Crexendo - 10-Q quarterly report FY2012 Q2

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).

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 August 1, 2012 was 10,669,201.

Basis of Presentation – These unaudited condensed consolidated financial statements include the financial statements of Crexendo, Inc. and its wholly-owned subsidiaries.  All intercompany balances and transactions have been eliminated.

Recently Adopted Accounting Guidance – As of January 1, 2012, the Company adopted Accounting Standards Update (ASU) 2011-04 related to guidance associated with fair value measurements and disclosures. This ASU clarifies the Financial Accounting Standards Board’s (FASB) intent on current guidance, modifies and changes certain guidance and principles, and expands disclosures concerning Level 3 fair value measurements in the fair value hierarchy (including quantitative information about significant unobservable inputs within Level 3 of the fair value hierarchy). In addition, this ASU requires disclosure of the fair value hierarchy for assets and liabilities not measured at fair value in the statement of financial position, but whose fair value is required to be disclosed. Adoption of this new guidance did not have a material impact on the Company’s financial statements.

As of January 1, 2012, the Company adopted ASU 2011-05 related to guidance on the presentation of comprehensive income. The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. This ASU requires an entity to present the components of net income and other comprehensive income and total comprehensive income (includes net income) either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of equity, but does not change the items that must be reported in other comprehensive income.  Adoption of this new guidance did not have a material impact on the Company’s financial statements.

As of January 1, 2012, the Company adopted ASU 2011-08 related to the testing of goodwill for impairment. The objective of this ASU is to simplify goodwill impairment testing by adding a qualitative review step to assess whether the required quantitative impairment analysis that exists today is necessary. The ASU permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. The ASU was effective for the Company beginning January 1, 2012. Adoption of this new guidance did not have a material impact on the Company’s financial statements.

Other Comprehensive Income (Loss) – ASU 2011-05 guidance on the presentation of comprehensive income requires an entity to present the components of net income and other comprehensive income and total comprehensive income (includes net income) either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company does not have any components of other comprehensive income (loss) other than net income (loss).  Net income (loss) has been presented in the condensed consolidated statement of stockholders’ equity.

Significant Customers – No customer accounted for 10% or more of our total net revenue or total accounts receivable for the six months ended June 30, 2012 or 2011.

During the six months ended June 30, 2012 and 2011, our Board of Directors declared the following cash dividends:

We classified $1,965,000 as restricted cash as of June 30, 2012 and December 31, 2011, due to acquiring a letter of credit related to our telecommunications registration in Arizona, the compensating balance requirement for our merchant accounts, and purchasing card agreements.

Our trade receivables balance primarily consists of Extended Payment Term Agreements (EPTAs) sold through our workshop seminars.  Below is an analysis of the days outstanding of our trade receivables as shown on our balance sheet (in thousands):

Our effective tax rate for the three months ended June 30, 2012, was 13% which resulted in an income tax provision of $13,000.  Our effective tax rate for the six months ended June 30, 2012 was 233%, which resulted in a benefit for income taxes of $140,000. The benefit for the six months ended June 30, 2012 was primarily due to the statute of limitations expiring for a few uncertain tax positions.

Our effective tax rate for the three and six months ended June 30, 2011 was 194% and 82%, respectively, which resulted in a provision for income taxes of $6,162,000 and $5,040,000, respectively.

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. During the three months ended June 30, 2011, we placed a full valuation allowance on net deferred tax assets.  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 division, the restructuring of the StoresOnline division, 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 in the three months ended June 30, 2011.  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.

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: 

Assets and liabilities measured at fair value on a recurring basis are summarized below as of June 30, 2012 and December 31, 2011 (in thousands):

The fair value measurement for the contingent consideration is based on significant inputs not observed in the market and thus represents a Level 3 measurement. 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.

The progressions of the Company’s Level 3 instruments for the three month period ended June 30, 2012 are shown in the table below (in thousands):

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 or 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. There have been no material changes to current legal events as outlined in our Annual Report on Form 10-K for the year ended December 31, 2011.

As of June 30, 2012 and December 31, 2011, we had liabilities primarily related to StoresOnline legal proceedings of $220,000 and $381,000, respectively. 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.

