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Crexendo
10-Q 2019-09-30 Quarter: 2019-09-30
10-Q 2019-06-30 Quarter: 2019-06-30
10-Q 2019-03-31 Quarter: 2019-03-31
10-K 2018-12-31 Annual: 2018-12-31
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
10-Q 2015-09-30 Quarter: 2015-09-30
10-Q 2015-06-30 Quarter: 2015-06-30
10-Q 2015-03-31 Quarter: 2015-03-31
10-K 2014-12-31 Annual: 2014-12-31
10-Q 2014-09-30 Quarter: 2014-09-30
10-Q 2014-06-30 Quarter: 2014-06-30
10-Q 2014-03-31 Quarter: 2014-03-31
10-K 2013-12-31 Annual: 2013-12-31
8-K 2019-11-11 Shareholder Vote
8-K 2019-11-05 Earnings, Exhibits
8-K 2019-09-04 Regulation FD, Exhibits
8-K 2019-08-06 Earnings, Exhibits
8-K 2019-06-03 Regulation FD, Exhibits
8-K 2019-04-30 Earnings, Exhibits
8-K 2019-03-05 Earnings, Exhibits
8-K 2018-11-06 Earnings, Exhibits
8-K 2018-09-05 Regulation FD, Exhibits
8-K 2018-08-02 Earnings, Exhibits
8-K 2018-06-25 Shareholder Vote
8-K 2018-05-22 Regulation FD, Exhibits
8-K 2018-03-12 Regulation FD, Exhibits
LFIN Longfin 2,124
INDU Industrea Acquisition 577
SNYR Synergy Chc 29
CRTG Coretec Group 6
CLSH CLS Holdings 0
LACP Lake Area Corn Processors 0
MMEX MMEX Resources 0
ENTB Entest Group 0
GTVI Joway Health Industries 0
JAKRO Jakroo 0
EXE 2019-09-30
EX-31.1 cxdo_ex311.htm
EX-31.2 cxdo_ex312.htm
EX-32.1 cxdo_ex321.htm
EX-32.2 cxdo_ex322.htm

Crexendo Earnings 2019-09-30

EXE 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

10-Q 1 cxdo_10q.htm QUARTERLY REPORT Blueprint
   

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
———————
 
FORM 10-Q
———————
 
(Mark One)
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2019
 
OR
 
 TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
For the transition period from ________ to ________.
 
Commission file number 001-32277
 
———————
 
 
Crexendo, Inc.
(Exact name of registrant as specified in its charter)
 
———————
 
Nevada
87-0591719
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
 
1615 South 52nd Street, Tempe, AZ
85281
(Address of Principal Executive Offices)
(Zip Code)
 
(602) 714-8500
 (Registrant’s telephone number, including area code)
 
 
 (Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes   No   
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   No 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (check one).
 
Large accelerated filer
 
 
Accelerated filer
 
Non-accelerated filer
 
(Do not check if a smaller reporting company)
Smaller reporting company
 
 
 
 
 
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐  
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐  No ☑.
 
The number of shares outstanding of the registrant’s common stock as of October 31, 2019 was 14,714,576.
 

 
 
INDEX
 
 

Page
 
 
Financial Statements
 3
Management's Discussion and Analysis of Financial Condition and Results of Operations
24
Quantitative and Qualitative Disclosures about Market Risk
38
Controls and Procedures
38
 

Legal Proceedings
39
Risk Factors
39
Unregistered Sales of Equity Securities and Use of Proceeds
39
Exhibits
40
  
41
 
 
 
 
 
PART I - FINANCIAL INFORMATION
 
Item 1. 
Financial Statements.
 
CREXENDO, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited, in thousands, except par value and share data)
 
 
 
 
September 30,
2019
 
 
 
December 31,
2018
 
Assets
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 $3,308 
 $1,849 
Restricted cash
  100 
  100 
Trade receivables, net of allowance for doubtful accounts of $28
    
    
as of September 30, 2019 and $14 as of December 31, 2018
  434 
  419 
Contract assets
  14 
  12 
Inventories
  162 
  270 
Equipment financing receivables
  126 
  67 
Contract costs
  367 
  371 
Prepaid expenses
  401 
  244 
Income tax receivable
  3 
  1 
Total current assets
  4,915 
  3,333 
 
    
    
Long-term trade receivables, net of allowance for doubtful accounts
    
    
of $0 as of September 30, 2019 and December 31, 2018
  6 
  10 
Long-term equipment financing receivables, net
  467 
  184 
Property and equipment, net
  167 
  124 
Operating lease right-of-use assets
  915 
  - 
Intangible assets, net
  127 
  167 
Goodwill
  272 
  272 
Contract costs, net of current portion
  414 
  342 
Other long-term assets
  103 
  117 
Total Assets
 $7,386 
 $4,549 
 
    
    
Liabilities and Stockholders' Equity
    
    
Current liabilities:
    
    
Accounts payable
 $92 
 $155 
Accrued expenses
  1,418 
  1,131 
Finance leases
  29 
  28 
Notes payable
  4 
  56 
Operating lease liabilities
  247 
  - 
Contract liabilities
  764 
  641 
Total current liabilities
  2,554 
  2,011 
 
