Crexendo, Inc. Q2 FY2021 Earnings Call

Good day, ladies and gentlemen and welcome to the Crexendo’s Second Quarter 2021 Earnings Conference Call. At this time, it is my pleasure to turn the floor over to your host, Mr. Steve Mihaylo, Crexendo’s Chairman and CEO. Sir, the floor is yours.

Thank you, Jess. Good afternoon, everyone. I am Steve Mihaylo, Chairman and CEO of Crexendo. I want to welcome all of you to Crexendo’s second quarter 2021 conference call. On the call with me today are Doug Gaylor, our President and COO; Ron Vincent, our CFO; and Jeff Korn, our General Counsel. Also here today joining us for the first time is Anand Buch, our Chief Strategy Officer. I am going to ask Jeff to read our Safe Harbor statement. After that, I will give some brief comments. Ron will provide extra detail on the numbers, Doug will provide a business and sales update, and then we will open the call up to questions. Jeff, would you please read the Safe Harbor statement?

Yes. Thank you, Steve. I want to take this opportunity to remind listeners that this call will contain forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for such forward-looking statements. All statements made in this conference call, other than statements of historical facts, are forward-looking statements. Forward-looking statements include, but are not limited to words like believe, expect, anticipate, estimate, will and other similar statements of expectation identifying forward-looking statements. Investors should be aware that any forward-looking statements are based on assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from those discussed here today. The risk factors are explained in more detail in the company’s filings with the Securities and Exchange Commission, including the Form 10-K in the fiscal year ended December 31, 2020 and the Form 10-Qs as filed. Crexendo does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, further events or any circumstance. I would now like to turn the call back to Steve.

Thank you, Jeff. I am very excited to be joining you today from our San Diego office, where Doug, Ron, Jeff and I have been continuing ongoing meetings with the newly acquired NetSapiens team. I believe our meetings have been going extremely well. We are working together to make sure that the teams are integrated and to maximize the operational benefits from the acquisition of NetSapiens. Our mission is to maximize shareholder value while providing the best products and service to our Crexendo customers and the NetSapiens community. We are beginning to see substantial dividends from our joining with NetSapiens. We have introduced the best telecom offering in the business, the Crexendo VIP Cloud Platform. This platform is built using the best of Crexendo right to cloud technology, combined with the NetSapiens platform, which supports over 1.7 million end users globally. This offering is remarkable; we provide an uptime guarantee, which we believe is the first in the industry. We were recently awarded the TMC 2021 Communications Solutions Product of the Year. Our rollout of VIP is just the first of many benefits from integrating these two companies together. We are beginning to see other advantages from the acquisition as well. The Crexendo engineers who specialize in telecom have been working closely with the NetSapiens team to continue to enhance NetSapiens as the best communications platform in the industry. We want to ensure that the institutional knowledge of both companies benefits all our shareholders, customers, and employees. The synergies and integration do not end with VIP. Our engineers working together will start to realize cost savings by moving Crexendo customers to the NetSapiens platform. Investing in one platform will be a significant benefit to our shareholders, customers, and employees. We are integrating other processes too. We have merged the legal and accounting teams, and we will be integrating HR soon. Additionally, we are upgrading our accounting to a single billing platform. We are also joining marketing efforts and noting considerable cross-functionality between our teams, which will enable us to reduce new hiring. There will be more cost savings as we continue this process. I am thrilled with our quarterly results. We increased our quarterly revenue by 43% year-over-year. This is impressive, especially considering it included only one month of NetSapiens revenue. In addition, our telecommunications service revenue increased 20% year-over-year, which shows we are making great progress. I will be disappointed if we do not maintain year-over-year growth of at least 50% with non-GAAP profit. We expect a GAAP loss for the first half of 2021 due to the investments we made in the business, the cost of acquisition, and intangible asset amortization. The loss was not surprising. Going forward, GAAP results will not be used to internally measure the business due to the substantial intangible asset amortization expense that will continue for probably the next couple of years. We will monitor cash flow from operations, non-GAAP income, EBITDA and adjusted EBITDA as key performance indicators. I am confident that those numbers will improve, impress our shareholders, and enable us to grow from internally generated cash. I have high expectations for growth at both NetSapiens and Crexendo telecom. I expect that within a couple of months, we will be announcing that NetSapiens has grown to 2 million end users. This will also encourage growth in Crexendo services and the new VIP platform expansion. Our results are very promising. The integration of these two companies is very promising, and I am very excited about the future. With that, I will turn the call over to Ron Vincent, who will provide more details on the numbers.