Management has chosen to organize the Company around differences in products and services.  Crexendo Web Services generates revenue from managing e-commerce or lead generation offerings, websites, search engine optimization/management and online promotional needs for small, medium, and large businesses.  Crexendo Network Services generates revenue from selling hosted telecommunication and broadband data services. We believe StoresOnline will continue to generate revenue by offering businesses a continuum of services and technology providing tools and training to establish a successful website on the Internet for entrepreneurs and small office/home office (SOHO) customers.

Information on reportable segments and reconciliation to condensed consolidated net (loss) income was as follows (in thousands):

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

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

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

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

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

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

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

In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet.  We believe that the estimates, assumptions and judgments involved in our accounting policies described in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates.  We believe that there were no significant changes to those critical accounting policies during the six months ended June 30, 2012.  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.

Loss before income tax was $104,000 and $3,183,000 in the three months ended June 30, 2012 and 2011, respectively.  Revenue for the three months ended June 30, 2012 decreased $12,582,000 compared to corresponding period of 2011. Total operating expenses decreased 75% to $5,528,000 for the three months ended June 30, 2012, compared to $21,955,000 in the corresponding period of 2011.

Our effective tax rate for the three months ended June 30, 2012 and 2011 was 13% and 194%, respectively, which resulted in a provision for income taxes of $13,000 and a provision for income taxes of $6,162,000, respectively.  The high tax expense for the three months ended June 30, 2011 was primarily the result of placing a full valuation allowance on our net deferred tax assets.

Total net revenue decreased 68% in the six months ended June 30, 2012 compared with the corresponding period of 2011, primarily due to the suspension of our direct mail seminar sales in June 2011, which caused a 100% decrease in seminar sales, a 75% decrease in commissions from third parties and other revenue, and approximately, a 40% decrease in principal collected on our StoresOnline EPTAs.  StoresOnline revenue decreased 73% to $8,464,000 during the six months ended June 30, 2012, compared with $31,017,000 in the corresponding period in 2011. The decrease was offset by increases in revenue from Web Services and Network Services offerings. Crexendo Web Services revenue increased 42% to $1,462,000 during the six months ended June 30, 2012, compared with $1,029,000 in the corresponding period in 2011. Crexendo Network Services increased  1,250% to $243,000 during the six months ended June 30, 2012, compared with $18,000  in the corresponding period in 2011.

Loss before income tax was $60,000 for the six months ended June 30, 2012 compared with a loss of $6,156,000 in the corresponding period of 2011. Revenue for the six months ended June 30, 2012 decreased $21,895,000 compared to corresponding period of 2011. Total operating expenses decreased 72% to $11,509,000 for the six months ended June 30, 2012, compared to $40,654,000 in the corresponding period of 2011.

Our effective tax rate for the six months ended June 30, 2012 and 2011 was 233% and 82%, respectively, which resulted in income tax benefit of $140,000 for the six months ended June 30, 2012 and a provision for income taxes of $5,040,000, for the six months ended June 30, 2011.  The income tax benefit in the current year is primarily due to the statute of limitations expiring for a few uncertain tax positions.  The high tax expense for the six months ended June 30, 2011 was primarily the result of placing a full valuation allowance on our net deferred tax assets.

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. During the three months ended June 30, 2011, we placed a full valuation allowance on net deferred tax assets.  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 division, the restructuring of the StoresOnline division, 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 in the three months ended June 30, 2011.  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.

Revenue from StoresOnline for the three months ended June 30, 2012 decreased 76% to $4,054,000, from $16,928,000 for the three months ended June 30, 2011.

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

Due to the suspension of our direct mail seminar sales channel in July 2011, we had no cash sales of StoresOnline Software licenses (“SOS licenses”) or other products at events during the three months ended June 30, 2012, compared to $9,241,000 of cash sales at events in the three months ended June 30, 2011.  Hosting revenue decreased to $829,000 in the three months ended June 30, 2012 compared to $1,326,000 in the three months ended June 30, 2011.  The decrease in hosting revenue was primarily due to attrition in the StoresOnline customer base since July 2011, primarily as a result of the suspension of the direct mail seminar sales channel.

 

Commissions from third parties and other revenue decreased 70% to $596,000 for the three months ended June 30, 2012, from $1,978,000 for the three months ended June 30, 2011, due primarily to our decision to suspend our direct mail seminar sales channel.  As a result of this decision, we no longer sent leads to these third parties, and as such, we do not expect this revenue source to be significant in the future.