    
    
Contract liabilities, net of current portion
  419 
  422 
Finance leases, net of current portion
  94 
  116 
Operating lease liabilities, net of current portion
  668 
  - 
Total liabilities
  3,735 
  2,549 
 
    
    
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, 14,711,474
    
    
shares issued and outstanding as of September 30, 2019 and 14,394,113 shares issued
    
    
and outstanding as of December 31, 2018
  15 
  14 
Additional paid-in capital
  61,892 
  61,153 
Accumulated deficit
  (58,256)
  (59,167)
Total stockholders' equity
  3,651 
  2,000 
 
    
    
Total Liabilities and Stockholders' Equity
 $7,386 
 $4,549 
 
The accompanying notes are an integral part of the condensed consolidated financial statements.
 
 
3
 
 
CREXENDO, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited, in thousands, except per share and share data)
 
 
 
Three Months Ended September 30,
 
 
Nine Months Ended September 30,
 
 
 
2019
 
 
2018
 
 
2019
 
 
2018
 
Service revenue
 $3,259 
 $2,712 
 $9,414 
 $7,694 
Product revenue
  343 
  314 
  1,294 
  1,117 
Total revenue
  3,602 
  3,026 
  10,708 
  8,811 
 
    
    
    
    
Operating expenses:
    
    
    
    
Cost of service revenue
  836 
  833 
  2,587 
  2,293 
Cost of product revenue
  172 
  161 
  664 
  549 
Selling and marketing
  1,003 
  910 
  2,865 
  2,506 
General and administrative
  1,040 
  1,101 
  3,051 
  3,080 
Research and development
  215 
  214 
  624 
  589 
Total operating expenses
  3,266 
  3,219 
  9,791 
  9,017 
 
    
    
    
    
Income/(loss) from operations
  336 
  (193)
  917 
  (206)
 
    
    
    
    
Other income/(expense):
    
    
    
    
Interest income
  1 
  1 
  4 
  5 
Interest expense
  (1)
  (5)
  (9)
  (8)
Other income/(expense), net
  (2)
  6 
  6 
  9 
Total other income/(expense), net
  (2)
  2 
  1 
  6 
 
    
    
    
    
Income/(loss) before income tax
  334 
  (191)
  918 
  (200)
 
    
    
    
    
Income tax provision
  - 
  (8)
  (7)
  (15)
 
    
    
    
    
Net income/(loss)
 $334 
 $(199)
 $911 
 $(215)
 
    
    
    
    
Earnings/(loss) per common share:
    
    
    
    
Basic
 $0.02 
 $(0.01)
 $0.06 
 $(0.02)
Diluted
 $0.02 
 $(0.01)
 $0.06 
 $(0.02)
 
    
    
    
    
Weighted-average common shares outstanding:
    
    
    
    
Basic
  14,663,151 
  14,346,092 
  14,507,696 
  14,311,190 
Diluted
  15,629,647 
  14,346,092 
  15,444,063 
  14,311,190 
 
The accompanying notes are an integral part of the condensed consolidated financial statements.
 
 
4
 
 
CREXENDO, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Stockholders' Equity
(Unaudited, in thousands, except share data)
 
 
 
For the Nine Month Period Ended September 30, 2019
 
 
 
 
 
 
 
 
 
Additional
 
 
 
 
 
Total
 
 
 
Common Stock
 
 
Paid-in
 
 
Accumulated
 
 
Stockholders'
 
 
 
Shares
 
 
Amount
 
 
Capital
 
 
Deficit
 
 
Equity
 
Balance, January 1, 2019
  14,394,113 
 $14 
 $61,153 
 $(59,167)
 $2,000 
Share-based compensation
  - 
  - 
  91 
  - 
  91 
Vesting of restricted stock units
  2,494 
  - 
  - 
  - 
  - 
Net income
  - 
  - 
  - 
  239 
  239 
Balance, March 31, 2019
  14,396,607 
 $14 
 $61,244 
 $(58,928)
 $2,330 
Share-based compensation
  - 
  - 
  95 
  - 
  95 
Vesting of restricted stock units
  7,498 
  - 
  - 
  - 
  - 
Issuance of common stock for exercise of stock options
  177,379 
  1 
  271 
  - 
  272 
Net income
  - 
  - 
  - 
  338 
  338 
Balance, June 30, 2019
  14,581,484 
 $15 
 $61,610 
 $(58,590)
 $3,035 
Share-based compensation
  - 
  - 
  107 
  - 
  107 
Vesting of restricted stock units
  7,496 
  - 
  - 
  - 
  - 
Issuance of common stock for exercise of stock options
  122,494 
  - 
  175 
  - 
  175 
Net income
  - 
  - 
  - 
  334 
  334 
Balance, September 30, 2019
  14,711,474 
 $15 
 $61,892 
 $(58,256)
 $3,651 
 
 
 
For the Nine Month Period Ended September 30, 2018
 
 
 
 
 
 
 
 
 
