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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
———————
 
FORM 10-Q
———————
 
(Mark One)
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2014
 
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)
 
———————
 
Delaware
87-0591719
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 
   
1615 South 52nd Street, Tempe, AZ
85281
(Address of Principal Executive Offices)
(Zip Code)
 
(602) 714-8500
 (Registrant’s telephone number, including area code)
 
 (Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ  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 þ  No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one).
 
Large accelerated filer
¨
 
Accelerated filer
¨
 
Non-accelerated filer
¨
 
Smaller reporting company
þ
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No þ.
 
The number of shares outstanding of the registrant’s common stock as of May 1, 2014 was 11,161,723.
 


 
 
 
 
 
INDEX
 
PART I – FINANCIAL INFORMATION
 
Item 1.        Financial Statements
3
   
Item 2.        Management's Discussion and Analysis of Financial Condition and Results of Operations
18
   
Item 3.        Quantitative and Qualitative Disclosures about Market Risk
28
   
Item 4.        Controls and Procedures
28
 
PART II – OTHER INFORMATION
   
Item 1.        Legal Proceedings
29
   
Item 1A.     Risk Factors
29
   
Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds
29
   
Item 6.        Exhibits
29
   
Signatures
30
 
 
 
2

 
 
PART I - FINANCIAL INFORMATION
 
Item 1.   Financial Statements.
 
CREXENDO, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In thousands, except par value and share data)
(unaudited)
 
   
March 31,
2014
   
December 31,
2013
 
Assets
           
             
Current Assets:
           
  Cash and cash equivalents
  $ 3,825     $ 3,076  
  Restricted cash
    484       487  
  Trade receivables, net of allowance of doubtful accounts of $95
               
     as of March 31, 2014 and $163 as of December 31, 2013
    750       1,090  
  Inventories
    146       217  
  Equipment financing receivables
    114       94  
  Income taxes receivable
    55       55  
  Prepaid expenses and other
    987       620  
    Total Current Assets
    6,361       5,639  
                 
Certificate of deposit
    251       250  
Long-term trade receivables, net of allowance of doubtful accounts of $23
             
     as of March 31, 2014 and $37 as of December 31, 2013
    97       116  
Long-term equipment financing receivables
    426       398  
Property and equipment, net
    298       2,195  
Deferred income tax assets, net
    244       244  
Intangible assets
    522       571  
Goodwill
    75       75  
Long-term prepaid rent
    617       -  
Other long-term assets
    93       119  
    Total Assets
  $ 8,984     $ 9,607  
                 
Liabilities and Stockholders' Equity
               
                 
Current Liabilities:
               
  Accounts payable
  $ 80     $ 201  
  Accrued expenses and other
    1,132       1,095  
  Deferred income tax liability
    244       244  
  Deferred revenue, current portion
    885       1,199  
  Contingent consideration
    31       51  
     Total Current Liabilities
    2,372       2,790  
                 
Deferred revenue, net of current portion
    97       116  
Other long-term liabilities
    273       -  
     Total Liabilities
    2,742       2,906  
                 
Stockholders' Equity:
               
  Preferred stock, par value $0.001 per share - authorized 5,000,000 shares; none issued
    -       -  
  Common stock, par value $0.001 per share - authorized 25,000,000 shares; 11,142,197
             
   shares outstanding as of March 31, 2014 and 10,801,315 shares outstanding
             
     as of December 31, 2013
    11       11  
  Additional paid-in capital
    52,244       50,998  
  Contingent consideration
    125       198  
  Accumulated deficit
    (46,138 )     (44,506 )
     Total Stockholders' Equity
    6,242       6,701  
     Total Liabilities and Stockholders' Equity
  $ 8,984     $ 9,607  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
3

 
 
CREXENDO, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(In thousands, except per share and share data)
(unaudited)
 
   
Three Months Ended March 31,
 
   
2014
   
2013
 
             
Revenue
  $ 2,072     $ 3,022  
                 
Operating expenses:
               
   Cost of revenue
    930       1,042  
   Selling and marketing
    653       908  
   General and administrative
    1,750       1,438  
   Research and development
    414       481  
          Total operating expenses
    3,747       3,869  
                 
Loss from operations
    (1,675 )     (847 )
                 
Other income (expense):
               
   Interest income
    48       219  
   Other income (expense), net
    29       (7 )
          Total other income, net
    77       212  
                 
Loss before income tax provision
    (1,598 )     (635 )
                 
Income tax (provision) benefit
    (34 )     237  
Net loss
  $ (1,632 )   $ (398 )
                 
Net loss per common share:
               
     Basic
  $ (0.15 )   $ (0.04 )
     Diluted
  $ (0.15 )   $ (0.04 )
                 
Weighted average common shares outstanding:
         
    Basic
    10,912,334       10,669,513  
    Diluted
    10,912,334       10,669,513  
                 
                 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
 
 
4

 
 
CREXENDO, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Stockholders' Equity
 For the Three Months Ended March 31, 2014
(In thousands, except share data)
(unaudited)
 
               
Additional
               
Total
 
   
Common Stock
   
Paid-in
   
Contingent
   
Accumulated
   
Stockholders'
 
   
Shares
   
Amount
   
Capital
   
Consideration
   
Deficit
   
Equity
 
Balance, January 1, 2014
    10,801,315     $ 11     $ 50,998     $ 198     $ (44,506 )   $ 6,701  
Expense for stock options granted to employees
    -       -       164       -       -       164  
Common stock issued upon exercise of options
    17,394       -       43       -       -       43  
Issuance of common stock for rent
    300,000       -       966       -       -       966  
Issuance of common stock from contingent
                                               
consideration
    23,488       -       73       (73 )     -       -  
Net loss
    -       -       -       -       (1,632 )     (1,632 )
Balance, March 31, 2014
    11,142,197     $ 11     $ 52,244     $ 125     $ (46,138 )   $ 6,242  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
5

 
 
CREXENDO, INC. AND SUBSIDIARIES
 Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
 
   
Three Months Ended March 31,
 
   
2014
   
2013
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net loss
  $ (1,632 )   $ (398 )
Adjustments to reconcile net loss to net cash used in
               
operating activities:
               
Release of lease abandonment
    -       (606 )
Depreciation and amortization
    226       317  
Amortization of prepaid rent
    27       -  
Amortization of deferred gain
    (8 )     -  
Share-based compensation
    164       230  
Gain on disposal of property and equipment
    (1 )     -  
Change in uncertain tax positions
    -       (253 )
Changes in assets and liabilities:
               
Trade receivables
    359       1,242  
Equipment financing receivables
    (48 )     (51 )
Inventories
    71       57  
Income taxes receivable
    -       358  
Prepaid expenses and other
    (45 )     (107 )
Other long-term assets
    26       6  
Accounts payable, accrued expenses and other
    (84 )     (1,344 )
Deferred revenue
    (333 )     (1,269 )
Net cash used in operating activities
    (1,278 )     (1,818 )
CASH FLOWS FROM INVESTING ACTIVITIES
               
Acquisition of property and equipment
    -       (55 )
Sale of property and equipment
    2,002       1  
Release of restricted cash
    3       -  
Purchase of certificate of deposit
    (1 )     -  
Net cash provided by (used in) investing activities
    2,004       (54 )
CASH FLOWS FROM FINANCING ACTIVITIES
               
Proceeds from exercise of stock options
    43       3  
Payments made on contingent consideration
    (20 )     (6 )
Net cash provided by (used in) financing activities
    23       (3 )
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    749       (1,875 )
                 
CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD
    3,076       7,440  
CASH AND CASH EQUIVALENTS, END OF PERIOD
  $ 3,825     $ 5,565  
                 
Supplemental disclosure of cash flow information:
             
Cash (paid) received during the period:
               
Income taxes, net
  $ (11 )   $ 342  
Supplemental disclosure of non-cash investing and financing information:
             
Purchases of property and equipment included in accounts payable
  $ -     $ 6  
Prepayment of rent with common stock
  $ 966     $ -  
                 
                 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
6

 
 
CREXENDO, INC. AND SUBSIDIARIES
 
Notes to the Condensed Consolidated Financial Statements (unaudited)
 
(1)           Significant Accounting Policies
 
Description of Business - Crexendo, Inc. is incorporated in the state of Delaware. 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”. We are a hosted services company that provides website hosting, hosted telecommunications services, e-commerce software, website development software, and broadband internet services for businesses and entrepreneurs.  Our services are designed to make enterprise-class hosting services available to small, medium-sized and enterprise-sized businesses at affordable monthly rates.  The Company has three operating segments, which consist of Crexendo Network Services, Crexendo Web Services, and StoresOnline.
 
