Crexendo, Inc. Q1 FY2023 Earnings Call

Greetings. Welcome to the Crexendo First Quarter 2023 Earnings Conference Call. Please note that this conference is being recorded. I will now turn the conference over to your host, Jeff Korn. You may begin.

Thank you, Mike. Good afternoon, everyone, and welcome to the Crexendo Q1 2023 Conference Call. On the call with me today are Doug Gaylor, our President and COO; Ron Vincent, our CFO; Jon Brinton, our CRO; and Anand Buch, our CSO. Also joining us today is Steve Mihaylo, our Chairman of the Board. I'm very grateful that Steve came here to show his support for me and the team on our first call going solo. So what I'm going to do is ask Luke to go ahead and read the safe harbor statement. After that, I'll give some brief comments, Ron will provide more detail on the numbers, and Doug will provide a business update after that, and then I'll open up the call for questions. So Luke, would you please read the safe harbor?

Thanks, Jeff. Before we begin, we would like to remind everyone that our prepared remarks contain forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for such forward-looking statements. The words believe, expect, anticipate, estimate, will and other similar statements of expectation identify forward-looking statements. Specific forward-looking statements in this conference call include information about Crexendo believing the top line performance in the first quarter was the result of continued execution from our legacy business as well as recent acquisitions, maintaining focus on successfully integrating the acquired companies and leading new initiatives designed to drive greater organic growth and bottom-line results for our combined organization, continuing to make great strides in improving the operational efficiency of the business and building a lean infrastructure capable of supporting growth, increasing both the quality and quantity of offerings, supporting expanded sales efforts to drive additional revenues through new sales to new customers and add-on sales to existing customers, prioritizing the profitability of the business and cutting expenses where necessary to maintain a strong financial footing and looking forward to building on the momentum and further cementing its position as a leading provider in the UCaaS industry. For a more detailed discussion of risk factors that may affect Crexendo's operations and results, please refer to the company's Form 10-K for the year ended December 31, 2022, and quarterly Form 10-Qs as filed with the SEC. These forward-looking statements speak only as of the date on which such statements are made, and the company undertakes no obligation to update such forward-looking statements, except as required by law. I will now turn the call back over to our CEO, Jeff Korn.

Thank you, Luke. Overall, we are very pleased with our results for the quarter, particularly the top line, but we recognize that we need to increase our profitability and be more intentional with where we are allocating capital. I will speak more about this shortly. I tend to be a straight shooter, so I will discuss bluntly what we need to do better and what changes we're going to make. Our non-GAAP net income of $625,000 or $0.02 per basic and diluted common share, as well as our 53% increase in total revenue year-over-year, show that we are poised for substantial growth, but we are spending too much cash on items that do not directly drive increases in our top and bottom lines. With this in mind, I've imposed a hiring freeze with the exception for necessary replacements and have implemented widespread restrictions on discretionary spending for all departments. Thankfully, we grew the legacy business correctly and are not limited by mounting debt obligations and overstaffing. We, unlike many in our sector, grew strategically and carefully. In this position, we have flexibility with our long-term strategy, and we are able to run a lean and effective organization. Throughout the year, our primary focus has been and will continue to be on driving organic growth and integrating our acquisitions fully into the company. And we will continue to strategically expand while optimizing our operations in future quarters. Regarding profitability, we are still working through some of the lower-margin business that was inherited from the acquisition of Allegiant. This is natural as an MSP has more result services and thus varying margins. We also believe that we can expand the MSP to get more telecom business, which is an initiative that will be rolled out in a careful and meticulous manner. Allegiant has enjoyed a smooth integration into our business, and the team members have assimilated well. While there are some residual processes and logistical matters that we are still ironing out, we have been exceptionally impressed by the performance of the team members who have come on board. We are focused on integrating the acquisition into both our corporate and direct operations and expect to see significant financial and operational efficiencies over the next three quarters. We also are working on targeted cost realignment and reporting structure realignment to fully recognize the synergies in Allegiant and all the acquisitions across the board in all divisions. These initiatives are aimed at ensuring that we maximize the efficiency and operations of the business, which will ultimately result in a smaller cost basis. In terms of personnel, we now have a hybrid workforce, which has proven to be more productive in our digital-based line of work due to the decreased need for physical space. We are in the process of listing and selling our corporate office in Tempe, after which we will lease the space back before a year. As part of that process, we are moving all of the clients from two exceptional operating systems to VIP. This will provide substantial cost savings as there will no longer be a need to maintain two exceptional operating systems and allow us to continue ensuring that Crexendo, powered by NetSapiens Systems, remains the absolute best operating system on the market. All these actions are intended to make us a better company, increase efficiencies, and result in substantial cost savings. Organically, we are starting the process of integrating artificial intelligence into our work streams. The engineering team is already using AI to supplement our efforts, and we are working on additional AI systems in customer service and other functions. This will result in additional cost savings and improved customer experience. AI is also helpful in crafting marketing messages and expanding sales efforts, which will increase lead generation and free up more time for our team to sell. To wrap up my portion, I am very encouraged by our top-line results, but I remain focused on the material changes to the business that need to happen in order to improve our bottom line. We have set ourselves up for success. We are the right team with the right initiatives in place. I expect substantial long-term profitability. Our primary goal for the remainder of the year is to drive improvements in revenue, cash, and profitability. And I believe that we have built the proper foundation to do that. I am extremely excited about our future and remind the team every day that our obligation is to drive shareholder value. Thank you for your support and interest in Crexendo. And with that, I'll turn the call over to Ron for more details on the financials.

