  3,449 
  3,443 
  3,574 
Operating expenses:
    
    
    
    
Cost of service revenue
  843 
  861 
  811 
  839 
Cost of product revenue
  249 
  243 
  172 
  231 
Research and development
  206 
  187 
  207 
  221 
Selling and marketing
  899 
  963 
  1,003 
  997 
General and administrative
  954 
  942 
  974 
  1,114 
Total operating expenses
  3,151 
  3,196 
  3,167 
  3,402 
Operating income
  163 
  253 
  276 
  172 
Other income/(expense)
  (3)
  (1)
  2 
  - 
Income before tax benefit/(provision)
 $160 
 $252 
 $278 
 $172 
 
 
 
For the three months ended
 
Cloud Telecommunications
 
March 31,
2018
 
 
June 30,
2018
 
 
September 30,
2018
 
 
December 31,
2018
 
Service revenue
 $2,217 
 $2,332 
 $2,509 
 $2,578 
Product revenue
  366 
  437 
  314 
  330 
Total revenue
  2,583 
  2,769 
  2,823 
  2,908 
Operating expenses:
    
    
    
    
Cost of service revenue
  708 
  704 
  797 
  764 
Cost of product revenue
  187 
  201 
  161 
  178 
Research and development
  175 
  188 
  207 
  206 
Selling and marketing
  829 
  767 
  910 
  897 
General and administrative
  872 
  965 
  1,032 
  948 
Total operating expenses
  2,771 
  2,825 
  3,107 
  2,993 
Operating loss
  (188)
  (56)
  (284)
  (85)
Other income/(expense)
  4 
  3 
  - 
  (2)
Loss before tax provision
 $(184)
 $(53)
 $(284)
 $(87)
 
 
26
 
 
Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
 
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 25% or $2,453,000, to $12,089,000 for the year ended December 31, 2019 as compared to $9,636,000 for the year ended December 31, 2018. The increase in service revenue is due to an increase in contracted service revenue, usage charges, and professional services revenue of $2,441,000 and an increase in sales-type lease interest of $12,000. A substantial portion of Cloud Telecommunications segment revenue is generated through thirty-six to sixty month service contracts.
 
Product Revenue
 
Product revenue consists primarily of fees collected for the sale of desktop phone devices and third party equipment. Product revenue increased 17% or $244,000, to $1,691,000 for the year ended December 31, 2019 as compared to $1,447,000 for the year ended December 31, 2018. Product revenue fluctuates from one period to the next based on timing of installations, as we recognize revenue when the installation is complete. 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.
 
Backlog
 
Backlog represents the total contract value of all contracts signed, less revenue recognized from those contracts as of December 31, 2019 and 2018. Backlog increased 13% or $3,081,000 to $26,110,000 as of December 31, 2019 as compared to $23,029,000 as of December 31, 2018. Below is a table which displays the Cloud Telecommunications segment revenue backlog as of December 31, 2019 and 2018, which we expect to recognize as revenue within the next thirty-six to sixty months (in thousands):
 
Cloud Telecommunications Services backlog as of December 31, 2019
 $26,110 
Cloud Telecommunications Services backlog as of December 31, 2018
 $23,029 
 
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, customer support salaries and benefits, and share-based compensation. Cost of service revenue increased 13% or $381,000, to $3,354,000 for the year ended December 31, 2019 as compared to $2,973,000 for the year ended December 31, 2018. The increase in cost of service revenue was due to an increase in bandwidth costs of $114,000, an increase in salaries and benefits of $109,000 as a result of an increase in customer support headcount and temporary labor, an increase in costs related to installations of $71,000, an increase in credit card processing fees of $65,000, an increase in project management software costs of $11,000, and an increase in freight of $11,000. These increases are directly related to the growth in monthly recurring revenue.
 
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 23% or $168,000, to $895,000 for the year ended December 31, 2019 as compared to $727,000 for the year ended December 31, 2018. The increase is primarily due to the increase in product sales, an increase in device costs, and an increase in warranty replacements.
 
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 6% or $45,000, to $821,000 for the year ended December 31, 2019 as compared to $776,000 for the year ended December 31, 2018. There was an increase in costs for the maintenance of our customer user interface, an Android mobile phone application, and Java development of $74,000, offset by a decrease in share-based compensation of $17,000, a decrease in salaries and benefits of $9,000 due to a decrease in headcount, and a decrease in product testing costs of $3,000.
 
 
27
 
 
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, third-party marketing services, the production of marketing materials, and sales support software. Selling and marketing expenses increased 13% or $459,000, to $3,862,000 for the year ended December 31, 2019 as compared to $3,403,000 for the year ended December 31, 2018. The increase in selling and marketing expense was due to an increase in commission expenses of $389,000 directly related to an increase in revenue, an increase in marketing expense of $80,000, an increase in sales lead generation expense of $77,000, and an increase in business development costs of $8,000, offset by a decrease in salaries and benefits of $77,000 and a decrease in travel expenses of $18,000.
 
General and Administrative
 
General and administrative expenses consist of salaries and benefits for executives, administrative personnel, legal, rent, equipment, accounting and other professional services, investor relations, and other administrative corporate expenses. General and administrative expenses increased 4% or $167,000, to $3,984,000 for the year ended December 31, 2019 as compared to $3,817,000 for the year ended December 31, 2018. Consolidated general and administrative expenses increased 4%, or $144,000 to $4,235,000 for the year ended December 31, 2019 compared to $4,091,000 for the year ended December 31, 2018. 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 administrative salaries, benefits, and bonuses of $176,000, an increase in share-based compensation of $55,000, an increase in software expense of $40,000, and an increase in investor relations expense of $10,000, offset by a decrease in in legal professional services expense of $33,000, a decrease in computer and office equipment purchases of $26,000, a decrease in tooling relocation expense of $19,000, a decrease in repairs and maintenance of $17,000, a decrease in rent expense of $16,000 due to the completion of a lease, a decrease in accounting professional service costs of $13,000, and a decrease in corporate website expense of $13,000.
 
Other Income/(Expense)
 
Other income/(expense) primarily relates to the allocated portions of interest expense, offset by sublease rental income and credit card cash back rewards. Net other income decreased 140% or $7,000 to net other expense of ($2,000) for the year ended December 31, 2019 as compared net other income of $5,000 for the year ended December 31, 2018. The decrease is due to a decrease in sub-lease rental income of $12,000 for a lease agreement in Reno, NV, which expired in the third quarter of 2018, offset by an increase in other income related to credit card rewards of $5,000.
 
Operating Results of our Web Services Segment (in thousands):
 
 
 
Year Ended December 31,
 
Web Services
 
2019
 
 
2018
 
Service revenue
 $656 
 $825 
Operating expenses:
    
    
Cost of service revenue
  102 
  119 
Research and development
  32 
  25 
General and administrative
  251 
  274 
Total operating expenses
  385 
  418 
Operating income
  271 
  407 
Other income/(expense)
  12 
  (7)
Income before tax provision
 $283 
 $400 
 
 
28
 
 
Quarterly Financial Information
 
 
 
For the three months ended
 
Web Services
 
March 31,
2019
 
 
June 30,
2019
 
 
September 30,
2019
 
 
December 31,
2019
 
Service revenue
 $178 
 $165 
 $159 
 $154 
Operating expenses:
    
    
    
    
Cost of service revenue
  34 
  13 
  25 
  30 
Research and development
  6 
  10 
  8 
  8 
General and administrative
  60 
  55 
  66 
  70 
Total operating expenses
  100 
  78 
  99 
  108 
Operating income
  78 
  87 
  60 
  46 
Other income/(expense)
  4 
  3 
  (4)
  9 
Income before tax benefit/(provision)
 $82 
 $90 
 $56 
 $55 
 
 
 
For the three months ended
 
Web Services
 
March 31,
2018
 
 
June 30,
2018
 
 
September 30,
2018
 
 
December 31,
2018
 
Service revenue
 $225 
 $208 
 $203 
 $189 
Operating expenses:
    
    
    
    
Cost of service revenue
  21 
  27 
  36 
  35 
Research and development
  6 
  6 
  7 
  6 
General and administrative
  73 
  69 
  69 
  63 
Total operating expenses
  100 
  102 
  112 
  104 
Operating income
  125 
  106 
  91 
  85 
Other income/(expense)
  - 
  (3)
  2 
  (6)
Income before tax provision
 $125 
 $103 
 $93 
 $79 
 
 
29
 
 
Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
 
Service Revenue
 
Service revenue is generated primarily through website hosting and professional web management services. Web services revenue decreased 20% or $169,000, to $656,000 for the year ended December 31, 2019 as compared to $825,000 for the year ended December 31, 2018. The decrease in service revenue is primarily due to a decrease in hosting revenue of $143,000 and a $26,000 decrease in professional web management services.
 
Cost of Service Revenue
 
Cost of service revenue consists primarily of bandwidth, web domain costs, customer service salaries and benefits, temporary labor cost, and credit card processing fees. Cost of service revenue decreased 14% or $17,000, to $102,000 for the year ended December 31, 2019 as compared to $119,000 for the year ended December 31, 2018. The decrease in cost of revenue is primarily related to a decrease in customer service salaries, benefits, and temporary labor of $6,000, a decrease in share-based compensation of $6,000, a decrease in credit card fees of $4,000 and a decrease in web domain costs of $1,000, directly related to 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 28% or $7,000, to $32,000 for the year ended December 31, 2019 as compared to $25,000 for the year ended December 31, 2018 due to an increase in salary and benefits.
 
General and Administrative
 
General and administrative expenses consist of salaries and benefits for executives, administrative personnel, legal, rent, equipment, accounting and other professional services, investor relations, and other administrative corporate expenses. General and administrative expenses decreased 8% or $23,000, to $251,000 for the year ended December 31, 2019 as compared to $274,000 for the year ended December 31, 2018. The decrease in general and administrative expenses is primarily due to less of an allocation of corporate general and administrative expenses resulting from the 20% decrease in revenue for the period. Consolidated general and administrative expenses increased 4%, or $144,000 to $4,235,000 for the year ended December 31, 2019 compared to $4,091,000 for the year ended December 31, 2018. 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 administrative salaries, benefits, and bonuses of $176,000, an increase in share-based compensation of $55,000, an increase in software expense of $40,000, and an increase in shareholder relations expense of $10,000, offset by a decrease in in legal professional services expense of $33,000, a decrease in computer and office equipment purchases of $26,000, a decrease in tooling relocation expense of $19,000, a decrease in repairs and maintenance of $17,000, a decrease in rent expense of $16,000 due to the completion of a lease, a decrease in accounting professional service costs of $13,000, and a decrease in corporate website expense of $13,000.
 
Other Income/(Expense)
 
Other income/(expense) primarily relates to interest income, foreign exchange gains or losses, and the allocated portions of interest expense, sublease rental income, and credit card cash back rewards. Net other income increased 271% or $19,000, to $12,000 for the year ended December 31, 2019 as compared to net other expense of ($7,000) for the year ended December 31, 2018. The increase is due to a an increase in net foreign exchange gains of $21,000, offset by a $1,000 decrease in interest income and a $1,000 decrease in sub-lease rental income for a lease agreement in Reno, NV, which expired in the third quarter of 2018.
 