The Company has transformed into a start-up telecom company with the inherent risks and uncertainties of funding operations until profitability is achieved. We currently plan to fund our operations during the next twelve months using our cash and cash equivalents of $3.8 million and the collection of the remaining $374,000 of accounts receivable from our former StoresOnline business. However, in the event that any factors impacting future cash flows fall below management's expectations, the Company would be required to obtain additional debt or equity financing such as that available from its CEO to sustain operations.  The Company received a commitment from the CEO, and major shareholder, in February of 2014 that the CEO would provide the necessary level of financial support to enable the Company to pay its debts as they become due through March 31, 2015.  Accordingly, the Company believes it will have sufficient funds to sustain its operations during the next twelve months as a result of the sources of funding detailed above.
 
 Basis of Presentation – These unaudited condensed consolidated financial statements include the accounts and operations of Crexendo, Inc. and its wholly owned subsidiaries, which include Avail 24/7 Inc., Crexendo Business Solutions, Inc., StoresOnline Inc., StoresOnline International Canada ULC, StoresOnline International, Inc., StoresOnline International Ltd., StoresOnline International Canada, Ltd., Internet Training Group, Inc., Crexendo International, Inc., Crexendo Telecom, Inc., Crexendo India Limited, and Crexendo Property Management, LLC.   All intercompany account balances and transactions have been eliminated in consolidation.  The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, consistent in all material respects with those applied in our financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. Because these financial statements address interim periods, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. Such interim financial information is unaudited but reflects all adjustments that in the opinion of management are necessary for the fair presentation of the interim periods presented. The results of operations presented in this Quarterly Report on Form 10-Q are not necessarily indicative of the results that may be expected for the year ending December 31, 2014 or for any future periods. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited financial statements and footnotes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.
 
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.

Restricted Cash – We classified $484,000 and $487,000 as restricted cash as of March 31, 2014 and December 31, 2013, respectively.  Cash is restricted for state licensing letters of credit, compensating balance requirements of our merchant accounts, and purchasing card agreements.  As of March 31, 2014, we had restricted cash in financial institutions in excess of federally insured limits in the amount of $484,000.
 
Trade Receivables – We have historically offered to our StoresOnline customers the option to finance, typically through 24-and 36-month extended payment term arrangements (“EPTAs”), purchases made at our Internet Training Workshops through our StoresOnline segment. EPTAs are reflected as short-term and long-term trade receivables, as applicable, as we have the intent and ability to hold the receivables for the foreseeable future, until maturity or payoff.  EPTAs are recorded on a nonaccrual status beginning on the contract date.
 
 
7

 
 
Allowance for Doubtful Accounts – For sales made through EPTA contracts, we record an allowance for doubtful accounts each reporting period based on the Company’s ongoing assessment of collectability. The allowance represents estimated losses resulting from customers’ failure to make required payments. The allowance for doubtful accounts for EPTAs is netted against the current and long-term trade receivables balances. 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. Because revenue generated from customers financing through EPTAs is deferred and not recognized prior to the collection of cash, adjustments to the allowance for doubtful accounts related to our EPTA contracts increase or decrease deferred revenue. Trade receivables are written off against the allowance when the related customers are no longer making required payments and the trade receivables are determined to be uncollectible, typically 90 days past their original due date.  For sales made in our Crexendo Web Services and Crexendo Network Services segments, the allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence.
 
Interest Income - Interest income is primarily earned from EPTA contracts. EPTA contract terms generally contain an 18% simple interest rate. Interest income is recognized on these accounts only to the extent cash is received as the receivables are generally 24-and 36-months in length and collection of the full amount of the receivable is not probable. We recognized $48,000 and $219,000 in interest income for the three months ended March 31, 2014 and 2013, respectively.
 
Inventory - Inventories consist of telecommunication equipment and is stated at the lower of cost (first-in, first-out method) or market. In accordance with applicable accounting guidance, we regularly evaluate whether inventory is stated at the lower of cost or market.

Certificate of Deposit - We hold a $250,000 certificate of deposit as collateral for merchant accounts, which automatically renews every 12 months. The certificate of deposit is classified as long-term in the condensed consolidated balance sheets.
 
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 twenty years. The cost of leasehold improvements is amortized using the straight-line method over the shorter of the estimated useful life of the asset or the term of the related lease. Depreciation and amortization expense is included in general and administrative expenses and totaled $177,000 and $311,000 for the three months ended March 31, 2014 and 2013, respectively. Depreciable lives by asset group are as follows:
 
Computer and office equipment
2 to 5 years
Computer software
3 years
Furniture and fixtures
4 years
Leasehold improvements
2 to 5 years
Building
20 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 net income or loss for the year.
 
Goodwill – Goodwill of $75,000 was recorded in connection with the acquisition of PBX Central on June 4, 2013. 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 primarily of assets acquired in the acquisition of CastleWave and PBX Central, which include customer relationships, developed technology, technical know-how, and a non-compete agreement.  The fair value of identifiable intangible assets is based upon the lower of discounted future cash flow projections or the amount paid in an arm’s length transaction.  The intangible assets are amortized following the patterns in which the economic benefits are consumed.  Amortization expense from these acquired assets is included in general and administrative expenses and totaled $49,000 and $6,000 for the three months ended March 31, 2014 and 2013, respectively.
 
 
8

 
 
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 inventory valuation and obsolescence, intangible assets, allowances for doubtful accounts, sales returns and allowances, uncertainties related to certain income tax benefits, valuation of deferred income tax assets, valuations of share-based payments, recoverability of long-lived assets and valuation of contingent consideration.  Actual results may differ from our current estimates and those differences may be material.
 
Revenue Recognition - In general, we recognize revenue when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the product or service has been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of our fees is probable.  We recognize revenue from our Web Services and Network Services segments on an accrual basis and revenue from our StoresOnline segment on a cash basis. Specifics to revenue category are as follows:
 
Software licenses and DVD training courses sold under EPTAs are recognized as revenue upon receipt of cash from customers and not at the time of sale. Accounting standards require revenue to be deferred until customer payments are received if collection of the original principal balance is not probable.
 
We enter into agreements where revenue is derived from multiple deliverables including any mix of products and/or services.  For these arrangements, we determine whether the delivered item(s) has value to the customer on a stand-alone basis, and in the event the arrangement includes a general right of return relative to the delivered item(s), whether the delivery or performance of the undelivered item(s) is considered probable and substantially in our control.  If these criteria are met, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative selling price.  If these criteria are not met, the arrangement is accounted for as a single unit of accounting which would result in revenue being recognized ratably over the contract term or deferred until the earlier of when such criteria are met or when the last undelivered element is delivered. The amount of product and services revenue recognized for arrangements with multiple deliverables is impacted by the allocation of arrangement consideration to the deliverables in the arrangement based on the relative selling prices. In determining our selling prices, we apply the selling price hierarchy using vendor specific objective evidence (VSOE) when available, third-party evidence of selling price (“TPE”) if VSOE does not exist, and best estimated selling price (“BESP”) if neither VSOE nor TPE is available.
 
VSOE of fair value for elements of an arrangement is based upon the normal pricing and discounting practices for a deliverable when sold separately.  In determining VSOE, we require that a substantial majority of the selling prices fall within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rate. In addition, we consider major service groups, geographies, customer classifications, and other variables in determining VSOE.
 
We are typically not able to determine TPE for our products or services. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality is difficult to obtain. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.
 
When we are unable to establish the selling price using VSOE or TPE, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine BESP for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies, customer classes and distribution channels.

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.

 
9

 
 
Professional Services Revenue - Fees collected for professional services, including website design and development, search engine optimization services, link-building, paid search management services, and telecom installation services are recognized as revenue, net of expected customer refunds, over the period during which the services are performed, based upon the value for such services.