Thank you, Jeff. All right. Financial highlights for the quarter. Total revenue for the first quarter of 2023 increased 53% to $12.5 million compared to $8.2 million for the first quarter of the prior year. The Allegiant acquisition contributed $3.1 million of the increase in total revenue, and organic revenue of $1.2 million increase was 15% for the period-over-period comparison. Service revenue for the first quarter of 2023 increased 63% to $7.2 million compared to $4.4 million for the first quarter of the prior year. The Allegiant acquisition contributed $2.6 million of the increase in service revenue. Organic revenue service revenue increase of 4% or $184,000 for the period. Software Solutions revenue for the first quarter increased 26% to $4.1 million compared to $3.3 million for the first quarter of the prior year. And product revenue for the first quarter increased 149% or $1.2 million compared to $492,000 for the first quarter of the prior year. Allegiant contributed $526,000 of the increase in product revenue, while organic growth contributed 42%. First quarter gross margins, telecom service margin of 57%, excluding Allegiant, Q1 gross margin was 69% compared to 67% for the first quarter of the prior year. Software Solutions gross margin, 71%, product gross margin, 32%, and overall gross margin 59%. Operating expenses for the first quarter of 2023 increased 47% to $14.1 million compared to $9.6 million for the first quarter of the prior year. The Allegiant acquisition contributed $3.4 million of those additional operating expenses. The company reported a net loss of $1.6 million for the first quarter or $0.06 loss per basic and diluted common share. That's compared to a net loss of $1.2 million or a $0.05 loss per basic and diluted common share for the first quarter of the prior year. Non-GAAP net income was $625,000 for the quarter or $0.02 per basic and diluted common share as compared to non-GAAP net income of $405,000 or $0.02 per basic and diluted common share for the first quarter of the prior year. EBITDA for the first quarter was a loss of $666,000 compared to a loss of $774,000 in the first quarter of the prior year, but our adjusted EBITDA for the first quarter increased 749% to $749,000 compared to $302,000 for the first quarter of the prior year. Our cash, cash equivalents at March 31 were $3.7 million compared to $5.5 million at December 31, 2022. Cash used for operating activities for the three-month period of $1.6 million compared to $1.7 million used for the same period in the prior year. Cash used for investing activities for the three-month period of $9,000 compared to $34,000 used for the same period of the prior year. Cash used for financing activities for the three-month period of $203,000 compared to cash provided by investing activities of $3,000 for the same period of the prior year. That concludes the highlights. With that, I'll turn it over to Doug Gaylor, our President and COO, for additional comments on sales and operations.