Thank you, Steve. Good afternoon, everyone. Before I discuss the quarter's details, I want to point out that we have reorganized our segment reporting as a result of the NetSapiens acquisition. Going forward, we will report two operating segments: Cloud Telecommunications Services, and Software Solutions. The new Software Solutions segment includes operations from our NetSapiens subsidiary. For the second quarter of 2020, our Cloud Telecommunications Services segment service revenue increased 20% as Steve mentioned, to $4.3 million, compared to $3.6 million reported for the same quarter last year. Our Software Solutions segment revenue was $1 million for the second quarter, reflecting NetSapiens revenue from the acquisition date of June 1, resulting in one month of revenue for the quarter. Product revenue for the second quarter was basically flat, with a 2% decrease of $9,000 to $440,000 compared to $449,000 for the second quarter of the prior year. Our consolidated total revenue for the second quarter increased 43%, reaching $5.8 million compared to $4.1 million for the second quarter of the prior year. Second quarter gross margins were as follows: Telecommunications Services segment had a service revenue gross margin of 69%. Our Software Solutions segment had a gross margin of 48% for June, and product revenue had a gross margin of 35% for the quarter. Consolidated operating expenses for the second quarter of 2021 increased by $3.5 million or 99% to $7 million, compared to $3.5 million for the second quarter of the prior year. During the second quarter, acquisition-related expenses accounted for $377,000 of additional general and administrative expenses. Acquisitions contributed an additional $2 million in operating expenses. Our net loss for the second quarter was $1,003,000 or $0.05 per basic and diluted common share, compared to net income of $508,000 or $0.03 per basic and diluted common share for the same quarter last year. Non-GAAP net income for the second quarter was $37,000 or breakeven for basic and diluted common shares, versus $660,000 or $0.04 per basic and diluted common share for the same period last year. EBITDA for the second quarter was a loss of $983,000, compared to earnings of $568,000 for the same period last year. Adjusted EBITDA for the second quarter was a loss of $153,000 versus recorded earnings of $704,000 for the same period in the prior year. Now, let me highlight results for the six months ended June 30. For the six-month period, our consolidated revenue increased 30% to $10.3 million compared to $7.9 million for the same period last year. The Telecommunications Services segment service revenue for the six-month period increased 19% or $1.4 million to $8.5 million compared to $7.1 million last year. The Software Solutions segment revenue was $1 million for the six-month period, beginning from the acquisition date of June 1. Product revenue for the six-month period decreased 2% to $808,000 compared to the $828,000 for the same period last year. Our consolidated operating expenses for the six-month period increased 71% to $12.4 million compared to $7.2 million last year. During this period, acquisition-related expenses accounted for $1.1 million of additional general and administrative expenses, while acquisitions contributed $2.4 million in additional operating expenses. Our net loss for the six-month period was $1.7 million or $0.09 per basic and diluted common share, compared to $648,000 in net income and $0.04 per basic and diluted common share for the same period last year. Non-GAAP net income for the six-month period was $345,000 or $0.03 per basic and diluted common share, compared to $935,000 or $0.06 per basic and diluted common share for the same period last year. Our EBITDA for the six-month period was a loss of $1.7 million, while adjusted EBITDA for this period reported earnings of $92,000 compared to $1.1 million for the same period last year. Our cash, cash equivalents, and restricted cash balance at June 30, 2021, was $7.9 million compared to $17.7 million at December 31, 2020. Operating activities utilized $224,000 of our cash and cash equivalents during this six-month period. Investing activities utilized $10.5 million of cash, primarily related to the cash outlay for the Centric Telecom and NetSapiens business combinations. Financing activities provided $966,000 of cash, primarily from stock option exercises. With that, I will pass it on to Doug Gaylor, our President and COO, for additional comments on sales and operations.