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
  - 
  - 
  62 
  - 
  62 
Issuance of common stock for exercise of stock options
  1,100 
  - 
  2 
  - 
  2 
Net loss
  - 
  - 
  - 
  (63)
  (63)
Balance, March 31, 2018
  14,288,656 
 $14 
 $60,624 
 $(59,007)
 $1,631 
Share-based compensation
  - 
  - 
  113 
  - 
  113 
Issuance of common stock for exercise of stock options
  19,813 
  - 
  28 
  - 
  28 
Net income
  - 
  - 
  - 
  47 
  47 
Balance, June 30, 2018
  14,308,469 
 $14 
 $60,765 
 $(58,960)
 $1,819 
Share-based compensation
  - 
  - 
  169 
  - 
  169 
Issuance of common stock for exercise of stock options
  85,644 
  - 
  125 
  - 
  125 
Net loss
  - 
  - 
  - 
  (199)
  (199)
Balance, September 30, 2018
  14,394,113 
 $14 
 $61,059 
 $(59,159)
 $1,914 
 
The accompanying notes are an integral part of the condensed consolidated financial statements.
 
 
5
 
CREXENDO, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)
 
 
 
Nine Months Ended September 30,
 
 
 
2019
 
 
2018
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
 
 
Net income/(loss)
 $911 
 $(215)
Adjustments to reconcile net income/(loss) to net cash provided by/(used for) operating activities:
    
    
Depreciation and amortization
  69 
  66 
Share-based compensation
  293 
  344 
Changes in assets and liabilities:
    
    
Trade receivables
  (11)
  11 
Contract assets
  (2)
  (6)
Equipment financing receivables
  (342)
  (24)
Inventories
  108 
  (162)
Contract costs
  (68)
  18 
Prepaid expenses
  (157)
  (2)
Income tax receivable
  (2)
  (2)
Other assets
  14 
  24 
Accounts payable and accrued expenses
  224 
  291 
Contract liabilities
  120 
  7 
Net cash provided by operating activities
  1,157 
  350 
 
    
    
CASH FLOWS FROM INVESTING ACTIVITIES
    
    
Purchase of property and equipment
  (72)
  (136)
Net cash used for investing activities
  (72)
  (136)
 
    
    
CASH FLOWS FROM FINANCING ACTIVITIES
    
    
Proceeds from capital lease obligations
  - 
  154 
Repayments made on finance leases
  (21)
  (4)
Proceeds from notes payable
  - 
  113 
Repayments made on notes payable
  (52)
  (118)
Proceeds from exercise of options
  447 
  155 
Net cash provided by financing activities
  374 
  300 
 
    
    
NET INCREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH
  1,459 
  514 
 
    
    
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT THE BEGINNING OF THE PERIOD
  1,949 
  1,382 
 
    
    
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT THE END OF THE PERIOD
 $3,408 
 $1,896 
 
    
    
Cash used during the year for:
    
    
Income taxes, net
 $(9)
 $(17)
Interest expense
  (9)
  (8)
Supplemental disclosure of non-cash investing and financing information:
    
    
 
The accompanying notes are an integral part of the condensed consolidated financial statements.
 
 
6
 
 
CREXENDO, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (unaudited)
 
 
1.            
Significant Accounting Policies
 
Description of Business – Crexendo, Inc. is incorporated in the state of Nevada. As used hereafter in the notes to condensed 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 (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.
 
Basis of Presentation – The condensed 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 condensed 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 condensed consolidated financial statements reflect the results of operations, financial position, changes in stockholders’ equity, and cash flows of our Company.
 
 Cash and Cash Equivalents – We consider all highly liquid, short-term investments with maturities of three months or less at the time of purchase to be cash equivalents. As of September 30, 2019 and December 31, 2018, we had cash and cash equivalents in financial institutions in excess of federally insured limits in the amount of $3,254,000 and $1,645,000, respectively.
 
Restricted Cash – We classified $100,000 and $100,000 as restricted cash as of September 30, 2019 and December 31, 2018, respectively. Cash is restricted for compensating balance requirements on purchasing card agreements. As of September 30, 2019 and December 31, 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 condensed consolidated statement of cash flows (in thousands):
 
 
 
September 30,
 
 
September 30,
 
 
 
2019
 
 
2018
 
Cash and cash equivalents
 $3,308 
 $1,796 
Restricted cash
  100 
  100 
Total cash, cash equivalents, and restricted cash shown in the condensed
    
    
   consolidated statement of cash flows
 $3,408 
 $1,896 
 
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 $781,000 and $713,000 at September 30, 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 three months ended September 30, 2019 and 2018, the Company amortized $127,000 and $125,000 respectively, and there was no impairment loss in relation to the costs capitalized. During the nine months ended September 30, 2019 and 2018, the Company amortized $376,000 and $352,000, respectively, and there was no impairment loss in relation to the costs capitalized.
 
 
7
 
 
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 $12,000 and $8,000 for the three months ended September 30, 2019 and 2018, respectively and $29,000 and $12,000 for the nine months ended September 30, 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.
 
Goodwill – Goodwill is tested for impairment using a fair-value-based approach on an annual basis (December 31) and between annual tests if indicators of potential impairment exist.
 