 
30
 
 
LIQUIDITY AND CAPITAL RESOURCES
 
As of December 31, 2019 and 2018, we had cash and cash equivalents of $4,180,000 and $1,849,000, 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 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.
 
Working Capital
 
Working capital increased 115% or $1,523,000 to $2,845,000 as of December 31, 2019 as compared to $1,322,000 as of December 31, 2018. The increase in working capital was primarily related to an increase in cash and cash equivalents of $2,331,000, an increase in contract assets of $10,000, an increase in inventories of $112,000, an increase in equipment financing receivables of $76,000, an increase in contract costs of $8,000, an increase in income tax receivable of $3,000, a decrease in accounts payable of $69,000, and a decrease notes payable, current portion, of $56,000, offset by a decrease in trade receivables, net of allowance for doubtful accounts of $39,000, a decrease in prepaid expenses of $103,000, an increase in accrued expenses of $623,000, an increase in finance leases, current portion, of $2,000, an increase in operating lease liabilities, current portion, of $50,000, an increase in contingent consideration of $175,000, and an increase in contract liabilities, current portion, of $150,000 during the year ended December 31, 2019.
 
Cash, Cash Equivalents, and Restricted Cash
 
Cash, cash equivalents, and restricted cash increased 120% or $2,331,000, to $4,280,000 as of December 31, 2019 as compared to $1,949,000 as of December 31, 2018. During the year ended December 31, 2019, operating activities provided $1,638,000. Financing activities provided $765,000, primarily related to proceeds from stock option exercises of $849,000, offset by repayments on notes payable of $56,000 and repayments on finance leases of $28,000. Cash used for investing activities was $72,000 for the purchase of property and equipment.
 
Inventories
 
Inventories increased 41% or $112,000 to $382,000 as of December 31, 2019 as compared to $270,000 as of December 31, 2018. Inventory balances fluctuate based on timing of installations and inventory shipments. The increase is attributable to the timing of inventory receipts. We received a large shipment of phones in October 2019.
 
Prepaid Expenses
 
Prepaid expenses decreased 42% or $103,000 to $141,000 as of December 31, 2019 as compared to $244,000 as of December 31, 2018. The decrease is from a $61,000 decrease in inventory deposits, a $45,000 decrease in prepaid tax liability deposit, and an $11,000 decrease in software services, offset by a $9,000 increase in other prepaid expense accounts and a $5,000 increase from the renewal of corporate insurance policies.
 
Trade Receivables
 
Current and long-term trade receivables, net of allowance for doubtful accounts, decreased 10% or $43,000, to $386,000 as of December 31, 2019 as compared to $429,000 as of December 31, 2018. Current trade receivables, net of allowance for doubtful accounts, decreased 9% or $39,000, to $380,000 as of December 31, 2019 as compared to $419,000 as of December 31, 2018. The decrease in current trade receivables can be attributed to the receipt of monthly payments from two large customers prior to the end of the year in 2019. Long-term trade receivables, net of allowance for doubtful accounts, decreased 40% or $4,000, to $6,000 as of December 31, 2019 as compared to $10,000 as of December 31, 2018. The decrease is primarily due to the receipt of monthly installment payments and the write-off of uncollectible accounts.
 
Accounts Payable and Accrued Expenses
 
Accounts payable decreased 45% or $69,000, to $86,000 as of December 31, 2019 as compared to $155,000 as of December 31, 2018. The aging of accounts payable as of December 31, 2019 and 2018 were generally within our vendors’ terms of payment. The increase is primarily related to the timing of the check processing schedule.
 
Accrued expenses increased 55% or $623,000 to $1,754,000 as of December 31, 2019 as compared to $1,131,000 as of December 31, 2018. Accrued bonuses increased $208,000, accrued invoices not received during the quarter increased $224,000, which includes the initial payment a customer relationships asset acquisition, accrued partner commissions increased $99,000, sales tax accrual increased $49,000, accrued salaries and benefits increased $30,000, and warranty reserve increased $21,000, offset by a $8,000 decrease in other accrued expenses.
 
 
31
 
 
Notes Payable
 
Notes payables decreased 100% or $56,000, to $0 as of December 31, 2019 as compared to $56,000 at December 31, 2018. The decrease in notes payable can be attributed to repayments made on financing contracts of $56,000.
 
Finance Lease
 
Finance lease obligations decreased 19%, or $28,000, to $116,000 as of December 31, 2019 as compared to $144,000 at December 31, 2018. The decrease in finance lease obligations can be attributed to repayments made on financing contracts of $28,000.
 
Contingent Consideration
 
Contingent consideration increased $175,000 to $175,000 at December 31, 2019 as compared to $0 at December 31, 2018. The increase is due to the DoubleHorn, LLC asset acquisition, see Note 5 for more details.
 
Operating Lease Liabilities
 
Operating lease liabilities increased $51,000 to $51,000 at December 31, 2019 as compared to $0 at December 31, 2018. The increase is related to the adoption of ASC 842, Leases, which requires lessees to record assets and liabilities on the balance sheet for all leases with terms longer than 12 months.
 
Contract Liabilities
 
Contract liabilities increased 14% or $151,000 to $1,214,000 as of December 31, 2019 as compared to $1,063,000 as of December 31, 2018. The increase is from a $102,000 increase in the prorated portion of monthly invoices with service dates in future periods for customers added during the period and a $49,000 increase in down payments of uninstalled contracts and other deferred revenue. 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.
 
Capital
 
Total stockholders’ equity increased 119% or $2,387,000, to $4,387,000 as of December 31, 2019 as compared to $2,000,000 as of December 31, 2018. The increase in total stockholders’ equity was attributable to net income of $1,139,000, and increases in additional paid-in capital of $849,000 from stock option exercises and $399,000 in share-based compensation for options issued to employees.
 
 
32
 
 
OFF BALANCE SHEET ARRANGEMENTS
 
As of December 31, 2019, 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
 
We lease our corporate office space in Tempe, Arizona from a Company that is owned by the major shareholder and CEO of the Company, a related party. On March 1, 2017, the lease agreement was renewed for a three year term with monthly rent payments of $25,000. Rental expense incurred on operating leases for the years ended December 31, 2019 and 2018 was approximately $300,000 and $300,000, respectively. As of December 31, 2019, we initiated the process to purchase our corporate office building and gave notice that we will not be exercising our option to renew for another three year term. The ROU asset and associated lease liabilities were revalued as of December 31, 2019 for the remaining two months of the lease term. This resulted in an adjustment of approximately $804,000 for the associated ROU, $250,000 for the operating lease liability, current portion, and $554,000 for the operating lease liability, net of current portion. 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.
 
RECENT ACCOUNTING PRONOUNCEMENTS
 
For a summary of recent accounting pronouncements and the anticipated effects on our consolidated financial statements, see Note 1 to the consolidated financial statements, which is incorporated by reference herein.
 
ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
 
Not required
 
 
33
 

ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
CREXENDO, INC. AND SUBSIDIARIES
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
 
 
 
PAGE
35
 
 
36
 
 
37
 
 
38
 
 
39
 
 
40
 
 
72
 

 
 
 
 
 
34
 
 
Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Stockholders of
Crexendo, Inc.
Tempe, AZ
 
Opinion on the Consolidated Financial Statements
 
We have audited the accompanying consolidated balance sheets of Crexendo, Inc. and subsidiaries (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended, and the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2019 and 2018, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
 
Adoption of New Accounting Standard
 
As discussed in Note 2 to the financial statements, the Company has changed its method for accounting for leases as a result of the adoption of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), and other subsequent amendments collectively identified as ASC 842 effective January 1, 2019.
 
Basis for Opinion
 
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
 
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
 
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
 
 
/s/ Urish Popeck & Co., LLC
 
We have served as the Company's auditor since 2016.
Pittsburgh, PA
March 3, 2020

 
35
 
 
CREXENDO, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except par value and share data)
 

 
December 31,
 
 
 
2019
 
 
2018
 
Assets
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 $4,180 
 $1,849 
Restricted cash
  100 
  100 
Trade receivables, net of allowance for doubtful accounts of $14
    
    
as of December 31, 2019 and $14 as of December 31, 2018
  380 
  419 
Contract assets
  22 
  12 
Inventories
  382 
  270 
Equipment financing receivables
  143 
  67 
Contract costs
  379 
  371 
Prepaid expenses
  141 
  244 
Income tax receivable
  4 
  1 
Total current assets
  5,731 
  3,333 
 
    
    
Long-term trade receivables, net of allowance for doubtful accounts
    
    
of $0 as December 31, 2019 and $0 as of December 31, 2018
  6 
  10 
Long-term equipment financing receivables, net
  561 
  184 
Property and equipment, net
  155 
  124 
Operating lease right-of-use assets
  51 
  - 
Intangible assets, net
  465 
  167 
Goodwill
  272 
  272 
Contract costs, net of current portion
  436 
  342 
Other long-term assets
  106 
  117 
Total Assets
 $7,783 
 $4,549 
 
    
    
Liabilities and Stockholders' Equity
    
    
Current liabilities:
    
    
Accounts payable
 $86 
 $155 
Accrued expenses
  1,754 
  1,131 
Finance leases
  30 
  28 
Notes payable
  - 
  56 
Operating lease liabilities
  50 
  - 
Contingent consideration
  175 
  - 
Contract liabilities
  791 
  641 
Total current liabilities
  2,886 
  2,011 
 
    
    
Contract liabilities, net of current portion
  423 
  422 
Finance leases, net of current portion
  86 
  116 
Operating lease liabilities, net of current portion
  1 
  - 
Total liabilities
  3,396 
  2,549 
 
    
    
Commitments and contingencies (Note 18)
    
    
 
    
    
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, 14,884,755
    
    
shares issued and outstanding as of December 31, 2019 and 14,394,113 shares issued
    
    
and outstanding as of December 31, 2018
  15 
  14 
Additional paid-in capital
  62,400 
  61,153 
Accumulated deficit
  (58,028)
  (59,167)
Total stockholders' equity
  4,387 
  2,000 
 
    
    
Total Liabilities and Stockholders' Equity
 $7,783 
 $4,549 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
36
 
 
CREXENDO, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except per share and share data)
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
Service revenue
 $12,745 
 $10,461 
Product revenue
  1,691 
  1,447 
Total revenue
  14,436 
  11,908 
 
    
    
Operating expenses:
    
    
Cost of service revenue
  3,456 
  3,092 
Cost of product revenue
  895 
  727 
Selling and marketing
  3,862 
  3,403 
General and administrative
  4,235 
  4,091 
Research and development
  853 
  801 
Total operating expenses
  13,301 
  12,114 
 
    
    
Income/(loss) from operations
  1,135 
  (206)
 
    
    
Other income/(expense):
    
    
Interest income
  6 
  7 
Interest expense
  (12)
  (12)
Other income, net
  16 
  3 
Total other income/(expense), net
  10 
  (2)
 
