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EXE > SEC Filings for EXE > Form 10-Q on 6-Nov-2012All Recent SEC Filings

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Form 10-Q for CREXENDO, INC.


6-Nov-2012

Quarterly Report


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, 2011 (the "2011 Form 10-K") filed with the SEC and the Condensed Consolidated Financial Statements and notes thereto included in the 2011 Form 10-K 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

We are a hosted services company that provides e-commerce software, website development, web hosting, search engine optimization, link building, hosted telecommunication services, and broadband internet for businesses and entrepreneurs. Our services are designed to make enterprise-class hosting services available to small and medium-sized businesses at affordable monthly rates. Our unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("US GAAP") and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). These unaudited consolidated financial statements reflect the results of operations, financial position, changes in stockholders' equity, and cash flows of the Company.

The Company has three operating segments, which consist of the StoresOnline, Crexendo Web Services, and Crexendo Network Services segments.

StoresOnline segment - We offer a continuum of services and technology providing tools and training for businesses to establish a successful web presence. Our Do-It-Yourself package includes our robust content management and website building solution, fully enabled e-commerce package, online marketing tools, and educational training modules.

We have historically derived a substantial portion of our revenue from cash collected on the sale of our content management and web building software licenses at workshop events held in prior years, as well as principal collected on the sale of software licenses sold through extended payment term arrangements ("EPTAs"). As a result of the restructuring plan we initiated in July 2011, we will no longer generate revenue from cash collected on the sale of our content management and web building software licenses at workshop events. We believe we will, however, continue to generate revenue from principal collected on our EPTA contracts for the next year to eighteen months at a decreasing rate over that time period.

Crexendo Web Services segment - We generate revenue from managing e-commerce or lead generation offerings, websites, search engine optimization/management and online promotional needs primarily for small and medium-sized businesses.

We generate professional services revenue primarily from website design and development, search engine optimization services, link building, paid search management services and conversion rate optimization services. These services are typically billed on a fixed price basis or on a monthly recurring basis with an initial term of six to twelve months. We generate SaaS subscription fees on our website builder and website hosting fees. Revenue is recognized ratably over the life of the contract for all subscription and hosting services. Our hosting contracts are month to month.


Crexendo Network Services Segment - Our hosted telecommunications services transmit calls using VoIP technology, which converts voice signals into digital data packets for transmission over the Internet. 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" to access and utilize services and features regardless of how the user is connected to the Internet, whether it be from a desktop device or a mobile device.

We generate subscription fees from our hosted telecommunications and broadband Internet services. Our hosted telecommunication contracts typically have a 36 month term. We generate product revenue and equipment financing revenue from the sale and lease of our hosted 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.

Economic Factors

The tight credit markets in place over the past several years have adversely affected our StoresOnline business as consumers and businesses continued to be limited in their ability to obtain alternate sources of financing. The tight credit markets contributed to our decision to suspend the sale of our products and services through the seminar sales channel. The high unemployment rate has had a negative impact on our StoresOnline customer base and has historically resulted in high default rates on our accounts receivable. While we have seen our collection rates stabilize and improve over the past several quarters, our default rate remains high. Since we recognize revenue when the cash is collected on our accounts receivable portfolio, an improvement in our collection rates will result in additional future revenue, while deterioration in our collection rate will decrease future revenue.

Opportunities

Technological and product innovation is the foundation of our long-term growth strategy, and we intend to increase our commitment to invest in product development, engineering excellence, and delivering high-quality products and services to customers. We have organized Crexendo Web Services segment and Crexendo Network Services segment around our primary business objectives which are to help entrepreneurs and small and medium-sized businesses increase the effectiveness and visibility of their online presence, as well as decreasing their infrastructure and communications costs.

We believe our long-term focus on investing in products and developing new and alternative sales channels is enabling us to build a foundation for growth by delivering innovative products, creating opportunities for potential channel partners, and improving customer satisfaction. Our focus continues to be to execute in key areas through ongoing innovation on our integrated content management software solution, responding effectively to customer and partner needs, and focusing internally on product excellence and accountability across our Company.

We have developed a University Program that allows universities to teach courses using our website builder that will provide free websites to small businesses. This program will provide an opportunity to expand our website hosting service offering as the Company will provide hosting services for websites developed by students to small businesses using our platform. We believe this program will allow us to grow our customer base.

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. We believe that the estimates, assumptions and judgments involved in our accounting policies described in Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates. During the three months ended June 30, 2012, the Company began entering into rental transactions for hosted telecommunication equipment that it accounted for under its critical accounting policies as Lease Sales and began recording Equipment Financing Receivables. Our senior management has reviewed the development and selection of our critical accounting policies and estimates and their disclosure in this Form 10-Q with the Audit Committee of our Board of Directors.