Intangible Assets – Our intangible assets consist of customer relationships. The intangible assets are amortized following the patterns in which the economic benefits are consumed. We periodically review the estimated useful lives of our intangible assets and review these assets for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. The determination of impairment is based on estimates of future undiscounted cash flows. If an intangible asset is considered to be impaired, the amount of the impairment will be equal to the excess of the carrying value over the fair value of the asset.
 
Contract Liabilities – Our contract liabilities consist primarily of advance consideration received from customers for telecommunications contracts. The product and monthly service revenue is recognized on completion of the implementation and the remaining activation fees are reclassified as deferred revenue.
 
Use of Estimates – In preparing the condensed 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 condensed 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, 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.
 
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.
 
 
8
 
 
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. Estimated cost of product warranties is included in accrued expenses (see Note 8).
 
Research and Development – Research and development costs are expensed as incurred. Costs related to internally developed software are expensed as research and development expense until technological feasibility has been achieved, after which the costs are capitalized.
 
Fair Value Measurements – The fair value of our financial assets and liabilities was determined based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following: 
 
Level 1 — Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.
 
Level 2 — Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:
 
·      Quoted prices for similar assets or liabilities in active markets;
·      Quoted prices for identical or similar assets in non-active markets;
·      Inputs other than quoted prices that are observable for the asset or liability; and
·      Inputs that are derived principally from or corroborated by other observable market data.
 
Level 3 — Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment.  These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.
 
Lease Obligations – We determine if an agreement is a lease at inception. We evaluate the lease terms to determine whether the lease will be accounted for as an operating or finance lease. Operating leases are included in operating lease right-of-use (“ROU”) assets, operating lease liabilities, current portion, and operating lease liabilities, net of current portion in our condensed 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 condensed 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 condensed consolidated statements of operations.
 
 
9
 
  
Stock-Based Compensation For equity-classified awards, compensation expense is recognized over the requisite service period based on the computed fair value on the grant date of the award.  Equity classified awards include the issuance of stock options and restricted stock units (“RSUs”).
 
Comprehensive Income/(Loss) – There were no other components of comprehensive income/(loss) other than net income/(loss) for the three and nine months ended September 30, 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 three and nine months ended September 30, 2019 and 2018. No customer accounted for 10% or more of our total trade accounts receivable as of September 30, 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 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 condensed consolidated statement of operations or our condensed 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 condensed 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 condensed consolidated financial statements.
 
 
10
 
 
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.
 
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 condensed 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 condensed 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 condensed 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 is in the process of evaluating the potential impact of this new ASU on our condensed consolidated financial statements.
 
2.            
Changes in Accounting Principles
 
Except for the changes below, the Company has consistently applied the accounting principles to all periods presented in these condensed 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 condensed consolidated statement of operations or our condensed consolidated statement cash flows.
 
 
11
 
 
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 13.
 
Cloud Telecommunications Segment
 
Products and services may be sold separately or in bundled packages. The typical length of a contract for service is thirty-six to sixty months. Customers are billed for these services on a monthly basis. For bundled packages, the Company accounts for individual products and services separately if they are distinct – i.e. if a product or service is separately identifiable from other items in the bundled package and if a customer can benefit from it on its own or with other resources that are readily available to the customer. The consideration (including any discounts) is allocated between separate products and services in a bundle based on their relative stand-alone selling prices. The stand-alone selling prices are determined based on the prices at which the Company separately sells the desktop devices and telecommunication services. For items that are not sold separately (e.g. additional features) the Company estimates stand-alone selling prices using the adjusted market assessment approach. When we provide a free trial period, we do not begin to recognize recurring revenue until the trial period has ended and the customer has been billed for the services.
 
Desktop Devices – Revenue generated from the sale of telecommunications equipment (desktop devices) is recognized when the customer takes possession of the devices and the cloud telecommunications services begin. The Company typically bills and collects the fees for the equipment upon entering into a contract with a customer. Cash receipts are recorded as a contract liability until implementation is complete and the services begin.
 
Equipment Financing Revenue – Fees generated from renting our cloud telecommunication equipment (IP or cloud telephone desktop devices) through leasing contracts are recognized as revenue based on whether the lease qualifies as an operating lease or sales-type lease. The two primary accounting provisions which we use to classify transactions as sales-type or operating leases are: 1) lease term to determine if it is equal to or greater than 75% of the economic life of the equipment and 2) the present value of the minimum lease payments to determine if they are equal to or greater than 90% of the fair market value of the equipment at the inception of the lease. The economic life of most of our products is estimated to be three years, since this represents the most frequent contractual lease term for our products, and there is no residual value for used equipment. Residual values, if any, are established at the lease inception using estimates of fair value at the end of the lease term. The vast majority of our leases that qualify as sales-type leases are non-cancelable and include cancellation penalties approximately equal to the full value of the lease receivables. Leases that do not meet the criteria for sales-type lease accounting are accounted for as operating leases. Revenue from sales-type leases is recognized upon installation and the interest portion is deferred and recognized as earned. Revenue from operating leases in recognized ratably over the applicable service period.
 
