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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, 2021

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
incorporation or organization) |  | Identification No.)
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, 2021 was 21,685,214.

INDEX

PART I – FINANCIAL INFORMATION
Item 1. | Financial Statements. |  | 3 |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |  | 21 |
Item 3. | Quantitative and Qualitative Disclosures about Market Risk |  | 48 |
Item 4. | Controls and Procedures |  | 48 |
PART II - OTHER INFORMATION
Item 1. | Legal Proceedings |  | 49 |
Item 1A. | Risk Factors |  | 49 |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |  | 50 |
Item 6. | Exhibits |  | 51 |
Signatures |  |  | 52 |

2
Table of Contents

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, 2021 |  |  | December 31, 2020 |
Assets |  |  |  |  |  |
Current assets: |  |  |  |  |  |
Cash and cash equivalents |  | $ | 7,701 |  |  | $ | 17,579 |
Restricted cash |  |  | - |  |  |  | 100 |
Trade receivables, net of allowance for doubtful accounts of $40 as of September 30, 2021 and $21 as of December 31, 2020 |  |  | 1,280 |  |  |  | 538 |
Contract assets |  |  | 209 |  |  |  | 159 |
Inventories |  |  | 479 |  |  |  | 504 |
Equipment financing receivables |  |  | 324 |  |  |  | 286 |
Contract costs |  |  | 519 |  |  |  | 421 |
Prepaid expenses |  |  | 650 |  |  |  | 190 |
Income tax receivable |  |  | 11 |  |  |  | 4 |
Total current assets |  |  | 11,173 |  |  |  | 19,781 |
Long-term trade receivables, net of allowance for doubtful accounts of $0 as of September 30, 2021 and $0 as of December 31, 2020 |  |  | 27 |  |  |  | - |
Long-term equipment financing receivables, net |  |  | 837 |  |  |  | 906 |
Property and equipment, net |  |  | 3,059 |  |  |  | 2,734 |
Deferred income tax assets, net |  |  | 8,883 |  |  |  | 6,054 |
Operating lease right-of-use assets |  |  | 732 |  |  |  | 1 |
Intangible assets, net |  |  | 23,237 |  |  |  | 252 |
Goodwill |  |  | 28,129 |  |  |  | 272 |
Contract costs, net of current portion |  |  | 696 |  |  |  | 549 |
Income tax receivable, net of current portion |  |  | 256 |  |  |  | - |
Other long-term assets |  |  | 287 |  |  |  | 156 |
Total Assets |  | $ | 77,316 |  |  | $ | 30,705 |
Liabilities and Stockholders' Equity |  |  |  |  |  |  |  |
Current liabilities: |  |  |  |  |  |  |  |
Accounts payable |  | $ | 624 |  |  | $ | 56 |
Accrued expenses |  |  | 4,351 |  |  |  | 1,628 |
Finance leases |  |  | 130 |  |  |  | 29 |
Notes payable |  |  | 73 |  |  |  | 71 |
Operating lease liabilities |  |  | 490 |  |  |  | 1 |
Contigent consideration |  |  | 746 |  |  |  | - |
Contract liabilities |  |  | 1,831 |  |  |  | 778 |
Total current liabilities |  |  | 8,245 |  |  |  | 2,563 |
Contract liabilities, net of current portion |  |  | 1,053 |  |  |  | 450 |
Finance leases, net of current portion |  |  | 237 |  |  |  | 55 |
Notes payable, net of current portion |  |  | 1,818 |  |  |  | 1,873 |
Operating lease liabilities, net of current portion |  |  | 269 |  |  |  | - |
Total liabilities |  |  | 11,622 |  |  |  | 4,941 |
Stockholders' equity: |  |  |  |  |  |  |  |
Preferred stock, par value $0.001 per share - authorized 5,000,000 shares; none issued |  |  | — |  |  |  | — |
Common stock, par value $0.001 per share - authorized 50,000,000 shares, 21,667,628 shares issued and outstanding as of September 30, 2021 and 17,983,177 shares issued and outstanding as of December 31, 2020 |  |  | 22 |  |  |  | 18 |
Additional paid-in capital |  |  | 117,593 |  |  |  | 75,834 |
Accumulated deficit |  |  | (51,931 | ) |  |  | (50,088 | )
Accumulated other comprehensive income |  |  | 10 |  |  |  | - |
Total stockholders' equity |  |  | 66,694 |  |  |  | 25,764 |
Total Liabilities and Stockholders' Equity |  | $ | 77,316 |  |  | $ | 30,705 |

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

3
Table of Contents

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, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
Service revenue |  | $ | 4,325 |  |  | $ | 3,654 |  |  | $ | 12,791 |  |  | $ | 10,747 |
Software solutions revenue |  |  | 3,784 |  |  |  | - |  |  |  | 4,796 |  |  |  | - |
Product revenue |  |  | 701 |  |  |  | 489 |  |  |  | 1,509 |  |  |  | 1,317 |
Total revenue |  |  | 8,810 |  |  |  | 4,143 |  |  |  | 19,096 |  |  |  | 12,064 |
Operating expenses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cost of service revenue |  |  | 1,210 |  |  |  | 946 |  |  |  | 3,816 |  |  |  | 2,824 |
Cost of software solutions revenue |  |  | 1,675 |  |  |  | - |  |  |  | 2,201 |  |  |  | - |
Cost of product revenue |  |  | 461 |  |  |  | 314 |  |  |  | 972 |  |  |  | 797 |
Selling and marketing |  |  | 2,070 |  |  |  | 1,051 |  |  |  | 5,106 |  |  |  | 3,151 |
General and administrative |  |  | 2,983 |  |  |  | 1,351 |  |  |  | 7,918 |  |  |  | 3,585 |
Research and development |  |  | 358 |  |  |  | 326 |  |  |  | 1,096 |  |  |  | 840 |
Total operating expenses |  |  | 8,757 |  |  |  | 3,988 |  |  |  | 21,109 |  |  |  | 11,197 |
Income/(loss) from operations |  |  | 53 |  |  |  | 155 |  |  |  | (2,013 | ) |  |  | 867 |
Other income/(expense): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest income |  |  | - |  |  |  | 1 |  |  |  | 1 |  |  |  | 3 |
Interest expense |  |  | (24 | ) |  |  | (23 | ) |  |  | (64 | ) |  |  | (54 | )
Other income/(expense), net |  |  | (17 | ) |  |  | 1 |  |  |  | (14 | ) |  |  | (28 | )
Total other income/(expense), net |  |  | (41 | ) |  |  | (21 | ) |  |  | (77 | ) |  |  | (79 | )
Income/(loss) before income tax |  |  | 12 |  |  |  | 134 |  |  |  | (2,090 | ) |  |  | 788 |
Income tax benefit/(provision) |  |  | (137 | ) |  |  | (3 | ) |  |  | 247 |  |  |  | (9 | )
Net income/(loss) |  | $ | (125 | ) |  | $ | 131 |  |  | $ | (1,843 | ) |  | $ | 779 |
Earnings per common share: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  | $ | (0.01 | ) |  | $ | 0.01 |  |  | $ | (0.09 | ) |  | $ | 0.05 |
Diluted |  | $ | (0.01 | ) |  | $ | 0.01 |  |  | $ | (0.09 | ) |  | $ | 0.05 |
Weighted-average common shares outstanding: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  |  | 21,596,415 |  |  |  | 15,244,804 |  |  |  | 19,757,658 |  |  |  | 15,058,192 |
Diluted |  |  | 21,596,415 |  |  |  | 17,249,035 |  |  |  | 19,757,658 |  |  |  | 16,793,896 |

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

4
Table of Contents

CREXENDO, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
Net income/(loss) |  | $ | (125 | ) |  | $ | 131 |  |  | $ | (1,843 | ) |  | $ | 779 |
Other comprehensive income/(loss), net of tax |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Foreign currency translation gain |  |  | 9 |  |  |  | - |  |  |  | 10 |  |  |  | - |
Total other comprehensive income |  |  | 9 |  |  |  | - |  |  |  | 10 |  |  |  | - |
Comprehensive income/(loss) |  | $ | (116 | ) |  | $ | 131 |  |  | $ | (1,833 | ) |  | $ | 779 |

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

5
Table of Contents

CREXENDO, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders’ Equity

Nine Months Ended Septmber 30, 2021 and 2020

(Unaudited, in thousands, except share data)

|  |  |  |  |  |  |  |  |  |  | Accumulated |  |  |  |  |  |  |
|  |  |  |  |  |  |  | Additional |  |  | other |  |  |  |  |  | Total |
|  | Common Stock |  |  | Paid-in |  |  | Comprehensive |  |  | Accumulated |  |  | Stockholders' |
|  | Shares |  |  | Amount |  |  | Capital |  |  | Income |  |  | Deficit |  |  | Equity |
Balance, January 1, 2021 |  |  | 17,983,177 |  |  | $ | 18 |  |  | $ | 75,834 |  |  | $ | - |  |  | $ | (50,088 | ) |  | $ | 25,764 |
Share-based compensation |  |  | - |  |  |  | - |  |  |  | 282 |  |  |  | - |  |  |  | - |  |  |  | 282 |
Vesting of restricted stock units |  |  | 14,367 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Issuance of common stock for exercise of stock options |  |  | 380,396 |  |  |  | - |  |  |  | 1,146 |  |  |  | - |  |  |  | - |  |  |  | 1,146 |
Taxes paid on the net settlement of stock options |  |  | - |  |  |  | - |  |  |  | (152 | ) |  |  | - |  |  |  | - |  |  |  | (152 | )
Issuance of common stock in connection with a business acquisition |  |  | 46,662 |  |  |  | - |  |  |  | 346 |  |  |  | - |  |  |  | - |  |  |  | 346 |
Net loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (715 | ) |  |  | (715 | )
Balance, March 31, 2021 |  |  | 18,424,602 |  |  | $ | 18 |  |  | $ | 77,456 |  |  | $ | - |  |  | $ | (50,803 | ) |  | $ | 26,671 |
Share-based compensation |  |  | - |  |  |  | - |  |  |  | 453 |  |  |  | - |  |  |  | - |  |  |  | 453 |
Vesting of restricted stock units |  |  | 13,622 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Foreign currency translation adjustment, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 1 |  |  |  | - |  |  |  | 1 |
Issuance of common stock for exercise of stock options |  |  | 18,520 |  |  |  | 1 |  |  |  | 30 |  |  |  | - |  |  |  | - |  |  |  | 31 |
Taxes paid on the net settlement of stock options |  |  | - |  |  |  | - |  |  |  | (3 | ) |  |  | - |  |  |  | - |  |  |  | (3 | )
Issuance of common stock in connection with a business acquisition |  |  | 3,097,309 |  |  |  | 3 |  |  |  | 39,059 |  |  |  | - |  |  |  | - |  |  |  | 39,062 |
Net loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (1,003 | ) |  |  | (1,003 | )
Balance, June 30, 2021 |  |  | 21,554,053 |  |  | $ | 22 |  |  | $ | 116,995 |  |  | $ | 1 |  |  | $ | (51,806 | ) |  | $ | 65,212 |
Share-based compensation |  |  | - |  |  |  | - |  |  |  | 415 |  |  |  | - |  |  |  | - |  |  |  | 415 |
Vesting of restricted stock units |  |  | 13,772 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Foreign currency translation adjustment, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 9 |  |  |  | - |  |  |  | 9 |
Issuance of common stock for exercise of stock options |  |  | 99,803 |  |  |  | - |  |  |  | 188 |  |  |  | - |  |  |  | - |  |  |  | 188 |
Taxes paid on the net settlement of stock options |  |  | - |  |  |  | - |  |  |  | (5 | ) |  |  | - |  |  |  | - |  |  |  | (5 | )
Net income |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (125 | ) |  |  | (125 | )
Balance, September 30, 2021 |  |  | 21,667,628 |  |  | $ | 22 |  |  | $ | 117,593 |  |  | $ | 10 |  |  | $ | (51,931 | ) |  | $ | 65,694 |

|  |  |  |  |  |  |  |  |  |  | Accumulated |  |  |  |  |  |  |
|  |  |  |  |  |  |  | Additional |  |  | other |  |  |  |  |  | Total |
|  | Common Stock |  |  | Paid-in |  |  | Comprehensive |  |  | Accumulated |  |  | Stockholders'
|  | Shares |  |  | Amount |  |  | Capital |  |  | Income |  |  | Deficit |  |  | Equity |
Balance, January 1, 2020 |  |  | 14,884,755 |  |  | $ | 15 |  |  | $ | 62,400 |  |  | $ | - |  |  | $ | (58,028 | ) |  | $ | 4,387 |
Share-based compensation |  |  | - |  |  |  | - |  |  |  | 105 |  |  |  | - |  |  |  | - |  |  |  | 105 |
Vesting of restricted stock units |  |  | 7,498 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Issuance of common stock for exercise of stock options |  |  | 49,200 |  |  |  | - |  |  |  | 84 |  |  |  | - |  |  |  | - |  |  |  | 84 |
Net income |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 140 |  |  |  | 140 |
Balance, March 31, 2020 |  |  | 14,941,453 |  |  | $ | 15 |  |  | $ | 62,589 |  |  | $ | - |  |  | $ | (57,888 | ) |  | $ | 4,716 |
Share-based compensation |  |  | - |  |  |  | - |  |  |  | 136 |  |  |  | - |  |  |  | - |  |  |  | 136 |
Vesting of restricted stock units |  |  | 15,363 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Issuance of common stock for exercise of stock options |  |  | 143,448 |  |  |  | - |  |  |  | 414 |  |  |  | - |  |  |  | - |  |  |  | 414 |
Net income |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 508 |  |  |  | 508 |
Balance, June 30, 2020 |  |  | 15,100,264 |  |  | $ | 15 |  |  | $ | 63,139 |  |  | $ | - |  |  | $ | (57,380 | ) |  | $ | 5,774 |
Share-based compensation |  |  | - |  |  |  | - |  |  |  | 136 |  |  |  | - |  |  |  | - |  |  |  | 136 |
Vesting of restricted stock units |  |  | 14,372 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Issuance of common stock for exercise of stock options |  |  | 672,255 |  |  |  | 1 |  |  |  | 1,509 |  |  |  | - |  |  |  | - |  |  |  | 1,510 |
Issuance of common stock in connection with an offering |  |  | 1,750,000 |  |  |  | 2 |  |  |  | 8,631 |  |  |  | - |  |  |  | - |  |  |  | 8,633 |
Net income |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 131 |  |  |  | 131 |
Balance, September 30, 2020 |  |  | 17,536,891 |  |  | $ | 18 |  |  | $ | 73,415 |  |  | $ | - |  |  | $ | (57,249 | ) |  | $ | 16,184 |