Thanks, Ron. We had a significant increase in revenue of 43% year-over-year during Q2, which included one month of NetSapiens revenue as we closed on that acquisition on June 1. In addition to the $1 million in revenue that NetSapiens had for the quarter, we are pleased that our traditional UCaaS revenue grew by 20% during the quarter. It was a busy quarter for us as we not only completed our game-changing acquisition but also released our new Crexendo VIP platform, recognized by TMC as its Communication Solutions Product of the Year. The demand for 'work from anywhere' systems helped increase our UCaaS revenues by 20% for the quarter. UCaaS technology and collaboration tools remain in high demand, and Frost & Sullivan's recent industry reports estimate that 60% of the U.S. business market has yet to migrate to the cloud for their communications. Additionally, this report highlighted the Crexendo NetSapiens division platform as the fastest-growing UCaaS platform in America with a rapidly growing 1.7 million end users. This platform, combined with our talented engineering, sales, and support teams, made the acquisition a perfect fit for Crexendo. Our first major initiative from the acquisition was launching the Crexendo VIP platform, which utilizes the NetSapiens system as its foundation. Our customers can expect an all-inclusive system with video collaboration, mobility, text messaging, call center capabilities, and smartphones, combined with the award-winning Crexendo telephone sets for an ultimate UCaaS offering. There is high demand for UCaaS providers looking for their own platforms or migrating from existing platforms. NetSapiens experienced a 30% revenue increase in 2020, and we continue to see strong demand. As Steve mentioned, we expect to soon announce over 2 million users on the NetSapiens platform. Our unique pricing model differentiates us from our two largest competitors, Cisco’s BroadSoft and Microsoft’s Metaswitch offerings. We have a favorable pricing model, combined with a tremendous suite of features and capabilities. It is not surprising that the platform was recently recognized as the 2021 Internet Telephony Product of the Year, as well as the 2021 TMC.net Remote Worker Pioneer award. We are diligently integrating the two organizations to start recognizing the operational benefits and synergies of the combined company. Both teams possess exceptional engineering talent and are already benefiting from best practices, and we've seen immediate synergies from consolidating our marketing efforts. Our sales teams are gaining from the exceptional industry knowledge and experience both organizations bring to the table. We are consolidating our accounting systems and personnel, and our operations and customer service departments are executing our plans to maximize efficiencies, productivity, and cost. I am very pleased with how the first two months of the combined organizations have progressed and I am excited about our forward plans. As Steve highlighted, due to acquisition costs, we expect GAAP losses for the quarter, but I am pleased to report a slight non-GAAP earnings for the quarter. We remain diligent on cost management, focusing on leveraging our larger organization’s buying power, as well as the consolidation of overlapping costs as we continue to grow. Our UCaaS service gross margin decreased slightly to 69% due to the introduction of our new VIP platform offering. We believe cost synergies will continue to improve as we consolidate onto one platform. Our Crexendo partners and the NetSapiens community are excited about our combined organization. I had the pleasure of meeting several NetSapiens partners at the IP Expo Show in Miami at the end of June, and they are very optimistic about the merger and combining resources to enhance the platform. Similarly, the Crexendo partner community is excited about the new VIP platform powered by NetSapiens, combined with our 100% uptime guarantee and lifetime warranty on Crexendo phone devices, increasing our funnel of opportunities and partner engagement. As we enter the second half of 2021, I am thrilled about the future direction and opportunities for Crexendo. In just 13 months, we've uplisted to the NASDAQ, had a successful S-1 offering, and made a significant acquisition that positions us strongly for growth. We are committed to delivering the best UCaaS offering in the industry to our customers and partners while providing the best return for our shareholders. We are confident that combining our organizations will make us a major force in the industry and fuel our continued growth. I will now turn it back over to Steve for any further comments.

Thank you, Doug, and thank you everyone for tuning in today. Jess, we would like to open it up to questions from anyone here. If they have the answer, if we don’t, we will let you know. Jess?

Thank you, Mr. Mihaylo. We will take our first question from Josh Nichols at B. Riley. Your line is open, sir. Please go ahead.

Good afternoon, Josh.

Hey, how is it going, Steve? Hope everything is going well. I know a lot of work went into getting this deal done. So, good to see everything moving in the right direction. I wanted to start with a higher-level question since you mentioned the awards and notoriety that the Crexendo VIP Communications Platform has already received. There are many UCaaS providers in the space, but how is the Crexendo VIP Cloud Communications Platform different in how it targets the market and what makes it a unique value-added offering?

I will let Doug answer that. Anyone else who wants to comment can do so. But obviously, TMC and Crexendo on NetSapiens thinks it’s the best.

Yes. Obviously, with the VIP platform, Josh, it’s really an evolution of where we were. UCaaS as an offering continues to expand and increase in capabilities. The rollout of our VIP platform underscores its features. VIP stands for Video, Interactions, and Phone. Today, UCaaS is much more about collaboration, interactions like text messaging and unified messaging, along with traditional telephone and video collaboration offerings. By bringing this offering to market, we provide a 100% uptime guarantee with our geo-redundant setup in multiple data centers, which is unique. We don’t know of anyone else offering that. We've also backed it with a lifetime guarantee on our Crexendo phone devices. The mobility applications, contact center applications, and inclusive offerings for all seat licenses make it quite unique. Jon Brinton has played an instrumental role in getting the product rolled out, so I will let him add any additional comments about the VIP platform.