Cloud Telecommunications Services – 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.
 
 
12
 
 
Disaggregation of Revenue
 
In the following table, revenue is disaggregated by primary major product line, and timing of revenue recognition. The table also includes a reconciliation of the disaggregated revenue with the reportable segments.
 
Three Months Ended September 30, 2019
 
Cloud
 
 
 
 
 
Total
 
(In thousands)
 
Telecommunications
 
 
Web Services
 
 
Reportable
 
 
 
Segment
 
 
Segment
 
 
Segments
 
Major products/services lines
 
 
 
 
 
 
 
 
 
Desktop devices
 $343 
 $- 
 $343 
Equipment financing revenue
  30 
  - 
  30 
Telecommunications services
  2,813 
  - 
  2,813 
Fees, commissions, and other, recognized over time
  176 
  - 
  176 
One time fees, commissions and other
  81 
  - 
  81 
Website hosting services
  - 
  146 
  146 
Website management services and other
  - 
  13 
  13 
 
 $3,443 
 $159 
 $3,602 
Timing of revenue recognition
    
    
    
Products and fees recognized at a point in time
 $424 
 $- 
 $424 
Services and fees transferred over time
  3,019 
  159 
  3,178 
 
 $3,443 
 $159 
 $3,602 
  
Three Months Ended September 30, 2018
 
Cloud
 
 
 
 
 
Total
 
(In thousands)
 
Telecommunications
 
 
Web Services
 
 
Reportable
 
 
 
Segment
 
 
Segment
 
 
Segments
 
Major products/services lines
 
 
 
 
 
 
 
 
 
Desktop devices
 $314 
 $- 
 $314 
Equipment financing revenue
  24 
  - 
  24 
Telecommunications services
  2,305 
  - 
  2,305 
Fees, commissions, and other, recognized over time
  162 
  - 
  162 
One time fees, commissions and other
  18 
  - 
  18 
Website hosting services
  - 
  167 
  167 
Website management services and other
  - 
  36 
  36 
 
 $2,823 
 $203 
 $3,026 
Timing of revenue recognition
    
    
    
Products and fees recognized at a point in time
 $332 
 $- 
 $332 
Services and fees transferred over time
  2,491 
  203 
  2,694 
 
 $2,823 
 $203 
 $3,026 
 
 
13
 
 
Nine Months Ended September 30, 2019
 
Cloud
 
 
 
 
 
Total
 
(In thousands)
 
Telecommunications
 
 
Web Services
 
 
Reportable
 
 
 
Segment
 
 
Segment
 
 
Segments
 
Major products/services lines
 
 
 
 
 
 
 
 
 
Desktop devices
 $1,294 
 $- 
 $1,294 
Equipment financing revenue
  79 
  - 
  79 
Telecommunications services
  7,949 
  - 
  7,949 
Fees, commissions, and other, recognized over time
  575 
  - 
  575 
One time fees, commissions and other
  309 
  - 
  309 
Website hosting services
  - 
  444 
  444 
Website management services and other
  - 
  58 
  58 
 
 $10,206 
 $502 
 $10,708 
Timing of revenue recognition
    
    
    
Products and fees recognized at a point in time
 $1,603 
 $- 
 $1,603 
Services and fees transferred over time
  8,603 
  502 
  9,105 
 
 $10,206 
 $502 
 $10,708 
 
Nine Months Ended Septmeber 30, 2018
 
Cloud
 
 
 
 
 
Total
 
(In thousands)
 
Telecommunications
 
 
Web Services
 
 
Reportable
 
 
 
Segment
 
 
Segment
 
 
Segments
 
Major products/services lines
 
 
 
 
 
 
 
 
 
Desktop devices
 $1,117 
 $- 
 $1,117 
Equipment financing revenue
  83 
  - 
  83 
Telecommunications services
  6,474 
  - 
  6,474 
Fees, commissions, and other, recognized over time
  448 
  - 
  448 
One time fees, commissions and other
  53 
  - 
  53 
Website hosting services
  - 
  552 
  552 
Website management services and other
  - 
  84 
  84 
 
 $8,175 
 $636 
 $8,811 
Timing of revenue recognition
    
    
    
Products and fees recognized at a point in time
 $1,170 
 $- 
 $1,170 
Services and fees transferred over time
  7,005 
  636 
  7,641 
 
 $8,175 
 $636 
 $8,811 
 
 
14
 
 
Contract balances
 
The following table provides information about receivables, contract assets, and contract liabilities from contracts with customers.
 