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

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CREXENDO, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited, in thousands)

|  | Nine Months Ended September 30, |
|  | 2021 |  |  | 2020 |
CASH FLOWS FROM OPERATING ACTIVITIES |  |  |  |  |  |
Net income/(loss) |  | $ | (1,843 | ) |  | $ | 779 |
Adjustments to reconcile net income/(loss) to net cash provided by operating activities: |  |  |  |  |  |  |  |
Depreciation and amortization |  |  | 931 |  |  |  | 197 |
Share-based compensation |  |  | 1,150 |  |  |  | 377 |
Non-cash operating lease amortization |  |  | (4 | ) |  |  | - |
Changes in assets and liabilities: |  |  |  |  |  |  |  |
Trade receivables |  |  | 199 |  |  |  | (248 | )
Contract assets |  |  | (50 | ) |  |  | (72 | )
Equipment financing receivables |  |  | 31 |  |  |  | (395 | )
Inventories |  |  | 37 |  |  |  | 119 |
Contract costs |  |  | (245 | ) |  |  | (100 | )
Prepaid expenses |  |  | (384 | ) |  |  | (191 | )
Income tax receivable |  |  | (263 | ) |  |  | 4 |
Other assets |  |  | 335 |  |  |  | (46 | )
Accounts payable and accrued expenses |  |  | 228 |  |  |  | (25 | )
Income tax payable |  |  | - |  |  |  | 5 |
Contract liabilities |  |  | (595 | ) |  |  | 19 |
Net cash provided by/(used for) operating activities |  |  | (473 | ) |  |  | 423 |
CASH FLOWS FROM INVESTING ACTIVITIES |  |  |  |  |  |  |  |
Purchase of property and equipment |  |  | (91 | ) |  |  | (745 | )
Acquisitions of assets and businesses, net of cash received |  |  | (10,505 | ) |  |  | (176 | )
Net cash used for investing activities |  |  | (10,596 | ) |  |  | (921 | )
CASH FLOWS FROM FINANCING ACTIVITIES |  |  |  |  |  |  |  |
Payment of contingent consideration |  |  | - |  |  |  | (54 | )
Repayments made on finance leases |  |  | (71 | ) |  |  | (22 | )
Proceeds from notes payable |  |  | - |  |  |  | 1,001 |
Repayments made on notes payable |  |  | (53 | ) |  |  | (39 | )
Proceeds from exercise of options |  |  | 1,365 |  |  |  | 2,007 |
Taxes paid on the net settlement of stock options and RSUs |  |  | (160 | ) |  |  | - |
Proceeds from issuance of common stock in connection with an offering |  |  | - |  |  |  | 8,778 |
Net cash provided by financing activities |  |  | 1,081 |  |  |  | 11,671 |
Effect of exchange rate changes on cash |  |  | 10 |  |  |  | - |
NET INCREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH |  |  | (9,978 | ) |  |  | 11,173 |
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT THE BEGINNING OF THE PERIOD |  |  | 17,679 |  |  |  | 4,280 |
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT THE END OF THE PERIOD |  | $ | 7,701 |  |  | $ | 15,453 |
Cash used during the year for: |  |  |  |  |  |  |  |
Income taxes, net |  | $ | (15 | ) |  | $ | - |
Interest expense |  | $ | (64 | ) |  | $ | (54 | )
Supplemental disclosure of non-cash investing and financing information: |  |  |  |  |  |  |  |
Stock issued for the acquisition of Centric Telecom |  | $ | 346 |  |  | $ | - |
Contingent consideration related to the acquisition of Centric Telecom |  | $ | 746 |  |  | $ | - |
Stock issued in connection with the merger with NetSapiens |  | $ | 16,942 |  |  | $ | - |
Stock options issued in connection with the merger with NetSapiens |  | $ | 22,120 |  |  | $ | - |
Property and equipment financed through finance leases |  | $ | 273 |  |  | $ | - |
Prepaid assets financed through finance leases |  | $ | 14 |  |  | $ | - |
Purchase of property and equipment with a note payable |  | $ | - |  |  | $ | 2,000 |
Adjustment to intangible assets and contingent consideration of customer relationship asset acquisition |  | $ | - |  |  | $ | (121 | )

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

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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 consolidated financial statements, we refer to Crexendo, Inc. and its wholly owned subsidiaries, as “we,” “us,” or “our Company.” Crexendo, Inc. is an award-winning premier provider of Unified Communications as a Service (UCaaS), Call Center as a Service (CCaaS), communication platform software solutions, and collaboration services designed to provide enterprise-class cloud communication solutions to any size business through our business partners, agents, and direct channels. Our solutions currently support over two Million end users globally and was recently recognized as the fastest growing UCaaS platform in the United States. Following the merger with NetSapiens, the Company has reorganized with two operating segments, which consist of cloud telecommunications services and software solutions.

Basis of Presentation – The consolidated financial statements include the accounts and operations of Crexendo, Inc. and its wholly owned subsidiaries, which include Crexendo Business Solutions, Inc., Crexendo International, Inc., Centric Telecom, Inc., NetSapiens, LLC, NSHC, Inc., NetSapiens Canada, Inc., and NetSapiens International Limited. The Company’s consolidated financial statements include the results of operations of NetSapiens, LLC. from the date of acquisition. 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.

Foreign Currency Translation - The functional currency of our international subsidiaries is the local currency. We translate assets and liabilities of foreign subsidiaries, whose functional currency is their local currency, at exchange rates in effect at the balance sheet date. We translate revenue and expenses at the monthly average exchange rates. We include accumulated net translation adjustments in stockholders’ equity as a component of accumulated other comprehensive income (loss).

Due to changes in exchange rates between reporting periods and changes in certain account balances, the foreign currency translation adjustment will change from period to period. During the three and nine months ended September 30, 2021 and 2020, we recorded foreign currency translation gains/(losses) of $1,000, and $9,000, respectively, in our statements of comprehensive income (loss).

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, 2021 and December 31, 2020, we had cash and cash equivalents in financial institutions in excess of federally insured limits in the amount of $6,742,000 and $17,175,000, respectively.

Restricted Cash – We classified $0 and $100,000 as restricted cash as of September 30, 2021 and December 31, 2020, respectively. During the three months ended March 31, 2021, our restricted cash requirement was waived and we released $100,000 into cash and cash equivalents. Cash was restricted for compensating balance requirements on purchasing card agreements. As of September 30, 2021 and December 31, 2020, we had restricted cash in financial institutions in excess of federally insured limits in the amount of $0 and $100,000, respectively.

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

|  | September 30, |  |  | September 30, |
|  | 2021 |  |  | 2020 |
Cash and cash equivalents |  | $ | 7,701 |  |  | $ | 15,353 |
Restricted cash |  |  | - |  |  |  | 100 |
Total cash, cash equivalents, and restricted cash shown in the condensed |  |  |  |  |  |  |  |
consolidated statement of cash flows |  | $ | 7,701 |  |  | $ | 15,453 |

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Trade Receivables – Trade receivables from our cloud telecommunications services and software solutions 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 $1,215,000 and $970,000 at September 30, 2021 and December 31, 2020, respectively. Capitalized commission costs are amortized based on the transfer of goods or services to which the assets relate which typically range from thirty-six to sixty months, and are included in selling and marketing expenses. During the three months ended September 30, 2021 and 2020, the Company amortized $201,000 and $123,000, respectively, and there was no impairment loss in relation to the costs capitalized. During the nine months ended September 30, 2021 and 2020, the Company amortized $444,000 and $368,000 respectively, and there was no impairment loss in relation to the costs capitalized.

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

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

Building | 39 years
Computer and office equipment | 2 to 5 years
Computer software | 3 years
Internal-use software | 3 years
Vehicles | 5 years
Leasehold improvements | 2 to 5 years

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

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

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

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

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

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

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

C ontingencies – 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.

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

Cost of Service Revenue – Cost of service revenue includes cloud telecommunications services. 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.

Cost of Software Solutions Revenue – Cost of software solutions revenue consists primarily of royalties and other fees paid to third parties whose technology or products are sold as part of the Company’s products, direct costs to manufacture and distribute products, direct costs to provide product support and professional support services, direct costs associated with delivery of the Company’s software offerings, and amortization expense related to developed technology intangible assets.

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

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

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

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

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

Research and Development – Research and development expenses consist primarily of personnel and related expenses for the Company’s research and development staff, including salaries, benefits, bonuses and stock-based compensation and the cost of certain third-party contractors. Research and development costs are expensed as incurred. Costs related to internally developed software are expensed as research and development expense until technological feasibility has been achieved, after which the costs are capitalized.

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

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

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

| · | Quoted prices for similar assets or liabilities in active markets;
| · | Quoted prices for identical or similar assets in non-active markets;
| · | Inputs other than quoted prices that are observable for the asset or liability; and
| · | Inputs that are derived principally from or corroborated by other observable market data.

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

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

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

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

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

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

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

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

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 reorganized into two operating segments, which consist of cloud telecommunications services and software solutions. The software solutions segment includes the results of operation of NetSapiens, LLC, NSHC, Inc., NetSapiens Canada, Inc., and NetSapiens International Limited. The cloud telecommunications segment includes the results of operations of Crexendo Business Solutions, Inc., Crexendo International, Inc., and Centric Telecom, Inc. We generate over 99% of our total revenue from customers within North America (United States and Canada) and less than 1% of our total revenues from customers in other parts of the world.

Significant Customers – No customer accounted for 10% or more of our total revenue for the three and nine months ended September 30, 2021 and 2020. No customer accounted for 10% or more of our total trade accounts receivable as of September 30, 2021 and one cloud telecommunications services customer accounted for 11% of total trade accounts receivable as of December 31, 2020.

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

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

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

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

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

2. 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, service, or software solution to a customer. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer, are excluded from revenue. The following is a description of principal activities – separated by reportable segments – from which the Company generates its revenue. For more detailed information about reportable segments, see Note 15.

Cloud Telecommunications Services 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.

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

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

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

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

| · | Contracted activation and flash fees – The Company generally allocates a portion of the activation fees to the desktop devices, which is recognized at the time of the installation or customer acceptance, and a portion to the service, which is recognized over the contract term using the straight-line method.
| · | Non-contracted carrier cost recovery fee – This fee recovers the various costs and expenses that the Company incurs in connection with complying with legal, regulatory, and other requirements, including without limitation federal, state, and local reporting and filing requirements. This fee is assessed as a set percentage of our monthly billing and is recognized monthly.
| · | Non-contracted administrative fees – Administrative fees are recognized as revenue on a monthly basis.

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

| · | Contracted professional service revenue – Professional service revenue includes professional installation services, custom integration, and other professional services. The Company typically bills and collects professional service revenue upon entering into a contract with a customer. Professional service revenue is recognized as revenue when the performance obligations are completed.
| · | Non-contracted cancellation fees – These cancellation fees relate to remaining contractual term buyout payments in connection with early cancellation and are billed and recognized as revenue upon receipt.
| · | Other non-contracted fees – These fees include disconnect fees, shipping fees, restocking fees, and porting fees. Other non-contracted fees are recognized as revenue upon receipt of payment.

Software Solutions Segment

The Software Solutions segment derives revenues from three primary sources: software licenses, software maintenance support and professional services. Software and services may be sold separately or in bundled packages. Generally, contracts with customers contain multiple performance obligations, consisting of software and services. 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 software licenses and professional 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.

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Software Licenses - The Company’s software licenses typically provide a perpetual right to use the Company’s software. The Company also sells term-based software licenses that expire and Software-as-a-Service (“SaaS”) based software which are referred to as subscription arrangements. The Company does not customize its software nor are installation services required, as the customer has a right to utilize internal resources or a third-party service company. The software is delivered before related services are provided and are functional without professional services or customer support. The Company has concluded that its software licenses are functional intellectual property that are distinct, as the user can benefit from the software on its own. The software license revenue could be recognized upon transfer of control or when the software is made available for download, as this is the point that the user of the software can direct the use of, and obtain substantially all of the remaining benefits from, the functional intellectual property. However, historical experience shows that customers regularly renegotiate the number of licenses during the installation process. Therefore, the Company recognizes revenue from software licenses when the setup is complete. The Company does not recognize software revenue related to the renewal of subscription software licenses earlier than the beginning of the subscription period.

| · | SNAPsolution® - a comprehensive, IP-based platform that provides a broad suite of UC services including hosted Private Branch Exchange (PBX), auto-attendant, call center, conferencing, and mobility. The platform includes a broad range of feature-sets, custom-built to provide unprecedented levels of flexibility, making the solution competitive with the market’s leading players. SNAPsolution includes a full suite of Voice over Internet Protocol (VoIP)/UC features with one low cost universal license, as opposed to pricing each feature individually. The Company licenses its platform based on concurrent sessions, not per seat/per feature. This allows service providers to oversubscribe their networks, driving down the cost per seat as volume increases. As the service provider increases their customer base, they only have to ensure they have sufficient concurrent call licenses to support users across the network. The Company recognizes one-time upfront software license revenue when the software setup is complete.
| · | SNAPaccel – a Software-as-a-Service (“SaaS”) based software license referred to as subscription arrangements. The Company recognizes revenue as subscriptions are provided in service revenue on a monthly basis.

Subscription Maintenance and Support - Subscription maintenance and support revenue includes revenue from maintenance service contracts, customer support, and other supportive services. The Company offers warranties on its products. The warranty period for the Company’s licensed software is generally 90 days. Certain of the Company’s warranties are considered to be assurance-type in nature and do not cover anything beyond ensuring that the product is functioning as intended. Based on the guidance in ASC 606, assurance-type warranties do not represent separate performance obligations. The Company also sells separately-priced maintenance service contracts, which qualify as service-type warranties and represent separate performance obligations. The Company does not typically allow and has no history of accepting material product returns. Customer support includes software updates on a when-and-if-available basis, telephone support, integrated web-based support and bug fixes or patches. Subscription and maintenance support revenue is recognized ratably over the term of the customer support agreement, which is typically one year.