Thanks, Ron. As shown by the results, we have started the year with impressive momentum, highlighted by significant organic growth in our core business. Our 53% year-over-year revenue increase was highlighted by our 26% organic growth in the Software Solutions segment, combined with greater-than-expected revenue contributions from our Allegiant acquisition, which saw a 17% organic growth from their Q1 2022 revenue numbers. The $12.5 million in revenue for the quarter, combined with our 11% increase in our backlog, which does not include Allegiant's backlog, gave us a solid foundation to build on for the remainder of the year. As a reminder, our backlog represents some of the remaining contract values for our telecom services and software solutions customers that will be recognized on a sliding scale over the next 36 to 60 months. We anticipate that the Allegiant backlog will be included in our Q2 report and will add significantly to our existing numbers. As Jeff mentioned, our revenue numbers were solid, but we remain focused on further optimizing synergies from our acquisitions as well as managing costs to continue to grow the business. We have identified substantial cost savings that we can recognize over the next three quarters and are executing on these initiatives as we speak. Against the backdrop of broader macroeconomic uncertainty, we continue to see strong demand and growth in the UCaaS industry. I believe that recessionary times actually benefit our industry as businesses look for ways to cut costs and improve efficiency and productivity, and that is exactly what our solutions offer. The widespread migration to the cloud for small, midsize, and enterprise-level businesses helped us eclipse 3 million users on our platform in the first quarter and has put us on target to double the 1.7 million end-users we had in June of 2021 by the end of Q2. This growth has been facilitated in part due to the strong sales bookings we continue to see from Crexendo licensees and agents. As our licensees grow, they also need additional services from Crexendo, which in turn drives organic software solutions and cross-selling opportunities. We added five new licensees for the quarter, which is on track with our internal expectations, and we anticipate a significant number of additional licensees that will come on board throughout the remainder of the year. Our Telecom Services segment also posted impressive results for the quarter, resulting in a record number of quarterly new customer installations driven by increased cloud adoption by end users. Our traditional Crexendo agent program continues to grow meaningfully as well. Our two large master agent partnerships with Talaris and OTG Consulting have strong performances for the quarter, and we also added Jenne Distributors as our newest master agent during the quarter. We continue to build our roster of partners, and we look forward to working with a growing number of companies as the program continues to scale. As Ron mentioned, our Telecom Services margins and product margins declined to 57% and 32%, respectively, for the quarter, which was driven by lower margins from Allegiant service revenue contributions. Allegiant offers additional managed and network services along with their UCaaS offering. Some of these services are lower margin but ultimately help in pulling in a much higher customer spend through a complete bundle of service offerings. Our Telecom Services margins without Allegiant's numbers increased from 68% to 69%. We expect the Telecom Services margins to quickly return to the 70% range as we continue to integrate the company and improve profitability on certain offerings. Our Software Solutions margins increased nicely to 71% for the quarter, fueled by a 26% organic growth rate. Because our technology stack is proprietary, we do not have the typical growth costs associated with increased usage and therefore expect to see these margins continue to improve as we add new logos and licensees. Our award-winning technology continues to be recognized as a leader in the space, being recognized in Q1 by G2, which is the premier business software and services review site as the leader in the 2023 spring VoIP report, along with us receiving multiple awards, including the Easiest to Do Business With, Best Usability, and Best Support awards. During Q1, we released our Insight Management Application for the Software Solutions platform and have had great reception from our licensees in terms of order numbers and performance reviews. Also on the technology front, we installed multiple instances of our newly released Contact Center as a Service or CCaaS offering during the quarter. Our CX offering, which stands for customer experience, provides omnichannel customer engagement for call centers, including text, e-mail, chatbots, and automations for larger call center applications. Our strong revenue growth, combined with the execution of our game plan and strategy, has helped set us apart and set us up for what we anticipate being a banner year for the company. We are committed to improving our margins and will continue managing the fundamentals of the business. We believe we have the best UCaaS offering in the industry, and that will continue to attract new customers and partners, allowing us to deliver strong returns for our shareholders. With our combination of the fastest-growing platform solution in the country, along with our growing licensee network and direct end-user offerings, we are positioned extremely well, and we'll keep executing against our strategic roadmap in the quarters to come.