RESULTS OF OPERATIONS

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

Results of Consolidated Operations (in thousands):

                                            Three Months Ended September 30,          Nine Months Ended September 30,
                                                2012                  2011              2012                  2011

Revenue                                    $         3,865         $    10,242     $        14,034       $        42,306
Income (loss) before income taxes                     (796 )             4,546                (856 )              (1,610 )
Income tax benefit (provision)                         (10 )               (39 )               130                (5,079 )
Net income (loss)                                     (806 )             4,507                (726 )              (6,689 )
Basic net income (loss) per share          $         (0.08 )       $      0.43     $         (0.07 )     $         (0.63 )
Diluted net income (loss) per share        $         (0.08 )       $      0.42     $         (0.07 )     $         (0.63 )

Three months ended September 30, 2012 compared to three months ended September 30, 2011

Revenue

Total revenue decreased 62% in the three months ended September 30, 2012 compared with the corresponding period of 2011, primarily due to the suspension of our direct mail seminar sales in June 2011, which caused a 100% decrease in seminar sales, a 81% decrease in commissions from third parties and other revenue, and approximately, a 49% decrease in principal collected on our StoresOnline EPTAs. StoresOnline segment revenue decreased 68% to $3,055,000 during the three months ended September 30, 2012, compared with $9,542,000 in the corresponding period in 2011. Crexendo Web Services segment revenue decreased 11% to $575,000 during the three months ended September 30, 2012, compared with $648,000 in the corresponding period in 2011. The decrease was offset by an increase in revenue from Network Services offerings. Crexendo Network Services segment increased 352% to $235,000 during the three months ended September 30, 2012, compared with $52,000 in the corresponding period in 2011.

Loss Before Income Taxes

Loss before income tax was $796,000 for the three months ended September 30, 2012 compared to income of $4,546,000 during the three months ended September 30, 2011. Revenue for the three months ended September 30, 2012 decreased $6,377,000 compared to corresponding period of 2011. Total operating expenses decreased 27% to $5,080,000 for the three months ended September 30, 2012, compared to $6,946,000 in the corresponding period of 2011.

Income Tax Provision

Our effective tax rate for the three months ended September 30, 2012 and 2011 was 1% for both periods, which resulted in a provision for income taxes of $10,000 and $39,000, respectively.


Nine Months Ended September 30, 2012 compared to Nine Months Ended September 30, 2011

Revenue

Total net revenue decreased 67% in the nine months ended September 30, 2012 compared with the corresponding period of 2011, primarily due to the suspension of our direct mail seminar sales in June 2011, which caused a 100% decrease in seminar sales, a 80% decrease in commissions from third parties and other revenue, and approximately, a 36% decrease in principal collected on our StoresOnline EPTAs. StoresOnline segment revenue decreased 72% to $11,519,000 during the nine months ended September 30, 2012, compared with $40,559,000 in the corresponding period in 2011. The decrease was offset by increases in revenue from Web Services and Network Services offerings. Crexendo Web Services segment revenue increased 22% to $2,037,000 during the nine months ended September 30, 2012, compared with $1,677,000 in the corresponding period in 2011. Crexendo Network Services segment increased 589% to $478,000 during the nine months ended September 30, 2012, compared with $70,000 in the corresponding period in 2011.

Loss Before Income Taxes

Loss before income tax was $856,000 for the nine months ended September 30, 2012 compared with a loss of $1,610,000 in the corresponding period of 2011. Revenue for the nine months ended September 30, 2012 decreased $28,272,000 compared to corresponding period of 2011. Total operating expenses decreased 65% to $16,589,000 for the nine months ended September 30, 2012, compared to $47,600,000 in the corresponding period of 2011.

Income Tax Provision

Our effective tax rate for the nine months ended September 30, 2012 and 2011 was 15% and 315%, respectively, which resulted in income tax benefit of $130,000 for the nine months ended September 30, 2012 and a provision for income taxes of $5,079,000, for the nine months ended September 30, 2011. The income tax benefit in the current year is primarily due to the statute of limitations expiring for a few uncertain tax positions. The high tax expense for the nine months ended September 30, 2011 was primarily the result of placing a full valuation allowance on our net deferred tax assets.

Segment Operating Results

The information below is organized in accordance with our three reportable segments. Segment operating income (loss) is equal to segment net revenue less segment cost of revenue, sales and marketing, and general and administrative expenses. Segment expenses do not include certain costs, such as corporate general and administrative expenses and share-based compensation expenses, which are not allocated to specific segments.