Professional Services and Other - The Company’s professional services include consulting, technical support, resident engineer services, design services and installation services. Revenue from professional services and other is recognized when the performance obligation is complete and the customer has accepted the performance obligation.

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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, 2021 |  | Cloud |  |  | Software |  |  | Total |
(In thousands) |  | Telecommunications |  |  | Solutions |  |  | Reportable |
|  | Segment |  |  | Segment |  |  | Segments |
Major products/services lines |  |  |  |  |  |  |  |  |
Desktop devices |  | $ | 701 |  |  | $ | - |  |  | $ | 701 |
Equipment financing revenue |  |  | 63 |  |  |  | - |  |  |  | 63 |
Telecommunications services |  |  | 3,718 |  |  |  | - |  |  |  | 3,718 |
Fees, commissions, and other, recognized over time |  |  | 419 |  |  |  | - |  |  |  | 419 |
One time fees, commissions and other |  |  | 125 |  |  |  | - |  |  |  | 125 |
Software licenses |  |  | - |  |  |  | 1,473 |  |  |  | 1,473 |
Subscription maintenance and support |  |  | - |  |  |  | 2,213 |  |  |  | 2,213 |
Professional services and other |  |  | - |  |  |  | 98 |  |  |  | 98 |
|  | $ | 5,026 |  |  | $ | 3,784 |  |  | $ | 8,810 |
Timing of revenue recognition |  |  |  |  |  |  |  |  |  |  |  |
Products, services, and fees recognized at a point in time |  | $ | 775 |  |  | $ | 1,917 |  |  | $ | 2,692 |
Products, services, and fees transferred over time |  |  | 4,251 |  |  |  | 1,867 |  |  |  | 6,118 |
|  | $ | 5,026 |  |  | $ | 3,784 |  |  | $ | 8,810 |

Three Months Ended September 30, 2020 |  | Cloud |  |  | Software |  |  | Total |
(In thousands) |  | Telecommunications |  |  | Solutions |  |  | Reportable |
|  | Segment |  |  | Segment |  |  | Segments |
Major products/services lines |  |  |  |  |  |  |  |  |
Desktop devices |  | $ | 489 |  |  | $ | - |  |  | $ | 489 |
Equipment financing revenue |  |  | 59 |  |  |  | - |  |  |  | 59 |
Telecommunications services |  |  | 3,182 |  |  |  | - |  |  |  | 3,182 |
Fees, commissions, and other, recognized over time |  |  | 373 |  |  |  | - |  |  |  | 373 |
One time fees, commissions and other |  |  | 40 |  |  |  | - |  |  |  | 40 |
|  | $ | 4,143 |  |  | $ | - |  |  | $ | 4,143 |
Timing of revenue recognition |  |  |  |  |  |  |  |  |  |  |  |
Products and fees recognized at a point in time |  | $ | 529 |  |  | $ | - |  |  | $ | 529 |
Services and fees transferred over time |  |  | 3,614 |  |  |  | - |  |  |  | 3,614 |
|  | $ | 4,143 |  |  | $ | - |  |  | $ | 4,143 |

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Nine Months Ended September 30, 2021 |  | Cloud |  |  | Software |  |  | Total |
(In thousands) |  | Telecommunications |  |  | Solutions |  |  | Reportable |
|  | Segment |  |  | Segment |  |  | Segments |
Major products/services lines |  |  |  |  |  |  |  |  |
Desktop devices |  | $ | 1,509 |  |  | $ | - |  |  | $ | 1,509 |
Equipment financing revenue |  |  | 198 |  |  |  | - |  |  |  | 198 |
Telecommunications services |  |  | 10,995 |  |  |  | - |  |  |  | 10,995 |
Fees, commissions, and other, recognized over time |  |  | 1,252 |  |  |  | - |  |  |  | 1,252 |
One time fees, commissions and other |  |  | 346 |  |  |  | - |  |  |  | 346 |
Software licenses |  |  | - |  |  |  | 2,210 |  |  |  | 2,210 |
Subscription maintenance and support |  |  | - |  |  |  | 2,451 |  |  |  | 2,451 |
Professional services and other |  |  | - |  |  |  | 135 |  |  |  | 135 |
|  | $ | 14,300 |  |  | $ | 4,796 |  |  | $ | 19,096 |
Timing of revenue recognition |  |  |  |  |  |  |  |  |  |  |  |
Products and fees recognized at a point in time |  | $ | 1,804 |  |  | $ | 2,633 |  |  | $ | 4,437 |
Services and fees transferred over time |  |  | 12,496 |  |  |  | 2,163 |  |  |  | 14,659 |
|  | $ | 14,300 |  |  | $ | 4,796 |  |  | $ | 19,096 |

Nine Months Ended September 30, 2020 |  | Cloud |  |  | Software |  |  | Total |
(In thousands) |  | Telecommunications |  |  | Solutions |  |  | Reportable |
|  | Segment |  |  | Segment |  |  | Segments |
Major products/services lines |  |  |  |  |  |  |  |  |
Desktop devices |  | $ | 1,317 |  |  | $ | - |  |  | $ | 1,317 |
Equipment financing revenue |  |  | 156 |  |  |  | - |  |  |  | 156 |
Telecommunications services |  |  | 9,321 |  |  |  | - |  |  |  | 9,321 |
Fees, commissions, and other, recognized over time |  |  | 1,147 |  |  |  | - |  |  |  | 1,147 |
One time fees, commissions and other |  |  | 123 |  |  |  | - |  |  |  | 123 |
|  | $ | 12,064 |  |  | $ | - |  |  | $ | 12,064 |
Timing of revenue recognition |  |  |  |  |  |  |  |  |  |  |  |
Products and fees recognized at a point in time |  | $ | 1,440 |  |  | $ | - |  |  | $ | 1,440 |
Services and fees transferred over time |  |  | 10,624 |  |  |  | - |  |  |  | 10,624 |
|  | $ | 12,064 |  |  | $ | - |  |  | $ | 12,064 |

Contract balances

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

|  | September 30, |  |  | December 31, |
(In thousands) |  | 2021 |  |  | 2020 |
Receivables, which are included in trade receivables, net of allowance |  |  |  |  |  |
for doubtful accounts |  | $ | 1,307 |  |  | $ | 538 |
Contract assets |  |  | 209 |  |  |  | 159 |
Contract liabilities |  |  | 2,884 |  |  |  | 1,228 |

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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, 2021 |  |  | December 31, 2020 |
|  | Contract Assets |  |  | Contract Liabilities |  |  | Contract Assets |  |  | Contract Liabilities |
Revenue recognized that was included in the contract liability balance at the beginning of the period |  | $ | - |  | $ | (986 | ) |  | $ | - |  |  | $ | (976 | )
Increase due to cash received, excluding amounts recognized as revenue during the period |  |  | - |  |  | 2,642 |  |  |  | - |  |  |  | 990 |
Transferred to receivables from contract assets recognized at the beginning of the period |  |  | (47 | ) |  |  | - |  |  |  | (21 | ) |  |  | - |
Increase due to additional unamortized discounts |  |  | 97 |  |  |  | - |  |  |  | 158 |  |  |  | - |

Transaction price allocated to the remaining performance obligations

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

|  | 2021 |  |  | 2022 |  |  | 2023 |  |  | 2024 |  |  | 2025 |  |  | 2026 |  |  | Total |
Desktop devices |  | $ | 242 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  | $ | 242 |
Telecommunications service |  | $ | 3,905 |  |  |  | 11,306 |  |  |  | 7,699 |  |  |  | 4,967 |  |  |  | 2,165 |  |  |  | 439 |  |  | $ | 30,481 |
All consideration from contracts with customers is included in the amounts presented above |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

The table above excludes backlog from the software solutions segment acquired in the NetSapiens acquisition, as additional time is required to compile the data.

3. Earnings Per Common Share

Basic net income/(loss) per common share is computed by dividing the net income for the period by the weighted-average number of common shares outstanding during the period. Diluted net income per common share is computed giving effect to all dilutive common stock equivalents, consisting of common stock options. Diluted net loss per common share for the three and nine months ended September 30, 2021 is the same as basic net loss per common share because the common share equivalents were anti-dilutive due to the net loss. The following table sets forth the computation of basic and diluted net income per common share:

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
Net income/(loss) (in thousands) (A) |  | $ | (125 | ) |  | $ | 131 |  |  | $ | (1,843 | ) |  | $ | 779 |
Weighted-average share reconciliation: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Weighted-average basic shares outstanding (B) |  |  | 21,596,415 |  |  |  | 15,244,804 |  |  |  | 19,757,658 |  |  |  | 15,058,192 |
Dilutive effect of stock-based awards |  |  | - |  |  |  | 2,004,231 |  |  |  | - |  |  |  | 1,735,704 |
Diluted weighted-average outstanding shares of common stock (C) |  |  | 21,596,415 |  |  |  | 17,249,035 |  |  |  | 19,757,658 |  |  |  | 16,793,896 |
Earnings per common share: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic (A/B) |  | $ | (0.01 | ) |  | $ | 0.01 |  |  | $ | (0.09 | ) |  | $ | 0.05 |
Diluted (A/C) |  | $ | (0.01 | ) |  | $ | 0.01 |  |  | $ | (0.09 | ) |  | $ | 0.05 |

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For the three and nine months ended September 30, 2021 and 2020, the following potentially dilutive common stock, including awards granted under our equity incentive compensation plans, were excluded from the computation of diluted net income per share because including them would be anti-dilutive.

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
Stock options |  |  | 970,631 |  |  |  | 18,685 |  |  |  | 840,623 |  |  |  | 91,845 |

4. Acquisitions

NetSapiens, Inc. Merger Agreement

On June 1, 2021, the Company acquired 100% of the issued and outstanding shares of NetSapiens, Inc. (“NetSapiens”), a provider of a comprehensive suite of unified communications (UC), video conferencing, collaboration & contact center solutions to service providers, servicing over two million users around the globe. The aggregate purchase price was approximately $49.1 million, consisting of $10 million in cash, and approximately $39 million in common stock and stock options. In connection with the closing of the Merger, the Company issued 3,097,309 shares of the Company’s common stock valued at $5.47 per share for common stock consideration of approximately $16.9 million, and 4,482,328 options under the Crexendo, Inc. 2021 Equity Incentive Plan with an aggregate value of $22.1 million, net of the aggregate exercise price of $5.6 million. Acquisition costs are included in general and administrative expenses and totaled $4,000 for the three months ended September 30, 2021 and $1,015,000 for the nine months ended September 30, 2021.

The acquisition was accounted for under the acquisition method of accounting, with the Company identified as the acquirer. The Company’s unaudited condensed consolidated financial statements include the results of operations of NetSapiens from the date of acquisition. The historical results of operations of NetSapiens were not significant to the Company’s unaudited condensed consolidated results of operations for the periods presented. Under the acquisition method of accounting, the aggregate amount of consideration paid by the Company was allocated to NetSapiens’s net tangible assets and intangible assets based on their estimated fair value on the acquisition date. The preliminary purchase price allocation, as set forth in the table below, reflects various preliminary fair value estimates and analysis prepared by the Company. The preliminary purchase price allocation is subject to revision as a more detailed analysis is completed by a third party valuation specialist and additional information on the fair values of NetSapiens’s assets and liabilities becomes available. Any change in the fair value of the net assets of NetSapiens will change the amount of the purchase price allocable to goodwill. Final purchase accounting adjustments may differ materially from preliminary purchase price allocation presented here. The preliminary areas of the purchase price allocation that are not yet finalized relate to the identification and valuation of intangible assets by an independent third party valuation firm and the determination of fair values of certain assets and liabilities; trade receivable, right-of-use assets and associated liabilities, deferred tax assets, and contract costs. We anticipate finalizing our purchase price allocation during 2021. The following table presents the preliminary allocation of the assets acquired and liabilities assumed as of June 1, 2021 (in thousands):

Total purchase price |  | $ | 49,062 |
Cash |  |  | 1,658 |
Trade receivables |  |  | 846 |
Prepaid expenses |  |  | 57 |
Other current assets |  |  | 319 |
Property and equipment, net |  |  | 62 |
Right-of-use assets |  |  | 551 |
Deferred tax assets |  |  | 2,829 |
Other long-term assets |  |  | 84 |
Intangible assets- existing technology |  |  | 5,047 |
Intangible assets- customer relationships |  |  | 16,473 |
Total identifiable assets |  |  | 27,926 |
Accounts payable |  |  | (438 | )
Accrued expenses |  |  | (2,412 | )
Finance leases |  |  | (17 | )
Contract liabilities |  |  | (1,475 | )
Operating lease liabilities |  |  | (379 | )
Contract liabilities, net of current portion |  |  | (629 | )
Finance leases, net of current portion |  |  | (29 | )
Operating lease liabilities, net of current portion |  |  | (219 | )
Total liabilities assumed |  |  | (5,598 | )
Total goodwill |  | $ | 26,734 |

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A preliminary estimate of $5.0 million has been allocated to existing technology, an intangible asset with an estimated useful life of approximately 6 years. A preliminary estimate of $16.5 million has been allocated to customer relationships with an estimated life of approximately 9 years. The estimated fair values of existing technology and customer relationships was established based upon the income approach. The income approach relies on an estimation of the present value of the future monetary benefits expected to flow to the owner of an asset during its remaining economic life. This approach requires a projection of the cash flow that the asset is expected to generate in the future. The projected cash flow is discounted to its present value using a rate of return, or discount rate that accounts for the time value of money and the degree of risk inherent in the asset. The income approach may take the form of a “relief from royalty” methodology, a cost savings methodology, a “with and without” methodology, or excess earnings methodology, depending on the specific asset under consideration.

The existing technology and customer relationships were valued using the multi-period excess earnings method. Inherent in the multi-period excess earnings method is the recognition that, in most cases, all of the assets of the business, both tangible and intangible, contribute to the generation of the cash flow of the business and the net cash flows attributable to the subject asset must recognize the support of the other assets which contribute to the realization of the cash flows. This future cash flow was then discounted using an estimated required rate of return for the asset to determine the present value of the future cash flows attributable to the asset. The key assumptions used in valuing the existing technology and customer relationships acquired are as follows: weighted average cost of capital of 17.4%, tax rate of 22.5%, and estimated economic life of 6 and 9 years, respectively.