Thank you, Doug, and thank you, Ron, for your comments and the additional information. At this point, I'm just ready to open the call up for questions.

And our first question comes from Eric Martinuzzi from Lake Street.

On the strong numbers there for Q1, so it's good to see that outperformance in a tough market. I wanted to dive into the Software Solutions, that 26% growth, it sounds like the 5 new licensees probably had something to do with that. But just wondering what sort of the form factor that the new licensees are coming aboard. Is that perpetual license? Or is that a subscription? How are people taking it?

Yes. So we're continuing to get a mix of perpetual license and subscription licensees. Both offers are very attractive. We also continue to have a mix of new licensees that choose to have us host the solution for them as well, which gives us additional revenue attachment based on actually delivering the product in our data centers that we control to them. So, if you look at the trend over time, it continues to be one of the two. And we're just excited because part of your question was about where they come from. No one generally starts their UCaaS journey with us. So almost all of them are coming from competitive platforms, both at the higher end and the lower end of the market, and we're very pleased to continue to have a good mix of new licensees join us.

And Eric, just to add to that, we also see a lot of upgrades coming from our existing licensees as well. If you think about the fact we now have over 220 licensees using our platform, as they continue to see growth in their organic business, they need to add more licenses with our platform, which, in turn, increases our revenue through the Software Solutions segment.

Okay. And I know you're not giving formal guidance, but just as we think about that business, historically, I would expect that to be up from Q1 to Q2. Is there anything that would break that trend for the Software Solutions business?

Yes. We do see some ups and downs when it comes to migrations and upgrades. When we think about our existing 220 licensees, we had some nice upgrades in Q1. So that's not a consistent cadence. Depending on how we see upgrades in Q2, we'll determine if that number continues to have that same percentage increase. But we're extremely positive that we'll continue to see strong increases in the Software Solutions segment. You may see a little choppiness just due to the fact that, as we discussed earlier, some of it may be subscriptions or may be perpetual, and there's no guarantees when we will see upgrades happening with our existing licensees.

Okay. And then the Allegiant business, that was strong. I think you said, what was it, 15%, 20%...

17% increase over what they did in Q1 of 2022.

Yes. So 17% growth. Was that in line with your expectations?

It was. They had some nice large opportunities that were in their funnel that came through to fruition during the quarter. So we're extremely excited about the pipeline of opportunities and the amount of opportunities that exist on the horizon for Allegiant. So a really strong right out of the gates first quarter with us is always a positive sign.

Okay. I understand we're focusing on managing costs, implementing a hiring freeze, and limiting discretionary spending. At what point did we decide on these measures? Are there any additional reductions in headcount planned?

I came to that conclusion looking at economic headwinds and my concern that there may be a deep recession. We're monitoring our receivables and how particularly our smaller customers are doing. We've not seen a huge concern thus far, but we have to manage in the event that there is a downturn. We have almost everything we need. So I've taken the wish list out of the budget and put in a freeze on expenses. We really have sufficient staff, especially when we complete the reorganization. We will have everybody in the right position, and I don't think there's a need for substantial hiring. We will replace essential positions. So it's not a complete hiring freeze, but we're just watching our dollars very, very carefully until our organic growth has improved, and we have some clarity on the economic front.

Last question for me. You finished out the quarter at $3.7 million in cash. What is the assumption on the cash we can expect from the headquarters sale-leaseback? Additionally, can you share any thoughts on where you anticipate finishing the year in terms of cash?

Yes. So the building sale, we're hoping to have that consummated. We've got a signed letter of intent going to contract this week. We anticipate that this should add upwards of about $2 million cash to the balance sheet. Ron, do you want to comment on where we think the...

Let me be more clear, it is a letter of intent. We're hoping it goes to contract. Obviously, there's no assurance of that. Now Ron, if you want to answer.