Cost of revenue consists primarily of the cost to conduct internet training workshops, credit card fees, the cost of products sold, as well as customer support costs. Cost of revenue for the three months ended June 30, 2012 decreased 93% to $471,000, from $7,046,000 for the three months ended June 30, 2011.   The decrease in cost of revenue was primarily due to suspension of our direct mail seminar sales channel in July 2011, as such, we no longer incurred the costs to conduct the internet training workshops.  The cost of revenue for the three months ended June 30, 2012 primarily related to the cost to fulfill products sold through our inside sales group and customer services costs.    

Selling and marketing expenses consist of payroll and related expenses for sales and marketing activities associated with our inside sales group. Selling and marketing expenses for the three months ended June 30, 2012 decreased 99% to $64,000, from $9,468,000 for the three months ended June 30, 2011.  The decrease was primarily related to the suspension of our direct mail sales seminars in July 2011, as such, we no longer incur the selling and marketing expenses associated with those seminars, which accounted for most of our selling and marketing expenses in 2011.

General and administrative expenses consist of payroll and related expenses for executive, administrative personnel, legal, rent, accounting and other professionals, finance company service fees, and other general corporate expenses. General and administrative expenses for the three months ended June 30, 2012 decreased to $409,000 from $1,589,000 for the three months ended June 30, 2011.  The decrease was primarily due to the suspension of our direct mail seminar sales channel, which resulted in decreases in head count and other general and administrative expenses.

 

Other income primarily relates to interest earned on EPTAs, which generally carry an 18% simple interest rate. For the three months ended June 30, 2012 and 2011, other income was $504,000 and $1,276,000, respectively.

Revenue

Revenue from StoresOnline for the six months ended June 30, 2012 decreased 73% to $8,464,000, from $31,017,000 for the six months ended June, 2011.

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

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

  

Due to the suspension of our direct mail seminar sales channel in July 2011, we had no cash sales of StoresOnline Software licenses (“SOS licenses”) or other products at events during the six months ended June 30, 2012, compared to $16,213,000 of cash sales at events in the six months ended June 30, 2011.  Hosting revenue decreased to $1,653,000 in the six months ended June 30, 2012 compared to $2,331,000 in the six months ended June 30, 2011.  The decrease in hosting revenue was primarily due to attrition in the StoresOnline customer base since June 2011, primarily as a result of the suspension of the direct mail seminar sales channel.

 

Commissions from third parties and other revenue decreased 73% to $1,062,000 for the six months ended June 30, 2012, from $3,886,000 for the six months ended June 30, 2011, due primarily to our decision to suspend our direct mail seminar sales channel.  As a result of this decision, we no longer sent leads to these third parties, and as such, we do not expect this revenue source to be significant in the future.

Cost of revenue consists primarily of the cost to conduct internet training workshops, credit card fees, the cost of products sold, as well as customer support costs. Cost of revenue for the six months ended June, 2012 decreased 91% to $1,117,000, from $12,804,000 for the six months ended June 30, 2011.   The decrease in cost of revenue was primarily due to suspension of our direct mail seminar sales channel in July 2011, as such, we no longer incurred the costs to conduct the internet training workshops.  The cost of revenue for the six months ended June 30, 2012 primarily related to the cost to fulfill products sold through our inside sales group and customer services costs.    

Other income primarily relates to interest earned on EPTAs, which generally carry an annual 18% simple interest rate. For the six months ended June 30, 2012 and 2011, other income was $1,268,000 and $2,434,000, respectively.

Below is a table which displays the Crexendo Web Services revenue backlog as of March 31, 2011 and 2012, and June 30, 2011 and 2012, which is expected to be recognized as revenue within the next twelve to eighteen months (in thousands):

Cost of revenue consists primarily of salaries related to fulfillment of our web services.  Cost of revenue for the three months ended June 30, 2012 was $483,000 compared to $439,000 for the three months ended June 30, 2011.  The increase in cost of revenue for the current period is related to an increase in headcount as we continue to increase our fulfillment capacity as revenue increases.

Selling and marketing expenses consist primarily of salaries and benefits, as well as advertising expenses.  Selling and marketing expense was $734,000 and $608,000 for the three months ended June 30, 2012 and 2011, primarily due to a $116,000 increase in our sales force expense.  