A preliminary estimate of $26.7 million has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. Goodwill will not be amortized and will be tested for impairment at least annually. The preliminary purchase price allocation for NetSapiens is subject to revision as more detailed analysis is completed and additional information on the fair values of NetSapiens’ assets and liabilities becomes available. Any changes in the fair value of the net assets of NetSapiens will change the amount of the purchase price allocable to goodwill. The final purchase accounting allocation may therefore differ materially from the pro forma adjustments presented herein. The final allocation may include (1) changes in fair values of property and equipment (2) changes in allocations to intangible assets such as technology, customer relationships, and deferred revenue as well as goodwill and (3) other changes to assets and liabilities.

The following unaudited pro forma information presents our condensed consolidated results of operations as if NetSapiens, Inc. had been included in our consolidated results since January 1, 2020:

|  | For the Nine Months Ended September 30, (Unaudited) |
(In thousands) |  | 2021 |  |  | 2020 |
Revenues |  | $ | 24,123 |  |  | $ | 20,867 |
Net income/(loss) |  |  | (12,671 | ) |  |  | 487 |
Earnings per share |  | $ | (0.64 | ) |  | $ | 0.03 |

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The unaudited pro forma financial information is presented for informational purposes only, and may not necessarily reflect the Company’s future results of operations or what the results of operations would have been had the Company owned and operated NetSapiens, Inc. as of January 1, 2020.

Centric Telecom, Inc. Business Acquisition

On January 14, 2021, the Company acquired 100% of the issued and outstanding shares of Centric Telecom, Inc., a provider of telecommunications products, services, and solutions in Northern Virginia. The aggregate purchase price of $3,255,000 consisted of $2,163,000 of cash paid at closing, 46,662 shares of our common stock with an estimated fair value of $346,000 issued at closing, and $746,000 of estimated contingent consideration to be paid out based on annualized revenue recognized during the nine month earn-out period. The fair value of the common stock issued as consideration was determined based on the closing market price of the Company’s common stock on the date of the acquisition of $7.42. The aggregate purchase price is subject to customary upward or downward adjustments for Centric Telecom’s net working capital. Acquisition costs are included in general and administrative expenses and totaled $0 for the three months ended September 30, 2021 and $50,000 for the nine months ended September 30, 2021.

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

Consideration (including estimated unpaid contingent consideration) |  |  |
Cash |  | $ | 2,163 |
Common stock |  |  | 346 |
Contingent consideration |  |  | 746 |
|  | $ | 3,255 |
Assets |  |  |  |
Cash |  | $ | 7 |
Accounts receivables |  |  | 122 |
Prepaid expenses |  |  | 4 |
Inventory |  |  | 12 |
Other assets |  |  | 12 |
Property and equipment |  |  | 57 |
Right to use assets |  |  | 134 |
Intangible assets acquired |  |  | 2,238 |
Other long-term assets |  |  | 44 |
Total assets acquired |  |  | 2,630 |
Liabilities |  |  |  |
Accounts Payable |  |  | 26 |
Accrued Expenses |  |  | 187 |
Contract Liability |  |  | 147 |
Operating Lease Liability |  |  | 118 |
Direct Financing Liability |  |  | 20 |
Total liabilities assumed |  |  | 498 |
Net identifiable assets acquired |  |  | 2,132 |
Goodwill |  |  | 1,123 |
Total purchase price |  | $ | 3,255 |

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

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, |
|  | 2021 |  |  | 2020 |
Gross trade receivables |  | $ | 1,347 |  |  | $ | 559 |
Less: allowance for doubtful accounts |  |  | (40 | ) |  |  | (21 | )
Trade receivables, net |  | $ | 1,307 |  |  | $ | 538 |
Current trade receivables, net |  | $ | 1,280 |  |  | $ | 538 |
Long-term trade receivables, net |  |  | 27 |  |  |  | - |
Trade receivables, net |  | $ | 1,307 |  |  | $ | 538 |

6. Prepaid Expenses

Prepaid expenses consisted of the following (in thousands):

|  | September 30, |  |  | December 31, |
|  | 2021 |  |  | 2020 |
Prepaid corporate insurance |  | $ | 158 |  |  | $ | 53 |
Prepaid software services and support |  |  | 281 |  |  |  | 20 |
Prepaid employee insurance premiums |  |  | 78 |  |  |  | 71 |
Prepaid Nasdaq listing fee |  |  | 15 |  |  |  | - |
Other prepaid expenses |  |  | 118 |  |  |  | 46 |
Total prepaid expenses |  | $ | 650 |  |  | $ | 190 |

7. Property and Equipment

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

|  | September 30, |  |  | December 31, |
|  | 2021 |  |  | 2020 |
Building |  | $ | 2,000 |  |  | $ | 2,000 |
Land |  |  | 500 |  |  |  | 500 |
Computer and office equipment |  |  | 1,925 |  |  |  | 1,436 |
Computer software |  |  | 576 |  |  |  | 526 |
Internal-use software |  |  | 14 |  |  |  | 14 |
Vehicles |  |  | 95 |  |  |  | - |
Leasehold improvements |  |  | 33 |  |  |  | - |
Less: accumulated depreciation |  |  | (2,084 | ) |  |  | (1,742 | )
Total property and equipment, net |  | $ | 3,059 |  |  | $ | 2,734 |

Depreciation and amortization expense is included in general and administrative expenses and totaled $63,000 and $34,000 for the three months ended September 30, 2021 and 2020, respectively and totaled $158,000 and $128,000 for the nine months ended September 30, 2021 and 2020, respectively.

8. Intangible Assets and Goodwill

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

|  | September 30, 2021 |  |  | December 31, 2020 |
|  | Gross Carrying Amount |  |  | Accumulated Amortization |  |  | Net Carrying Amount |  |  | Gross Carrying Amount |  |  | Accumulated Amortization |  |  | Net Carrying Amount |
Customer relationships |  | $ | 19,882 |  |  | $ | (1,331 | ) |  | $ | 18,551 |  |  | $ | 1,171 |  |  | $ | (919 | ) |  | $ | 252 |
Developed technologies |  |  | 5,047 |  |  |  | (361 | ) |  |  | 4,686 |  |  |  | - |  |  |  | - |  |  |  | - |
Total acquired intangible assets |  | $ | 24,929 |  |  | $ | (1,692 | ) |  | $ | 23,237 |  |  | $ | 1,171 |  |  | $ | (919 | ) |  | $ | 252 |

As of September 30, 2021, the weighted average remaining useful life for customer relationships was 8.5 years and developed technologies was 5.7 years.

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Amortization expense for customer relationships intangible assets is included in general and administrative expenses and totaled $236,000 and $16,000 for the three months ended September 30, 2021 and 2020, respectively, and totaled $412,000 and $46,000 for the nine months ended September 30, 2021 and 2020, respectively. Amortization expense for developed technologies intangible assets is included in cost of software solutions revenue and totaled $270,000 and $0 for the three months ended September 30, 2021 and 2020, respectively, and totaled $361,000 and $0 for the nine months ended September 30, 2021 and 2020, respectively.

During the three months ended June 30, 2021, the Company acquired $21,520,000 in intangible assets in connection with the NetSapiens business acquisition. During the three months ended March 31, 2021, the Company acquired $2,238,000 in intangible assets in connection with the Centric Telecom business acquisition. During the year ended December 31, 2020, we reduced customer relationships by $121,000 due to an adjustment to the total consideration payable under the DoubleHorn customer relationships asset purchase agreement.

As of September 30, 2021, annual amortization of definite lived intangible assets, based on existing intangible assets and current useful lives, is estimated to be the following (in thousands):

Year ending December 31, |  |  |
2021 remaining |  | $ | 507 |
2022 |  |  | 2,110 |
2023 |  |  | 2,553 |
2024 |  |  | 2,849 |
2025 and thereafter |  |  | 15,218 |
Total |  | $ | 23,237 |

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

|  | Goodwill |
Balance at December 31, 2020 |  |  | 272 |
Centric Telecom business acquisition |  |  | 1,123 |
NetSapiens business acquisition |  |  | 26,734 |
Balance at September 30, 2021 |  | $ | 28,129 |

9. Accrued Expenses

Accrued expenses consisted of the following (in thousands):

|  | September 30, |  |  | December 31, |
|  | 2021 |  |  | 2020 |
Accrued wages, benefits and payroll taxes |  | $ | 698 |  |  | $ | 513 |
Accrued accounts payable |  |  | 915 |  |  |  | 505 |
Accrued sales and telecommunication taxes |  |  | 2,616 |  |  |  | 438 |
Product warranty liability |  |  | 34 |  |  |  | 33 |
Other accrued expenses |  |  | 88 |  |  |  | 139 |
Total accrued expenses |  | $ | 4,351 |  |  | $ | 1,628 |

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The changes in aggregate product warranty liabilities for the year ended December 31, 2020 and nine months ended September 30, 2021 were as follows (in thousands):

|  | Warranty Liabilities |
Balance at January 1, 2020 |  | $ | 37 |
Accrual for warranties |  |  | 33 |
Adjustments related to pre-existing warranties |  |  | (10 | )
Warranty settlements |  |  | (27 | )
Balance at December 31, 2020 |  |  | 33 |
Accrual for warranties |  |  | 27 |
Warranty settlements |  |  | (26 | )
Balance at September 30, 2021 |  | $ | 34 |

Product warranty expense is included in cost of product revenue expense and totaled $15,000 and $11,000 for the three months ended September 30, 2021 and 2020, respectively, and $27,000and $29,000for the nine months ended September 30, 2021 and 2020, respectively.

10. Notes Payable

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

|  | September 30, |  |  | December 31, |
|  | 2021 |  |  | 2020 |
Notes payable |  | $ | 1,891 |  |  | $ | 1,944 |
Less: current notes payable |  |  | (73 | ) |  |  | (71 | )
Notes payable, net of current portion |  | $ | 1,818 |  |  | $ | 1,873 |

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

As of September 30, 2021, future principal payments are scheduled as follows (in thousands):

Year ending December 31, |  |  |
2021 remaining |  | $ | 19 |
2022 |  |  | 74 |
2023 |  |  | 76 |
2024 |  |  | 79 |
2025 and thereafter |  |  | 1,643 |
Total |  | $ | 1,891 |

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11. Fair Value Measurements

We have financial instruments as of September 30, 2021 and December 31, 2020 for which the fair value is summarized below (in thousands):

|  | September 30, 2021 |  |  | December 31, 2020 |
|  | Carrying Value |  |  | Estimated Fair Value |  |  | Carrying Value |  |  | Estimated Fair Value |
Assets: |  |  |  |  |  |  |  |  |  |  |  |
Trade receivables, net |  | $ | 1,307 |  |  | $ | 1,307 |  |  | $ | 538 |  |  | $ | 538 |
Equipment financing receivables |  |  | 1,161 |  |  |  | 1,161 |  |  |  | 1,192 |  |  |  | 1,192 |
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Finance lease obligations |  | $ | 367 |  |  | $ | 367 |  |  | $ | 84 |  |  | $ | 84 |
Notes payable |  |  | 1,891 |  |  |  | 1,891 |  |  |  | 1,944 |  |  |  | 1,944 |
Business acquisition contigent consideration |  |  | 746 |  |  |  | 746 |  |  |  | - |  |  |  | - |

Liabilities for which fair value is recognized in the balance sheet on a recurring basis are summarized below as of September 30, 2021 and December 31, 2020 (in thousands):

|  | As of September 30, |  |  | Fair value measurement at reporting date |
Description |  | 2021 |  |  | Level 1 |  |  | Level 2 |  |  | Level 3 |
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |
Business acquisition contingent consideration |  | $ | 746 |  |  | $ | - |  |  | $ | - |  |  | $ | 746 |
Description |  | As of December 31, 2020 |  |  | Level 1 |  |  | Level 2 |  |  | Level 3 |
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Asset acquisition contingent consideration |  | $ | - |  |  | $ | - |  |  | $ | - |  |  | $ | - |

The recurring Level 3 measurement of our business acquisition contingent consideration liability includes the following significant unobservable inputs at September 30, 2021 (in thousands):

Contingent consideration liability |  | Fair Value at September 30, 2021 |  |  | Valuation technique |  | Unobservable inputs |  | Range |
Revenue - based payments |  | $ | 746 |  |  | Discounted cash flow |  | Discount Rate |  |  | 17.38 | %
|  |  |  |  |  |  |  | Probability of milestone payment |  |  | 90 | %
|  |  |  |  |  |  |  | Projected year of payments |  | 2021 |

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

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During the three months ended March 31, 2021, the Company recorded $746,000 of contingent consideration in connection with the Centric Telecom business acquisition, to be paid based on the completion of the earn-out period. During the year ended December 31, 2020, the Company reduced the contingent consideration to be paid based on the completion of the earn-out period by $121,000 and recognized a reduction in the cost of the assets acquired in the DoubleHorn Asset Acquisition. The progression of the Company’s Level 3 instruments fair valued on a recurring basis for the three months ended September 30, 2021 and the year ended December 31, 2020 are shown in the table below (in thousands):

|  | Asset and Business Acquisition Contingent Consideration |
Balance at January 1, 2020 |  | $ | 175 |
Cash payments |  |  | (54 | )
Adjustment |  |  | (121 | )
Balance at December 31, 2020 |  | $ | - |
Additions |  |  | 746 |
Cash payments |  |  | - |
Adjustment |  |  | - |
Balance at September 30, 2021 |  | $ | 746 |

12. Income Taxes

Our effective tax rate for the three months ended September 30, 2021 and 2020 was 1167.4% and 2.2%, respectively, which resulted in an income tax benefit/(provision) of $(137,000) and $(3,000), respectively. Our effective tax rate for the nine months ended September 30, 2021 and 2020 was (11.8%) and 1.1%, respectively, which resulted in an income tax benefit/(provision) of $247,000 and $(9,000), respectively.

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

13. Leases

Lessee Accounting

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

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

We previously leased our corporate office building in Tempe, Arizona from a Company that is owned by the major shareholder and CEO of the Company. The building was purchased on January 27, 2020 and the lease was cancelled. Amortization of the ROU assets and operating lease liabilities for the three months ended September 30, 2021 and 2020 was $0 and $0, respectively, and for the nine months ended September 30, 2021 and 2020 was $0 and $50,000, respectively. Rental expense incurred on operating leases for the three months ended September 30, 2021 and 2020 was approximately $0 and $0, respectively, and for the nine months ended September 30, 2021 and 2020 was approximately $0 and $25,000, respectively.