 
 
September 30,
 
 
December 31,
 
(In thousands)
 
2019
 
 
2018
 
Receivables, which are included in Trade receivables, net of allowance
 
 
 
 
 
 
for doubtful accounts
 $440 
 $429 
Contract assets
  14 
  12 
Contract liabilities
  1,183 
  1,063 
 
Significant changes in the contract assets and the contract liabilities balances during the period are as follows:
 
 
 
 
Nine Months Ended
 
 
For the Year Ended
 
(In thousands)
 
September 30, 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
 $- 
 $(809)
 $- 
 $(837)
Increase due to cash received, excluding amounts recognized as revenue during the period
  - 
  929 
  - 
  912 
Transferred to receivables from contract assets recognized at the beginning of the period
  (11)
  - 
  (2)
  - 
Increase due to additional unamortized discounts
  13 
  - 
  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):
 
 
 
2019
 
 
2020
 
 
2021
 
 
2022
 
 
2023
 
 
2024
 
 
Total
 
Desktop devices
 $160 
  - 
  - 
  - 
  - 
  - 
 $160 
Telecommunications service
 $2,768 
  8,873 
  6,465 
  4,295 
  2,220 
  554 
 $25,175 
All consideration from contracts with customers is included in the amounts presented above
    
    
    
    
    
    
    
 
 
15
 
 
4.            
Earnings/(Loss) Per Common Share
 
Basic net income/(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 net income/(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 three and nine months ended September 30, 2018 is the same as basic net loss per common share because the common share equivalents were anti-dilutive due to the net loss. The following table sets forth the computation of basic and diluted net income/(loss) per common share:
 
 
 
 
Three Months Ended September 30,
 
 
Nine Months Ended September 30,
 
 
 
2019
 
 
2018
 
 
2019
 
 
2018
 
Net income/(loss) (in thousands) (A)
 $334 
 $(199)
 $911 
 $(215)
 
    
    
    
    
Weighted-average share reconciliation:
    
    
    
    
Weighted-average basic shares outstanding (B)
  14,663,151 
  14,346,092 
  14,507,696 
  14,311,190 
Dilutive effect of stock-based awards
  966,496 
  - 
  936,367 
  - 
   Diluted weighted-average outstanding shares of common stock (C)
  15,629,647 
  14,346,092 
  15,444,063 
  14,311,190 
 
    
    
    
    
Earnings/(loss) per common share:
    
    
    
    
   Basic (A/B)
 $0.02 
 $(0.01)
 $0.06 
 $(0.02)
   Diluted (A/C)
 $0.02 
 $(0.01)
 $0.06 
 $(0.02)
 
For the three and nine months ended September 30, 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 net income/(loss) per share because including them would be anti-dilutive.
 
 
 
Three Months Ended September 30,
 
 
Nine Months Ended September 30,
 
 
 
2019
 
 
2018
 
 
2019
 
 
2018
 
Stock options
  1,271,559 
  1,852,065 
  1,662,311 
  1,564,196 
 
5.            
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):
 
 
 
September 30,
 
 
December 31,
 
 
 
2019
 
 
2018
 
Gross trade receivables
 $468 
 $443 
Less: allowance for doubtful accounts
  (28)
  (14)
Trade receivables, net
 $440 
 $429 
 
    
    
Current trade receivables, net
 $434 
 $419 
Long-term trade receivables, net
  6 
  10 
Trade receivables, net
 $440 
 $429 
 
 
16
 
 
6.            
Prepaid Expenses
 
Prepaid expenses consisted of the following (in thousands):
 
 
 
September 30,
 
 
December 31,
 
 
 
2019
 
 
2018
 
Prepaid corporate insurance
 $78 
 $43 
Prepaid software services and support
  79 
  37 
Prepaid tax liability deposit
  - 
  48 
Prepaid inventory deposits
  178 
  61 
Other prepaid expenses
  66 
  55 
Total prepaid expenses
 $401 
 $244 
 
7.            
Intangible Assets
 
The net carrying amount of intangible assets are as follows (in thousands):
 
 
 
September 30,
 
 
December 31,
 
 
 
2019
 
 
2018
 
Customer relationships
 $941 
 $941 
Less: accumulated amortization
  (814)
  (774)
Total
 $127 
 $167 
 
Amortization expense is included in general and administrative expenses and totaled $13,000 and $18,000 for the three months ended September 30, 2019 and 2018, respectively, and $40,000 and $54,000 for the nine months ended September 30, 2019 and 2018, respectively.
 
 
17
 
 
8.            
Accrued Expenses
 
Accrued expenses consisted of the following (in thousands):
 
 
 
September 30,
 
 
December 31,
 
 
 
2019
 
 
2018
 
Accrued wages and benefits
 $413 
 $301 
Accrued accounts payable
  316 
  221 
Accrued sales and telecommunication taxes
  511 
  480 
Product warranty liability
  15 
  16 
Other
  163 
  113 
Total accrued expenses
 $1,418 
 $1,131 
 
The changes in aggregate product warranty liabilities for the year ended December 31, 2018 and nine months ended September 30, 2019 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
  14 
Warranty settlements
  (15)
Balance at September 30, 2019
 $15 
 
Product warranty expense is included in cost of product revenue and totaled $4,000 and $5,000 for the three months ended September 30, 2019 and 2018, respectively, and $14,000 and $14,000 for the nine months ended September 30, 2019 and 2018, respectively.
 
9.            
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 $4,000 and $56,000 as of September 30, 2019 and December 31, 2018, respectively.
 