Web and Telecommunications Services Hosting Revenue - Fees collected for hosting revenue are recognized ratably as services are provided.  Customers are billed for these services on a monthly or annual basis at the customer’s option.We recognize revenue ratably over the applicable service period.  

Equipment Sales and Financing Revenue - Fees generated from the sale of telecommunications equipment are recognized when the devices are installed and hosted telecommunications services begin.

Fees generated from renting our hosted telecommunication equipment (IP or cloud telephone 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.

Commission Revenue - We have contracts with third-party entities with respect to telemarketing product sales to our customers following the sale of the initial software licenses. These products and services are intended to assist the customers with their Internet businesses. These products are sold and delivered completely by third parties. We receive commissions from these third parties, and recognize the revenue as the commissions are received, net of expected customer refunds.

We have affiliate agreements with third-party entities that are resellers of satellite television services and internet service provider services. We receive commissions when the services are bundled with our hosted service offerings.

Cost of Revenue – Cost of revenue consists primarily of salaries for fulfillment services, and the cost of telecommunications equipment, services, and other products sold.

Prepaid Sales Commissions - For arrangements where we recognize revenue over the relevant contract period, we defer related commission payments to our direct sales force and amortize these amounts over the same period that the related revenues are recognized.  This is done to match commission expense with the related revenues.  Commission payments are nonrefundable unless amounts due from a customer are determined to be uncollectible or if the customer subsequently changes or terminates the level of service, in which case commissions which were paid are recoverable by us.  Deferred sales commissions were as follows:

   
March 31,
   
December 31,
 
   
2014
   
2013
 
Deferred sales commissions
  $ 211,000     $ 189,000  
Accumulated amortization
    (28,000 )     (13,000 )
Deferred sales commissions, net
  $ 183,000     $ 176,000  
                 
 
We amortized commission expense of $15,000 and $0 for the three months ended March 31, 2014 and 2013, respectively.

 
10

 
 
Research and Development - Research and development costs are expensed as incurred. Costs related to internally developed software are expensed as research and development expense until technological feasibility has been achieved, after which the costs are capitalized.

Fair Value Measurements - The fair value of our financial assets and liabilities was determined based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following: 
 
Level 1 — Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.
 
Level 2 — Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:
 
       Quoted prices for similar assets or liabilities in active markets;
       Quoted prices for identical or similar assets in non-active markets;
       Inputs other than quoted prices that are observable for the asset or liability; and
       Inputs that are derived principally from or corroborated by other observable market data.
 
Level 3 — Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment.  These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

Financial Instruments - The carrying values of cash and cash equivalents, restricted cash, certificates of deposit, and merchant account deposits approximate their fair values due to either the short maturity of the instruments or the recent date of the initial transaction.

Income Taxes - We recognize a liability or asset for the deferred tax consequences of all temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years when the reported amounts of the assets and liabilities are recovered or settled. Accruals for uncertain tax positions are provided for in accordance with accounting guidance. Accordingly, we may recognize the tax benefits from an uncertain tax position only if it is more-likely-than-not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting guidance is also provided on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in the financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our financial position, results of operations, and cash flows.  In assessing the need for a valuation allowance, we evaluate all significant available positive and negative evidence, including historical operating results, estimates of future taxable income and the existence of prudent and feasible tax planning strategies.  We have placed a full valuation allowance on net deferred tax assets, see Note 5.

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

We do not intend to indefinitely reinvest the undistributed earnings of our United Kingdom subsidiary, therefore, we have provided for U.S. deferred income taxes on such undistributed foreign earnings.  All other foreign subsidiaries are considered disregarded foreign entities for US tax purposes.
 
 
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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.  The restricted stock includes all dividend rights and is a participating security; however, the restricted stock does not change earnings per share under the two-class method.

Comprehensive Income (Loss) – There were no other components of comprehensive income (loss) other than net income (loss) for the three months ended March 31, 2014 and 2013.

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 three operating segments, which consist of StoresOnline, Crexendo Web Services and Crexendo Network Services.  Research and development expenses are allocated to StoresOnline and Crexendo Network Services segments based on the level of effort, measured primarily by wages and benefits attributed to our engineering department.  Indirect sales and marketing expenses are allocated to the Crexendo Web Services and Crexendo Network Services segments based on level of effort, measured by month-to-date contract bookings.  General and administrative expenses are allocated to all three segments based on revenue recognized for each segment.  Accounting guidance also establishes standards for related disclosure about products and services, geographic areas and major customers. We generate over 90% of our total revenue from customers within North America (United States and Canada) and less than 10% of our total revenues from customers in other parts of the world.

Significant Customers – No customer accounted for 10% or more of our total revenue or total accounts receivable for the three months ended March 31, 2014 and 2013.
 
 (2)           Net Income (Loss) Per Common Share
 
Basic net income (loss) per common share is computed by dividing the net income (loss) for the period by the weighted-average number of common shares outstanding during the period. Diluted net income per common share is computed giving effect to all dilutive common stock equivalents, consisting of common stock options and restricted shares held in escrow. Diluted net loss per common share for the three months ended March 31, 2014 and 2013 was the same as basic net loss per common share, as the common share equivalents were anti-dilutive.  The following table sets forth the computation of basic and diluted net loss per common share:
 
   
Three Months Ended March 31,
 
   
2014
   
2013
 
             
Net loss (in thousands)
  $ (1,632 )   $ (398 )
                 
Weighted-average share reconciliation:
               
        Weighted-average shares outstanding
    10,912,334       10,669,513  
        Weighted-average restricted shares held in escrow
    -       -  
        Weighted-average basic shares outstanding
    10,912,334       10,669,513  
        Dilutive employee stock options
    -       -  
        Dilutive restricted shares held in escrow
    -       -  
Diluted shares outstanding
    10,912,334       10,669,513  
Net loss per common share:
               
        Basic
  $ (0.15 )   $ (0.04 )
        Diluted
  $ (0.15 )   $ (0.04 )
 
Common stock equivalent shares are not included in the computation of diluted loss per share, because the Company has a net loss and the inclusion of such shares would be anti-dilutive due to the net loss. At March 31, 2014 and 2013, the common stock equivalent shares were 2,394,312 and 2,285,620, respectively.

 
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 (3)            Trade Receivables, net
 
Our trade receivables balance consists of the residual Extended Payment Term Agreements (EPTAs) sold through our workshop seminars that we discontinued in July 2011 and receivables from the Crexendo Network Services and Crexendo Web Services segments.  Below is an analysis of the days outstanding of our trade receivables as shown on our balance sheet (in thousands):
 
   
March 31,
   
December 31,
 
   
2014
   
2013
 
Non-EPTA trade receivables
  $ 503     $ 688  
Conforming EPTAs
    378       577  
Non-Conforming EPTAs:
               
    1 - 30 days
    36       68  
    31 - 60 days
    30       30  
    61 - 90 days
    18       43  
Gross trade receivables
    965       1,406  
Less allowance for doubtful accounts
    (118 )     (200 )
Trade receivables, net
  $ 847     $ 1,206  
                 
Current trade receivables, net
  $ 750     $ 1,090  
Long-term trade receivables, net
    97       116  
Trade receivables, net
  $ 847     $ 1,206  
 
All current and long-term EPTAs in the table above had original contract terms of greater than one year.  The Company wrote off $74,000 of EPTAs during the three months ended March 31, 2014 and $1,027,000 during the year ended December 31, 2013, of which, all had original contract terms of greater than one year.

(4)           Equipment Financing Receivables

       We rent our hosted telecommunication equipment (VoIP telephone devices) through leasing contracts that we classify as either operating leases or sale-type leases. Equipment finance receivables arising from the rental of our hosted telecommunication equipment through sales-type leases were as follows (in thousands):
 
   
March 31,
   
December 31,
 
   
2014
   
2013
 
Gross financing receivables
  $ 1,489     $ 1,369  
Less: unearned income
    (949 )     (877 )
Financing receivables, net
    540       492  
Less: current portion of finance receivables, net
    (114 )     (94 )
Finance receivables due after one year
  $ 426     $ 398  
 
           Equipment finance receivables are expected to be collected within the next thirty-six to sixty months.