    
    
Income/(loss) before income tax
  1,145 
  (208)
 
    
    
Income tax provision
  (6)
  (15)
 
    
    
Net income/(loss)
 $1,139 
 $(223)
 
    
    
Earnings/(loss) per common share:
    
    
Basic
 $0.08 
 $(0.02)
Diluted
 $0.07 
 $(0.02)
 
    
    
Weighted-average common shares outstanding:
    
    
Basic
  14,570,286 
  14,332,092 
Diluted
  15,559,863 
  14,332,092 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
37
 
 
CREXENDO, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(In thousands, except share data)
 

 
 
 
 
 
 
 
Additional
 
 
 
 
 
Total
 
 
 
Common Stock
 
 
Paid-in
 
 
Accumulated
 
 
Stockholders'
 
 
 
Shares
 
 
Amount
 
 
Capital
 
 
Deficit
 
 
Equity
 
Balance, January 1, 2018
  14,287,556 
 $14 
 $60,560 
 $(58,944)
 $1,630 
Share-based compensation
  - 
  - 
  438 
  - 
  438 
Issuance of common stock for exercise of stock options
  106,557 
  - 
  155 
  - 
  155 
Net loss
  - 
  - 
  - 
  (223)
  (223)
Balance, December 31, 2018
  14,394,113 
  14 
  61,153 
  (59,167)
  2,000 
Share-based compensation
  - 
  - 
  399 
  - 
  399 
Vesting of restricted stock units
  24,992 
  - 
  - 
  - 
  - 
Issuance of common stock for exercise of stock options
  465,650 
  1 
  848 
  - 
  849 
Net income
  - 
  - 
  - 
  1,139 
  1,139 
Balance, December 31, 2019
  14,884,755 
 $15 
 $62,400 
 $(58,028)
 $4,387 
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
38
 
 
CREXENDO, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
 
 
Net income/(loss)
 $1,139 
 $(223)
Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
    
    
Depreciation and amortization
  94 
  92 
Share-based compensation
  399 
  438 
Changes in assets and liabilities:
    
    
Trade receivables
  43 
  (26)
Contract assets
  (10)
  (9)
Equipment financing receivables
  (453)
  (77)
Inventories
  (112)
  (139)
Contract costs
  (102)
  30 
Prepaid expenses
  103 
  32 
Income tax receivable
  (3)
  (1)
Other assets
  11 
  14 
Accounts payable and accrued expenses
  378 
  246 
Contract liabilities
  151 
  75 
Net cash provided by operating activities
  1,638 
  452 
 
    
    
CASH FLOWS FROM INVESTING ACTIVITIES
    
    
Purchase of property and equipment
  (72)
  (7)
Net cash used for investing activities
  (72)
  (7)
 
    
    
CASH FLOWS FROM FINANCING ACTIVITIES
    
    
Repayments made on finance leases
  (28)
  (10)
Proceeds from notes payable
  - 
  130 
Repayments made on notes payable
  (56)
  (153)
Proceeds from exercise of options
  849 
  155 
Net cash provided by financing activities
  765 
  122 
 
    
    
NET INCREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH
  2,331 
  567 
 
    
    
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT THE BEGINNING OF THE YEAR
  1,949 
  1,382 
 
    
    
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT THE END OF THE YEAR
 $4,280 
 $1,949 
 
    
    
Supplemental disclosure of cash flow information:
    
    
Cash used during the year for:
    
    
Income taxes, net
 $(9)
 $(16)
Interest expense
 $(12)
 $(12)
Supplemental disclosure of non-cash investing and financing information:
    
    
Prepaid assets financed through finance leases
 $- 
 $25 
Property and equipment financed through finance leases
 $- 
 $129 
Contingent consideration related to intangible asset acquisition
 $175 
 $- 
Purchase of intangible assets included in accrued expenses
 $176 
 $- 
 
    
    
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
39
 
 
CREXENDO, INC. AND SUBSIDIARIES
 
Notes to Consolidated Financial Statements
 
1.            
Description of Business and 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. and Crexendo International, 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.
 
Certain prior year amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect on the reported results of operations.
 
 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 December 31, 2019 and 2018, we had cash and cash equivalents in financial institutions in excess of federally insured limits in the amount of $4,004,000 and $1,645,000, respectively.
 
Restricted Cash – We classified $100,000 and $100,000 as restricted cash as of December 31, 2019 and 2018, respectively. Cash is restricted for compensating balance requirements on purchasing card agreements. As of December 31, 2019 and 2018, we had restricted cash in financial institutions in excess of federally insured limits in the amount of $100,000 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 consolidated statement of cash flows (in thousands):
 
 
 
December 31,
 
 
December 31,
 
 
 
2019
 
 
2018
 
Cash and cash equivalents
 $4,180,000 
 $1,849,000 
Restricted cash
  100,000 
  100,000 
Total cash, cash equivalents, and restricted cash shown in the
    
    
   consolidated statement of cash flows
 $4,280,000 
 $1,949,000 
 
 
40
 
 
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 $815,000 and $713,000 at December 31, 2019 and December 31, 2018, 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 year ended December 31, 2019 and 2018, the Company amortized $499,000 and $476,000, 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 five 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. Depreciation expense is included in general and administrative expenses and totaled $41,000 and $20,000 for the years ended December 31, 2019 and 2018, respectively. Depreciable lives by asset group are as follows:
 
Computer and office equipment
2 to 5 years
Computer software
3 years
Furniture and fixtures
4 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. During the years ended December 31, 2019 and 2018, the Company acquired customer relationships for an aggregate purchase price of $351,000 and $0, respectively. The assets acquired were not material to our consolidated financial statements.
 
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. There was no impairment of intangible assets identified for the years ended December 31, 2019 and 2018.
 
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.
 
 
41
 
 
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 3.
 
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. For 2019, actual warranty costs were approximately 1.6% of prior year net product revenue and the annual warranty provision was approximately 2.2% of current year net product revenue.
 
Contingent Consideration – Contingent consideration represents deferred 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 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.
 
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.
 
 
42
 
 
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. We have placed a full valuation allowance on net deferred tax assets.
 
Interest and penalties associated with income taxes are classified as income tax expense in the consolidated statements of operations.
 
 
43
 
 
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 years ended December 31, 2019 and 2018.
 
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 90% of our total revenue from customers within North America (United States and Canada) and less than 10% 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 years ended December 31, 2019 and 2018. One telecommunications services customer accounted for 11% and 22% of total trade accounts receivable as of December 31, 2019 and 2018, respectively.
 
Recently Adopted Accounting Pronouncements – In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), and in December 2018, ASU No. 2018-20, Narrow-Scope Improvements for Lessors, and in July 2018, ASU No. 2018-10, Codification Improvements to Topic 842, Leases, and ASU 2018-11, Leases (Topic 842) - Targeted Improvements (collectively, “the new lease standard” or “ASC 842”). The new standard requires lessees to record assets and liabilities on the balance sheet for all leases with terms longer than 12 months. This ASU does not significantly change the previous lease guidance for how a lessee should recognize, measure, and present expenses and cash flows arising from a lease. Additionally, the criteria for classifying a finance lease versus an operating lease are substantially the same as the previous guidance. We adopted Topic 842 as of January 1, 2019, using the alternative transition method that allowed us to recognize a cumulative-effect adjustment to the opening balance of retained earnings at the beginning of the period of adoption. We used the package of practical expedients permitted under the transition guidance that allowed us to not reassess: (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases and (3) initial direct costs for any expired or existing leases. We elected the practical expedient that allows lessees to treat the lease and non-lease components of leases as a single lease component. Additionally, we elected the hindsight practical expedient to determine the reasonably certain lease terms for existing leases. The adoption of Topic 842 did not have a material adjustment to the opening balance of retained earnings. The adoption of Topic 842 had a material impact on our consolidated balance sheet due to the recognition of right-of-use (“ROU”) assets and lease liabilities. As a result of the adoption of the standard, the Company recognized ROU assets and lease liabilities of $1,088,000 as of January 1, 2019. The adoption of Topic 842 did not have a material impact on our consolidated statement of operations or our consolidated statement cash flows.
 
In August 2018, the FASB issued ASU 2018-07, to simplify the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. The new guidance expands the scope of Accounting Standards Codification (ASC) 718 to include share-based payments granted to nonemployees in exchange for goods or services used or consumed in an entity’s own operations and supersedes the guidance in ASC 505-50. The guidance also applies to awards granted by an investor to employees and nonemployees of an equity method investee for goods or services used or consumed in the investee’s operations. The guidance in ASC 718 does not apply to instruments issued to a lender or an investor in a financing (e.g., in a capital raising) transaction. It also does not apply to equity instruments granted when selling goods or services to customers in the scope of ASC 606. However, the guidance states that share-based payments granted to a customer in exchange for a distinct good or service to be used or consumed in the grantor’s own operations are accounted for under ASC 718. The Company adopted ASU 2018-07 effective January 1, 2019. The adoption of this ASU did not have an impact on our consolidated financial statements.
 
 In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805) Clarifying the Definition of a Business, that provides guidance to assist entities with evaluating when a set of transferred assets and activities (set) is a business. Under the new guidance, an entity first determines whether substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If this threshold is met, the set is not a business. If it’s not met, the entity then evaluates whether the set meets the requirement that a business include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. Under today’s guidance, it doesn’t matter whether all the value relates primarily to one asset. Under ASU 2017-01, a set is not a business when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. The ASU includes guidance on which types of assets can and cannot be combined into a single identifiable asset or a group of similar identifiable assets for the purpose of applying the threshold. We adopted this guidance effective January 1, 2018. The adoption of this guidance did not have an impact on our consolidated financial statements.
 
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We adopted the new accounting standards effective January 1, 2018. Amounts generally described as restricted cash are now presented with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. As a result of adoption, there was no impact to cash flows from operating, investing or financing activities. A reconciliation of cash and cash equivalents and restricted cash presented on the balance sheet to the totals presented in the statement of cash flows as cash, cash equivalents, and restricted cash has been added to the footnote disclosures, see Note 1.
 
 
44
 
 
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which amends ASC 230, to clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. The changes to the classification of how certain cash receipts and payments are presented within the statement of cash flows had no impact on our consolidated financial statements. The Company adopted ASU 2016-5 effective January 1, 2018. The adoption of these new ASUs required us to restate the previously reported cash and cash equivalent amounts reported in prior periods to include restricted cash.
 
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. The objective of ASU 2014-09 is to establish a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The Company adopted this guidance on January 1, 2018 utilizing the full retrospective method of adoption allowed by the standard, in order to provide for comparative results in all periods presented. Under the standard, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. We elected to adopt the standard effective January 1, 2018. The most significant impact of the standard relates to our accounting for incremental costs to obtain a contract and principal versus agent considerations. Specifically, incremental sales leadership commission were expensed immediately rather than ratably over the term of the related contracts. Revenue from the resale of broadband Internet services and professional website management services were recognized on a gross basis as a principal rather than on net basis as an agent. The new standard focuses on control of the specified goods and service as the overarching principle and the Company does not control the delivery of the goods and services. Revenue recognition related to our hardware, telecommunications services and website hosting services remains substantially unchanged.
 