As of September 30, 2019, future principal payments are scheduled as follows (in thousands):
 
Year ending December 31,
 
 
 
2019 remaining
 $4 
Total
 $4 
 
 
18
 
 
10.            
Fair Value Measurements
 
We have financial instruments as of September 30, 2019 and December 31, 2018 for which the fair value is summarized below (in thousands):
 
 
 
September 30, 2019
 
 
December 31, 2018
 
 
 
Carrying Value
 
 
Estimated Fair Value
 
 
Carrying Value
 
 
Estimated Fair Value
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Trade receivables, net
 $440 
 $440 
 $429 
 $429 
Equipment financing receivables
  593 
  593 
  251 
  251 
Liabilities:
    
    
    
    
Finance lease obligations
 $123 
 $123 
 $144 
 $144 
Notes payable
  4 
  4 
  56 
  56 
 
 
11.            
Income Taxes
 
Our effective tax rate for the three months ended September 30, 2019 and 2018 was 0.1% and (4.3)%, respectively, which resulted in an income tax provision of $0 and $(8,000), respectively. Our effective tax rate for the nine months ended September 30, 2019 and 2018 was 0.7% and (7.6)%, respectively, which resulted in an income tax provision of $(7,000) and $(15,000), respectively. The tax provision is due to state tax payments made with extensions filed.
 
Significant management judgment is required in determining our provision for income taxes and in determining whether deferred tax assets will be realized in full or in part. In assessing the recovery of the deferred tax assets, we considered whether it is more likely than not that some portion or all of our deferred tax assets will not be realized.  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 considered the scheduled reversals of future deferred tax assets, projected future taxable income, the suspension of the sale of product and services through the seminar sales channel, and tax planning strategies in making this assessment.  As a result, we determined it was more likely than not that the deferred tax assets would not be realized; accordingly, we recorded a full valuation allowance. Subsequent to placing a full valuation allowance on our net deferred tax assets, adjustments impacting our tax rate have been and are expected to continue to be insignificant.
  
12.            
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 may include options, at our sole discretion, to extend or terminate the lease. At the adoption date of ASC Topic 842, the Company is 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.
 
 
19
 
 
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 we are reasonably certain we would exercise the renewal option. Amortization of the ROU assets and operating lease liabilities for the three months ended September 30, 2019 and 2018 was $59,000 and $0, respectively, and for the nine months ended September 30, 2019 and 2018 was $174,000 and $0, respectively. Rental expense incurred on operating leases for the three months ended September 30, 2019 and 2018 was approximately $75,000 and $80,000, respectively, and for the nine months ended September 30, 2019 and 2018 was approximately $225,000 and $240,000, respectively.
 
We have lease agreements with lease and non-lease components, and we account for the lease and non-lease components as a single lease component. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company leases equipment and support under a finance lease agreement which extends through 2023. The outstanding balance for finance leases was $123,000 and $144,000 as of September 30, 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 September 30, 2019 and December 31, 2018, respectively. Related accumulated depreciation totaled $34,000 and $15,000 as of September 30, 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 $2,000 and $2,000 for the three months ended September 30, 2019 and 2018, respectively, and $6,000 and $6,000 for the nine months ended September 30, 2019 and 2018, respectively. The interest rate on the finance lease obligation is 6.7% and interest expense was $1,000 and $2,000 for the three months ended September 30, 2019 and 2018, respectively, and $7,000 and $2,000 for the nine months ended September 30, 2019 and 2018, respectively.
 
The maturity of operating leases and finance lease liabilities as of September 30, 2019 are as follows:
 
Year ending December 31,
 
Operating Leases
 
 
Finance Leases
 
2019 remaining
 $75 
 $9 
2020
  301 
  37 
2021
  300 
  36 
2022
  300 
  37 
2023
  50 
  21 
Total minimum lease payments
  1,026 
  140 
Less: amount representing interest
  (111)
  (17)
Present value of minimum lease payments
 $915 
 $123 
 
Lease term and discount rate
 
September 30,
2019
 
Weighted-average remaining lease term (years)
 
 
 
Operating leases
  3.4 
Finance leases
  3.8 
Weighted-average discount rate
    
Operating leases
  6.7%
Finance leases
  6.7%
 
 
20
 
 
 
 
Nine Months Ended September 30,
2019
 
Cash paid for amounts included in the measurement of lease liabilities:
 
 
 
Operating cash flows from operating leases
 $225 
Operating cash flows from finance leases
  7 
Financing cash flows from finance leases
  21 
 
 
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.
 
Equipment finance receivables arising from the rental of our cloud telecommunications equipment through sales-type leases, were as follows (in thousands):
 
 
 
September 30,
 
 
December 31,
 
 
 
2019
 
 
2018
 
Gross financing receivables
 $905 
 $392 
Less unearned income
  (312)
  (141)
Financing receivables, net
  593 
  251 
Less: Current portion of finance receivables, net
  (126)
  (67)
Finance receivables due after one year
 $467 
 $184 
 
 
21
 
 
Future minimum lease payments as of September 30, 2019, consisted of the following:
 
Year ending December 31,
 
Lease Receivables
 
2019 remaining
 $64 
2020
  252 
2021
  242 
2022
  180 
2023
  128 
2024
  39 
Gross equipment financing receivables
  905 
Less: unearned income
  (312)
Equipment financing receivables, net
 $593 
 
13.            
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). Based on our financial performance as of September 30, 2019, it is reasonably possible that the bonus will be payable in whole or in part, however a reasonable estimate of liability cannot be made at this time.