(5)
Income Taxes
 
Our effective tax rate for the three months ended March 31, 2014 and 2013 was (2.1)%  and 37.4%, respectively, which resulted in an income tax (provision) benefit of $(34,000) and $237,000, respectively.  The tax provision for the three months ended March 31, 2014 was due to state tax payments made with extensions filed.  The benefit for the three months ended March 31, 2013 was primarily due to the statute of limitations expiring on two uncertain tax positions.

Significant management judgment is required in determining our provision for income taxes and in determining whether deferred tax assets will be realized in full or in part.  In assessing the recovery of the deferred tax assets, we considered whether it is more likely than not that some portion or all of our deferred tax assets will not be realized.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in the periods in which those temporary differences become deductible.  We considered the scheduled reversals of future deferred tax assets, projected future taxable income, the suspension of the sale of product and services through the seminar sales channel for our StoresOnline segment, the restructuring of the StoresOnline segment, and tax planning strategies in making this assessment.  As a result, we determined it was more likely than not that the deferred tax assets would not be realized; accordingly, we recorded a full valuation allowance. Subsequent to placing a full valuation allowance on our net deferred tax assets, adjustments impacting our tax rate have been and are expected to continue to be insignificant.

 
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(6)           Fair Value Measurements
 
We have financial instruments as of March 31, 2014 and December 31, 2013 for which the fair value is summarized below (in thousands):
 
   
March 31, 2014
   
December 31, 2013
 
   
Carrying Value
   
Estimated Fair Value
   
Carrying Value
   
Estimated Fair Value
 
Assets:
                       
Trade receivables, net
  $ 847     $ 879     $ 1,206     $ 1,190  
Certificate of deposit
    251       251       250       250  
Liabilities:
                               
Acquisition related contingent consideration
  $ 31     $ 31     $ 51     $ 51  
 
The carrying amount of certificates of deposit approximates fair value, as determined by certificates of deposit with similar terms and conditions.  The trade receivables consist primarily of extended payment term agreements and the fair value is computed using a discounted cash flow model with an estimated market rate.

Liabilities measured at fair value on a recurring basis are summarized below as of March 31, 2014 and December 31, 2013, respectively (in thousands).
 
         
Fair value measurement at reporting date
 
Description
 
As of March 31,
2014
   
Level 1
   
Level 2
   
Level 3
 
                         
Liabilities:
                       
Acquisition related contingent consideration
  $ 31     $ -     $ -     $ 31  
 
         
Fair value measurement at reporting date
 
Description
 
As of December 31,
2013
   
Level 1
   
Level 2
   
Level 3
 
                         
Liabilities:
                       
Acquisition related contingent consideration
  $ 51     $ -     $ -     $ 51  
 
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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The progression of the Company’s Level 3 instruments fair valued on a recurring basis for the three months ended March 31, 2014 are shown in the table below (in thousands):

   
Acquisition Related Contingent Consideration
 
Balance at December 31, 2013
  $ 51  
Cash payments
    (20 )
Balance at March 31, 2014
  $ 31  
 
(7)
Commitments and Contingencies
 
Legal Proceedings
 
From time to time we receive inquiries from federal, state, city and local government officials in the various jurisdictions in which we operate. These inquiries and investigations generally concern compliance with various city, county, state and/or federal regulations involving sales, representations made, customer service, refund policies, and marketing practices. We respond to these inquiries and have generally been successful in addressing the concerns of these persons and entities, without a formal complaint or charge being made, although there is often no formal closing of the inquiry or investigation. There can be no assurance that the ultimate resolution of these or other inquiries and investigations will not have a material adverse effect on our business or operations, or that a formal complaint will not be initiated. We also receive complaints and inquiries in the ordinary course of business from both customers and governmental and non-governmental bodies on behalf of customers, and in some cases these customer complaints have risen to the level of litigation. There can be no assurance that the ultimate resolution of these matters will not have a material adverse effect on our business or results of operations.   
 
We have recorded liabilities of approximately $193,000 and $202,000 as of March 31, 2014 and December 31, 2013, respectively, for estimated losses resulting from various legal proceedings in which we are engaged. Attorney’s fees associated with the various legal proceedings are expensed as incurred. We are also subject to various claims and legal proceedings covering matters that arise in the ordinary course of business. We believe that the resolution of these other cases will not have a material adverse effect on our business, financial position, or results of operations.

Sale-Leaseback

On February 28, 2014, the Company sold and leased back the land, building and furniture associated with the corporate headquarters in Tempe, Arizona for $2.0 million in cash (Note 10).  The Company recognized a deferred gain of $281,000 on sale-leaseback, which will be amortized over the initial lease term of 36 months to offset rent expense.  The net deferred gain is included in other long-term liabilities in the condensed consolidated balance sheets as of March 31, 2014.

The lease agreement called for rent payments for the initial three year term to be made in advance in the form of 300,000 shares of common stock of Crexendo, Inc.  The fair value price per share at the time of the lease was $3.22 per share, resulting in rent expense of $322,000 per year for three years.  Prepaid rent included in the condensed consolidated balance sheets as of March 31, 2014, is as follows:

Prepaid rent, current
  $ 322,000  
Long-term prepaid rent
    617,000  
Total prepaid rent, net
  $ 939,000  
 
Rent expense incurred on the sale-leaseback, including the effects of the deferred gain amortization, during the three months ended March 31, 2014 and 2013 was $19,000 and $0, respectively.

 (8)
Segments
 
Management has chosen to organize the Company around differences based on its products and services.  Crexendo Network Services segment generates revenue from selling hosted telecommunication services and broadband internet services. Crexendo Web Services segment generates revenue from managing e-commerce or lead generation offerings, websites, search engine optimization/management and linkbuilding services.  We believe that the StoresOnline segment will continue to generate revenue by offering businesses website hosting services.
 
 
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The Company has three operating segments, which consist of Crexendo Network Services, Crexendo Web Services, and StoresOnline. Segment revenue and income (loss) before income tax provision was as follows (in thousands):
 
   
Three Months Ended March 31,
 
   
2014
   
2013
 
Revenue:
           
Crexendo Network Services
  $ 955     $ 385  
Crexendo Web Services
    252       533  
StoresOnline
    865       2,104  
Consolidated revenue
    2,072       3,022  
                 
Income (loss) from Operations:
               
Crexendo Network Services
    (1,508 )     (1,234 )
Crexendo Web Services
    (226 )     (629 )
StoresOnline
    59       1,016  
Total operating loss
    (1,675 )     (847 )
Other Income, net:
               
Crexendo Network Services
    20       3  
Crexendo Web Services
    6       3  
StoresOnline
    51       206  
Total other income
    77       212  
Income (loss) before income tax provision:
               
Crexendo Network Services
    (1,488 )     (1,231 )
Crexendo Web Services
    (220 )     (626 )
StoresOnline
    110       1,222  
Loss before income tax provision
  $ (1,598 )   $ (635 )
                 
                 
 
(9) Business Acquisition
 
PBX Holdings, LLC. Acquisition
 
On June 4, 2013, we acquired certain assets from PBX Holdings, LLC., dba PBX Central, a privately-held provider of IP Telecom and Cloud communications located in Austin, Texas. The aggregate purchase price of approximately $770,000 consisted of $300,000 of cash paid at closing and 38,516 shares of our common stock with an estimated fair value of approximately $107,000. The fair value of the issuance of common stock issued as consideration for PBX Central was determined on the basis of the closing market price of the Company’s common stock on the acquisition date. In addition, the Company recorded as part of the purchase price approximately $363,000 of contingent consideration it estimates will be earned relating to an additional payment provision. The estimated additional payment obligation is comprised of approximately $87,000 of cash consideration and 115,385 shares of the Company’s common stock with an estimated value of approximately $276,000 at the time of the acquisition.  The Company’s consolidated financial statements include the results of operations of PBX Central from the date of acquisition. The historical results of operations of PBX Central were not significant to the Company’s consolidated results of operations for the periods presented. The total purchase consideration was allocated to the assets acquired and liabilities assumed at their estimated fair values as of the date of acquisition, as determined by management.  The excess of the purchase price over the amounts allocated to assets acquired and liabilities assumed has been recorded as goodwill. In accordance with current accounting standards, goodwill associated with the PBX Central acquisition will not be amortized and will be tested for impairment at least annually.
 
