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13. Leases

6 Months Ended

Jun. 30, 2020

Lessee Accounting

We determine if an agreement is a lease at inception. We previously leased our corporate office building 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 was reasonably certain that we would exercise our option to renew our corporate office building operating lease. Lease expense is recognized on a straight-line basis over the lease term.

We previously leased the corporate office building 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 was a renewal option for another three year term at the end of the lease that was considered in valuing the ROU asset as we were reasonably certain we would exercise the renewal option. Amortization of the ROU assets and operating lease liabilities for the three months ended June 30, 2020 and 2019 was $0 and $58,000, respectively, and for the six months ended June 30, 2020 and 2019 was $50,000 and $115,000, respectively. Rental expense incurred on operating leases for the three months ended June 30, 2020 and 2019 was approximately $0 and $75,000, respectively, and for the six months ended June 30, 2020 and 2019 was approximately $25,000 and $150,000, respectively.

As of December 31, 2019 we initiated the process to purchase the corporate office building 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 $102,000 and $116,000 as of June 30, 2020 and December 31, 2019, respectively. The Company recorded assets classified as property and equipment under finance lease obligations of $129,000 and $129,000 as of June 30, 2020 and December 31, 2019, respectively. Related accumulated depreciation totaled $54,000 and $28,000 as of June 30, 2020 and 2019, 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 June 30, 2020 and 2019, respectively, and $4,000 and $4,000 for the six months ended June 30, 2020 and 2019, respectively. The interest rate on the finance lease obligation is 6.7% and interest expense was $2,000 and $2,000 for the three months ended June 30, 2020 and 2019, respectively and $4,000 and $5,000 for the six months ended June 30, 2020 and 2019, respectively.

The maturity of finance lease liabilities as of June 30, 2020 are as follows:

Year ending December 31,	Operating Leases		Finance Leases
2020 remaining	$	-	$	19
2021		1		36
2022		-		37
2023		-		21
Total minimum lease payments		1		113
Less: amount representing interest		-		(11	)
Present value of minimum lease payments	$	1	$	102

Lease term and discount rate	June 30, 2020
Weighted-average remaining lease term (years)
Operating leases		3.6
Finance leases		3.1
Weighted-average discount rate
Operating leases		6.7	%
Finance leases		6.7	%

	Six Months Ended June 30, 2020
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	25
Operating cash flows from finance leases		4
Financing cash flows from finance leases		14

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):

	June 30, 2020			December 31, 2019
Gross financing receivables	$	1,449		$	1,086
Less: unearned income		(490	)		(382	)
Financing receivables, net		959			704
Less: current portion of finance receivables, net		(211	)		(143	)
Finance receivables due after one year	$	748		$	561

Future minimum lease payments as of June 30, 2020, consisted of the following:

Year ending December 31,	Lease Receivables
2020 remaining	$	212
2021		411
2022		361
2023		277
2024		166
2025		22
Gross equipment financing receivables		1,449
Less: unearned income		(490	)
Equipment financing receivables, net	$	959