General and administrative expenses consist of payroll and related expenses for administrative personnel.  General and administrative expenses were $141,000 and $102,000 for the three months ended June 30, 2012 and 2011, respectively.  The increase in general and administrative expenses is primarily due to a $49,000 increase in the office space rent allocation for the three months ended June 30, 2012 compared to the three months ended June 30, 2011.

Below is a table which displays the Crexendo Web Services revenue backlog as of December 31, 2010 and 2011, and June 30, 2011 and 2012, which is expected to be recognized as revenue within the next twelve to eighteen months (in thousands):

Cost of revenue consists primarily of salaries related to fulfillment of our web services.  Cost of revenue for the six months ended June 30, 2012 was $995,000 compared to $847,000 for the six months ended June 30, 2011.  The increase in cost of revenue for the current period is related to an increase in headcount as we continue to increase our fulfillment capacity as revenue increases.

Selling and marketing expenses consist primarily of salaries and benefits, as well as advertising expenses.  Selling and marketing expense was $1,417,000 and $1,289,000 for the six months ended June 30, 2012 and 2011, respectively. The increase in selling and marketing expenses is primarily related to the increase in our direct sales representatives, which resulted in $237,000 increase in salaries and wages. This increase was off-set by a decrease in advertising spend of approximately $115,000, as we have shifted our focus from an advertising sale primarily through paid search advertising to less expensive vertical specific lead channels.

General and administrative expenses consist of payroll and related expenses for administrative personnel.  General and administrative expenses were $279,000 and $162,000 for the six months ended June 30, 2012 and 2011, respectively.  The increase in general and administrative expenses is primarily due to a $100,000 increase in the office space rent allocation for the six months ended June 30, 2012 compared to the six months ended June 30, 2011.

Crexendo Network Services revenue for the three months ended June 30, 2012 was $168,000 compared to $18,000 for the three months ended June 30, 2011.  We began selling our network services products through a limited launch during the first half of 2011 with no dedicated sales representatives.  As of June 30, 2012 we had twenty-four direct sales representatives.  A substantial portion of Crexendo Network Services’ revenue is generated through twenty-four to thirty-six month service contracts.  As such, we believe growth in Crexendo Network Services will initially be seen through increases in our backlog.

Below is a table which displays the Crexendo Network Services revenue backlog as of March 31, 2011 and 2012, and June 30, 2011 and 2012, which we expect to recognize as revenue within the next twenty-four to thirty-six months (in thousands):

Cost of revenue consists primarily of product cost and customer support department salaries of our hosted communication services.  Cost of revenue for the three months ended June 30, 2012 was $329,000 compared to $158,000 for the three months ended June 30, 2011.  The increase in cost of revenue from the three months ended June 30, 2011 was primarily due to an increase in customer support costs of $96,000 and an increase in bandwidth costs of $57,000.

Selling and marketing expenses consist primarily of salaries and benefits, as well as advertising expenses.  Selling and marketing expenses for the three months ended June 30, 2012 was $142,000 compared to no expenses for the three months ended June 30, 2011.  The increase in selling and marketing expenses was primarily due to an $87,000 increase in the direct sales force expense combined with a $55,000 increase in advertising spend.    

 

General and administrative expenses consist primarily of payroll and related expenses for rent, professional fees, and administrative personnel.  General and administrative expenses were $127,000 and $58,000 for the three months ended June 30, 2012 and 2011, respectively.  The increase in general and administrative expenses for the three months ended June 30, 2012 primarily consisted of additional salaries and benefits, increase in rental expense allocation and various professional services costs.

Research and development expenses consist primarily of payroll and related expenses which are attributable to the development of new hosted telecommunications products.  Research and development expenses were $253,000 and $291,000 for the three months ended June 30, 2012 and 2011, respectively.  The decrease was primarily attributable to a decrease in our engineering head count.

Crexendo Network Services revenue for the six months ended June 30, 2012 was $243,000 compared to $18,000 for the six months ended June 30, 2011.  We began selling our network services products through a limited launch during the first half of 2011 with no dedicated sales representatives, as such; we had no revenue during the six months ended June 30, 2011.  As of June 30, 2012 we had twenty-four direct sales representatives.  A substantial portion of Crexendo Network Services’ revenue is generated through twenty-four to thirty-six month service contracts.  As such, we believe growth in Crexendo Network Services will initially be seen through increases in our backlog.