I would add that we aim to make it consumable for partners to sell and customers to understand. It offers a basic mix and match seat type with good, better, best options, along with add-ons for contact center agents and supervisors. Collectively, this makes the VIP platform a winning formula.

Does that answer your question, Josh?

Yes, thank you. I also read and heard in your comments that you made additional investments in sales and marketing. Where are you investing some extra capital to accelerate growth?

This is a moving target, but I think Jon is best qualified to give you an answer.

We have been expanding our presence in the agent channel, adding a couple of new master agents in the last quarter. Also, we've made investments into demand generation to create opportunities for our direct sales teams. Additionally, we've improved our sales and marketing tools to provide better business intelligence, proposal management, etc., streamlining our sales process to meet the demands of the current market.

This is a moving target. I have told the team here that the two most important metrics are growth and at least GAAP breakeven with non-GAAP profitability. Keep in mind there is approximately $2 million from this transaction, with about $1.8 or $2 million in amortization impacting the bottom line. While we expect some dilution from future acquisitions, we aim to minimize it and focus on accretion. We do plan to cover future acquisitions with a blend of stock, seller financing, and debt; we want to avoid diluting our existing shareholders.

I appreciate you clarifying that. My last question: While the integration is underway, I know you're aiming to move Crexendo customers to the NetSapiens platform. How soon do you anticipate that and any potential upside for gross margin as that transition occurs?

That process is high on our priority list. Running one platform is far more efficient than two. We anticipate it could take up to 12 months, but the process is already underway and running smoothly. We have begun migrating customers and we plan to keep this process efficient. The benefits will be seen in gross margin improvements once we have just one operating platform.

Has that answered your question, Josh?

Yes, thank you. I appreciate it.

Alright. Jess, do you have another question?

Thank you. We will go next to Andrew King at Colliers Securities. Andrew, your line is open. Please go ahead.

Good afternoon.

Hey, guys. Thanks for taking the question. Really good quarter here. To drill into the gross margins a little bit: Last quarter, you guys announced a small acquisition and had some pressure on your gross margins due to some additional costs. How do you look at gross margins, and how much of an impact did this have on the Crexendo gross margins?

Well, right now, we are acutely aware of gross margins. We are under pressure, and I’ll let Ron give you some insights.

Due to some downward pressure, gross margins are currently all over the place. We still have exposure with customers on the $4 platform. During the quarter, we initiated the migration plan and expect to complete the majority by the end of Q3. As we migrate customers, we anticipate improvements in gross margins.

Just to interject, we remain committed to monitoring our gross margins closely.

Do you have additional questions around this, Andrew?

Just one more: Obviously, you have been focused on achieving both GAAP and non-GAAP profitability. How do you plan to balance increasing operating expenses to drive growth versus returning to profitability?

I personally realize we must compensate employees differently. We are keen on growth, non-GAAP profit, and GAAP breakeven, so we are open to thoughtfully managing our expenses.

For the upcoming two quarters, our focus will be on integrating the NetSapiens acquisition and identifying synergies through excluding duplicate services and processes. As we identify those, we’ll recognize cost savings that will help return us to a more normal rate of expenses. We will still monitor our spending closely.

Our Board and the rest of the team echo this approach.

During the quarter, there was mention of the BCM One acquisition. Can you talk about how that affects the competitive environment, especially concerning NetSapiens?

I’ll turn this question over to Doug.

Yes, SkySwitch is our largest NetSapiens partner. BCM One's acquisition creates opportunities for growth. We met with both BCM One and SkySwitch folks at an expo recently, and they feel optimistic about their growth and how we fit into that.

This showcases our partners' commitment to surpassing growth while reflecting the integral role we play in the community.

Great, thanks for taking my questions and congratulations on a strong quarter and welcome to the team, Anand.

Thank you. Thanks, Andrew.

Thanks, Andrew.

Jess?

We will take our next question from Michael Kaufman, MK Investments.

Good afternoon, Michael.

Hi, Steve. I applaud the integration of NetSapiens and the financial prudence you’ve maintained regarding growth with profitability. I appreciated the insights into expanding the customer base; could you detail what you are doing to expand the investor base and tell the new Crexendo story?

We always prioritize communicating with investors, and I've handed over that responsibility to Doug Gaylor. He can provide further details.