In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting, the amendments provide guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. The Company adopted ASU 2017-09 effective January 1, 2018. The adoption of this ASU did not impact our consolidated financial statements.
 
Recently Issued Accounting Pronouncements – In August 2018, the FASB issued ASU 2018-13, which changes the fair value measurement disclosure requirements of ASC 820. The amendments in this ASU are the result of a broader disclosure project called FASB Concepts Statement, Conceptual Framework for Financial Reporting — Chapter 8: Notes to Financial Statements, which the Board finalized in August 2018. The Board used the guidance in the Concepts Statement to improve the effectiveness of ASC 820’s disclosure requirements. The ASU is effective for all entities for fiscal years beginning after December 15, 2019, including interim periods therein. Early adoption is permitted. The Company is in the process of evaluating the impact of this new ASU on our consolidated financial statements.
 
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. This guidance is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted. ASU 2017-04 should be adopted on a prospective basis. The Company will adopt this standard effective January 1, 2020 and the adoption of this ASU will not have a material impact on our consolidated financial statements.
 
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.
 
 
45
 
 
2.            
Changes in Accounting Principles
 
Except for the changes below, the Company has consistently applied the accounting principles to all periods presented in these consolidated financial statements. The Company adopted Topic 842, Leases with a date of the initial application of January 1, 2019.
 
We adopted Topic 842 as of January 1, 2019, using the alternative transition method that allowed us to recognize a cumulative-effect adjustment to the opening balance of retained earnings at the beginning of the period of adoption. We used the package of practical expedients permitted under the transition guidance that allowed us to not reassess: (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases and (3) initial direct costs for any expired or existing leases. We elected the practical expedient that allows lessees to treat the lease and non-lease components of leases as a single lease component. Additionally, we elected the hindsight practical expedient to determine the reasonably certain lease terms for existing leases. The adoption of Topic 842 did not have a material adjustment to the opening balance of retained earnings. The adoption of Topic 842 had a material impact on our condensed consolidated balance sheet due to the recognition of right-of-use (“ROU”) assets and lease liabilities. As a result of the adoption of the standard, the Company recognized ROU assets and lease liabilities of $1,088,000 as of January 1, 2019. The adoption of Topic 842 did not have a material impact on our consolidated statement of operations or our consolidated statement of cash flows.
 
3.            
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 20.
 
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.
 
 
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Cloud Telecommunications Services – Telecommunication services include voice, data, and collaboration software. The Company recognizes revenue as services are provided in service revenue. Telecommunications services are billed and paid on a monthly basis.
 
Broadband Internet Access – Fees generated from reselling broadband Internet access are recognized as revenue net of the costs charged by the third party service providers. Broadband Internet access services are billed and paid on a monthly basis.
 
Professional Services Revenue – Professional services revenue includes activation fees and any professional installation services. Installation services are recognized as revenue when the services are completed. 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. Our telecommunications services contracts typically have a term of thirty-six to sixty months.
 
Commission Revenue – We have affiliate agreements with third-party entities that are resellers of satellite television services and Internet service providers. We receive commissions when the services are bundled with our offerings and we recognize commission revenue when received.
 
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.
 
Year Ended December 31, 2019
 
Cloud
 
 
 
 
 
Total
 
(In thousands)
 
Telecommunications
 
 
Web Services
 
 
Reportable
 
 
 
Segment
 
 
Segment
 
 
Segments
 
Major products/services lines
 
 
 
 
 
 
 
 
 
Desktop devices
 $1,691 
 $- 
 $1,691 
Equipment financing revenue
  117 
  - 
  117 
Telecommunications services
  10,809 
  - 
  10,809 
Fees, commissions, and other, recognized over time
  844 
  - 
  844 
One time fees, commissions and other
  319 
  - 
  319 
Website hosting services
  - 
  586 
  586 
Website management services and other
  - 
  70 
  70 
 
 $13,780 
 $656 
 $14,436 
Timing of revenue recognition
    
    
    
Products and fees recognized at a point in time
 $2,010 
 $- 
 $2,010 
Services and fees transferred over time
  11,770 
  656 
  12,426 
 
 $13,780 
 $656 
 $14,436 
 
 
47
 
 
Year Ended December 31, 2018
 
Cloud
 
 
 
 
 
Total
 
(In thousands)
 
Telecommunications
 
 
Web Services
 
 
Reportable
 
 
 
Segment
 
 
Segment
 
 
Segments
 
Major products/services lines
 
 
 
 
 
 
 
 
 
Desktop devices
 $1,447 
 $- 
 $1,447 
Equipment financing revenue
  105 
  - 
  105 
Telecommunications services
  8,817 
  - 
  8,817 
Fees, commissions, and other, recognized over time
  629 
  - 
  629 
One time fees, commissions and other
  85 
  - 
  85 
Website hosting services
  - 
  708 
  708 
Website management services and other
  - 
  117 
  117 
 
 $11,083 
 $825 
 $11,908 
Timing of revenue recognition
    
    
    
Products and fees recognized at a point in time
 $1,532 
 $- 
 $1,532 
Services and fees transferred over time
  9,551 
  825 
  10,376 
 
 $11,083 
 $825 
 $11,908 

Contract balances
 
The following table provides information about receivables, contract assets, and contract liabilities from contracts with customers.
 
 
 
December 31,
 
 
December 31,
 
(In thousands)
 
2019
 
 
2018
 
Receivables, which are included in Trade receivables, net of allowance
 
 
 
 
 
 
for doubtful accounts
 $386 
 $429 
Contract assets
  22 
  12 
Contract liabilities
  1,214 
  1,063 
 
 
48
 
 
Significant changes in the contract assets and the contract liabilities balances during the period are as follows:
 
 
 
For the Year Ended
 
 
For the Year Ended
 
(In thousands)
 
December 31, 2019
 
 
December 31, 2018
 
 
 
Contract Assets
 
 
Contract Liabilities
 
 
Contract Assets
 
 
Contract Liabilities
 
Revenue recognized that was included in the contract liability balance at the beginning of the period
 $- 
 $(882)
 $- 
 $(837)
Increase due to cash received, excluding amounts recognized as revenue during the period
  - 
  1,033 
  - 
  912 
Transferred to receivables from contract assets recognized at the beginning of the period
  (13)
  - 
  (2)
  - 
Increase due to additional unamortized discounts
  23 
  - 
  11 
  - 

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):
 
 
 
2020
 
 
2021
 
 
2022
 
 
2023
 
 
2024
 
 
2025
 
 
Total
 
Desktop devices
 $166 
  - 
  - 
  - 
  - 
 
 
 
 $166 
Telecommunications service
 $10,012 
  7,134 
  4,984 
  2,878 
  934 
  2 
 $25,944 
All consideration from contracts with customers is included in the amounts presented above
    
    
    
    
    
    
    

4.            
Earnings/(Loss) Per Common Share
 
Basic earnings/(loss) per common share is computed by dividing the net income/(loss) for the period by the weighted-average number of common shares outstanding during the period. Diluted earnings/(loss) 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 year ended December 31, 2018 is the same as basic net loss per common share as the common share equivalents were anti-dilutive due to the net loss. The following table sets forth the computation of basic and diluted net loss per common share:
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
Net income/(loss) (in thousands) (A)
 $1,139 
 $(223)
 
    
    
Weighted-average share reconciliation:
    
    
Weighted-average basic shares outstanding (B)
  14,570,286 
  14,332,092 
Dilutive effect of stock-based awards
  989,577 
  - 
   Diluted weighted-average outstanding shares of common stock (C)
  15,559,863 
  14,332,092 
 
    
    
Earnings/(loss) per common share:
    
    
   Basic (A/B)
 $0.08 
 $(0.02)
   Diluted (A/C)
 $0.07 
 $(0.02)
 
 
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For the year ended December 31, 2019 and 2018, respectively, the following potentially dilutive common stock, including awards granted under our equity incentive compensation plans, were excluded from the computation of diluted earnings/(loss) per share because including them would be anti-dilutive.
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
Stock options
  1,236,096 
  1,585,458 

5.            
Acquisitions
 
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. The following table presents the cost of the acquisition and the allocation to assets acquired based upon their relative fair value:
 
Consideration (including estimated unpaid contingent consideration):
 
 
 
Cash
 $176 
Contingent consideration
  175 
Total consideration
 $351 
 
    
Recognized amounts of identifiable assets acquired and liabilities assumed:
    
Customer Relationships
 $351 
Net assets acquired
  351 

6.            
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):
 
 
 
December 31,
 
 
 
2019
 
 
2018
 
Gross trade receivables
 $400 
 $443 
Less: allowance for doubtful accounts
  (14)
  (14)
Trade receivables, net
 $386 
 $429 
 
    
    
Current trade receivables, net
 $380 
 $419 
Long-term trade receivables, net
  6 
  10 
Trade receivables, net
 $386 
 $429 
 
 
50
 
 
7.            
Prepaid Expenses
 
Prepaid expenses consisted of the following (in thousands):
 
 
 
December 31,
 
 
 
2019
 
 
2018
 
Prepaid corporate insurance
 $48 
 $43 
Prepaid software services
  17 
  28 
Prepaid tax liability deposit
  3 
  48 
Prepaid inventory deposits
  - 
  61 
Other prepaid expenses
  73 
  64 
Total prepaid assets
 $141 
 $244 
 
8.            
Property and Equipment
 
Property and equipment consisted of the following (in thousands):
 
 
 
December 31,
 
 
 
2019
 
 
2018
 
Software
 $346 
 $333 
Computers and office equipment
  1,388 
  1,524 
Leasehold improvements
  85 
  25 
Less accumulated depreciation
  (1,664)
  (1,758)
Total property and equipment, net
 $155 
 $124 
 
Depreciation expense is included in general and administrative expenses and totaled $41,000 and $20,000 for the years ended December 31, 2019 and 2018, respectively.
 
 
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9.            
Intangible Assets
 
The net carrying amount of intangible assets is as follows (in thousands):
 
 
 
December 31,
 
 
 
2019
 
 
2018
 
Customer relationships
 $1,292 
 $941 
Less: accumulated amortization
  (827)
  (774)
Total intangible assets, net
 $465 
 $167 
 
Amortization expense is included in general and administrative expenses and totaled $53,000 and $72,000 for the years ended December 31, 2019 and 2018, respectively.
 
The following table outlines the estimated future amortization expense related to intangible assets held at December 31, 2019 (in thousands):
 
Year ending December 31,
 
 
 
2020
 $120 
2021
  99 
2022
  82 
2023
  71 
2024
  53 
2025
  40 
Total
 $465 
 
10.            
Goodwill
 
The Company has recorded goodwill as a result of its business acquisitions. Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. In each of the Company’s acquisitions, the objective of the acquisition was to expand the Company’s product offerings and customer base and to achieve synergies related to cross selling opportunities, all of which contributed to the recognition of goodwill.
 