We leased office space in McLean, Virginia under a non-cancelable operating lease agreement that expired on July 31, 2021. The operating lease contains customary escalation clauses. Rental expense for the three months ended September 30, 2021 and 2020 was approximately $9,000 and $0, respectively, and for the nine months ended September 30, 2021 and 2020 was $56,000 and $0, respectively.

We currently lease office space in Reston, Virgina under a non-cancelable operating lease agreement that expires in 2025. The operating lease contains customary escalation clauses. Rental expense for the three months ended September 30, 2021 and 2020 was approximately $9,000 and $0, respectively, and for the nine months ended September 30, 2021 and 2020 was approximately $9,000, and $0, respectively.

We currently lease office space in La Jolla, California under a non-cancelable operating lease agreement that expires in 2022. The operating lease contains customary escalation clauses. Rental expense for the three months ended September 30, 2021 and 2020 was approximately $94,000 and $0, respectively, and for the nine months ended September 30, 2021 and 2020 was approximately $124,000, and $0, respectively.

We currently lease other assets under multiple operating leases. The leases expire on various dates through 2023 and the interest rates range from 3.00% to 15.09%. The expense is included in cost of product expenses and totaled approximately $20,000 and $0 for the three months ended September 30, 2021 and 2020, respectively, and for the nine months ended September 30, 2021 and 2020 was $48,000 and $0, respectively.

We currently lease data center colocation space in Grand Rapids, Michigan, Las Vegas, Nevada and Dallas, Texas under non-cancelable operating lease agreements that expire in 2022. Rental expense for the three months ended September 30, 2021 and 2020 was approximately $13,000 and $0, respectively, and for the nine months ended September 30, 2021 and 2020 was approximately $21,000 and $0, 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 finance lease agreements which extends through 2025. The Company also leases three vehicles under financing agreements. One vehicle lease extends through 2021 and two vehicle leases extend through 2022. The outstanding balance for finance leases was $367,000 and $84,000 as of September 30, 2021 and December 31, 2020, respectively. The Company recorded assets classified as property and equipment under finance lease obligations of $497,000 and $129,000 as of September 30, 2021 and December 31, 2020, respectively. Related accumulated depreciation totaled $165,000 and $60,000 as of September 30, 2021 and 2020, respectively. The $39,000 in support contracts were classified as a prepaid expense and are being amortized over the service period of 3 years. One support contract expired in January 2021 and the other expires in June 2024. Amortization expense is included in general and administrative expenses and totaled $1,000 and $2,000 for the three months ended September 30, 2021 and 2020, respectively, and $4,000 and $6,000 for the nine months ended September 30, 2021 and 2020, respectively. The interest rates on the finance lease obligations range from 1.37% and 6.7% and interest expense was $2,000 and $2,000 for the three months ended September 30, 2021 and 2020, respectively and $5,000 and $5,000 for the nine months ended September 30, 2021 and 2020, respectively.

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The maturity of operating leases and finance lease liabilities as of September 30, 2021 are as follows:

Year ending December 31, |  | Operating Leases |  |  | Finance Leases |
2021 remaining |  | $ | 130 |  |  | $ | 23 |
2022 |  |  | 461 |  |  |  | 136 |
2023 |  |  | 58 |  |  |  | 114 |
2024 |  |  | 44 |  |  |  | 77 |
2025 |  |  | - |  |  |  | 31 |
Total minimum lease payments |  |  | 693 |  |  |  | 386 |
Less: amount representing interest |  |  | (11 | ) |  |  | (14 | )
Present value of minimum lease payments |  | $ | 682 |  |  | $ | 373 |

Lease term and discount rate |  | September 30, 2021 |
Weighted-average remaining lease term (years) |  |  |
Operating leases |  |  | 1.6 |
Finance leases |  |  | 3.2 |
Weighted-average discount rate |  |  |  |
Operating leases |  |  | 4.3 | %
Finance leases |  |  | 2.2 | %

|  | Three Months Ended September 30, 2021 |
Cash paid for amounts included in the measurement of lease liabilities: |  |  |
Operating cash flows from operating leases |  | $ | 66 |
Operating cash flows from finance leases |  |  | 4 |
Financing cash flows from finance leases |  |  | 71 |

Lessor Accounting

Lessor accounting remained substantially unchanged with the adoption of ASC Topic 842. Crexendo offers its customers lease financing for the lease of our cloud telecommunication equipment (IP or cloud telephone desktop devices). We account for these transactions as sales-type leases. The vast majority of our leases that qualify as sales-type leases are non-cancelable and include cancellation penalties approximately equal to the full value of the lease receivables. Leases that do not meet the criteria for sales-type lease accounting are accounted for as operating leases. Operating lease revenue is classified as product revenue and totaled $54,000 and $0 for the three months ended September 30, 2021 and 2020, respectively, and $148,000 and $0 for the nine months ended September 30, 2021 and 2020, respectively. Revenue from sales-type leases is recognized upon installation and the interest portion is deferred and recognized as earned. Revenue from operating leases is recognized ratably over the applicable service period.

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

|  | September 30, |  |  | December 31, |
|  | 2021 |  |  | 2020 |
Gross financing receivables |  | $ | 1,669 |  |  | $ | 1,774 |
Less: unearned income |  |  | (508 | ) |  |  | (582 | )
Financing receivables, net |  |  | 1,161 |  |  |  | 1,192 |
Less: current portion of finance receivables, net |  |  | (324 | ) |  |  | (286 | )
Finance receivables due after one year |  | $ | 837 |  |  | $ | 906 |

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Future minimum lease payments as of September 30, 2021, consisted of the following:

Year ending December 31, |  | Lease Receivables |
2021 remaining |  | $ | 157 |
2022 |  |  | 590 |
2023 |  |  | 484 |
2024 |  |  | 308 |
2025 and thereafter |  |  | 130 |
Gross equipment financing receivables |  |  | 1,669 |
Less: unearned income |  |  | (508 | )
Equipment financing receivables, net |  | $ | 1,161 |

14. Commitments and Contingencies

Legal Proceedings

In the ordinary course of business, the Company may be involved in a variety of claims, lawsuits, investigations, and other proceedings, including patent infringement claims, employment litigation, regulatory compliance matters, and contractual disputes, that can arise in the normal course of the Company’s operations. The Company recognizes a provision when management believes information available prior to the issuance of the financial statements indicates it is probable a loss has been incurred as of the date of the financial statements and the amount of loss can be reasonably estimated. The Company adjusts the amount of the provision to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. As of September 30, 2021, the Company does not have a recorded liability for estimated losses. Legal costs are expensed as incurred.

15. Segment Reporting

Our chief operating decision maker (who is our Chief Executive Officer) reviews our financial information presented on an operating segment basis for purposes of allocating resources and evaluating our financial performance. Following the merger with NetSapiens, Inc., the Company reorganized into two operating segments, a software solutions operating segment and a cloud telecommunications services operating segment. The cloud telecommunications services segment generates revenue from selling cloud telecommunication services, products, and other internet services. The software solutions segment generates revenue from selling perpetual software licenses and software subscriptions, subscription maintenance and support, and professional services. The Company has two reportable operating segments, which consist of cloud telecommunications services and software solutions. Segment revenue, income/(loss) from operations, other income/(expense) and income/(loss) before income tax provision are as follows (in thousands):

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
Revenue: |  |  |  |  |  |  |  |  |  |  |  |
Cloud telecommunications services |  | $ | 5,026 |  |  | $ | 4,143 |  |  | $ | 14,300 |  |  | $ | 12,064 |
Software solutions |  |  | 3,784 |  |  |  | - |  |  |  | 4,796 |  |  |  | - |
Consolidated revenue |  |  | 8,810 |  |  |  | 4,143 |  |  |  | 19,096 |  |  |  | 12,064 |
Income/(loss) from operations: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cloud telecommunications services |  |  | (253 | ) |  |  | 155 |  |  |  | (2,004 | ) |  |  | 867 |
Software solutions |  |  | 306 |  |  |  | - |  |  |  | (9 | ) |  |  | - |
Total operating income/(loss) |  |  | 53 |  |  |  | 155 |  |  |  | (2,013 | ) |  |  | 867 |
Other income/(expense), net: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cloud telecommunications services |  |  | (22 | ) |  |  | (21 | ) |  |  | (58 | ) |  |  | (79 | )
Software solutions |  |  | (19 | ) |  |  | - |  |  |  | (19 | ) |  |  | - |
Total other income/(expense), net |  |  | (41 | ) |  |  | (21 | ) |  |  | (77 | ) |  |  | (79 | )
Income/(loss) before income tax provision: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cloud telecommunications services |  |  | (275 | ) |  |  | 134 |  |  |  | (2,062 | ) |  |  | 788 |
Software solutions |  |  | 287 |  |  |  | - |  |  |  | (28 | ) |  |  | - |
Income/(loss) before income tax provision |  | $ | 12 |  |  | $ | 134 |  |  | $ | (2,090 | ) |  | $ | 788 |

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Depreciation and amortization was $60,000 and $57,000 for the cloud telecommunications services segment for the three months ended September 30, 2021 and 2020, respectively. Depreciation and amortization was $152,000 and $197,000 for the cloud telecommunications segment for the nine months ended September 30, 2021 and 2020, respectively. Depreciation and amortization was $6,000 and $0 for the software solutions segment for the three months ended September 30, 2021 and 2020, respectively. Depreciation and amortization was $7,000 and $0 for the software solutions segment for the nine months ended September 30, 2021 and 2020, respectively.

Interest income was $0 and $1,000 for the cloud telecommunications services segment for the three months ended September 30, 2021 and 2020, respectively. Interest income was $1,000 and $3,000 for the cloud telecommunications segment for the nine months ended September 30 2021 and 2020, respectively. Interest income was $0 for the software solutions segment for the three and nine months ended September 30, 2021 and 2020.

Interest expense was $24,000 and $23,000 for the cloud telecommunications services segment for the three months ended September 30, 2021 and 2020, respectively. Interest expense was $64,000 and $54,000 for the cloud telecommunications services segment for the nine months ended September 30, 2021 and 2020, respectively. Interest expense was $0 for the software solutions segment for the three and nine months ended September 30, 2021 and 2020.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This section and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and our Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A, “Risk Factors,” which are incorporated herein by reference. The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 Form 10-K”) filed with the SEC and the Condensed Consolidated Financial Statements and notes thereto included in the 2021 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, 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, Inc. is an award-winning premier provider of Unified Communications as a Service (UCaaS), Call Center as a Service (CCaaS), communication platform software solutions, and collaboration services designed to provide enterprise-class cloud communication solutions to any size business through our business partners, agents, and direct channels. Our solutions currently support over two Million end users globally and was recently recognized as the fastest growing UCaaS platform in the United States. Following the merger with NetSapiens, the Company has reorganized with two operating segments, which consist of cloud telecommunications services and software solutions.

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

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

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

Software Solutions – Our software solutions segment derives revenues from three primary sources: software licenses, software maintenance support and professional services. Software and services may be sold separately or in bundled packages. Generally, contracts with customers contain multiple performance obligations, consisting of software and services. 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 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 software licenses and professional 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.

We generate software license revenue from the sale of perpetual software licenses, term-based software licenses that expire, and Software-as-a-Service (“SaaS”) based software which are referred to as subscription arrangements. The Company does not recognize software revenue related to the renewal of subscription software licenses earlier than the beginning of the subscription period.

We generate subscription and maintenance support revenue from customer support and other supportive services. The Company offers warranties on its products. The warranty period for our licensed software is generally 90 days. Certain of the Company’s warranties are considered to be assurance-type in nature and do not cover anything beyond ensuring that the product is functioning as intended. Based on the guidance in ASC 606, assurance-type warranties do not represent separate performance obligations. The Company also sells separately-priced maintenance service contracts, which qualify as service-type warranties and represent separate performance obligations. The Company does not typically allow and has no history of accepting material product returns. Customer support includes software updates on a when-and-if-available basis, telephone support, integrated web-based support and bug fixes or patches. Subscription and maintenance support revenue is recognized ratably over the term of the customer support agreement, which is typically one year.

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We generate professional services and other revenue from consulting, technical support, resident engineer services, design services and installation services. Revenue for professional services and other is recognized when the performance obligation is complete and the customer has accepted the performance obligation.

Our software solutions revenue was $3,784,000 for the three months ended September 30, 2021 and $0 for the three months ended September 30, 2020. Our software solutions revenue was $4,796,000 for the nine months ended September 30, 2021 and $0 for the nine months ended September 30, 2020.

OUR SERVICES AND PRODUCTS

Crexendo, Inc. is an award-winning premier provider of Unified Communications as a Service (UCaaS), Call Center as a Service (CCaaS), communication platform software solutions, and collaboration services designed to provide enterprise-class cloud communication solutions to any size business through our business partners, agents, and direct channels. Our solutions currently support over two million end users globally and was recently recognized as the fastest growing UCaaS platform in the United States. 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 Services – Our cloud telecommunications service offering includes hardware, software, and unified ng IP or cloud technology over any high-speed Internet connection. These services are rendered through a variety of devices and communication solutions for businesses using user interfaces such as a Crexendo branded desktop phones and/or mobile and desktop applications. Some examples of mobile devices are Android cell phones, iPhones, iPads or Android tablets. These services enable our customers to seamlessly communicate with others through phone calls that originate/terminate on our network or PSTN networks. Our cloud telecommunications services are powered by our proprietary implementation of standards based Web and VoIP cloud technologies. Our services use our highly scalable complex infrastructure that we build and manage based on industry standard best practices to achieve greater efficiencies, better quality of service (QoS) and customer satisfaction. Our infrastructure comprises of compute, storage, network technologies, 3rd party products and vendor relationships. We also develop end user portals for account management, license management, billing and customer support and adopt other cloud technologies through our partnerships.