 
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During the third quarter of 2013, the Company completed the valuation of the intangible assets acquired.  The final assessment resulted in no changes to the amounts recorded.  The following table presents the final allocation of the purchase price for PBX Central (in thousands):
 
Consideration (including estimated unpaid contingent consideration):
 
Cash
  $ 300  
Common stock
    107  
Contingent consideration
    363  
Total consideration
  $ 770  
         
Recognized amounts of identifiable assets acquired and liabilities assumed:
 
Property and equipment
  $ 7  
Identifiable intangible assets
    688  
Total identifiable net assets
    695  
     Goodwill
    75  
    $ 770  
 
The following were the identified intangible assets acquired and the respective estimated periods over which such assets will be amortized (in thousands):
 
   
Amount
   
Weighted Average useful life (In years)
 
Technology
  $ 180       2  
Customer relationships
    508       10  
Total
  $ 688          
 
In determining the preliminary purchase price allocation, the Company considered, among other factors, its intention to use the acquired assets and the historical and estimated future demand for PBX Central services. The estimated fair value of customer relationships was 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 cost approach was used to determine the fair value of the technology acquired from PBX Central.  The cost approach estimates the value of the intangible asset by quantifying the aggregate expenditures that would be required to replace the intangible asset.  Such expenditures include the developers’ time and materials.  The underlying assumption is that the cost to purchase or develop an asset is commensurate with the economic benefits the asset is expected to generate over its remaining economic life.  Management has estimated the cost to develop a similar product with current technology.  The key assumption used in valuing the technology acquired is developers’ time.
 
The customer relationships were valued using a form of the income approach known as 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 customer relationships acquired are as follows: discount rate of 18%, tax rate of 38.1%, contributory asset charges for technology license and tangible assets used to deliver services, and estimated economic life of 10 years.
 
The total weighted average amortization period for the identified intangible assets acquired from PBX Central is 6 years. The goodwill resulting from the PBX Central acquisition is not currently deductible for income tax purposes.
 
(10)           Related Party Transactions

On February 28, 2014, the Company entered into a Deed of Sale with SGM EXE, LLC, a Nevada limited liability company controlled by Steven G. Mihaylo, the Chairman of the Board, Chief Executive Officer and principal shareholder of the Company.  The land, building and furniture of the corporate headquarters were sold for $2.0 million in cash, which resulted in a deferred gain on sale of disposal of $281,000.
 
On March 1, 2014, the Company entered into a sale-leaseback agreement with SGM EXE, LLC.  The Company has signed a three-year lease agreement, with the option to renew the lease at fair market value rates for two consecutive three-year terms.  The lease agreement called for rent payments for the initial three year term to be made in advance in the form of 300,000 shares of common stock of Crexendo, Inc.  The fair value price per share at the time of the lease was $3.22 per share, resulting in rent expense of $322,000 per year for three years. The Company has the option to pay rent expense for the subsequent renewal periods in stock or cash.  If stock, the number of shares is computed as the average of the last sale price for each business day for the thirty (30) days prior to the first day of the three year renewal term.
 
 
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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, 2013 (the “2013 Form 10-K”) filed with the SEC and the Condensed Consolidated Financial Statements and notes thereto included in the 2013 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 website hosting, hosted telecommunications services, e-commerce software, website development software, and broadband internet services 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.  The Company has three operating segments, which consist of Crexendo Network Services, Crexendo Web Services, and StoresOnline.
 
Crexendo Network Services segment - Our hosted 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 a mobile device.
 
Crexendo Web Services segment –We generate professional services revenue primarily from search engine optimization services, link building, paid search management services, conversion rate optimization services, and website design and development. 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. During the quarter ended September 30, 2013, the Company made a strategic decision to limit our provision of web services to our enterprise sized customers.
 
StoresOnline segment – Our StoresOnline segment serves the small office/ home office (SOHO) business owner and entrepreneur seeking the tools and training to establish a successful website on the Internet. Specifically, StoresOnline services a market segment looking for a “do-it-yourself” option as an alternative to the high cost of contracting an e-commerce or lead generation web developer and, most importantly, an ad agency for website promotion. Both are difficult barriers to many entrepreneurs looking to establish a presence on the Internet.
 
We have historically sold our StoresOnline products and services through a direct mail seminar format utilizing direct response marketing campaigns.  In July 2011, we suspended the sale of our products and services through the direct mail seminar format.  Following the suspension of the direct mail seminar format, our primary marketing channel for our StoresOnline segment has been through in-house telemarketing, online marketing channels, and direct prospecting.
 
We generate revenue from the cash collections from our extended payment term agreements (EPTAs), website hosting, and Avail 24/7 services.
 
We generate subscription fees from our hosted telecommunications and broadband Internet services.  Our hosted telecommunications contracts typically have a thirty-six to sixty month term.  We generate product revenue and equipment financing revenue from the sale and lease of our 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.
 
OUR SERVICES AND PRODUCTS

Our goal is to provide a broad range of Cloud-based products and services that nearly eliminate the cost of a businesses’ technology infrastructure and enable businesses of any size to more efficiently run their business.  By providing a variety of comprehensive and scalable solutions, we are able to provide these solutions on a monthly basis to businesses and entrepreneurs 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:

Hosted Website Services - Our website hosting services allows businesses and entrepreneurs to host their websites in our data center for a monthly fee.

Hosted Telecommunications Services - Our hosted telecommunications service offering includes hardware and software and unified communication solutions for businesses using IP or cloud technology over any high-speed internet connection. These services are rendered through a variety of devices and user interfaces such as a Crexendo branded desktop phones, 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 hosted telecommunications services are powered by our proprietary implementation of standard Internet, Web and IP or cloud technologies. Our services also use our complex infrastructure that we build and manage based on industry standard best practices to achieve greater efficiencies and customer satisfaction. Our infrastructure comprises of computing, 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.
 
 
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Crexendo’s hosted telecommunications service offers a wide variety of essential and advanced features for small and medium-size businesses.  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 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-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
 
  
Call Center Features such as Automated Call Distribution (ACD), Call Monitor, Whisper and Barge, Automatic Call Recording
 
  
Advanced Unified Communication Features such as Find-Me-Follow-Me, Sequential Ring and Simultaneous Ring
 
  
Mobile Features such as extension dialing, transfer and conference and seamless hand-off from Wifi to/from 3G and 4G, as well as other data services. These features are available on CrexMo, an intelligent mobile application for iPhone 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 Provisioning the system, manage the account, billing and activity
 
Many of these services are available and 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 SaaS offerings to make them more competitive and profitable.

Search Engine Optimization (SEO) - There are two general aspects to Search Engine Optimization (“SEO”).  First, the tactical level, that includes conditioning a website and/or its pages to be relevant and search-engine friendly.  Second, we help businesses strategically select keywords and keyword phrases.  The popularity of a site plays a role in what keyword phrases a business can compete on versus what keyword phrases might be “out of their league”.  We focus on the strategic selection of keywords and prioritize keywords that have healthy search volumes and high ‘win’ capability.  Our experience coupled with our software allow us to strategically select the best choices for keyword phrases to target which provide the highest probability of getting high search engine positions and draws maximum traffic to the website.  Our SEO packages include a keyword interview, strategic keyword research, baseline ranking report, search engine optimization plan, and comparison ranking report.

Link Building - Link building is a critical component of off-page SEO.  To be effective, a link building campaign must be done manually.  Search engines can detect links obtained via automated submission.  Also, links need to come from many different types of sites, not just one or two.  Link building is closely related to search engine optimization, as such; we carefully synchronize all our link building efforts and anchor text with our search engine optimization efforts.

An effective link building effort is labor intensive, with no real shortcuts.  We use a broad based approach for link building that follows search engine webmaster guidelines.  We use strategies that include, but aren’t limited to:  Web 2.0 sites, social media and social bookmarking sites, vertical portals, local directories, live directories, and others.