The Company tests goodwill for impairment on an annual basis or more frequently if events or changes in circumstances indicate that goodwill might be impaired. The changes in the carrying amount of goodwill for the years ended December 31, 2019 and 2018 were as follows (in thousands):
 
 
 
Goodwill
 
Balance at January 1, 2018
 $272 
   Increase (decrease)
  - 
Balance at December 31, 2018
  272 
   Increase (decrease)
  - 
Balance at December 31, 2019
 $272 
 
 
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11.            
Accrued Expenses
 
Accrued expenses consisted of the following (in thousands):
 
 
December 31,
 
 
 
2019
 
 
2018
 
Accrued wages and benefits
 $538 
 $301 
Accrued accounts payable
  566 
  243 
Accrued sales and telecommunications taxes
  529 
  480 
Product warranty liability
  37 
  16 
Other
  84 
  91 
Total accrued expenses
 $1,754 
 $1,131 
 
The changes in aggregate product warranty liabilities for the years ended December 31, 2019 and 2018 were as follows (in thousands):
 
 
 
Warranty Liabilities
 
Balance at January 1, 2018
 $- 
Accrual for warranties
  31 
Warranty settlements
  (15)
Balance at December 31, 2018
  16 
Accrual for warranties
  37 
Adjustments related to pre-existing warranties
  7 
Warranty settlements
  (23)
Balance at December 31, 2019
 $37 
 
Product warranty expense is included in cost of product revenue expense and totaled $44,000 and $31,000 for the years ended December 31, 2019 and 2018, respectively.
 
12.            
Notes Payable
 
Notes payable consists of short-term financing arrangements for equipment and corporate insurance. The Company’s outstanding balances under its note payable agreements were $0 and $56,000 as of December 31, 2019 and 2018, respectively.
 
 
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13.            
Fair Value Measurements
 
We have financial instruments as of December 31, 2019 and 2018 for which the fair value is summarized below (in thousands):
 
 
 
December 31, 2019
 
 
December 31, 2018
 
 
 
Carrying Value
 
 
Estimated Fair Value
 
 
Carrying Value
 
 
Estimated Fair Value
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Trade receivables, net
 $386 
 $386 
 $429 
 $429 
Equipment financing receivables
  704 
  704 
  251 
  251 
Liabilities:
    
    
    
    
Finance leases
 $116 
 $116 
 $144 
 $144 
Notes payable
  - 
  - 
  56 
  56 
Asset acquisition contingent consideration
  175 
  175 
  - 
  - 
 
Liabilities for which fair value is recognized in the balance sheet on a recurring basis are summarized below as of December 31, 2019 and 2018 (in thousands):
 
 
 
 
 
 
Fair value measurement at reporting date
 
Description
 
As of December 31, 2019
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Asset acquisition contingent consideration
 $175 
 $- 
 $- 
 $175 
 
Description
 
As of December 31, 2018
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
    
    
    
    
Liabilities:
    
    
    
    
Asset acquisition contingent consideration
 $- 
 $- 
 $- 
 $- 
 
 
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The recurring Level 3 measurement of our asset acquisition contingent consideration liability includes the following significant unobservable inputs at December 31, 2019 (in thousands):
 
Contingent consideration liability
 
Fair Value at December 31, 2019
 
Valuation technique
 
Unobservable inputs
 
Range
 
Revenue - based payments
 $175 
Discounted cash flow
 
Discount Rate
  3.67%
 
    
 
 
 
    
 
    
 
 
Probability of milestone payment
  90%
 
    
 
 
Projected year of payments
  2020 
 
    
 
 
 
    
 
    
 
 
 
    

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.
 
The progression of the Company’s Level 3 instruments fair valued on a recurring basis for the year ended December 31, 2019 are shown in the table below (in thousands):
 
 
 
Asset Acquisition Contingent Consideration
 
Balance at December 31, 2017
 $- 
Additions
  - 
Balance at December 31, 2018
 $- 
Additions
  175 
Balance at December 31, 2019
 $175 
 
14.            
Equity
 
Common Stock
 
Shares of common stock reserved for future issuance as of December 31, 2019 were as follows:
 
Stock-based compensation plans:
 
 
 
Outstanding option awards
  3,286,672 
Available for future grants
  1,714,542 
 
  5,001,214 
 
 
55
 

15.            
Stock-Based Compensation
 
We have various incentive stock-based compensation plans that provide for the grant of stock options, restricted stock units (RSUs), and other share-based awards of up to 5,001,214 shares to eligible employees, consultants, and directors. As of December 31, 2019, we had 1,714,542 shares remaining in the plans available to grant.
 
Stock Options
 
The weighted-average fair value of stock options on the date of grant and the assumptions used to estimate the fair value of stock options granted during the years ended December 31, 2019 and 2018 using the Black-Scholes option-pricing model were as follows:
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
Weighted-average fair value of options granted
 $1.76 
 $1.86 
Expected volatility
  89%
  88%
Expected life (in years)
  4.20 
  4.30 
Risk-free interest rate
  2.18%
  2.69%
Expected dividend yield
  0.00%
  0.00%
 
The expected volatility of the options is determined using historical volatilities based on historical stock prices. The expected life of the options granted is based on our historical share option exercise experience. The risk-free interest rate is determined using the yield available for zero-coupon U.S. government issues with a remaining term equal to the expected life of the option. The Company has not declared any dividends, therefore, it is assumed to be zero.
 
The following table summarizes the stock option activity under the plans for the years ended December 31, 2019 and 2018:
 
 
 
 
 
Number
of
Shares
 
 
Weighted-Average
Exercise
Price
 
 
Weighted-Average
Remaining
Contract Life
 
 
Aggregate
Intrinsic Value
(in thousands)
 
Outstanding at January 1, 2018
  3,648,939 
 $2.61 
4.3 years
 $1,346 
Granted
  329,000 
  2.83 
 
    
Exercised
  (106,557)
  1.46 
 
    
Cancelled/forfeited
  (207,382)
  1.72 
 
    
Outstanding at December 31, 2018
  3,664,000 
  2.71 
3.5 years
  1,007 
Granted
  210,500 
  2.70 
 
    
Exercised
  (465,650)
  1.82 
 
    
Cancelled/forfeited
  (219,690)
  6.26 
 
    
Outstanding at December 31, 2019
  3,189,160 
  2.60 
2.9 years
  5,668 
Shares vested and expected to vest
  3,128,660 
  2.60 
2.9 years
  5,576 
Exercisable as of December 31, 2019
  2,926,485 
  2.59 
2.6 years
  5,266 
Exercisable as of December 31, 2018
  3,363,569 
  2.73 
3.3 years
  968 
 
 
56
 
 
The total intrinsic value of options exercised during the years ended December 31, 2019 and 2018, was $829,000 and $107,000 respectively.
 
As of December 31, 2019, the total future compensation expense related to non-vested options not yet recognized in the consolidated statements of operations was approximately $446,000 and the weighted-average period over which these awards are expected to be recognized is approximately 1.8 years.
 
Restricted Stock Units:
 
The following table summarizes the RSUs outstanding:
 
 
 
Years Ended December 31,
 
 
 
2020
 
 
2021
 
 
2022
 
RSUs with service-based vesting conditions
  29,990 
  29,988 
  5,030 

The following table summarizes the RSUs activity under the plans for the years ended December 31, 2019 and 2018:
 
 
   
 
Weighted-Average
 
 
 
Number of Units
 
 
Fair Value
 
Outstanding at January 1, 2018
  - 
 $- 
Granted
  - 
  - 
Vested/released
  - 
  - 
Cancelled/forfeited
  - 
  - 
Outstanding at December 31, 2018
  - 
  - 
Granted
  90,000 
  2.25 
Vested/released
  (24,992)
  2.25 
Cancelled/forfeited
  - 
  - 
Outstanding at December 31, 2019
  65,008 
  2.25 
 
The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2019 and 2018 was $2.25 and $0, respectively.
 
The total intrinsic value of RSUs that vested and were released during the years ended December 31, 2019 and 2018, was $86,000 and $0 respectively.
 
As of December 31, 2019, the total future compensation expense related to non-vested options not yet recognized in the consolidated statements of operations was approximately $143,000 and the weighted-average period over which these awards are expected to be recognized is approximately 2.1 years.
 
 
57
 
 
The following table summarizes the statement of operations effect of stock-based compensation for the years ended December 31, 2019 and 2018 (in thousands):
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
Share-based compensation expense by type:
 
 
 
 
 
 
Stock options
 $339 
 $438 
Restricted stock units
  60 
  - 
Total cost related to share-based compensation expense
 $399 
 $438 
Share-based compensation expense by financial statement line item:
    
    
Cost of revenue
 $57 
 $136 
Research and development
  46 
  71 
Selling and marketing
  72 
  69 
General and administrative
  224 
  162 
Total cost related to share-based compensation expense
 $399 
 $438 
 
There is no tax benefit related to stock compensation expense due to a full valuation allowance on net deferred tax assets at December 31, 2019 and 2018, respectively.
 
16.            
Income Taxes
 
The income tax benefit/(expense) consisted of the following for the years ended December 31, 2019 and 2018 (in thousands):
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
Current income tax (expense):
 
 
 
 
 
 
   Federal
 $- 
 $- 
   State and local
  (6)
  (15)
Current income tax (expense)
 $(6)
 $(15)

There was no deferred income tax benefit/(expense) for the years ended December 31, 2019 and 2018.
 
 
58
 
 
The income tax provision attributable to income/(loss) before income tax benefit/(expense) for the years ended December 31, 2019 and 2018 differed from the amounts computed by applying the U.S. federal statutory tax rate of 21% and 21%, respectively, as a result of the following (in thousands):
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
U.S. federal statutory income tax benefit/(expense)
 $(241)
 $43
Increase in income tax benefit resulting from:
    
    
State and local income tax expense, net of federal effect
  (831)
  (539)
Change in the valuation allowance for net deferred income tax assets
  972
  583
Other, net
  94
  (102)
Income tax (expense)
 $(6)
 $(15)
 
As of December 31, 2019 and 2018, significant components of net deferred income tax assets and liabilities were as follows (in thousands):
 
 
 
December 31,
 
 
 
2019
 
 
2018
 
Deferred income tax assets:
 
 
 
 
 
 
Accrued expenses
 $83 
 $45 
Deferred revenue
  314 
  278 
Net operating loss carry-forwards
  4,760 
  5,946 
Stock-based compensation
  2,262 
  2,258 
Other
  398 
  505 
Subtotal
  7,817 
  9,032 
Valuation allowance
  (7,548)
  (8,755)
Total deferred income tax assets
  269 
  277 
 
    
    
Deferred income tax liabilities:
    
    
Property and equipment
  (19)
  (28)
Prepaid expenses and other
  (250)
  (249)
Total deferred income tax liabilities
  (269)
  (277)
 
    
    
Net deferred income tax assets (liabilities)
 $- 
 $- 
 
 
59
 
 
As of December 31, 2019, we had NOL and research and development tax credit carry-forwards for U.S. federal income tax reporting purposes of approximately $18,520,000 and $81,000 respectively. $18,336,000 of the NOLs will begin to expire in 2031 through 2037, and the remaining $184,000 of the NOLs will not expire. The research and development credits will expire in 2020.
 