Yes. As far as the guidance on cash, I don't think that we're burning cash. If you look at our cash flow from operating activities for the quarter, it looks a little negative, but we paid down $1.1 million in payables during the quarter as well as had a slight increase of about $500,000 to $600,000 in our accounts receivable, which is attributed to the majority of that change and just the timing of payrolls; we had three payrolls in March. So just fluctuations in cash, but we're not concerned about continued cash burn.

So we're expecting positive cash from operations in 2023.

For the full year.

Yes. Okay. Congrats on the quarter.

Next, we have Josh Nichols from B. Riley Securities.

Yes, this is Kat speaking for Josh Nichols. My first question is, what are you observing regarding the acquisition integration? Also, what opportunities do you see for gross margin expansion?

I'll take the acquisition, and I'll let Ron or Doug discuss the second part of it. As I discussed during the call, we really have much of the NetSapiens acquisition completed. We are moving some people around because of Allegiant, as there were individuals who can work across all of the divisions of the company. It's going quite well. Everybody is rolling up their sleeves and working. As I said in my prepared remarks, we're working on a realignment plan. I'm not ready to discuss too much of that, but it should help us reduce our costs and make the company far more efficient, and I'm very, very encouraged by what we're working on and what I think the results will be.

Yes. And there's some strong synergies there, but we haven't recognized yet. But as contracts come up and as we can renegotiate existing agreements, we're doing that. So we anticipate some significant cost savings over the next few quarters. And as far as gross margins go, I mean, obviously, the gross margins came down. That was expected through the first quarter as we integrate Allegiant into the organization, but we anticipate getting those margins right back on track. If you look at the Software Solutions segment, those margins have increased nicely and will continue to increase because we own that technology stack. On the Telecom Services, if you look at the margin increase of 68% to 69% without the inclusion of the acquisition, that's heading in the right direction. We've been consistently at that 68% to 70% gross margin range on Telecom Services prior to the acquisition. Again, with the synergies of the acquisition, we're confident those margins will come up very rapidly.

Let me just add that the Allegiant margins will never be what the Software Solutions margins are or the pure telecom margins are simply because they involve a fair amount of resold services. But that is not a big concern to me because every time we act as an MSP it is a stickier customer. It is taking lower margin business to gain much higher margin business, and it makes it much more difficult for that customer to leave. So I'm not too concerned if margins go down slightly because we're making a customer that essentially is married to us. That will be something that affects it, which is why Ron and Doug broke out the margins separately for Allegiant and the others so you can see the difference. There will always be a slightly lower margin based upon the fact that they sell a lot of resold services.

Okay. Great. And then one other from me. Can you just talk a little bit more about what you're seeing in terms of adoption in foreign markets, maybe Australia in particular?

Yes. Let me just give a quick highlight, and then I'm going to turn it over to Anand Buch, to give you a little bit more. When we look at the international markets, we've talked in the past and in our investor presentations about the adoption of cloud communications in the states and outside of the States. If you look at the United States, the adoption numbers are about 45% to 55%, depending on the reports that you look at. So there's still the majority of customers in the U.S. that haven't migrated over to the cloud, which is actually probably some of the highest in the world today. If you look at the European market and the Australian market, the adoption is much, much lower, which means there's even more opportunity in those two markets. We’re extremely pleased with the results that we saw out of our international efforts in Q1. To add to that, I'll have Anand give you a little more detail.

Yes. I think echo what Doug was saying is that we’re probably up to around 20 service providers internationally across the board, and we continue to see that. As you dig through the numbers, you'll also see that the growth came quite significant from that area with a very small and highly efficient team. We continue to see improvement in that area. We have mentioned before that there are a number of partners out there, both in the ecosystem today and our partners today, and they are looking to move off of some legacy platforms, competing with likes of Cisco and Microsoft. So we continue to see a lot of improvement in that area. We're being very tactical and surgical about doing it, given the size of our team, but the opportunities that we have relative to the bigger players are very good.

Our next question is Chris Sakai from Singular Research.

Can you discuss how a hiring freeze, along with unrestricted spending, might impact your growth and your capacity to manage new opportunities?