Operating Results of StoresOnline (in thousands):

                                               Three Months Ended September 30,             Nine Months Ended September 30,
                                                 2012                     2011                2012                  2011
StoresOnline
Revenue                                    $          3,055         $          9,542     $        11,519       $        40,559
Operating expenses:
Cost of revenue                                         402                    1,402               1,519                14,206
Selling and marketing                                    23                      151                 164                17,666
General and administrative                              366                    1,297               1,276                 3,955
Operating income                                      2,264                    6,692               8,560                 4,732
Other income                                            406                    1,241               1,674                 3,675
Income before taxes                        $          2,670         $          7,933     $        10,234       $         8,407


Three months ended September 30, 2012 compared to three months ended September 30, 2011

Revenue

Revenue from StoresOnline for the three months ended September 30, 2012 decreased 68% to $3,055,000, from $9,542,000 for the three months ended September 30, 2011.

Following our decision to suspend our direct mail seminar sales in July 2011, revenue from our StoresOnline segment has been generated primarily through principal amounts collected on historical sales of StoresOnline products and services sold through EPTAs. Fees for our StoresOnline products and services sold under EPTAs are recognized as revenue as cash payments are received from the customer and not at the time of sale.

Revenue related to cash collected under EPTA agreements decreased to $2,132,000 for the three months ended September 30, 2012, compared to $4,190,000 for the three months ended September 30, 2011. Our typical EPTA agreement has a term of two to three years. As such, while we no longer plan to offer EPTAs to our customers as a result of the suspension of our direct mail seminar sales, we will continue to recognize revenue from those EPTA contracts executed prior to July 2011 as cash is collected from those contracts. EPTAs were originally recognized in our balance sheet, net of an allowance for doubtful accounts, through our deferred revenue balance. The remaining deferred revenue balance is expected to be recognized as revenue, however, at a decreasing rate over the next year to eighteen months. The following table summarizes the activity within deferred revenue for the three months ended September 30, 2012 and 2011 (in thousands):

        StoresOnline deferred revenue as of July 1, 2012         $  9,228
        Cash collected on principal of EPTA contracts              (2,132 )
        Writeoff of EPTA deferred revenue                          (2,370 )
        StoresOnline deferred revenue as of September 30, 2012   $  4,726

        StoresOnline deferred revenue as of July 1, 2011         $ 27,967
        Cash collected on principal of EPTA contracts              (4,190 )
        Writeoff of EPTA deferred revenue                          (4,691 )
        StoresOnline deferred revenue as of September 30, 2011   $ 19,086

Due to the suspension of our direct mail seminar sales channel in July 2011, we had no cash sales of StoresOnline Software licenses ("SOS licenses") or other products at events during the three months ended September 30, 2012 and no significant cash sales at events in the three months ended September 30, 2011. During the three months ended September 30, 2011, we recognized $3,626,000 in revenue related to prior year sales that had been deferred until fulfillment had been completed. Hosting revenue decreased to $777,000 in the three months ended September 30, 2012 compared to $940,000 in the three months ended September 30, 2011. The decrease in hosting revenue was primarily due to attrition in the StoresOnline customer base since July 2011, primarily as a result of the suspension of the direct mail seminar sales channel.

Commissions from third parties and other revenue decreased 81% to $146,000 for the three months ended September 30, 2012, from $786,000 for the three months ended September 30, 2011, due primarily to the suspension our direct mail seminar sales channel. As a result of this decision, we no longer sent leads to third parties, and as such, we do not expect this revenue source to be significant in the future.

Cost of Revenue

Cost of revenue consists primarily of the cost to conduct internet training workshops, credit card fees, the cost of products sold, as well as customer support costs. Cost of revenue for the three months ended September 30, 2012 decreased 71% to $402,000, from $1,402,000 for the three months ended September 30, 2011. The decrease in cost of revenue was primarily due to suspension of our direct mail seminar sales channel in July 2011, as such, we no longer incurred the costs to conduct the internet training workshops. The cost of revenue for the three months ended September 30, 2012 primarily related to the cost to fulfill products sold through our inside sales group, credit card fees, and customer services costs.


Selling and Marketing

Selling and marketing expenses consist of payroll and related expenses for sales and marketing activities associated with our inside sales group. Selling and marketing expenses for the three months ended September 30, 2012 decreased 85% to $23,000, from $151,000 for the three months ended September 30, 2011. The decrease was primarily related to the suspension of our direct mail sales seminars in July 2011, as such, we no longer incur the selling and marketing expenses associated with those seminars, which accounted for most of our selling and marketing expenses in 2011.

General and Administrative

General and administrative expenses consist of payroll and related expenses for executive, administrative personnel, legal, rent, accounting and other professionals, finance company service fees, and other general corporate expenses. General and administrative expenses for the three months ended September 30, 2012 decreased to $366,000 from $1,297,000 for the three months ended September 30, 2011. The decrease was primarily due to the suspension of our direct mail seminar sales channel, which resulted in decreases in personnel and other general and administrative expenses.

Other Income

Other income primarily relates to interest earned on EPTAs, which generally carry an 18% simple interest rate. For the three months ended September 30, 2012 and 2011, other income was $406,000 and $1,241,000, respectively. The decrease relates to the decrease to the outstanding EPTA balance of $4,726,000 as of September 30, 2012 compared to $19,086,000 at September 30, 2011.