During the fiscal year ended June 30, 2002 (our fiscal year was subsequently changed to December 31), we experienced a change in ownership, as defined by the Internal Revenue Code, as amended (the “Code”) under Section 382. A change of ownership occurs when ownership of a company increases by more than 50 percentage points over a three-year testing period of certain stockholders. As a result of this ownership change we determined that our annual limitation on the utilization of our federal pre-ownership change net operating loss (“NOL”) carry-forwards is approximately $461,000 per year. We determined that the Company would only be able to utilize $4,760,000 of our pre-ownership change NOL carry-forwards and will forgo utilizing $14,871,000 of our pre-ownership change NOL carry-forwards as a result of this ownership change. We do not account for forgone NOL carryovers in our deferred tax assets and only account for the NOL carry-forwards that will not expire unutilized as a result of the restrictions of Code Section 382.
 
We also have state NOL and research and development credit carry-forwards of approximately $14,746,000 and $61,000, which expire on specified dates as set forth in the rules of the various states to which the carry-forwards relate.
 
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. Based on the significant negative evidence of cumulative losses and history of loss carryforwards expiring unutilized, the positive evidence of forecasts of future profitability was not sufficient to overcome the negative evidence. As a result, we determined it was more likely than not that the deferred tax assets would not be realized as of December 31, 2019 and 2018; accordingly, we recorded a full valuation allowance. The valuation allowance for deferred tax assets as of December 31, 2019 and 2018 was $7,548,000 and $8,755,000 respectively.
 
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“Tax Act”) was signed into law. The new law includes, among other items, a permanent reduction to the U.S. corporate income tax rate from 34% to 21% effective January 1, 2018. As a result of the reduction of the corporate income tax rate to 21%, U.S. GAAP requires companies to remeasure their deferred tax assets and liabilities as of the date of enactment, with resulting tax effects accounted for in the reporting period of enactment. The Company remeasured deferred tax assets and liabilities based on the rates at which they are expected to be utilized in the future. As a result, our net deferred tax assets, without regard to the valuation allowance, decreased by $4.5 million. This decrease was offset by a corresponding decrease in our valuation allowance. There was no charge to our income tax expense as a result of the reduction in corporate income tax rate.
 
The net change in our valuation allowance was a decrease of $1,207,000 for the year ended December 31, 2019 and a decrease of $583,000 for the year ended December 31, 2018.
 
Accounting guidance clarifies the accounting for uncertain tax positions and requires companies to recognize the impact of a tax position in their financial statements, if that position is more likely than not of being sustained on audit, based on the technical merits of the position.
 
Although we believe our estimates are reasonable, there can be no assurance that the final tax outcome of these matters will not be different from that which we have reflected in our historical income tax provisions and accruals. Such difference could have a material impact on our income tax provision and operating results in the period in which it makes such determination.
 
The aggregate changes in the balance of unrecognized tax benefits during the years ended December 31, 2019 and 2018 were as follows (in thousands):
 
Balance as of January 1, 2018
 $- 
Reductions due to lapsed statute of limitations
  - 
Balance as of December 31, 2018
  - 
Reductions due to lapsed statute of limitations
  - 
Balance as of December 31, 2019
 $- 
 
 
60
 
 
Estimated interest and penalties related to the underpayment or late payment of income taxes are classified as a component of income tax provision in the consolidated statements of operations. There were no accrued interest and penalties as of December 31, 2019 and 2018, respectively.
 
Our U.S. federal income tax returns for fiscal 2016 through 2019 are open tax years. We also file in various states, with few exceptions, we are no longer subject to state income tax examinations by tax authorities for years prior to fiscal 2015.
 
17.            
Leases
 
Lessee Accounting
 
We determine if an agreement is a lease at inception. We lease our corporate office space and equipment under operating leases. We lease data center equipment, including maintenance contracts under finance leases.
 
Operating leases are recorded as right-of-use (“ROU”) assets and lease liabilities on the balance sheet. 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 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 space operating lease. Lease expense is recognized on a straight-line basis over the lease term.
 
We lease the corporate office space in Tempe, Arizona from a Company that is owned by the major shareholder and CEO of the Company. Effective March 1, 2017, the lease agreement was renewed for a three year term with monthly rent payments of $25,000. There is a renewal option for another three year term at the end of the lease that was considered in valuing the ROU asset as of the adoption date of ASC Topic 842, and at the time we were reasonably certain we would exercise the renewal option. Amortization of the ROU assets and operating lease liabilities for the years ended December 31, 2019 and 2018 was $234,000 and $0, respectively. Rental expense incurred on operating leases for the years ended December 31, 2019 and 2018 was approximately $300,000 and $300,000, respectively.
 
As of December 31, 2019 we initiated the process to purchase the corporate office space back from our lessor and gave notice that we will not be exercising our option to renew for another three year term. The ROU asset and associated lease liabilities were revalued as of December 31, 2019 for the remaining two months of the lease term. This resulted in an adjustment of approximately $804,000 for the associated ROU, $250,000 for the operating lease liability, current portion, and $554,000 for the operating lease liability, net of current portion.
 
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 outstanding balance for finance leases was $116,000 and $144,000 as of December 31, 2019 and December 31, 2018, respectively. The Company recorded assets classified as property and equipment under finance lease obligations of $129,000 and $129,000 as of December 31, 2019 and December 31, 2018, respectively. Related accumulated depreciation totaled $41,000 and $15,000 as of December 31, 2019 and December 31, 2018, 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 $8,000 and $8,000 for the years ended December 31, 2019 and 2018, respectively. The interest rate on the finance lease obligation is 6.7% and interest expense was $9,000 and $4,000 for the years ended December 31, 2019 and 2018, respectively.
 
 
61
 
 
The maturity of operating leases and finance lease liabilities as of December 31, 2019 are as follows:
 
Year ending December 31,
 
Operating Leases
 
 
Finance Leases
 
2020
 $51 
 $36 
2021
  1 
  37 
2022
  - 
  36 
2023
  - 
  22 
2024
  - 
  - 
Total minimum lease payments
  52 
  131 
Less: amount representing interest
  (1)
  (15)
Present value of minimum lease payments
 $51 
 $116 
 
Lease term and discount rate
 
December 31,
2019
 
Weighted-average remaining lease term (years)
 
 
 
Operating leases
  0.3 
Finance leases
  3.6 
Weighted-average discount rate
    
Operating leases
  6.7%
Finance leases
  6.7%
 
 
 
Year Ended
December 31,
2019
 
Cash paid for amounts included in the measurement of lease liabilities:
 
 
 
Operating cash flows from operating leases
 $300 
Operating cash flows from finance leases
  9 
Financing cash flows from finance leases
  28 
 
 
62
 
 
We adopted ASC Topic 842 utilizing a practical expedient that does not require application to periods prior to adoption. As previously disclosed in our 2018 Annual Report on Form 10-K and under ASC Topic 840, the predecessor to Topic 842, future aggregate minimum lease obligations under the operating lease and sale-leaseback as of December 31, 2018, exclusive of taxes and insurance, are as follows (in thousands):
 
Year ending December 31,
 
 
 
2019
 $300 
2020
  50 
Total
 $350 

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. 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.
 
Revenue from sales-type leases is presented on a gross basis when the Company enters into a lease to realize value from a product that it would otherwise sell in its ordinary course of business, whereas in transactions where the company enters into a lease for the purpose of generating revenue by providing financing, the profit or loss, if any, is presented on a net basis. In addition, we have elected to account for sales tax and other similar taxes collected from a lessee as lessee costs and therefore we exclude these costs from contract consideration and variable consideration and present revenue net of these costs.
 
The components of lease income is as follows (in thousands):
 
 
 
Year Ended December 31,
 
 
 
2019
 
 
2018
 
Lease income - sales type
 $576 
 $205 
Interest income on lease receivables
  117 
  105 
Total lease income
  693 
  310 
 
Equipment finance receivables arising from the rental of our cloud telecommunications equipment through sales-type leases, were as follows (in thousands):
 
 
 
December 31,
 
 
 
2019
 
 
2018
 
Gross financing receivables
 $1,086 
 $392 
Less unearned income
  (382)
  (141)
Financing receivables, net
  704 
  251 
Less: Current portion of finance receivables, net
  (143)
  (67)
Finance receivables due after one year
 $561 
 $184 
 
 
63
 
 
Future minimum lease payments as of December 31, 2019, consisted of the following:
 
Year ending December 31,
 
Lease Receivables
 
2020
 $300 
2021
  289 
2022
  237 
2023
  177 
2024
  83 
Gross equipment financing receivables
  1,086 
Less: unearned income
  (382)
Equipment financing receivables, net
 $704 
 
18.            
Commitments and Contingencies
 
Annual Incentive Bonuses Accrual
 
We utilize incentive bonuses to reward performance achievements and have in place annual target incentive bonuses, payable either in whole or in part, depending on the extent to which the financial performance goals set by the Compensation Committee are achieved.  Under our 2019 Profit Sharing Plan, incentive bonuses for all of the participants, including the participating officers excluding the CEO, were determinable based upon two measures of corporate financial performance. For there to be any award to a participant, the following two criterial must be met (a) The revenue for the year ended December 31, 2019 must exceed the budgeted revenue approved by the Board; and (b) adjusted EBITDA must exceeds the budgeted adjusted EBITDA approved by the board. If the requirement of (a) are met there shall be an award pool of fifty (50) percent of the excess above the budgeted adjusted EBITDA, to be allocated to participants based on the participant’s proportionate share. The total maximum amount that may be placed in the pool would be $200,000 (which would require adjusted EBITDA to exceed target by $400,000). Both of these measures were met and the $200,000 was included in accrued expenses in the accompanying balance sheet as of December 31, 2019.
 
19.            
Employee Benefit Plan
 
We have established a retirement savings plan for eligible employees. The plan allows employees to contribute a portion of their pre-tax compensation in accordance with specified guidelines. For the years ended December 31, 2019 and 2018, we contributed approximately $123,000 and $115,000 to the retirement savings plan, respectively.
 
 
64
 
 
20.            
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/(loss) before income tax provision was as follows (in thousands):
 
 
 
 Year Ended December 31,
 
 
 
2019
 
 
2018
 
Revenue:
 
 
 
 
 
 
Cloud telecommunications
 $13,780 
 $11,083 
Web services
  656 
  825 
Consolidated revenue
  14,436 
  11,908 
 
    
    
Income/(loss) from operations:
    
    
Cloud telecommunications
  864 
  (613)
Web services
  271 
  407 
Total operating income/(loss)
  1,135 
  (206)
Other income/(expense), net:
    
    
Cloud telecommunications
  (2)
  5 
Web services
  12 
  (7)
Total other income/(expense), net
  10 
  (2)
Income/(loss) before income tax provision:
    
    
Cloud telecommunications
  862 
  (608)
Web services
  283 
  400 
Income/(loss) before income tax provision
 $1,145 
 $(208)

Depreciation and amortization was $90,000 and $86,000 for the Cloud Telecommunications segment for the years ended December 31, 2019 and 2018, respectively. Depreciation and amortization was $4,000 and $6,000 for the Web Services segment for the years ended December 31, 2019 and 2018, respectively.
 