Below is a table which displays the Crexendo Network Services revenue backlog as of December 31, 2010 and 2011, and June 30, 2011 and 2012, which we expect to recognize as revenue within the next twenty-four to thirty-six months (in thousands):

Cost of revenue consists primarily of product cost and customer support department salaries of our hosted telecommunication services.  Cost of revenue for the six months ended June 30, 2012 was $579,000 compared to $265,000 for the six months ended June 30, 2011.  The increase in cost of revenue from the three months ended June 30, 2011 was primarily was primarily due to an increase in customer support costs of $180,000 and an increase in bandwidth costs of $86,000.   

Selling and marketing expenses consist primarily of salaries and benefits, as well as advertising expenses.  Selling and marketing expenses for the six months ended June 30, 2012 was $275,000 compared to $22,000 for the six months ended June 30, 2011.  The increase in selling and marketing expenses was primarily due to a $165,000 increase in the direct sales force expense combined with a $88,000 increase in advertising spend.

 

General and administrative expenses consist primarily of payroll and related expenses for rent, professional fees, and administrative personnel.  General and administrative expenses were $266,000 and $122,000 for the six months ended June 30, 2012 and 2011, respectively.  The increase in general and administrative expenses for the six months ended June 30, 2012 primarily consisted of additional salaries and benefits, increase in rental expense allocation and various professional services costs.

Research and development expenses consist primarily of payroll and related expenses which are attributable to the development of new hosted telecommunication products.  Research and development expenses were $494,000 and $584,000 for the six months ended June 30, 2012 and 2011, respectively.  The decrease was primarily attributable to a decrease in our engineering head count.

Unallocated corporate expenses, which are not allocated to specific segments of our operations, totaled $2,375,000 and $2,196,000 for the three months ended June 30, 2012 and 2011, respectively.  Unallocated costs increased for the three months ended June 30, 2012 due primarily to an increase in unallocated costs for rent, option expense, insurance, accounting services and software license and maintenance expense.  Following the suspension of the direct mail seminar sales channel, certain costs were reallocated back to corporate unallocated expenses.

Unallocated corporate cost of revenue consists of share-based compensation expense of $15,000 and $32,000 for the three months ended June 30, 2012 and 2011, respectively.

Unallocated corporate selling and marketing expenses consist of share-based compensation which was $44,000 and no expenses for the three months ended June 30, 2012 and 2011, respectively.

Unallocated corporate research and development expenses consist primarily of payroll and share-based compensation expenses, related to our engineering team, whose cost cannot be specifically allocated to any particular segment. Unallocated research and development expenses were $252,000 and $580,000 for the three months ended June 30, 2012 and 2011, respectively. The decrease was due primarily to a reduction in headcount in our engineering department.

Unallocated corporate expenses, which are not allocated to specific segments of our operations, totaled $5,036,000 and $4,386,000 for the six months ended June 30, 2012 and 2011, respectively.  Unallocated costs increased for the six months ended June 30, 2012 due primarily to an increase in unallocated costs for rent, option expense, insurance, accounting services and software license and maintenance expense.  Following the suspension of the direct mail seminar sales channel, certain costs were reallocated back to corporate unallocated expenses.

Unallocated corporate cost of revenue consists of share-based compensation expense of $28,000 and $64,000 for the six months ended June 30, 2012 and 2011, respectively.

Unallocated corporate selling and marketing expenses consist of share-based compensation which was $84,000 and $13,000 for the six months ended June 30, 2012 and 2011, respectively.

Working Capital

Accounts Payable

Accounts payable as of June 30, 2012 totaled $463,000, compared to $1,153,000 as of December 31, 2011. Our accounts payable as of June 30, 2012 were generally within our vendors’ terms of payment.

Capital

Off Balance Sheet Arrangements

As of June 30, 2012, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Not Applicable

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:

Not required

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 2011 Form 10-K.

We have a share purchase program that authorizes us to purchase outstanding shares of our common stock. The aggregate dollar amount originally authorized in September 2006 for purchase was $20,000,000 through September 2009.  In September 2007, our Board of Directors authorized the purchase of an additional $50,000,000 of our common stock through September 2012.  We had no share purchases during the six months ended June 30, 2012.

Exhibits