Paid Search Management - We offer paid search management services, such as management of Google® AdWords™, Yahoo and Microsoft Advertising adCenter™ accounts for our customers.

Modern paid search networks are incredibly sophisticated and require a tremendous amount of experience and expertise to avoid the many potential pitfalls of paid search.  We assist customers by taking a conservative approach to paid search management. By using a combination of proprietary automation tools, split test dedicated landing pages, as well as the practiced eye of an expert monitoring our customer accounts on a daily basis, we are able to consistently raise conversion rates and lower the cost of pay-per-click (PPC) acquisition.
 
 
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Website Design and Development - Using our proprietary software and processes we design and develop websites with “conversion” in mind.  The term conversion means different things to different websites.  To a lead-generation website, it means getting prospects to submit their contact information so the sales team can contact them.  For an e-commerce website, conversion means getting an online customer to complete an order.

Our website design packages range from a semi-custom template based design package to a completely custom design package.  We incorporate analytics into every website we build.  Proper analytics allow identification of weak spots in the conversion process.  Once weak spots are identified, the site can be adjusted to smooth out the process and help turn more prospects into customers.

Once the site is complete, we provide tutorials and tools to allow customers to make changes to their sites as often as necessary without having to pay additional programming fees.  Alternatively, customers can elect to have us manage the changes to their websites for an additional fee.
 
TECHNOLOGY
 
We believe our proprietary implementation of standard Web, VoIP, Mobile and Internet technologies represent a key component of our business model. We believe these technologies and how we deliver them to our customers distinguish our services and products from the services and products offered by our competitors. Our technology infrastructure and virtual network operation center, all of which is built and managed on industry standard computing, storage, data and platforms offers us greater efficiencies. The synergies between Web and Telecommunication protocols such as TCP/IP, HTTP, XML, SIP and innovations in computing, load balancing, redundancy and high availability of Web and Telecommunications technologies offers us a unique advantage in delivering these services to our customers seamlessly from our data center.
 
Our Hosted Telecommunications technology is continuously being enhanced with additional features and software functionality. Our current functionality includes:
 
  
High-end desktop telephony devices such as Gigabit, PoE, 6 Line Color Phone with 10 programmable buttons, and lower end Monochrome 2 Line wall mountable device
 
  
Basic Business Telephony Features such as those offered in a traditional private branch exchange (“PBX”) systems like extension dialing, Direct Inward Dialing (DID), Hold/Resume, Music-On-Hold, Call Transfer (Attended and Unattended), Conferencing, Local, Long Distance, Toll-Free and International Dialing, Voicemail, Auto-Attendant, and traditional faxing
 
  
Advanced telephony features such as Call Park, Call Pickup, Paging(through the phones), Overhead paging, Call Recording
 
  
Call Center Functionality such as Agent Log In/Log Out,  Whisper, Barge, and Call center reporting
 
  
Unified Communications features like Simultaneous Ring, Sequential Ring, Status based Routing (Find-Me-Follow-Me), 10-party instant conference, and Mobile application (CrexMo)
 
  
Crexendo Mobile Application (CrexMo), which allows users to place and receive extension calls using Crexendo’s network, transfer and conference other users right from their mobile phone as if they were in the office. It also provides users instant access to visual voicemail and call logs
 
  
End User Portal and Unified Messaging with Voicemail, Call Recording, and eFax inbox
 
Our web software platform is continuously being enhanced and is an innovative website-building environment. Features and functions of our software include:
 
 
  
during website development, our customers can experience the look and feel of their websites as if they were their own customers. They can shop, navigate, order products, track orders, and more. If they want to change or add more elements, they can edit, rearrange, add, and delete the elements all within a dynamic, point-and-click environment;
 
 
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●  
designs that are customized based on the customers’ choices and arrangements. Customers can modify the look and feel of the design to complement their services or products. In addition, design modification and arrangement are executed within a streamlined, point-and-click environment;
 
 
●  
blogs, online journals, message boards, and forums that are easily integrated into the content of the website. As administrators, the customers have full control in terms of filtering content, allowing images, and other blog, message board, and forum permissions;
 
 
●  
customizable forms that address customer-specific needs. By using customized forms, our customers can set up secure, encrypted forms with improved ease to collect sensitive information from their customers. This is especially useful for service-based businesses, as these forms can be used for job, loan, applications, questionnaires, bids, quotes, lead generation, etc.;
 
 
●  
advanced out of the box eCommerce features include: shopping cart, ordering rules setup for shipping, sales tax, discount codes, UPS integration, inventory control system, gift certificate and gift card purchasing and redemption, integration with Amazon® Checkout and/or Google® Checkout, Google® Base integration, eBay® auctions integration, shopping cart supporting multiple currencies and price sets, automatic sitemap generation used by search engines, and advanced website product search using filters to quickly narrow down the product offering based on product attributes.
 
We continue to invest and develop on our Web platform to make it more easy-to-use, enable larger mobile and 3rd party integration features thus enabling our web customers to drive more traffic to their web-sites.
 
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, 2013 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates.  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 condensed 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 March 31,
 
   
2014
   
2013
 
Revenue
  $ 2,072     $ 3,022  
Loss before income taxes
    (1,598 )     (635 )
Income tax (provision) benefit
    (34 )     237  
Net loss
    (1,632 )     398  
Basic net loss per share
  $ (0.15 )   $ (0.04 )
Diluted net loss per share
  $ (0.15 )   $ (0.04 )
 
 
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Three months ended March 31, 2014 compared to three months ended March 31, 2013
 
Revenue
 
Total revenue decreased 31% or $950,000, to $2,072,000 for the three months ended March 31, 2014 as compared to $3,022,000 for the three months ended March 31, 2013. Crexendo Network Services segment revenue increased 148% or $570,000, to $955,000 for the three months ended March 31, 2014 as compared to $385,000 for the three months ended March 31, 2013.  Crexendo Web Services segment revenue decreased 53% or $281,000, to $252,000 for the three months ended March 31, 2014 as compared to $533,000 for the three months ended March 31, 2013.  StoresOnline segment revenue decreased 59% or $1,239,000, to $865,000 for the three months ended March 31, 2014, as compared to $2,104,000 for the three months ended March 31, 2013.
 
Loss Before Income Taxes
 
Loss before income tax increased $963,000, to $1,598,000 for the three months ended March 31, 2014 as compared to loss before income tax of $635,000 for the three months ended March 31, 2013.  The increase in loss before income tax is primarily due to the decrease in revenue of 31% or $950,000, to $2,072,000 for the three months ended March 31, 2014 as compared to $3,022,000 for the three months ending March 31, 2013.
 
Income Tax Provision
 
Our effective tax rate for the three months ended March 31, 2014 and 2013 was (2.1)% and 37.4%, respectively, which resulted in a (provision) benefit for income taxes of $(34,000) and $237,000, respectively.
 
Segment Operating Results

The Company has three operating segments, which consist of Crexendo Network Services, Crexendo Web Services, and StoresOnline. 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.
 
Operating Results of our Crexendo Network Services segment (in thousands):
 
   
Three Months Ended March 31,
 
   
2014
   
2013
 
Crexendo Network Services
           
Revenue
  $ 955     $ 385  
Operating expenses:
               
Cost of revenue
    663       448  
Research and development
    245       291  
Selling and marketing
    618       522  
General and administrative
    937       358  
Operating loss
    (1,508 )     (1,234 )
Other Income
    20       3  
Loss before taxes
  $ (1,488 )   $ (1,231 )
 
Three months ended March 31, 2014 compared to three months ended March 31, 2013

Revenue

Crexendo Network Services total segment revenue increased 148% or $570,000, to $955,000 for the three months ended March 31, 2014 as compared to $385,000 for the three months ended March 31, 2013.  Equipment sales, including sales of equipment under sales-type leases, increased 113% or $131,000, to $247,000 for the three months ended March 31, 2014 as compared to $116,000 for the three months ended March 31, 2013.  Interest revenue associated with the sales-type leases increased 259% or $70,000, to $97,000 for the three months ended March 31, 2014 as compared to $27,000 for the three months ended March 31, 2013.  Revenue from recurring and one-time services increased 152% or $369,000 to $611,000 for the three months ended March 31, 2014 as compared to $242,000 for the three months ended March 31, 2013.  A substantial portion of Crexendo Network Services segment revenue is generated through thirty-six to sixty month service contracts.  As such, we believe growth in Crexendo Network Services segment will initially be seen through increases in our backlog. Backlog represents contracts signed with no service or payment provided at March 31, 2014 and 2013.