Interest income was $6,000 and $7,000 for the Web Services segment for the years ended December 31, 2019 and 2018, respectively.
 
Interest expense was $11,000 and $12,000 for the Cloud Telecommunications segment for the years ended December 31, 2019 and 2018 respectively. Interest expense was $1,000 and $0 for the Web Services segment for the years ended December 31, 2019 and 2018, respectively.
 
 
65
 
 
21.            
Quarterly Financial Information (in thousands, unaudited)
 
 
 
For the three months ended
 
Consolidated
 
March 31,
2019
 
 
June 30,
2019
 
 
September 30,
2019
 
 
December 31,
2019
 
Service revenue
 $3,008 
 $3,147 
 $3,259 
 $3,331 
Product revenue
  484 
  467 
  343 
  397 
Total revenue
  3,492 
  3,614 
  3,602 
  3,728 
Operating expenses:
    
    
    
    
Cost of service revenue
  877 
  874 
  836 
  869 
Cost of product revenue
  249 
  243 
  172 
  231 
Selling and marketing
  899 
  963 
  1,003 
  997 
General and administrative
  1,014 
  997 
  1,040 
  1,184 
Research and development
  212 
  197 
  215 
  229 
Total operating expenses
  3,251 
  3,274 
  3,266 
  3,510 
Income from operations
  241 
  340 
  336 
  218 
Total other income/(expense), net
  1 
  2 
  (2)
  9 
Income before income taxes
  242 
  342 
  334 
  227 
Income tax benefit/(provision)
  (3)
  (4)
  - 
  1 
Net income
 $239 
 $338 
 $334 
 $228 
 
    
    
    
    
Basic earnings per common share (1)
 $0.02 
 $0.02 
 $0.02 
 $0.02 
Diluted earnings per common share (1)
 $0.02 
 $0.02 
 $0.02 
 $0.01 
 
 
66
 
 
 
 
For the three months ended
 
Consolidated
 
March 31,
2018
 
 
June 30,
2018
 
 
September 30,
2018
 
 
December 31,
2018
 
Service revenue
 $2,442 
 $2,540 
 $2,712 
 $2,767 
Product revenue
  366 
  437 
  314 
  330 
Total revenue
  2,808 
  2,977 
  3,026 
  3,097 
Operating expenses:
    
    
    
    
Cost of service revenue
  729 
  731 
  833 
  799 
Cost of product revenue
  187 
  201 
  161 
  178 
Selling and marketing
  829 
  767 
  910 
  897 
General and administrative
  945 
  1,034 
  1,101 
  1,011 
Research and development
  181 
  194 
  214 
  212 
Total operating expenses
  2,871 
  2,927 
  3,219 
  3,097 
Income/(loss) from operations
  (63)
  50 
  (193)
  - 
Total other income/(expense), net
  4 
  - 
  2 
  (8)
Income/(loss) before income taxes
  (59)
  50 
  (191)
  (8)
Income tax provision
  (4)
  (3)
  (8)
  - 
Net income/(loss)
 $(63)
 $47 
 $(199)
 $(8)
 
    
    
    
    
Basic earnings/(loss) per common share (1)
 $(0.00)
 $0.00 
 $(0.01)
 $(0.00)
Diluted earnings/(loss) per common share (1)
 $(0.00)
 $0.00 
 $(0.01)
 $(0.00)
 
———————
 
 (1) 
Earnings/(loss) per common share is computed independently for each of the quarters presented. Therefore, the sums of quarterly earnings/(loss) per common share amounts do not necessarily equal the total for the twelve month periods presented.
 
22.            
Subsequent Events
 
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. Simultaneously with the execution of the purchase agreement and the closing of the purchase of the Property, we entered into a Fixed Rate Term Loan Agreement with Bank of America, N.A. to finance Two Million Dollars ($2,000,000) of the purchase price. 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 office building.
 
 
67
 
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None
 
ITEM 9A.  CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13(a)-15(b) under the Exchange Act, as the end of the period covered by this annual report on Form 10-K.
 
Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2019 our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provided reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
 
Changes in Internal Control over Financial Reporting
 
There were no changes in our internal control over financial reporting that occurred during the year ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
Management's Report on Internal Control over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework). Based on this assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2019.
 
Limitations of Effectiveness of Control and Procedures
 
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
 
ITEM 9B.  OTHER INFORMATION
 
None
 
 
68
 
 
PART III
  
ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
Information with respect to this item will be set forth in the definitive proxy statement to be delivered to stockholders in connection with the 2020 Annual Meeting of Stockholders (the “Proxy Statement”). Such information is incorporated herein by reference.
 
We have adopted a code of ethics that applies to all employees, including employees of our subsidiaries, as well as each member of our Board of Directors. The code of ethics is available at our website at www.crexendo.com.
 
ITEM 11.  EXECUTIVE COMPENSATION
 
Information with respect to this item will be set forth in the Proxy Statement under the heading “Executive Compensation and Other Matters,” and is incorporated herein by reference.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
 
Information with respect to this item will be set forth in the Proxy Statement under the heading “Beneficial Ownership of Shares,” and is incorporated herein by reference.
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
Information with respect to this item will be set forth in the Proxy Statement under the heading “Corporate Governance” and is incorporated herein by reference.
 
ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
Information with respect to this item will be set forth in the Proxy Statement under the headings “Fees of Independent Registered Public Accounting Firm” and “Pre-Approval Policies and Procedures,” and is incorporated herein by reference.
 
 
69
 
 
PART IV
 
ITEM 15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
Documents filed as part of this Report:
 
1.
Financial Statements – consolidated financial statements of Crexendo, Inc. and subsidiaries as set forth under Item 8 of this Report.
2.
The Financial Statement Schedule on page 66 of this Annual Report.
3.
Exhibit Index as seen below.
EXHIBIT INDEX
 
 
 
 
 
Incorporated By Reference
 
Filed
Exhibit No.
 
Exhibit Description
 
Form
 
Date
 
Number
 
Herewith
2.1
 
Agreement and Plan of Merger dated February 28, 2000 by and among Netgateway, Inc., Galaxy Acquisition Corp. and Galaxy Enterprises, Inc.
 
8-K
 
3/21/00
 
10.1
 
 
3.1
 
Certificate of Incorporation
 
S-1
 
6/1/99
 
3.1
 
 
 
Certificate of Amendment to Certificate of Incorporation
 
S-1
 
9/7/00
 
3.1
 
 
 
Certificate of Amendment to Certificate of Incorporation
 
10-K
 
10/15/02
 
3.3
 
 
 
Amended and Restated Bylaws
 
10-Q
 
11/20/01
 
3.2
 
 
3.5
 
Certificate of Ownership and Merger (4)
 
S-1/A
 
11/12/99
 
3.3
 
 
3.6
 
Articles of Merger
 
S-1/A
 
11/12/99
 
3.4
 
 
 
Form of Common Stock Certificate
 
10-K
 
10/15/02
 
4.1
 
 
4.2*
 
Form of Representatives’ Warrant
 
S-1
 
6/1/99
 
4.1
 
 
4.3 
 
Description of Capital Stock 
 
10-K 
 
3/3/20 
 
  4.3
 
 X
10.1*
 
1998 Stock Compensation Program
 
S-1
 
6/1/99
 
10.6
 
 
 
Amended and Restated 1998 Stock Option Plan for Senior Executives
 
10-K
 
9/29/03
 
10.2
 
 
 
Amended and Restated 1999 Stock Option Plan for Non-Executives
 
10-K
 
9/29/03
 
10.3
 
 
 
2003 Equity Incentive Plan
 
10-K
 
9/10/04
 
10.11
 
 
 
2013 Long-Term Incentive Plan
 
14-A
 
4/30/13
 
 
 
 
 
Deed of Sale, dated February 28, 2014, from Crexendo, Inc. to SGM EXE, LLC.
 
8-K
 
3/4/14
 
10.1
 
 
10.8   
 
Lease Agreement dated as of March 1, 2014 between Crexendo, Inc. and SGM EXE, LLC.    
 
8-K
 
3/4/14
 
10.2
 
 
10.9  
 
Stock Purchase Agreement, dated December 24, 2014 between Crexendo, Inc. and CEO Steven G. Mihaylo  
 
8-K
 
12/24/14
 
10.1
 
 
10.10  
 
Term Loan Agreement, dated December 31, 2015 between Crexendo, Inc. and CEO Steven G. Mihaylo  
 
8-K
 
12/31/15
 
10.1
 
 
 
Amendment to a term Loan Agreement, dated June 28, 2016, between Crexendo, Inc. and Steven G. Mihaylo, as Trustee of the Steven G. Mihaylo Trust dated August 19, 1999
 
8-K
 
6/30/16
 
10.1
 
 
 
Reincorporation in state of Nevada for Crexendo, Inc. (Nevada) Articles of Incorporation
 
8-K
 
12/14/16
 
3.1
 
 
 
Reincorporation in state of Nevada for Crexendo, Inc. (Nevada) bylaws
 
8-K
 
12/14/16
 
3.2
 
 
 
Amendment to a term Loan Agreement, dated February 27, 2017, between Crexendo, Inc. and Steven G. Mihaylo, as Trustee of the Steven G. Mihaylo Trust dated August 19, 1999
 
8-K
 
2/28/17
 
10.1
 
 
 
Purchase and Sale Agreement with an effective date of January 27, 2020 by and among SGM EXE, LLC, Seller and Crexendo, Business Solutions, Inc. Purchaser.
 
8-K
 
1/29/2020
 
10.1
 
 
 
Loan Agreement between Bank of America, N.A. and Crexendo Business Solutions, Inc. dated January 22 2020, entered into on January 27, 2020.
 
8-K
 
1/29/2020
 
10.2
 
 
 
Subsidiaries of Crexendo, Inc.
 
 
 
 
 
 
 
X
 
Consent of Independent Registered Public Accounting Firm (Urish Popeck & Co., LLC)
 
 
 
 
 
 
 
X
 
Certification Pursuant to Rules 13a-14(a) under the Securities Exchange Act of 1934 as amended
 
 
 
 
 
 
 
X
 
Certification Pursuant to Rules 13a-14(a) under the Securities Exchange Act of 1934 as amended
 
 
 
 
 
 
 
X
 
Certification Pursuant to 18 U.S.C. Section 1350
 
 
 
 
 
 
 
X
 
Certification Pursuant to 18 U.S.C. Section 1350
 
 
 
 
 
 
 
X
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
 
 
 
 
 
 
 
 
———————
* Indicates a management contract or compensatory plan or arrangement.
 
 
70
 
 
SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) 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.
 