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

| · | Business Productivity Features such as dial-by extension and name, transfer, conference, call recording, Unlimited calling to anywhere in the US and Canada, International calling, Toll free (Inbound and Outbound)
| · | Individual Productivity Features such as Caller ID, Call Waiting, Last Call Return, Call Recording, Music/Message-On-Hold, Voicemail, Unified Messaging, Hot-Desking
| · | Group Productivity Features such as Call Park, Call Pickup, Interactive Voice Response (IVR), Individual and Universal Paging, Corporate Directory, Multi-Party Conferencing, Group Mailboxes, Web and mobile devices based collaboration applications
| · | Call Center Features such as Automated Call Distribution (ACD), Call Monitor, Whisper and Barge, Automatic Call Recording, One way call recording, Analytics
| · | Advanced Unified Communication Features such as Find-Me-Follow-Me, Sequential Ring and Simultaneous Ring, Voicemail transcription
| · | Mobile Features such as extension dialing, transfer and conference and seamless hand-off from WiFi to/from 3G and 4G, LTE, as well as other data services. These features are also available on CrexMo, an intelligent mobile application for iPhones and Android smartphones, as well as iPads and Android tablets
| · | Traditional PBX Features such as Busy Lamp Fields, System Hold. 16-48 Port density Analog Devices
| · | Expanded Desktop Device Selection such as Entry Level Phone, Executive Desktop, DECT Phone for roaming users
| · | Advanced Faxing solution such as Cloud Fax (cFax) allowing customers to send and receive Faxes from their Email Clients, Mobile Phones and Desktops without having to use a Fax Machine simply by attaching a file
| · | Web based online portal to administer, manage and provision the system.
| · | Asynchronous communication tools like SMS/MMS, chat and document sharing to keep in pace with emerging communication trends.

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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.

Software Solutions – Our software solutions offering provides a comprehensive suite of unified communications (UC), video conferencing, Collaboration & contact center solutions to over 190 service providers, servicing over two million users around the globe. Our platform enables its service provider partners to customize packages with unprecedented levels of flexibility, profitability, and ease of use.

Our software solutions offering are as follows:

| · | SNAPsolution® - a comprehensive, IP-based platform that provides a broad suite of UC services including hosted Private Branch Exchange (PBX), auto-attendant, call center, conferencing, and mobility. The platform includes a broad range of feature-sets, custom-built to provide unprecedented levels of flexibility, making the solution competitive with the market’s leading players. SNAPsolution includes a full suite of Voice over Internet Protocol (VoIP)/UC features with one low cost universal license, as opposed to pricing each feature individually. The Company licenses its platform based on concurrent sessions, not per seat/per feature. This allows service providers to oversubscribe their networks, driving down the cost per seat as volume increases. As the service provider increases their customer base, they only have to ensure they have sufficient concurrent call licenses to support users across the network.
| · | SNAPaccel – a Software-as-a-Service (“SaaS”) based software license referred to as subscription arrangements.
| · | Subscription Maintenance and Support - The Company also sells separately-priced maintenance service contracts, which qualify as service-type warranties and represent separate performance obligations and customer support. Customer support includes software updates on a when-and-if-available basis, telephone support, integrated web-based support and bug fixes or patches.
| · | Professional Services and Other - The Company’s professional services include consulting, technical support, resident engineer services, design services and installation services.

Results of Operations

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

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

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
Service revenue |  | $ | 4,325 |  |  | $ | 3,654 |  |  | $ | 12,791 |  |  | $ | 10,747 |
Software solutions revenue |  |  | 3,784 |  |  |  | - |  |  |  | 4,796 |  |  |  | - |
Product revenue |  |  | 701 |  |  |  | 489 |  |  |  | 1,509 |  |  |  | 1,317 |
Total revenue |  | $ | 8,810 |  |  | $ | 4,143 |  |  | $ | 19,096 |  |  | $ | 12,064 |
Income/(loss) before income taxes |  |  | 12 |  |  |  | 134 |  |  |  | (2,090 | ) |  |  | 788 |
Income tax benefit/(provision) |  |  | (137 | ) |  |  | (3 | ) |  |  | 247 |  |  |  | (9 | )
Net income/(loss) |  |  | (125 | ) |  |  | 131 |  |  |  | (1,843 | ) |  |  | 779 |
Basic earnings per share |  | $ | (0.01 | ) |  | $ | 0.01 |  |  | $ | (0.09 | ) |  | $ | 0.05 |
Diluted earnings per share |  | $ | (0.01 | ) |  | $ | 0.01 |  |  | $ | (0.09 | ) |  | $ | 0.05 |

Three months ended September 30, 2021 compared to three months ended September 30, 2020

Total Revenue

Total revenue consists of service revenue, software solutions revenue and product revenue. The following table reflects our total revenue for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Total revenue |  | $ | 8,810 |  |  | $ | 4,143 |  |  | $ | 4,667 |  |  |  | 113 | %

The increase in total revenue is due to an increase in service revenue of $671,000, an increase in software solutions revenue of $3,784,000 and an increase in product revenue of $212,000.

Income Before Income Taxes

The following table reflects our income before income taxes for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Income before income taxes |  | $ | 12 |  |  | $ | 134 |  |  | $ | (122 | ) |  |  | -91 | %

The decrease in income before income tax is primarily due to an increase in operating expenses of $4,769,000 and an increase in interest expense and other expense of $20,000, offset by an increase in revenue of $4,667,000. The increase in operating expenses is primarily related to increases in salaries and benefits and stock compensation expense.

Income Tax Benefit/(Provision)

The following table reflects our income tax benefit/(provision) for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Income tax benefit/(provision) |  | $ | (137 | ) |  | $ | (3 | ) |  | $ | (134 | ) |  |  | 4,467 | %

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We had an income tax provision of $137,000 for the three months ended September 30, 2021 compared to an income tax provision of $3,000 for the three months ended September 30, 2020. We had pre-tax income for the three months ended September 30, 2021 and 2020 of $12,000 and $134,000, respectively.

Nine months ended September 30, 2021 compared to nine months ended September 30, 2020

Total Revenue

Total revenue consists of service revenue, software solutions revenue and product revenue. The following table reflects our service revenue for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Total revenue |  | $ | 19,096 |  |  | $ | 12,064 |  |  | $ | 7,032 |  |  |  | 58 | %

The increase in total revenue is due to an increase in service revenue of $2,044,000, an increase in software solutions revenue of $4,796,000, and an increase in product revenue of $192,000.

Income/(Loss) Before Income Taxes

The following table reflects our income/(loss) before income taxes for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Income/(loss) before income taxes |  | $ | (2,090 | ) |  | $ | 788 |  |  | $ | (2,878 | ) |  |  | -365 | %

The decrease in income before income tax is primarily due to an increase in operating expenses of $9,912,000, offset by an increase in revenue of $7,032,000 and a decrease in interest expense and other expense of $2,000. The increase in operating expenses is primarily related to increases in salaries and benefits, stock compensation expense and acquisition related expenses. During the nine months ended September 30, 2021 the Company recognized $1,065,000 in one-time acquisition related expenses associated with the NetSapiens and Centric Telecom business acquisitions.

Income Tax Provision

The following table reflects our income tax benefit/(provision) for the nine months ended September 30, 2021, compared to the nine months ended Sept 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Income tax benefit/(provision) |  | $ | 247 |  |  | $ | (9 | ) |  | $ | 256 |  |  |  | -2844 | %

We had an income tax benefit of $247,000 for the nine months ended September 30, 2021 compared to an income tax provision of $9,000 for the nine months ended September 30, 2020. We had pre-tax income/(loss) for the nine months ended September 30, 2021 and 2020 of $(2,090,000) and $654,000, respectively.

USE OF NON-GAAP FINANCIAL MEASURES

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

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In our November 9, 2021 earnings press release, as furnished on Form 8-K, we included Non-GAAP net income, EBITDA and Adjusted EBITDA. The terms Non-GAAP net income, EBITDA, and Adjusted EBITDA are not defined under U.S. GAAP, and are not measures of operating income, operating performance or liquidity presented in analytical tools, and when assessing our operating performance, Non-GAAP net income, EBITDA, and Adjusted EBITDA should not be considered in isolation, or as a substitute for net income/(loss) or other consolidated income statement data prepared in accordance with U.S. GAAP. Some of these limitations include, but are not limited to:

| · | EBITDA and Adjusted EBITDA do not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments;
| · | they do not reflect changes in, or cash requirements for, our working capital needs;
| · | they do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt that we may incur;
| · | they do not reflect income taxes or the cash requirements for any tax payments;
| · | although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will be replaced sometime in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements;
| · | while share-based compensation is a component of operating expense, the impact on our financial statements compared to other companies can vary significantly due to such factors as the assumed life of the options and the assumed volatility of our common stock; and
| · | other companies may calculate EBITDA and Adjusted EBITDA differently than we do, limiting their usefulness as comparative measures.

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

RECONCILIATION OF NON-GAAP FINANCIAL MEASURES

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

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Reconciliation of U.S. GAAP Net Income/(Loss) to Non-GAAP Net Income
(Unaudited, in thousands, except for per share and share data)
|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
U.S. GAAP net income/(loss) |  | $ | (125 | ) |  | $ | 131 |  |  | $ | (1,843 | ) |  | $ | 779 |
Share-based compensation |  |  | 415 |  |  |  | 136 |  |  |  | 1,150 |  |  |  | 377 |
Acquisition related expenses |  |  | 4 |  |  |  | - |  |  |  | 1,065 |  |  |  | - |
Amortization of intangible assets |  |  | 506 |  |  |  | 23 |  |  |  | 773 |  |  |  | 69 |
Non-GAAP net income |  | $ | 800 |  |  | $ | 290 |  |  | $ | 1,145 |  |  | $ | 1,225 |
Non-GAAP earnings per common share: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  | $ | 0.04 |  |  | $ | 0.02 |  |  | $ | 0.06 |  |  | $ | 0.08 |
Diluted |  | $ | 0.03 |  |  | $ | 0.02 |  |  | $ | 0.05 |  |  | $ | 0.07 |
Weighted-average common shares outstanding: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  |  | 21,596,415 |  |  |  | 15,244,804 |  |  |  | 19,757,658 |  |  |  | 15,058,192 |
Diluted |  |  | 26,196,240 |  |  |  | 17,249,035 |  |  |  | 22,481,104 |  |  |  | 17,249,035 |

Reconciliation of U.S. GAAP Net Income/(Loss) to EBITDA to Adjusted EBITDA
(Unaudited, in thousands)
|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
U.S. GAAP net income/(loss) |  | $ | (125 | ) |  | $ | 131 |  |  | $ | (1,843 | ) |  | $ | 779 |
Depreciation and amortization |  |  | 569 |  |  |  | 57 |  |  |  | 931 |  |  |  | 197 |
Interest expense |  |  | 24 |  |  |  | 23 |  |  |  | 64 |  |  |  | 54 |
Interest and other expense/(income) |  |  | 17 |  |  |  | (2 | ) |  |  | 13 |  |  |  | 25 |
Income tax provision/(benefit) |  |  | 137 |  |  |  | 3 |  |  |  | (247 | ) |  |  | 9 |
EBITDA |  |  | 622 |  |  |  | 212 |  |  |  | (1,082 | ) |  |  | 1,064 |
Acquisition related expenses |  |  | 4 |  |  |  | - |  |  |  | 1,065 |  |  |  | - |
Share-based compensation |  |  | 415 |  |  |  | 136 |  |  |  | 1,150 |  |  |  | 377 |
Adjusted EBITDA |  | $ | 1,041 |  |  | $ | 348 |  |  | $ | 1,133 |  |  | $ | 1,441 |

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

Segment Operating Results

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

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

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
Cloud Telecommunications Services |  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
Service revenue |  | $ | 4,325 |  |  | $ | 3,654 |  |  | $ | 12,791 |  |  | $ | 10,747 |
Product revenue |  |  | 701 |  |  |  | 489 |  |  |  | 1,509 |  |  |  | 1,317 |
Total revenue |  | $ | 5,026 |  |  | $ | 4,143 |  |  | $ | 14,300 |  |  | $ | 12,064 |
Operating expenses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cost of service revenue |  | $ | 1,210 |  |  | $ | 946 |  |  | $ | 3,816 |  |  | $ | 2,824 |
Cost of product revenue |  |  | 461 |  |  |  | 314 |  |  |  | 972 |  |  |  | 797 |
Selling and marketing |  |  | 1,443 |  |  |  | 326 |  |  |  | 4,148 |  |  |  | 840 |
General and administrative |  |  | 1,807 |  |  |  | 1,051 |  |  |  | 6,272 |  |  |  | 3,151 |
Research and development |  |  | 358 |  |  |  | 1,351 |  |  |  | 1,096 |  |  |  | 3,585 |
Total operating expenses |  |  | 5,279 |  |  |  | 3,988 |  |  |  | 16,304 |  |  |  | 11,197 |
Operating income/(loss) |  |  | (253 | ) |  |  | 155 |  |  |  | (2,004 | ) |  |  | 867 |
Other income/(expense) |  |  | (22 | ) |  |  | (21 | ) |  |  | (58 | ) |  |  | (79 | )
Income/(loss) before tax benefit/(provision) |  | $ | (275 | ) |  | $ | 134 |  |  | $ | (2,062 | ) |  | $ | 788 |

Three months ended September 30, 2021 compared to three months ended September 30, 2020

Service Revenue

Cloud telecommunications 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. The following table reflects our service revenue for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Service revenue |  | $ | 4,325 |  |  | $ | 3,654 |  |  | $ | 671 |  |  |  | 18 | %

The increase in service revenue is due to an increase in telecommunications services of $536,000, an increase in one time fees, commissions and other of $85,000, an increase in fees, commissions, and other, recognized over time of $46,000, and an increase in sales-type lease interest of $4,000. A substantial portion of Cloud Telecommunications service revenue is generated through thirty-six to sixty month service contracts.

Product Revenue

Product revenue consists primarily of fees collected from the sale of desktop phone devices and third-party equipment. The following table reflects our product revenue for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Product revenue |  | $ | 701 |  |  | $ | 489 |  |  | $ | 212 |  |  |  | 43 | %

Product revenue fluctuates from one period to the next based on timing of installations. Our typical customer installation is complete within 30-60 days. However, larger enterprise customers can take multiple months, depending on size and the number of locations. Product revenue is recognized when products have been installed and services commence. Additionally, product revenue can fluctuate due to the allocation of discounts or sales promotions across the performance obligations.