Attracting the investment community is critical. We have two analysts following us, and we’re working on getting additional coverage. We will present at upcoming conferences, including the SNN Network Virtual Summit on August 18 and the Collier Virtual Investor Conference on September 9. We're also actively reaching out to investors and aim to continue increasing our following, as evidenced by today's record conference call participants.

We focus keenly on our balance sheet and P&L, including investor interests.

What’s the current headcount with the company now that you’ve merged?

I focus on productivity. Our target productivity is north of $300,000. We have around 100 people in the right position for the current operation size. I prefer discussing productivity metrics rather than exact headcount figures, but I can say we are working towards enhancing productivity.

That was a very satisfying answer. Best of luck to you all. What are your thoughts on the current headcount?

Thank you, Michael. Do we have another question, Jess?

We will take our next question from Charles Ronson at Amato and Partners.

Good afternoon, Charles.

Thank you very much. Congratulations on a super quarter. I wanted to ask two questions. Concerning revenue projections beyond this quarter, you’ve hinted at revenue growth, but could you elaborate on your ongoing acquisition strategy?

While I set a target for 50% growth over the next year or two, I cannot divulge specifics about potential acquisitions, as I discussed headcount and productivity, which may guide you in your expectations.

Regarding acquisitions, we are currently focused on integrating the existing merger with NetSapiens. However, we are always on the lookout for new opportunities that align with our strategic goals.

There are many partners from the NetSapiens acquisition that will eventually seek exits. We are carefully analyzing all the opportunities. As our company grows, so too will our acquisition options and partnerships.

Understood. Thank you.

Thank you. Do we have any more questions?

Hi, guys. Congratulations on the excellent quarter. I have a few questions about NetSapiens. Are you targeting any new customers now that you have largely consolidated into one platform?

I'll let Doug answer that; he may pass it to Anand or Jon.

As we continue to grow the NetSapiens partner community, we are targeting larger opportunities. Our integration provides more leverage for both of us in that space. Our financial stability and growth will encourage larger clients to migrate from competitors, such as Cisco or Microsoft, to our platform.

The integration increases our ability to scale and target more substantial customers, fostering growth in our service offerings.

Are you able to provide an updated backlog status?

The backlog has stayed flat year-over-year primarily due to the recent acquisition not being included. However, we are updating those tables in Q3 and expect a significant increase.

As mentioned before, we are actively working on this.

Regarding cloud migration, how much potential remains in the industry for your business, and how has acquiring NetSapiens affected that?

While I can't give a precise answer, I anticipate that in 3-4 years, most of the market will have migrated to the cloud. We are committed to providing exceptional service to entice end users from competitors. Doug, do you want to add?

Currently, 61% of businesses in the U.S. have yet to migrate to cloud communications. The pandemic accelerated this trend but many companies are still awaiting a stable environment for this transition. The demand remains high, and our offerings are ideally positioned to capture those moving towards the cloud.

As Doug stated, we expect steady growth opportunities as the market continues its shift.

Thank you! That answers my questions.

Thank you to everyone else. Is there anyone else, Jess?

We will take our next question from Damon Tanabe, a private investor. Your line is open.

Good afternoon, Damon.

Congratulations on the positive results. What is your strategy to compete with Zoom Phone, especially after their acquisition of 59?

The VIP platform includes video services that complements our offering. Doug?

We offer a strong solution. Zoom's recent activity demonstrates their commitment to entering our field with higher-end call center applications. However, we have a solid product for the SMB market, and with our integration of NetSapiens, we are confident in our position.

Do you think the Frost & Sullivan report includes Zoom when analyzing market penetration?

No, I don’t believe they included Zoom in their UCaaS market report at this time. They have acknowledged other competitors but haven’t yet categorized Zoom in that space.

Thank you for the insights. What are your thoughts on how Microsoft is performing in this sector?

The Microsoft Teams offering presents a great opportunity for us to integrate with. We have seen substantial uptake in Teams integration, as many users seek flexibility beyond what Microsoft provides. Our VIP platform aims to complement Teams offerings well.

We aim to provide tools so partners can effectively compete against bigger players. Our agility allows us to target profitable sub-segments without the constraints faced by larger conglomerates.

With APIs, all we need to do is integrate with any competitor’s platform.

Thank you for clarifying. Is there anyone else, Jess?

I do not have further questions at this time.

Thank you all for joining today. We look forward to discussing the third quarter with you in early November. Thank you, everyone.

Thank you, we appreciate it.

Ladies and gentlemen, that will conclude today’s conference. We thank you for your participation. You may disconnect at this time and have a great day.