 
 
Date: March 3, 2020
By:
/s/ Steven G. Mihaylo
 
 
Steven G. Mihaylo
Chief Executive Officer
 
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
Date: March 3, 2020
By:
/s/ Steven G. Mihaylo
 
 
Steven G. Mihaylo
Chief Executive Officer, Chairman of the Board of Directors
 
 
 
 
 
Date: March 3, 2020
By:
/s/ Ronald Vincent
 
 
Ronald Vincent
Chief Financial Officer
 
 
 
Date: March 3, 2020
By:
/s/ Todd Goergen  
 
 
Todd Goergen Director  
 
 
 
Date: March 3, 2020
By:
/s/ Jeffrey P. Bash  
 
 
Jeffrey P. Bash Director  
 
 
 
Date: March 3, 2020
By:
/s/ David Williams
 
 
David Williams
Director
 
Date: March 3, 2020
By:
/s/ Anil Puri
 
 
Anil Puri
Director
 
 
71
 
 
CREXENDO, INC. AND SUBSIDIARIES
Schedule II- Valuation and Qualifying Accounts
 
 
 
Balance at
 
 
 
 
 
 
 
 
Balance at
 
 
 
Beginning
 
 
 
 
 
 
 
 
End of
 
 
 
of Year
 
 
Additions
 
 
Deductions
 
 
Year
 
 
 
 
 
 
(in thousands)
 
 
 
 
Year ended December 31, 2019
 
 
 
 
 
 
 
 
 
 
 
 
    Allowance for doubtful accounts receivable
 $14 
  - 
  - 
 $14 
    Deferred income tax asset valuation allowance
 $8,755 
  - 
  (1,207)
 $7,548 
Year ended December 31, 2018
    
    
    
    
    Allowance for doubtful accounts receivable
 $29 
  - 
  (15)
 $14 
    Deferred income tax asset valuation allowance
 $9,338 
  - 
  (583)
 $8,755 
 
 
 
 
 
 
 
72
 
Exhibit 4.3
 
DESCRIPTION OF CAPITAL STOCK
 
The following is a description of the capital stock of Crexendo, Inc. (the “Company”) and certain provisions of the Company’s Articles of Incorporation, as amended (“Articles”), Bylaws, as amended (“Bylaws”), and certain provisions of applicable law. The following is only a summary and is qualified by applicable law and by the provisions of the Company’s Articles and Bylaws, copies of which have been filed with the Securities and Exchange Commission (“SEC”) and are also available upon request from the Company.
 
General
 
Under our Articles of Incorporation, as amended, we have authority to issue up to 30,000,000, par value $0.001 per share, of which 25,000,000 shares shall be designated as Common Shares and 5,000,000 shall be designated as Preferred Stock. Each share of our common stock has the same relative rights as, and is identical in all respects to, each other share of our common stock.
 
Authority to issue shares is expressly granted to the Board of Directors of Crexendo, Inc. (or a committee thereof designated by the Board of Directors pursuant to the Bylaws of Crexendo, Inc. as amended from time to time) to issue the Preferred Shares from time to time as Preferred Shares of any series and declare and pay dividends thereon in accordance with the terms thereof in connection with the creation of each such series, to fix by resolution or resolutions providing for the issuance of shares thereof, the number of such shares, the designations, powers, preferences, and rights (including voting rights) and the qualifications, limitations, and restrictions of such series, subject to the full extent and not or hereafter permitted by the laws of the state of Nevada.
 
As of December 31, 2019, 14,884,755 shares of our common stock were issued and outstanding, and 5,001,214 shares of common stock were reserved for issuance pursuant to the Company’s incentive stock-based compensation plan. Our common stock is listed on the OTCQX Marketplace. The outstanding shares of our common stock are validly issued, fully paid and non-assessable.
 
As of December 31, 2019, no shares of our preferred stock were issued and outstanding. The Company has no present plans to issue any shares of its preferred stock.
 
Certain Provisions of the Articles and Bylaws
 
Annual Meeting. A meeting of the shareholders for the election of directors and for the transaction of such other business as may properly come before the meeting shall be held at such date, time and place, if any, as shall be determined by the Board of Directors and stated in the notice of the meeting.
 
Notice of Meetings. Notice of the place, if any, date, hour, the record date for determining the shareholders entitled to vote at the meeting (if such date is different from the record date for shareholders entitled to notice of the meeting) and means of remote communication, if any, of every meeting of shareholders shall be given by the Corporation not less than ten days nor more than 60 days before the meeting (unless a different time is specified by law) to every stockholder entitled to vote at the meeting as of the record date for determining the shareholders entitled to notice of the meeting. Notices of special meetings shall also specify the purpose or purposes for which the meeting has been called. Except as otherwise provided herein or permitted by applicable law, notice to shareholders shall be in writing and delivered personally or mailed to the shareholders at their address appearing on the books of the Corporation. Without limiting the manner by which notice otherwise may be given effectively to shareholders, notice of meetings may be given to shareholders by means of electronic transmission in accordance with applicable law. Notice of any meeting need not be given to any stockholder who shall, either before or after the meeting, submit a waiver of notice or who shall attend such meeting, except when the stockholder attends for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Any stockholder so waiving notice of the meeting shall be bound by the proceedings of the meeting in all respects as if due notice thereof had been given.
 
Voting; Proxies. Unless otherwise required by law or the Certificate of Incorporation the election of directors shall be by decided by a plurality of the votes cast at a meeting of the shareholders by the holders of stock entitled to vote in the election. Unless otherwise required by law, the Certificate of Incorporation or these by-laws, any matter, other than the election of directors, brought before any meeting of shareholders shall be decided by the affirmative vote of the majority of shares present in person or represented by proxy at the meeting and entitled to vote on the matter. Each stockholder entitled to vote at a meeting of shareholders or to express consent to corporate action in writing without a meeting may authorize another person or persons to act for such stockholder by proxy, but no such proxy shall be voted or acted upon after three years from its date, unless the proxy provides for a longer period. A proxy shall be irrevocable if it states that it is irrevocable and if, and only as long as, it is coupled with an interest sufficient in law to support an irrevocable power. A stockholder may revoke any proxy which is not irrevocable by attending the meeting and voting in person or by delivering to the secretary of the Corporation a revocation of the proxy or a new proxy bearing a later date. Voting at meetings of shareholders need not be by written ballot.
 
 
 
  
Written Consent of Shareholders Without a Meeting. The Bylaws provide that any action to be taken at any annual or special meeting of shareholders may be taken without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action to be so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and shall be delivered (by hand or by certified or registered mail, return receipt requested) to the Corporation by delivery to its registered office in the State of Nevada, its principal place of business or an officer or agent of the Corporation having custody of the book in which proceedings of meetings of shareholders are recorded. Every written consent shall bear the date of signature of each stockholder who signs the consent, and no written consent shall be effective to take the corporate action referred to therein unless, within 60 days of the earliest dated consent delivered in the manner required by the By-laws, written consents signed by a sufficient number of holders to take action are delivered to the Corporation as aforesaid. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall, to the extent required by applicable law, be given to those shareholders who have not consented in writing, and who, if the action had been taken at a meeting, would have been entitled to notice of the meeting if the record date for notice of such meeting had been the date that written consents signed by a sufficient number of holders to take the action were delivered to the Corporation. 
 
Right of Indemnification. The Bylaws provide that Each director or officer of the corporation, whether or not then in office, and any person whose testator or intestate was such a director or officer, shall be indemnified by the corporation for the defense of, or in connection with, any threatened, pending or completed actions or proceedings and appeals therein, whether civil, criminal, administrative or investigative, in accordance with and to the fullest extent permitted by the Business Corporation Law of the State of Nevada or other applicable law, as such law now exists or may hereafter be adopted or amended, against, without limitation, all judgments, fines, amounts paid in settlements, and all expenses, including attorneys' and other experts' fees, costs and disbursements, actually and reasonably incurred by such person as a result of such action or proceeding, or actually and reasonably incurred by such person.
 
Dividends. Subject to applicable law and the Certificate of Incorporation, dividends upon the shares of capital stock of the Corporation may be declared by the Board of Directors at any regular or special meeting of the Board of Directors. Dividends may be paid in cash, in property or in shares of the Corporation's capital stock, unless otherwise provided by applicable law or the Certificate of Incorporation.
 
Transfer Agent. The transfer agent and registrar for our common stock is Direct Transfer, LLC, One Glenwood Ave, Suite 1001, Raleigh, NC 27603.
 
 
 
 
 
EXHIBIT 21.1
 
SUBSIDIARIES OF THE REGISTRANT
 
 
 
 
 
 
 
 
State of their jurisdiction of
 
Other names under
 
     
incorporation or
 
which subsidiary does
Name of subsidiary
 
organization
 
business
Crexendo Business Solutions, Inc.
 
 
Arizona
 
 
None
 
Crexendo International, Inc.
 
 
Arizona
 
 
None
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
EXHIBIT 23.1
 
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
We consent to the incorporation by reference in Registration Statements No. 333-120433 and No. 333-190636 on Form S-8 of our report dated March 3, 2020, relating to the consolidated financial statements and financial statement schedule of Crexendo, Inc. and subsidiaries appearing in this Annual Report on Form 10-K of Crexendo Inc. and subsidiaries for the year ended December 31, 2019.
 
/s/ URISH POPECK & CO., LLC
 
 
Pittsburgh, PA
March 3, 2020
 
 
 
EXHIBIT 31.1
 
 
I, Steven G. Mihaylo, certify that:
 
1.            
I have reviewed this Annual Report on Form 10-K of Crexendo, Inc.;
 
2. 
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3. 
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4. 
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
 
(a) 
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
(b) 
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
(c) 
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
(d) 
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5. 
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
 
 
 
Date: March 3, 2020
 
/s/ Steven G. Mihaylo
 
 
Steven G. Mihaylo
 
 
Chief Executive Officer
 
 
EXHIBIT 31.2
 
 
I, Ronald Vincent, certify that:
 
1.            
I have reviewed this Annual Report on Form 10-K of Crexendo, Inc.;
 
2. 
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3. 
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4. 
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
(a) 
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
(b) 
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
(c) 
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
(d) 
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5. 
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 
 
 
 
Date: March 3, 2020
 
 
/s/ Ronald Vincent
 
 
Ronald Vincent
 
 
Chief Financial Officer
 
 
EXHIBIT 32.1
 
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
 
 
In connection with the Crexendo, Inc. (the Company) Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Steven G. Mihaylo, Chief Executive Officer of the Company, do hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:
 
1. 
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended; and
 
2. 
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
 
 
 
Date: March 3, 2020
 
 
/s/ Steven G. Mihaylo
 
 
Steven G. Mihaylo
 
 
Chief Executive Officer
 
 
EXHIBIT 32.2
 
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
 
 
In connection with the Crexendo, Inc. (the Company) Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Ronald Vincent, Chief Financial Officer of the Company, do hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:
 
1. 
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended; and
 
2. 
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
 
 
 
Date: March 3, 2020
 
 
/s/ Ronald Vincent
 
 
Ronald Vincent
 
 
Chief Financial Officer