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Backlog

Backlog represents the total contract value of all contracts signed, less revenue recognized from those contracts as of September 30, 2021 and 2020. Backlog increased 9%, or $2,410,000 to $30,723,000 as of September 30, 2021 as compared to $28,313,000 as of September 30, 2020. Below is a table which displays the Cloud Telecommunications segment revenue backlog as of July 1, 2021 and 2020, and September 30, 2021 and 2020, which we expect to recognize as revenue within the next thirty-six to sixty months (in thousands):

Cloud Telecommunications backlog as of July 1, 2021 |  | $ | 27,227 |
Cloud Telecommunications backlog as of September 30, 2021 |  | $ | 30,723 |
Cloud Telecommunications backlog as of July 1, 2020 |  | $ | 27,349 |
Cloud Telecommunications backlog as of September 30, 2020 |  | $ | 28,313 |

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. The following table reflects our cost of service revenue for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Cost of service revenue |  | $ | 1,210 |  |  | $ | 946 |  |  | $ | 264 |  |  |  | 28 | %

The increase in cost of service revenue was primarily due to an increase in salaries, wages and benefits of $274,000 as a result of an increase in customer support and implementation specialist headcount directly related to the increase in service revenue, an increase in professional consulting services of $12,000, an increase in credit card processing fees of $12,000, and an increase in other cost of service revenue of $14,000, offset by a decrease in bandwidth costs of $48,000.

Cost of Product Revenue

Cost of product revenue consists of the costs associated with desktop phone devices and third-party equipment. The following table reflects our cost of product revenue for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Cost of product revenue |  | $ | 461 |  |  | $ | 314 |  |  | $ | 147 |  |  |  | 47 | %

The increase is primarily related to the increase in product revenue and an increase in device costs.

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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. The following table reflects our research and development expenses for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Research and development |  | $ | 358 |  |  | $ | 326 |  |  | $ | 32 |  |  |  | 10 | %

The increase in research and development expenses is due to an increase in salaries, wages and benefits of $25,000 as a result of an increase in headcount as we continue to invest in our solution. We also incurred increased costs for maintenance on our mobile applications and other development costs of $7,000.

Selling and Marketing

Selling and marketing expenses consist primarily of direct and channel sales representative salaries and benefits, share-based compensation, partner channel commissions, amortization of costs to acquire contracts, travel expenses, lead generation services, trade shows, internal and third-party marketing costs, the production of marketing materials, and sales support software. The following table reflects our selling and marketing expenses for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Selling and marketing |  | $ | 1,443 |  |  | $ | 1,051 |  |  | $ | 392 |  |  |  | 37 | %

The increase in selling and marketing expense is due to an increase in salaries, wages and benefits of $300,000 related to expansion of our sales team and the addition of our chief revenue officer, an increase in commission expense of $40,000 directly related to the increase in revenue, an increase in travel related costs and tradeshows of $28,000, we incurred $30,000 in marketing related expenses for the rollout of our new Crexendo VIP platform and consultation fees, offset by a decrease in other sales and marketing expenses of $6,000.

General and Administrative

General and administrative expenses consist of salaries, benefits and stock compensation for executives, administrative personnel, legal, rent, equipment, accounting and other professional services, investor relations, depreciation, amortization of intangibles, and other administrative corporate expenses. The following table reflects our general and administrative expenses for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
General and administrative |  | $ | 1,807 |  |  | $ | 1,351 |  |  | $ | 456 |  |  |  | 34 | %

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The increase in general and administrative expenses is primarily due to an increase in administrative salaries, wages and benefits of $296,000 as a result of an increase in headcount, increase in stock compensation, and company-wide salary increases. We incurred $4,000 in acquisition related legal, accounting, and other professional services in connection with the NetSapiens acquisition. We invested $55,000 in costs related to maintaining and improving our data center, which includes outside consulting fees, new hardware and software licenses along with the associated depreciation, costs related to our disaster recovery failover solution, and other costs. There was an increase of $40,000 in amortization expense directly related to the Centric Telecom business acquisition. We incurred $31,000 in costs related to the implementation of a new billing platform. There was an increase in corporate insurance costs of $26,000, an increase in rent expense of $18,000, an increase in repairs and maintenance expense of $18,000 for our building, an increase in bank processing fees of $12,000, and an increase in other general and administrative expense of $35,000, offset by a decrease in stock exchange listing fees of $79,000.

Other Expense

Other expense primarily relates to interest expense and net foreign exchange gains or losses, offset by credit card cash back rewards. The following table reflects our other expense for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended June 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Other expense |  | $ | (22 | ) |  | $ | (21 | ) |  | $ | (1 | ) |  |  | 5 | %

Nine months ended September30, 2021 compared to nine months ended September 30, 2020

Service Revenue

Cloud telecommunications 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. The following table reflects our service revenue for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Service revenue |  | $ | 12,791 |  |  | $ | 10,747 |  |  | $ | 2,044 |  |  |  | 19 | %

The increase in service revenue is due to an increase in telecommunications service revenue of $1,674,000, an increase in one time fees, commissions and other of $223,000, an increase in fees, commissions, and other, recognized over time of $104,000, and an increase in sales-type lease interest of $42,000. A substantial portion of Cloud Telecommunications service revenue is generated through thirty-six to sixty month service contracts.

Product Revenue

Product revenue consists primarily of fees collected from the sale of desktop phone devices and third-party equipment. The following table reflects our product revenue for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Product revenue |  | $ | 1,509 |  |  | $ | 1,317 |  |  | $ | 192 |  |  |  | 15 | %

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Product revenue fluctuates from one period to the next based on timing of installations. Our typical customer installation is complete within 30-60 days. However, larger enterprise customers can take multiple months, depending on size and the number of locations. Product revenue is recognized when products have been installed and services commence. Additionally, product revenue can fluctuate due to the allocation of discounts or sales promotions across the performance obligations.

Backlog

Backlog represents the total contract value of all contracts signed, less revenue recognized from those contracts as of September 30, 2021 and 2020. Backlog increased 9%, or $2,410,000 to $30,723,000 as of September 30, 2021 as compared to $28,313,000 as of September 30, 2020. Below is a table which displays the Cloud Telecommunications segment revenue backlog as of January 1, 2021 and 2020, and September 30, 2021 and 2020, which we expect to recognize as revenue within the next thirty-six to sixty months (in thousands):

Cloud Telecommunications backlog as of January 1, 2021 |  | $ | 28,551 |
Cloud Telecommunications backlog as of September 30, 2021 |  | $ | 30,723 |
Cloud Telecommunications backlog as of January 1, 2020 |  | $ | 26,110 |
Cloud Telecommunications backlog as of September 30, 2020 |  | $ | 28,313 |

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. The following table reflects our cost of service revenue for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Cost of service revenue |  | $ | 3,816 |  |  | $ | 2,824 |  |  | $ | 992 |  |  |  | 35 | %

The increase in cost of service revenue was primarily due to an increase in salaries, wages and benefits of $729,000 as a result of an increase in customer support and implementation specialist headcount directly related to the increase in service revenue, an increase in bandwidth costs of $132,000 directly related to the increase in service revenue, an increase in professional consulting services of $53,000, an increase in credit card processing fees of $43,000, an increase of $20,000 in setup and implementation costs for our new Crexendo VIP platform, and an increase in other cost of service revenue of $15,000.

Cost of Product Revenue

Cost of product revenue consists of the costs associated with desktop phone devices and third-party equipment. The following table reflects our cost of product revenue for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Cost of product revenue |  | $ | 972 |  |  | $ | 797 |  |  | $ | 175 |  |  |  | 22 | %

The increase is primarily related to the increase in product revenue and an increase in device costs.

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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. The following table reflects our research and development expenses for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Research and development |  | $ | 1,096 |  |  | $ | 840 |  |  | $ | 256 |  |  |  | 30 | %

The increase in research and development expenses is due to an increase in salaries, wages and benefits of $210,000 as a result of an increase in headcount as we continue to invest in our solution. We also incurred increased costs for maintenance on our mobile applications and other development costs of $40,000 and incurred an increase in other research and development costs of $6,000.

Selling and Marketing

Selling and marketing expenses consist primarily of direct and channel sales representative salaries and benefits, share-based compensation, partner channel commissions, amortization of costs to acquire contracts, travel expenses, lead generation services, trade shows, third-party marketing services, the production of marketing materials, and sales support software. The following table reflects our selling and marketing expenses for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Selling and marketing |  | $ | 4,148 |  |  | $ | 3,151 |  |  | $ | 997 |  |  |  | 32 | %

The increase in selling and marketing expense is due to an increase in salaries, wages and benefits of $703,000 related to expansion of our sales team and the addition of our chief revenue officer, an increase in commission expense of $200,000 directly related to the increase in revenue, we incurred $55,000 in marketing related expenses for the rollout of our new Crexendo VIP platform and consultation fees, an increase in travel related costs of $22,000, and a $17,000 increase in other sales and marketing expenses.

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. The following table reflects our general and administrative expenses for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
General and administrative |  | $ | 6,272 |  |  | $ | 3,585 |  |  | $ | 2,687 |  |  |  | 75 | %

The increase in general and administrative expenses is due to an increase in administrative salaries, wages and benefits of $1,126,000 as a result of an increase in headcount, increase in stock compensation, and company-wide salary increases. We incurred $1,065,000 in acquisition related legal, accounting, and other professional services in connection with the NetSapiens acquisition. We invested $160,000 in costs related to maintaining and improving our data center, which includes outside consulting fees, new hardware and software licenses along with the associated depreciation, costs related to our disaster recovery failover solution, and other costs. There was an increase of $113,000 in intangible asset amortization expense directly related to the Centric Telecom business acquisition. We incurred $58,000 in costs related to the implementation of a new billing platform. There was an increase in corporate insurance costs of $52,000, an increase in rent expense of $30,000, an increase in bank processing fees of $29,000, and an increase in other general and administrative expense of $105,000, offset by a decrease in stock exchange listing fees of $51,000.

Other Expense

Other expense primarily relates to interest expense and net foreign exchange gains or losses, offset by credit card cash back rewards. The following table reflects our other expense for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Other expense |  | $ | (58 | ) |  | $ | (79 | ) |  | $ | 21 |  |  |  | -27 | %

The decrease in other expense is due to a decrease in net foreign exchange loss of $30,000 offset by an increase in interest expense of $9,000 for interest paid on finance agreements.

Operating Results of Software Solutions segment (in thousands):

In connection with the merger with NetSapiens, Inc., on June 1, 2021, the following Software Solutions operating segment was created. The operating results for the Software Solutions segment are included in our consolidated results of operations from the acquisition date of June 1, 2021.

|  | Three Months Ended September 30, |  |  | Nine Months Ended September 30, |
Software Solutions |  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
Software solutions revenue |  | $ | 3,784 |  |  | $ | - |  |  | $ | 4,796 |  |  | $ | - |
Operating expenses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cost of software solutions revenue |  |  | 1,675 |  |  |  | - |  |  |  | 2,201 |  |  |  | - |
Research and development |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Selling and marketing |  |  | 627 |  |  |  | - |  |  |  | 958 |  |  |  | - |
General and administrative |  |  | 1,176 |  |  |  | - |  |  |  | 1,646 |  |  |  | - |
Total operating expenses |  |  | 3,478 |  |  |  | - |  |  |  | 4,805 |  |  |  | - |
Operating income/(loss) |  |  | 306 |  |  |  | - |  |  |  | (9 | ) |  |  | - |
Other expense |  |  | (19 | ) |  |  | - |  |  |  | (19 | ) |  |  | - |
Income/(loss) before tax benefit/(provision) |  | $ | 287 |  |  | $ | - |  |  | $ | (28 | ) |  | $ | - |

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Three months ended September 30, 2021 compared to three months ended September 30, 2020

Software Solutions Revenue

Software solutions revenue consists primarily of software license fees, subscription maintenance and support, and professional services. Software licenses are billed by the number of concurrent sessions a Partner has purchased or subscribes to. Subscription maintenance and support is ongoing and provides for software updates and improvements, support for add-on modules, bug fix, and other general maintenance items. Professional services and other revenues consist of professional services such as the installation of software and integration of other modules, training and implementation as well as custom mobile branding. The following table reflects our service revenue for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Software solutions revenue |  | $ | 3,784 |  |  | $ | - |  |  | $ | 3,784 |  |  |  | - |

Software solutions revenue is included in the results of operations from the acquisition date of June 1, 2021.

Cost of Software Solutions Revenue

Cost of software solutions revenue consists primarily of salaries and benefits, amortization expense related to the technology, cost of Data Center hosting, third-party software modules and outsourced services required to install and support software solutions. The following table reflects our cost of service revenue for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Cost of software solutions revenue |  | $ | 1,675 |  |  | $ | - |  |  | $ | 1,675 |  |  |  | - |

Cost of software solutions revenue is included in the results of operations from the acquisition date of June 1, 2021.

Selling and Marketing

Selling and marketing expenses consist primarily of sales and marketing salaries and benefits, commissions, share-based compensation, travel expenses, lead generation services, trade shows, third-party marketing services, the production of marketing materials, and sales support software. The following table reflects our selling and marketing expenses for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Selling and marketing |  | $ | 627 |  |  | $ | - |  |  | $ | 627 |  |  |  | - |

Selling and marketing expense is included in the results of operations from the acquisition date of June 1, 2021.

General and Administrative

General and administrative expenses consist of salaries and benefits for executives, administrative personnel, amortization of intangible asset related to customer lists, legal, rent, equipment, accounting and other professional services, and other administrative corporate expenses. The following table reflects our general and administrative expenses for the three months ended September 30, 2021, compared to the three months ended September 30, 2020:

|  | Three Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
General and administrative |  | $ | 1,176 |  |  | $ | - |  |  | $ | 1,176 |  |  |  | - |

General and administrative expense is included in the results of operations from the acquisition date of June 1, 2021.

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Nine months ended September 30, 2021 compared to Nine months ended September 30, 2020

Software Solutions Revenue

Software solutions revenue consists primarily of software license fees, subscription maintenance and support, and professional services. Software licenses are billed by the number of concurrent sessions a Partner has purchased or subscribes to. Subscription maintenance and support is ongoing and provides for software updates and improvements, support for add-on modules, bug fix, and other general maintenance items. Professional services and other revenues consist of professional services such as the installation of software and integration of other modules, training and implementation as well as custom mobile branding. The following table reflects our service revenue for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Software solutions revenue |  | $ | 4,796 |  |  | $ | - |  |  | $ | 4,796 |  |  |  | - |

Software solutions revenue is included in the results of operations from the acquisition date of June 1, 2021

Cost of Software Solutions Revenue

Cost of software solutions revenue consists primarily of salaries and benefits, amortization expense related to the technology, cost of Data Center hosting, third-party software modules and outsourced services required to install and support software solutions. The following table reflects our cost of service revenue for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Cost of software solutions revenue |  | $ | 2,201 |  |  | $ | - |  |  | $ | 2,201 |  |  |  | - |

Cost of software solutions revenue is included in the results of operations from the acquisition date of June 1, 2021.