Nine Months Ended September 30, 2012 compared to Nine Months Ended September 30, 2011

Revenue

Revenue from our StoresOnline segment for the nine months ended September 30, 2012 decreased 72% to $11,519,000, from $40,559,000 for the nine months ended September 30, 2011.

Following our decision to suspend our direct mail seminar sales in July 2011, revenue from StoresOnline has been generated primarily through principal amounts collected on historical sales of StoresOnline products and services sold through EPTAs. Fees for our StoresOnline products and services sold under EPTAs are recognized as revenue as cash payments are received from the customer and not at the time of sale.

Revenue related to cash collected under EPTA agreements decreased to $8,088,000 for the nine months ended September 30, 2012, compared to $12,778,000 for the nine months ended September 30, 2011. Our typical EPTA agreement has a term of two to three years. As such, while we no longer plan to offer EPTAs to our customers as a result of the suspension of our direct mail seminar sales, we will continue to recognize revenue from those EPTA contracts entered into prior to July 2011 as cash is collected on those contracts. EPTAs are originally recognized in our balance sheet, net of an allowance for doubtful accounts, through our deferred revenue balance. The remaining deferred revenue balance is expected to be recognized as revenue, however, at a decreasing rate over the next year to eighteen months.


The following table summarizes the activity within deferred revenue for the nine months ended September 30, 2012 and 2011 (in thousands):

       StoresOnline deferred revenue as of January 1, 2012       $  15,196
       Cash collected on principal of EPTA contracts                (8,088 )
       Writeoff of EPTA deferred revenue                            (2,382 )
       StoresOnline deferred revenue as of September 30, 2012    $   4,726

       StoresOnline deferred revenue as of January 1, 2011       $  23,229
       Cash collected on principal of EPTA contracts               (12,778 )
       Deferred revenue added during period (net of writeoffs)       8,635
       StoresOnline deferred revenue as of September 30, 2011    $  19,086

Due to the suspension of our direct mail seminar sales channel in July 2011, we had no cash sales of StoresOnline Software licenses ("SOS licenses") or other products at events during the nine months ended September 30, 2012, compared to $19,838,000 of cash sales at events in the nine Months Ended September 30, 2011. Hosting revenue decreased to $2,502,000 in the nine months ended September 30, 2012 compared to $3,271,000 in the nine months ended September 30, 2011. The decrease in hosting revenue was primarily due to attrition in the StoresOnline segment customer base since June 2011, primarily as a result of the suspension of the direct mail seminar sales channel.

Commissions from third parties and other revenue decreased 80% to $929,000 for the nine months ended September 30, 2012, from $4,672,000 for the nine months ended September 30, 2011, due primarily to our decision to suspend our direct mail seminar sales channel. As a result of this decision, we no longer sent leads to these third parties, and as such, we do not expect this revenue source to be significant in the future.

Cost of Revenue

Cost of revenue consists primarily of the cost to have conducted internet training workshops, credit card fees, the cost of goods sold, as well as customer support costs. Cost of revenue for the nine months ended September 30, 2012 decreased 89% to $1,519,000, from $14,206,000 for the nine months ended September 30, 2011. The decrease in cost of revenue was primarily due to suspension of our direct mail seminar sales channel in July 2011, as such, we no longer incurred the costs to conduct the internet training workshops. The cost of revenue for the nine months ended September 30, 2012 primarily related to the cost to fulfill products sold through our inside sales group, credit card fees, and customer services costs.

Selling and Marketing

Selling and marketing expenses consist of payroll and related expenses for sales and marketing activities, associated with our inside sales group. Selling and marketing expenses for the nine months ended September 30, 2012 decreased 99% to $164,000, from $17,666,000 for the nine months ended September 30, 2011. The decrease was primarily related to the suspension of our direct mail sales seminars in July 2011. As a result of this suspension, we no longer incur the selling and marketing expenses associated with those seminars, which accounted for most of our selling and marketing expenses in 2011.

General and Administrative

General and administrative expenses consist of payroll and related expenses for executive and administrative personnel, rent, legal, accounting and other professional fees, finance company service fees, and other general corporate expenses. General and administrative expenses for the September 30, 2012 decreased to $1,276,000 from $3,955,000 for the nine months ended September 30, 2011. The decrease was primarily due to the suspension of our direct mail seminar sales channel, which resulted in decreases in personnel and other general and administrative expenses.


Other Income

Other income primarily relates to interest earned on EPTAs, which generally
carry an annual 18% simple interest rate. For the nine months ended September
30, 2012 and 2011, other income was $1,674,000 and $3,675,000, respectively.

Operating Results of Crexendo Web Services segment (in thousands):

. . .
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