 
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Below is a table which displays the Crexendo Network Services segment revenue backlog as of January 1, 2014 and 2013, and March 31, 2014 and 2013, which we expect to recognize as revenue within the next thirty-six to sixty months (in thousands):

Crexendo Network Services backlog as of January 1, 2014
  $ 7,019  
Crexendo Network Services backlog as of March 31, 2014
  $ 7,152  
         
Crexendo Network Services backlog as of January 1, 2013
  $ 2,374  
Crexendo Network Services backlog as of March 31, 2013
  $ 3,451  
 
Cost of Revenue
 
Cost of revenue consists primarily of product cost and customer support department salaries of our hosted telecommunication services and bandwidth.  Cost of revenue increased 48% or $215,000, to $663,000 for the three months ended March 31, 2014 as compared to $448,000 for the three months ended March 31, 2013.  The increase in cost of revenue was primarily due to an increase in product cost of $78,000 and customer support costs of $86,000, as we continue to increase personnel to fulfill our increasing hosted telecommunications services orders, and an increase in bandwidth costs of $32,000.

Research and Development

Research and development expenses consist primarily of salaries and benefits which are attributable to the development of our hosted telecommunications products and features.  Research and development expenses decreased 16% or $46,000, to $245,000 for the three months ended March 31, 2014 as compared to $291,000 for the three months ended March 31, 2013.  The decrease was primarily due to changes in staffing which resulted in lower salaries and benefits for the engineering department.

Selling and Marketing
 
Selling and marketing expenses consist primarily of salaries and benefits, as well as advertising expenses.  Selling and marketing expenses increased 18% or $96,000, to $618,000 for the three months ended March 31, 2014 as compared to $522,000 for the three months ended March 31, 2013.  The increase was due to a greater percentage of selling and marketing costs allocated to the network services segment as bookings increased.
 
General and Administrative

General and administrative expenses consist primarily of payroll and related expenses for executives and administrative personnel, legal services, rent, accounting and other professional services, and other general corporate expenses.  General and administrative expenses increased 162% or $579,000, to $937,000 for the three months ended March 31, 2014 as compared to $358,000 for the three months ended March 31, 2013.  The increase in general and administrative expenses for the three months ended March 31, 2014 was primarily due to more of an allocation of corporate general and administrative expenses due to the 148% increase in revenue in this segment for the three months ended March 31, 2014 compared to the three months ended March 31, 2013.
 
 
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Operating Results of Crexendo Web Services segment (in thousands):

   
Three Months Ended March 31,
 
   
2014
   
2013
 
Crexendo Web Services
           
Revenue
  $ 252     $ 533  
Operating Expenses:
               
Cost of revenue
    202       389  
Selling and marketing
    32       374  
General and administrative
    244       399  
Operating loss
    (226 )     (629 )
Other income
    6       3  
Loss before taxes
  $ (220 )   $ (626 )
 
Three months ended March 31, 2014 compared to three months ended March 31, 2013
 
Revenue
 
Crexendo Web Services segment revenue decreased 53% or $281,000, to $252,000 for the three months ended March 31, 2014 as compared to $533,000 for the three months ended March 31, 2013.  The decrease in revenue is primarily related to our shift in focus to only providing web services to enterprise-sized customers.  We expect web services revenue to decrease as we complete existing contractual obligations.  Revenue from Crexendo Web Services segment is generated primarily through on-page and off-page Search Engine Optimization (“SEO”) services, search engine management services, conversion rate optimization services, and website design and development services.  A substantial portion of Crexendo Web Services segment’s revenue is generated through three to twelve-month service contracts.

Below is a table which displays the Crexendo Web Services segment revenue backlog as of January 1, 2014 and 2013, and March 31, 2014 and 2013, which is expected to be recognized as revenue within the next twelve months (in thousands):

Crexendo Web Services backlog as of January 1, 2014
  $ 553  
Crexendo Web Services backlog as of March 31, 2014
  $ 208  
         
Crexendo Web Services backlog as of January 1, 2013
  $ 1,135  
Crexendo Web Services backlog as of March 31, 2013
  $ 1,329  
 
Cost of Revenue
 
Cost of revenue consists primarily of salaries and related expenses related to fulfillment of our web services.  Cost of revenue decreased 48% or $187,000, to $202,000 for the three months ended March 31, 2014 as compared to $389,000 for the three months ended March 31, 2013. The decrease is primarily related to the reduction in employee salaries and benefits associated with the fulfillment of service for the Crexendo Web Services segment.  
 
Selling and Marketing
 
Selling and marketing expenses consist primarily of salaries and benefits, as well as advertising expenses.  Selling and marketing expense decreased 91% or $342,000, to $32,000 for the three months ended March 31, 2014 as compared to $374,000 for the three months ended March 31, 2013.  This decrease was primarily attributable to the decrease in allocated salaries and benefits based on reduced bookings.  Additionally, our direct sales representatives have been reduced from 18 at March 31, 2013 to 9 at March 31, 2014.
 
 
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General and Administrative
 
General and administrative expenses consist of salaries and related expenses for executives and administrative personnel, legal services, rent, accounting and other professional services, and other general corporate expenses.  General and administrative expenses decreased 39% or $155,000, to $244,000 for the three months ended March 31, 2014 as compared to $399,000 for the three months ended March 31, 2013.  The decrease in general and administrative expenses is primarily due to less of an allocation of corporate general and administrative expenses due to the 53% reduction in revenue for the three months ended March 31, 2014 compared to the three months ended March 31, 2013, and a company-wide reduction in general and administrative expenses as we continue to cut unnecessary expenses.

Operating Results of StoresOnline (in thousands):

   
Three Months Ended March 31,
 
   
2014
   
2013
 
StoresOnline
           
Revenue
  $ 865     $ 2,104  
Operating expenses:
               
Cost of revenue
    65       205  
Research and development
    169       190  
Selling and marketing
    3       12  
General and administrative
    569       681  
Operating income
    59       1,016  
Other income
    51       206  
Income before taxes
  $ 110     $ 1,222  
                 
                 
 
Three months ended March 31, 2014 compared to three months ended March 31, 2013
 
Revenue

StoresOnline segment revenue decreased 59% or $1,239,000, to $865,000 for the three months ended March 31, 2014 as compared to $2,104,000 for the three months ended March 31, 2013.

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, and through hosting revenue.  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 77% or $1,075,000, to $320,000 for the three months ended March 31, 2014 as compared to $1,395,000 for the three months ended March 31, 2013.  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 March 31, 2014 and 2013 (in thousands):

StoresOnline deferred revenue as of January 1, 2014
  $ 545  
Cash collected on principal of EPTA contracts
    (320 )
Adjustments of EPTA deferred revenue
    149  
StoresOnline deferred revenue as of March 31, 2014
  $ 374  
         
StoresOnline deferred revenue as of January 1, 2013
  $ 3,173  
Cash collected on principal of EPTA contracts
    (1,395 )
Adjustments of EPTA deferred revenue
    2  
StoresOnline deferred revenue as of March 31, 2013
  $ 1,780  
 
 
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Hosting revenue decreased 27% or $134,000, to $505,000 for the three months ended March 31, 2014 as compared to $639,000 for the three months ended March 31, 2013.  The decrease in hosting revenue was primarily due to attrition in the StoresOnline customer base since July 2011, as a result of the suspension of the direct mail seminar sales channel.
 
 Cost of Revenue

Cost of revenue consists primarily of credit card fees and customer support costs. Cost of revenue decreased 68% or $140,000, to $65,000 for the three months ended March 31, 2014 as compared to $205,000 for the three months ended March 31, 2013.   The decrease in cost of revenue was primarily due to a reduction in fees as the number of processed transactions decreases.