Selling and Marketing

Selling and marketing expenses consist primarily of sales and marketing salaries and benefits, commissions, share-based compensation, travel expenses, lead generation services, trade shows, third-party marketing services, the production of marketing materials, and sales support software. The following table reflects our selling and marketing expenses for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Selling and marketing |  | $ | 958 |  |  | $ | - |  |  | $ | 958 |  |  |  | - |

Selling and marketing expense is included in the results of operations from the acquisition date of June 1, 2021.

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General and Administrative

General and administrative expenses consist of salaries and benefits for executives, administrative personnel, amortization of intangible asset related to customer lists, legal, rent, equipment, accounting and other professional services, and other administrative corporate expenses. The following table reflects our general and administrative expenses for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
General and administrative |  | $ | 1,646 |  |  | $ | - |  |  | $ | 1,646 |  |  |  | - |

General and administrative expense is included in the results of operations from the acquisition date of June 1, 2021.

Liquidity and Capital Resources

Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. We finance our operations primarily through services, software solutions, and product sales to our customers. As of September 30, 2021 and December 31, 2020, we had cash and cash equivalents of $7,701,000 and $17,579,000, respectively. Changes in cash and cash equivalents are dependent upon changes in, among other things, working capital items such as contract liabilities, contract costs, accounts payable, accounts receivable, prepaid expenses, and various accrued expenses, as well as purchases of property and equipment, asset acquisitions, business combinations, and changes in our capital and financial structure due to debt repayments and issuances, stock option exercises, sales of equity investments and similar events. We believe that our operations along with existing liquidity sources will satisfy our cash requirements for at least the next 12 months.

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

On January 14, 2021, the Company acquired 100% of the issued and outstanding shares of Centric Telecom, Inc., a provider of telecommunications products, services, and solutions in Northern Virginia. The aggregate purchase price of $3,255,000 consisted of $2,163,000 of cash paid at closing, 46,662 shares of our common stock with an estimated fair value of $346,000 issued at closing, and $746,000 of estimated contingent consideration to be paid out based on annualized revenue recognized during the nine month earn-out period.

On June 1, 2021, the Company closed the Merger with NetSapiens, Inc. The transaction was valued at approximately $49.1 million, consisting of $10 million in cash, and approximately $39 million in common stock and stock options. In connection with the closing of the Merger, the Company issued 3,097,309 shares of the Company’s common stock valued at $5.47 per share for common stock consideration of approximately $16.9 million, and 4,482,328 options under the Crexendo, Inc. 2021 Equity Incentive Plan with an aggregate value of $22.1 million, net of the aggregate exercise price of $5.6 million.

Operating Activities

Cash provided by or used in operating activities is driven by our net loss, the timing of customer collections, as well as the amount and timing of disbursements to our vendors, the amount of cash we invest in personnel, marketing, and infrastructure costs to support the anticipated growth of our business. The following table reflects our net cash provided by/(used in) operating activities for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Net cash provided by/(used in) operating activities |  | $ | (473 | ) |  | $ | 423 |  |  | $ | (896 | ) |  |  | -212 | %

The net cash used for operations was primarily driven by our net loss for the nine months ended September 30, 2021 of $1,706,000, of which $1,065,000 is associated with acquisition related expenses for the Centric Telecom and NetSapiens business acquisitions, an increase in prepaid expenses, an increase in income tax receivable, and a decrease in contract liabilities.

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Investing Activities

Cash provided by or used in investing activities is driven by the purchase of property and equipment, business combinations, and asset acquisitions. The following table reflects our net cash provided by/(used in) investing activities for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended Sept 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Net cash used in investing activities |  | $ | (10,596 | ) |  | $ | (921 | ) |  | $ | (9,675 | ) |  | 1050% |

During the nine months ended June 30, 2021, the Company acquired 100% of the issued and outstanding shares of Centric Telecom, Inc., a provider of telecommunications products, services, and solutions in Northern Virginia. The aggregate purchase price of $3,255,000 consisted of $2,163,000 of cash paid at closing, 46,662 shares of our common stock with an estimated fair value of $346,000 issued at closing, and $746,000 of estimated contingent consideration to be paid out based on annualized revenue recognized during the nine month earn-out period. On June 1, 2021, the Company acquired 100% of the issued and outstanding shares of NetSapiens, Inc. (“NetSapiens”), a provider of a comprehensive suite of unified communications (UC), video conferencing, collaboration & contact center solutions to service providers, servicing over two Million end users around the globe. The aggregate purchase price was approximately $49.1 million, consisting of $10 million in cash, and approximately $39 million in common stock and stock options. In connection with the closing of the Merger, the Company issued 3,097,309 shares of the Company’s common stock valued at $5.47 per share for common stock consideration of approximately $16.9 million, and 4,482,328 options under the Crexendo, Inc. 2021 Equity Incentive Plan with an aggregate value of $22.1 million, net of the aggregate exercise price of $5.6 million.

For the nine months ended September 30, 2020, net cash used in investing activities related to cash used for capital expenditures, primarily for the cash portion of the purchase of the Company’s corporate office building of $500,000. The remaining $2,000,000 of the purchase price was financed through a note payable with a bank. The Company also paid $176,000 under the DoubleHorn customer relationships asset purchase agreement during the nine months ended September 30, 2020.

Financing Activities

Cash provided by or used in financing activities is driven by the proceeds from the exercise of options, taxes paid on the net settlement of stock options and RSUs, payment of contingent consideration, proceeds from finance leases and notes payable, repayments made on finance leases and notes payable, and proceeds from the issuance of common stock in connection with an offering. The following table reflects our net cash provided by financing activities for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020:

|  | Nine Months Ended September 30, 2021 |
|  | 2021 |  |  | 2020 |  |  | Dollar Change |  |  | Percent Change |
Net cash provided by financing activities |  | $ | 1,081 |  |  | $ | 11,671 |  |  | $ | (10,590 | ) |  |  | -91 | %

Net cash provided by financing activities in the nine months ended September 30, 2021, primarily relates to cash proceeds from the exercise of stock options of $1,365,000 offset by the payments of employee tax withholdings related to the net settlement of stock options and RSUs of $160,000. Net cash provided by financing activities in the nine months ended September 30, 2020, primarily relates to $8,778,000 of proceeds from the issuance of common stock in connection with an offering and $1,001,000 of cash received pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act. The loan was forgiven in December 2020. We also received cash from the exercise of stock options of $2,007,000.

Contractual Obligations and Commitments

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

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Off Balance Sheet Arrangements

As of, September 30, 2021, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

RELATED PARTY TRANSACTIONS

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

Impact of Recent Accounting Pronouncements

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Foreign Currency Risk

For all periods presented, our sales and operating expenses were predominately denominated in U.S. dollars. We therefore have not had material foreign currency risk associated with sales and cost-based activities. The functional currency of our material operating entities is the U.S. dollar.

For the periods presented, we believe the exposure to foreign currency fluctuation from operating expenses is immaterial as the related costs do not constitute a significant portion of our total expenses. As we grow operations, our exposure to foreign currency risk may become more significant.

Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

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

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended September 30, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

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

There is no guarantee that Crexendo and NetSapiens will fully integrate operations or that the merger will be accretive. Failure to properly manage the merger could impact our stock price and our future business and financial results.

The success of the Merger will depend, in part, on our ability to successfully integrate NetSapiens’ business and operations and fully realize the anticipated benefits and synergies from combining the businesses of Crexendo and NetSapiens. However, to realize these anticipated benefits and synergies, the businesses of Crexendo and NetSapiens must be successfully combined. If we are not able to achieve these objectives following the Merger, the anticipated benefits and synergies of the Merger may not be realized fully or at all or may take longer to realize than expected. Any failure to timely realize these anticipated benefits could have a material adverse effect on our revenues, expenses and operating results.

Crexendo and NetSapiens are in the process of combining operations and attempting to implement operational efficiencies, however for the time being the operations are not fully integrated and many facets of the businesses are still being run independently. It is possible that the ongoing integration process could result in the loss of key employees, loss of key customers, decreases in revenues, increases in operating costs, as well as the disruption of each company’s ongoing businesses, any or all of which could limit our ability to achieve the anticipated benefits and synergies of the Merger and have an adverse effect on our operating results. Integration efforts between the two companies could also divert management’s attention and resources, which could also adversely affect our operating results.

We are planning to migrate most of Crexendo’s customers to the NetSapiens Communication Platform, the failure to do that efficiently and properly may impact our business revenue and stock price.

We are in the process of moving certain Crexendo customers to the NetSapiens communication platform while retaining the Crexendo Ride the Cloud® system. There can be significant cost savings associated with consolidating all customers on one communication platform while maintaining the Crexendo system for redundancies. The failure to properly migrate customers could cause customer service issues which could cause cancellations and loss of revenue. There may be expenses and other difficulties involved in migrating customers which may cause substantial short-term expenses prior to realizing the anticipated cost savings from primarily operating one system. We may be unable to realize efficiencies of primarily maintaining one communication platform.

We have incurred and still have some continuing transaction costs in connection with the Merger. There may be difficulties in combining operations and employee benefits.

We have incurred significant costs in connection with the Merger including legal, accounting, financial consulting, and related fees. Certain of these costs may continue particularly in relation to combining benefit and employee programs. There will be costs associated with combining accounting systems, legal, compliance, and employee benefits. The employee benefits provided historically to NetSapiens employees are different than the benefits provided to Crexendo employees. There may be expenses and other difficulties involved in having one set of employee benefit programs. We may incur additional costs to retain key employees. We may lose certain employees who may perceive there is a diminution in value of benefits previously received under the NetSapiens benefits compared to Crexendo benefits. We may also incur fees and costs related to these integration plans. We may be unable to realize efficiencies with the Merger that would allow us, over time, to offset the costs incurred in connection with the Merger.

Crexendo and NetSapiens may have difficulty attracting, motivating and retaining executives and other key employees in light of the Merger.

While the Merger Agreement provided for covenants attempting to acknowledge NetSapiens employees’ pre-closing services to NetSapiens for benefits eligibility purposes and to provide a similar level of compensation accorded to the NetSapiens employees should they continue their employment with the post-closing business, uncertainty about the effect of the Merger on Crexendo and NetSapiens’ employees remains and may have an adverse effect on Crexendo and NetSapiens and consequently the combined business. This uncertainty may impair Crexendo and NetSapiens’ ability to attract, retain and motivate key personnel for the combined entity. NetSapiens employees may experience uncertainty about their future roles with the combined business. Additionally, NetSapiens officers and employees may own shares of NetSapiens’ common stock and/or have stock option grants and may have received both cash and Crexendo stock and Options to purchase common stock of Crexendo, the payment of which could provide sufficient financial incentive for certain officers and employees to no longer pursue employment with the combined business. If key employees of Crexendo or NetSapiens depart, we may have to incur significant costs in identifying, hiring and retaining replacements for departing employees, which could reduce our ability to realize the anticipated benefits of the Merger.

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Crexendo’s and NetSapiens’ business relationships, including customer relationships, may be subject to disruption due to the Merger.

Parties with which Crexendo and NetSapiens do business with may experience uncertainty associated with the Transaction, including with respect to business relationships with Crexendo, NetSapiens or the combined business. Crexendo’s and NetSapiens’ business relationships may be subject to disruption as customers and others may attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than Crexendo, NetSapiens or the combined business. These disruptions could have an adverse effect on the businesses, financial condition, results of operations or prospects of the combined business.

Our public stockholders have and will continue to experience dilution as a consequence of, among other transactions, the issuance of Merger Shares and options to purchase Common Stock of Crexendo as consideration for the Merger. Having a minority share position may reduce the influence that our current stockholders have on the management of the post-closing business.

As a consequence of the merger, we have issued an aggregate of 6,462,036 shares of Common Stock and options of Crexendo (including those Common Stock underlying the Exchange Options to be registered on a Form S-8), to the equity holders of NetSapiens. The issuance of Common Stock to the equityholders of NetSapiens pursuant to the Merger Agreement may dilute the equity interests of our existing stockholders and may adversely affect prevailing market prices for our Common Stock. Such dilution could, among other things, limit the ability of our existing stockholders to influence the Company’s management through the election of directors following the closing of the Transaction.

The market price of our Common Stock after the Merger may be affected by factors different from those affecting our Common Stock currently. The market price of our Common Stock may decline as a result of the Merger.

The businesses of Crexendo and NetSapiens differ and, accordingly, the results of operations and the market price of our Common Stock following the Merger and the combination of the two businesses may be affected by factors different from those currently affecting the independent results of operations and market prices of common stock of each of Crexendo and NetSapiens. The market price of our Common Stock may decline as a result of the Merger if, among other things, we are unable to achieve growth in earnings or, if we incur expenses in excess of what is anticipated, or we otherwise fail to achieve anticipated operational efficiencies. The market price also may decline if we do not achieve the perceived benefits of the Merger as rapidly or to the extent anticipated by the investment community or if the effect of the Merger on our financial results is not consistent with the expectations of the investment community. There may be substantial selling of stock by shareholders who received shares of Crexendo stock in the merger after the six month lock up period has expired, there may be substantial sale of shares by employees who received Options to purchase common stock in the merger all of which may negatively affect the market price of our Common Stock.

We expect to continue to 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 expect to continue to attempt to acquire or merge with certain businesses. Whether we realize benefits from any such transactions will depend in part upon the integration of any 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.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

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Item 6. Exhibits

Exhibits

31.1 |  | Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities and Exchange Act of 1934, as amended
31.2 |  | Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities and Exchange Act of 1934, as amended
32.1 |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2 |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

101.INS* |  | XBRL INSTANCE DOCUMENT
101.SCH* |  | XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT
101.CAL* |  | XBRL TAXONOMY EXTENSION CALCULATION LINKBASE DOCUMENT
101.DEF* |  | XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT
101.LAB* |  | XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT
101.PRE* |  | XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE DOCUMENT

* | In accordance with Rule 406T of Regulation S-T, these XBRL (eXtensible Business Reporting Language) documents are furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.

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SIGNATURES

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

| Crexendo, Inc. |
November 9, 2021 | By: | /s/ STEVEN G. MIHAYLO |
|  | Steven G. Mihaylo Chief Executive Officer |

November 9, 2021 | By: | /s/ RONALD VINCENT |
|  | Ronald Vincent Chief Financial Officer |

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