 
22
 
  
14.            
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 are as follows (in thousands):
 
 
 
Three Months Ended September 30,
 
 
Nine Months Ended September 30,
 
 
 
2019
 
 
2018
 
 
2019
 
 
2018
 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
Cloud telecommunications
 $3,443 
 $2,823 
 $10,206 
 $8,175 
Web services
  159 
  203 
  502 
  636 
Consolidated revenue
  3,602 
  3,026 
  10,708 
  8,811 
 
    
    
    
    
Income/(loss) from operations:
    
    
    
    
Cloud telecommunications
  276 
  (284)
  692 
  (528)
Web services
  60 
  91 
  225 
  322 
Total operating income/(loss)
  336 
  (193)
  917 
  (206)
Other income/(expense), net:
    
    
    
    
Cloud telecommunications
  2 
  - 
  (2)
  7 
Web services
  (4)
  2 
  3 
  (1)
Total other income/(expense), net
  (2)
  2 
  1 
  6 
Income/(loss) before income tax provision:
    
    
    
    
Cloud telecommunications
  278 
  (284)
  690 
  (521)
Web services
  56 
  93 
  228 
  321 
Income/(loss) before income tax provision
 $334 
 $(191)
 $918 
 $(200)
 
 
Depreciation and amortization was $24,000 and $24,000 for the Cloud Telecommunications segment for the three months ended September 30, 2019 and 2018, respectively. Depreciation and amortization was $66,000 and $61,000 for the Cloud Telecommunications segment for the nine months ended September 30, 2019 and 2018, respectively. Depreciation and amortization was $1,000 and $2,000 for the Web Services segment for the three months ended September 30, 2019 and 2018, respectively. Depreciation and amortization was $3,000 and $5,000 for the Web Services segment for the nine months ended September 30, 2019 and 2018, respectively.
 
Interest income was $1,000 and $1,000 for the Web Services segment for the three months ended September 30, 2019 and 2018, respectively. Interest income was $4,000 and $5,000 for the Web Services segment for the nine months ended September 30, 2019 and 2018, respectively.
 
Interest expense was $1,000 and $5,000 for the Cloud Telecommunications segment for the three months ended September 30, 2019 and 2018, respectively. Interest expense was $9,000 and $8,000 for the Cloud Telecommunications segment for the nine months ended September 30, 2019 and 2018, respectively.
 
 
23
 
 
Item 2.                   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
This section and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and our Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A, “Risk Factors,” which are incorporated herein by reference. The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Form 10-K”) filed with the SEC and the Condensed Consolidated Financial Statements and notes thereto included in the 2019 Form 10-Qs and elsewhere in this Form 10-Q. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.
 
OVERVIEW
 
Crexendo is an award-winning premier provider of cloud communications, UCaaS (Unified Communications as a Service), call center, collaboration services, and other cloud business services that are designed to provide enterprise-class cloud services to any size business at affordable monthly rates. The Company has two operating segments, which consist of Cloud Telecommunications and Web Services.
 
Cloud Telecommunications – Our cloud telecommunications services transmit calls using IP or cloud technology, which converts voice signals into digital data packets for transmission over the Internet or cloud. Each of our calling plans provides a number of basic features typically offered by traditional telephone service providers, plus a wide range of enhanced features that we believe offer an attractive value proposition to our customers. This platform enables a user, via a single “identity” or telephone number, to access and utilize services and features regardless of how the user is connected to the Internet or cloud, whether it’s from a desktop device or an application on a mobile device.
 
We generate recurring revenue from our cloud telecommunications and broadband Internet services. Our cloud telecommunications contracts typically have a thirty-six to sixty month term. We 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 24% or $591,000 to $3,100,000 for the three months ended September 30, 2019 as compared to $2,509,000 for the three months ended September 30, 2018. Cloud Telecommunications service revenue increased 26% or $1,854,000 to $8,912,000 for the nine months ended September 30, 2019 as compared to $7,058,000 for the nine months ended September 30, 2018. Our Cloud Telecommunications product revenue increased 9% or $29,000 to $343,000 for the three months ended September 30, 2019 as compared to $314,000 for the three months ended September 30, 2018. Cloud Telecommunications product revenue increased 16% or $177,000 to $1,294,000 for the nine months ended September 30, 2019, as compared to $1,117,000 for the nine months ended September 30, 2018. As of September 30, 2019 and 2018, our backlog was $25,335,000 and $21,734,000 respectively.
 
Web Services – We generate recurring revenue from website hosting and other professional services.
 
Our Web Services revenue decreased 22% or $44,000 to $159,000 for the three months ended September 30, 2019 as compared to $203,000 for the three months ended September 30, 2018. Our Web Services revenue decreased 21% or $134,000 to $502,000 for the nine months ended September 30, 2019 as compared to $636,000 for the nine months ended September 30, 2018.
 
 
24
 
 
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