If I thought it affected our growth, we wouldn't be doing it. We have sufficient staff and sufficient technology to expand. This is not perpetual. Most of the people in our sector are cutting back. As I mentioned during my prepared remarks, we didn't have to do that because we didn't go on a tear and hire too many people during COVID. We're at the right size for substantial growth. We will reevaluate this position next year, but I'm confident in our staff and the technology we have, and I'm quite confident we'll do great.

If you look at some of the revenue-driving positions, we've hired some additional salespeople at the end of last year who have already contributed significant increases for us. When we look at replacing someone, that's always an option. But right now, we're extremely well-staffed to continue the growth that we currently see.

Chris, this is Jon. I will give you a little more color, too. Just with the same existing staff from a revenue growth perspective, we're targeting larger opportunities. Doug talked about in his prepared remarks the awards we won with G2.com, the largest third-party software review site. We're getting larger opportunities coming to us organically through sources like G2 and others. With our service provider on the software solutions side, we're getting opportunities from some of the pain that is going on in the Cisco and Microsoft channel for cloud communications providers. So not hiring people doesn't mean we can't reach a higher level of sales effectiveness and sustain our revenue growth.

And Chris, don't forget, we still have the dealer channel, which is not a direct cost, and they are driving a significant portion of our sales. We have costs that are reducing through the rest of the year through some contractual obligations that will no longer exist. As Doug discussed, as contracts come up, when we combine the forces of all organizations together, we have a much better negotiating power, and we expect certain costs to decrease substantially. But we are in a position where we have all the runway for substantial growth. We're taking precautionary positions in light of uncertainties in the economy, and we will reevaluate next year depending upon where we are.

Okay. And did you mention what the backlog was for this quarter?

Our backlog increased to $47.86 million, which was up 11% from Q1 of last year. So we saw a nice increase in our backlog. That number did not include the Allegiant backlog. We'll have that calculated for our Q2 report.

Can you talk about whether you have seen any more customer migration from Avaya?

We do. We see that in the context of the Allegiant acquisition; some of their accounts and customer base are Avaya accounts. We've seen a lot of interest from Avaya resellers looking at Crexendo as an alternative. When our competitors face challenges, that's a good thing for us. We welcome all those Avaya customers to call us up, and we'll gladly take care of them.

We now hear from Mike Latimore with Northland Securities.

This is Logan on for Mike. Great quarter. We have two questions for you guys today. First one, can you provide some information around your current subscriber count? And what are some key drivers for growth of subscribers?

Yes. So subscriber count right now, we announced in Q1 we eclipsed 3 million end users. That number combines all of the end users through our licensees and direct offerings, which has over 65,000 end users on our direct offering. The majority of that 3 million comes from our licensees. Those end-user numbers continue to increase as our licensees add more and more customers to their platforms. We anticipate those numbers to double what we had when we acquired the platform in July of 2021.

Perfect. And are you expecting to be free cash flow positive this coming year?

Ron already answered that, and we said yes.

Okay. All right. In BroadSoft, telecom, what is the biggest owner of subscribers to your software business?

Yes. If you think about our two segments, we've got different competitors in each segment. On the telecom services side, we don't see BroadSoft and Microsoft in their initial formats; we see them through resellers. On the Telecom Services side, competitors include RingCentral, 8x8, and Vonage. On the platform side, that's where we see BroadSoft and Microsoft's Metaswitch being the #1 and #2 platform providers. We're the third largest platform provider in the U.S. Again, it's a big difference in how we present ourselves because we have a completely different model than Microsoft and Cisco. Microsoft and Cisco are charging per license, which is costly. Our model charges based on sessions, not seats, making us much more competitive with a product that has just as much, if not more, feature functionality for a lesser price.

We have reached the end of our question-and-answer session, and I will now turn the call over to Jeff Korn for closing remarks.

Well, I want to thank all of you for calling in and listening to our call this quarter, and we look forward to our second quarter results. Thank you very much.

This concludes today's conference call, and you may disconnect your lines at this time. Thank you for your participation.