Research and Development

Research and development expenses consist primarily of salaries and benefits which are attributable to the maintenance and development of our StoresOnline products.  Research and development expenses decreased 11% or $21,000, to $169,000 for the three months ended March 31, 2014 as compared to $190,000 for the three months ended March 31, 2013. The decrease was primarily due to changes in staffing which resulted in lower salaries and benefits for the engineering department.

Selling and Marketing

Selling and marketing expenses consist of salaries and related expenses for sales and marketing activities associated with our inside sales group. Selling and marketing expenses decreased 75% or $9,000, to $3,000 for the three months ended March 31, 2014 as compared to $12,000 for the three months ended March 31, 2013.   

General and Administrative
 
General and administrative expenses consist of salaries and related expenses for executives and administrative personnel, legal services, rent, accounting and other professional services, finance company service fees, and other general corporate expenses. General and administrative expenses decreased 16% or $112,000, to $569,000 for the three months ended March 31, 2014 as compared to $681,000 for the three months ended March 31, 2013.  The decrease in general and administrative expenses is primarily due to less of an allocation of corporate general and administrative expenses due to the 59% reduction in revenue for the three months ended March 31, 2014 compared to the three months ended March 31, 2013, and a company-wide reduction in general and administrative expenses as we continue to cut unnecessary expenses.

Other Income
 
Other income primarily relates to interest earned on EPTAs, which generally carry an 18% simple interest rate.  Other income decreased 75% or $155,000, to $51,000 for the three months ended March 31, 2014 as compared to $206,000 for the three months ended March 31, 2013.  The decrease primarily relates to the decrease in the outstanding EPTA balance to $374,000 as of March 31, 2014 compared to $1,780,000 at March 31, 2013.

 
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Liquidity and Capital Resources
 
In July 2011, we announced the suspension of our direct mail seminar sales channel in our StoresOnline segment. Accordingly, the Company has transformed into a start-up telecom company with the inherent risks and uncertainties of funding operations until profitability is achieved. We currently plan to fund our operations during the next twelve months using our cash and cash equivalents of $3.8 million, and the collection of the remaining $374,000 of accounts receivable from our former StoresOnline business. However, in the event that any factors impacting future cash flows fall below management's expectations, the Company would be required to obtain additional debt or equity financing such as that available from its CEO to sustain operations.  The Company received a commitment from the CEO, and major shareholder, in February of 2014 that the CEO would provide the necessary level of financial support to enable the Company to pay its debts as they become due through March 31, 2015.  Accordingly the Company believes it will have sufficient funds to sustain its operations during the next twelve months as a result of the sources of funding detailed above.
 
Working Capital
 
Working capital increased 40% or $1,140,000, to $3,989,000 as of March 31, 2014 as compared to $2,849,000 for the year ended December 31, 2013.  Working capital, excluding deferred revenue, increased 20% or $826,000, to $4,874,000 as of March 31, 2014 as compared to $4,048,000 as of December 31, 2013. Deferred revenue balances represent historical contract sales for which we cannot immediately recognize revenue. We currently anticipate that the costs and expenses we will incur as these deferred revenue amounts are recognized as revenue will be insignificant. Consequently, we do not consider deferred revenue to be a factor that impacts our future cash requirements. The increase in working capital excluding deferred revenue is primarily attributable to the infusion of cash related to the sale of the corporate office facility for $2.0 million, and the prepayment of rent on the corporate headquarters with common stock (Note 10).
 
Cash and Cash Equivalents
 
Cash and cash equivalents increased 24% or $749,000, to $3,825,000 at March 31, 2014 as compared to $3,076,000 as of December 31, 2013. During the three months ended March 31, 2014, we used $1,278,000 in cash for operating activities, investing activities provided $2,004,000 from the sale-leaseback of our corporate office facility, and financing activities provided $23,000 from stock option exercises.
 
Trade Receivables
 
Current and long-term trade receivables, net of allowance for doubtful accounts, decreased 30% or $359,000, to $847,000 at March 31, 2014 as compared to $1,206,000 at December 31, 2013. Long-term trade receivables, net of allowance for doubtful accounts, decreased 16% or $19,000, to $97,000 at March 31, 2014 as compared to $116,000 at December 31, 2013. We offer our customers a contract with payment terms between 24 and 36 months, as one of several payment options. The payments that become due more than 12 months after the end of the fiscal period are classified as long-term trade receivables.  The decrease in our accounts receivable balance at March 31, 2014 is primarily related to cash collections of EPTA agreements of $320,000.
 
Accounts Payable
 
Accounts payable decreased 60% or $121,000, to $80,000 at March 31, 2014 as compared to $201,000 at December 31, 2013.  Our accounts payable as of March 31, 2014 were generally within our vendors’ terms of payment.
 
Capital
 
Total stockholders’ equity decreased 7% or $459,000, to $6,242,000 at March 31, 2014 as compared to $6,701,000 at December 31, 2013. The significant changes in stockholders’ equity during the three months ended March 31, 2014 included an increase of additional paid-in capital of $164,000 for options granted, $43,000 in proceeds from stock option exercises, and $966,000 for issuance of common stock related to the prepayment of rent on the corporate headquarters (Note 10).  Offsetting these additions was a net loss of $1,632,000 for the three month period ending March 31, 2014.
 
Off Balance Sheet Arrangements
 
As of March 31, 2014, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
 
 
27

 
 
Impact of Recent Accounting Pronouncements
 
Not Applicable
 
Forward-Looking Statements and Factors That May Affect Future Results and Financial Condition
 
With the exception of historical facts, the statements contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which reflect our current expectations and beliefs regarding our future results of operations, performance and achievements. These statements are subject to risks and uncertainties and are based upon assumptions and beliefs that may or may not materialize. These forward-looking statements include, but are not limited to, statements concerning:
 
 
our belief that our target market will increasingly look to Internet solutions providers who leverage industry and customer practices, increase predictability of success of their Internet initiatives and decrease implementation risks by providing low-cost, scalable solutions with minimal lead time;
 
 
our belief that we can compete successfully by relying on our infrastructure and marketing strategies as well as techniques, systems and procedures, and by adding additional products and services in the future;
 
 
our belief that we can continue our success by periodic review and revision of our methods of doing business and by continuing our expansion into domestic and international markets;
 
 
our belief that a key component of our success comes from a number of new, recently developed proprietary technologies and that these technologies and advances distinguish our services and products from our competitors and further help to substantially reduce our operating costs and expenses;
 
 
our contention that we do not offer our customers a “business opportunity” or a “franchise” as those terms are defined in applicable statutes of the states in which we operate;
 
 
our belief that there is a large, fragmented and under-served population of small businesses and entrepreneurs searching for professional services firms that offer business-to-consumer e-commerce solutions coupled with support and continuing education;
 
 
our expectation that our offering of products and services will evolve as some products are replaced by new and enhanced products intended to help our customers achieve success with their Internet-related businesses; and
 
 
our expectation that the costs and expenses we incur will be insignificant as deferred revenue amounts are recognized as product and other revenues when cash is collected.
 
We caution readers that our operating results are subject to various risks and uncertainties that could cause our actual results and outcomes to differ materially from those discussed or anticipated, including changes in economic conditions and internet technologies, interest rate fluctuations, and the factors set forth in the section entitled, “Risk Factors,” under Part I, Item 1A of the 2013 Form 10-K. We also advise readers not to place any undue reliance on the forward-looking statements contained in this Form 10-Q, which reflect our beliefs and expectations only as of the date of this Report. We assume no obligation to update or revise these forward-looking statements to reflect new events or circumstances or any changes in our beliefs or expectations, other than as required by law.
 
Item 3.   Quantitative and Qualitative Disclosures about Market Risk
 
Not required
 
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 March 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
28

 
 
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 2013 Form 10-K.
 
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
 
None
 
Item 6.   Exhibits
 
Exhibits
 
 
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
 
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
 
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
 
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.
     
     
May 6, 2014
By:
/s/ Steven G. Mihaylo
   
Steven G. Mihaylo
Chief Executive Officer

 
May 6, 2014
By:
/s/ Ronald Vincent
   
Ronald Vincent
Chief Financial Officer

 
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