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Edited Transcript of CXDO earnings conference call or presentation 5-May-20 9:30pm GMT

Q1 2020 Crexendo Inc Earnings Call

TEMPE May 15, 2020 (Thomson StreetEvents) -- Edited Transcript of Crexendo Inc earnings conference call or presentation Tuesday, May 5, 2020 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Douglas Walter Gaylor

Crexendo, Inc. - COO & President

* Jeffrey G. Korn

Crexendo, Inc. - Secretary

* Ronald Vincent

Crexendo, Inc. - CFO

* Steven G. Mihaylo

Crexendo, Inc. - Chairman of the Board & CEO

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Conference Call Participants

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* Allen Robert Klee

National Securities Corporation, Research Division - Research Analyst

* Aman Raj Gulani

B. Riley FBR, Inc., Research Division - Associate Analyst

* Andrew King

Dougherty & Company LLC, Research Division - Research Analyst

* Kevin Darryl Dede

H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst

* Michael D. Kaufman

MK Investments I LLC - President

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to your Crescendo First Quarter 2020 Earnings Call. (Operator Instructions)

At this time, it is my pleasure to turn the floor over to Steve Mihaylo, CEO and Chairman of the Board. Sir, the floor is yours.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [2]

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Thank you. Good afternoon, everyone. I'm Steve Mihaylo, Chairman and CEO of Crexendo. I want to welcome all of you to Crexendo's First Quarter 2020 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. I am going to ask Jeff to read the Safe Harbor statement. After that, I will give some brief general comments about the quarter. Ron will then provide more 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 give the Safe Harbor statement?

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Jeffrey G. Korn, Crexendo, Inc. - Secretary [3]

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Yes, Steve, and thank you. 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 fact, are forward-looking statements. Forward-looking statements include, but are not limited to words such as 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.

These risk factors are explained in detail in the Company's filings with the Securities and Exchange Commission, including the Form 10-K for the fiscal year ended December 31, 2019 and the Form 10-Q's 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 -- or any other reason. I'd now like to turn the call back to Steve. Steve?

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [4]

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Thank you, Jeff. I hope this call finds all of you safe and -- that you and yours are healthy. This is our first call since the new normal. We are clearly at a critical time for our country. We realize that many people are suffering; not just the health effects of COVID-19 but the effects of isolation and quarantine as well as the economic crisis we find ourselves in. We also know that we are providing essential communication services and are assisting our customers in navigating these issues during this crisis.

I talked to some of our customers and what I am most impressed with is the optimism I hear in the face of this unchartered worldwide pandemic. At Crexendo we are working with our customers to assist them in keeping their businesses and communication with their world; essentially their communication lifeline. The ability of our customers to reach out and communicate with their customers is essential. We take that responsibility very seriously and we went full steam ahead in supporting our customers as they navigated the new remote reality. Our engineers and customer service really met every challenge thrown at them, at us, and to assist and meet those needs of our customers. I am very proud of the efforts of our entire team. We realize we provide essential services and that our customers depend on us.

As part of the responsibility, we took the FCC, Keep America Connected Pledge and agreed not to disconnect any Crexendo customers, business or residential service, for nonpayment during, or until at least the middle of May. We knew that this could have a short-term impact on us but in these times of crisis, businesses have an obligation to do the right thing. We also realized that some of our customers may reduce their operations or even seize operations entirely. We have also found that some customers have deferred expenditures of new or additional systems. This is the current state of the world that we and most businesses are in today.

Even with these unprecedented issues, we had, what I believe, is an excellent quarter. We maintained profitable continuing -- and we remained profitable continuing a long-streak of GAAP and non-GAAP profitability. This is frankly an exceptional accomplishment. I am really excited that we actually increased our UCaaS service revenue for the first quarter of 2020 and that revenue increased 18% to $3.3 million compared to $2.8 million for the first quarter of 2019.

I believe this is the most important metric and shows the strong growth of our business. And I'm also convinced that Crexendo is a very unique position to capitalize on the post COVID-19 world. We champion a business phone system that seamlessly transitioned from office to the home or other remote locations and back again and this was long before remote working was the norm.

We have been contacted by customers who thank us for all we did for them to save their businesses. We take great pride in that and it shows us the value of what we are doing. As businesses transition to the Cloud, they will realize that our systems are essential and we are prepared to meet the needs of those customers. I continue to be extremely optimistic about our future and I am overly excited about our long-term growth and strong balance sheet. We have, as I discussed before, started to increase our investment in the business. I believe this is essential for us to continue to grow. We are mindful of current economic conditions and we will do as we have always done; watch every penny of shareholder money very carefully and only spend money when it makes sense for the business. We have always been careful and will not spend more than is absolutely necessary.

We have applied for listing on NASDAQ as we have now met all the organic requirements. We believe the business has grown to where listing on a national exchange makes sense. We are not certain how long this review will take; particularly in the current situation but we expect to receive a positive response and will, of course, keep you updated as to the status.

In addition to organic growth, we believe that we can accelerate our growth through accretive acquisitions. We are always looking at targets and will continue to do so even while doing that we will not lose the focus of sales and service and products. The current crisis has actually increased our M&A activity. We work every day to increase and maximize shareholder value. With that, I'll turn it over to Ron. Ron?

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Ronald Vincent, Crexendo, Inc. - CFO [5]

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Thank you, Steve. Financial highlights of the first quarter of 2020 are as follows. Consolidated revenue for the first quarter increased 11%, to $3.9 million compared to $3.5 million for the first quarter of the prior year. Service revenue for the first quarter increased 16% to $3.5 million compared to $3 million reported to the first quarter of the prior year. Our Cloud-telecommunications, UCaaS service revenue for the quarter increased 18%, or $503,000 to $3.3 million compared to $2.8 million reported for the first quarter of the prior year offset by a 12% or $22,000 decrease in our Web Service Segment service revenue for the quarter.

Product revenue for the first quarter decreased 22% to $379,000 compared to $484,000 for the first quarter of the prior year. Consolidated operating expenses for the first quarter increased 13% to $3.7 million compared to $3.3 million for the first quarter of the prior year. Net income for the first quarter, $140,000 or $0.01 for basic and diluted common share compared to $239,000 or $0.02 for basic and diluted common share for the first quarter of the prior year.

Non-GAAP net income for the first quarter, $275,000 or $0.02 per basic and diluted common share as compared to $343,000 or $0.02 per basic and diluted common shares for the same period of the prior year. EBITDA for the first quarter of $284,000 compared to $263,000 for the same period of the prior year. Adjusted EBITDA for the first quarter was $389,000 compared to $354,000 for the same period of the prior year.

Our cash, cash equivalence and restricted cash at March 31, 2020, $3.5 million compared to $4.3 million at December 31, 2019. Operating activities utilized $288,000 of cash, cash equivalence and restricted cash. Our investing activities utilize $528,000 of cash, cash equivalence for the purchase of property and equipment. During the first quarter we purchased our office building for $2.5 million utilizing $500,000 of our cash reserves and we entered into a term loan for the remaining $2 million.

Financing activities provided $71,000 of cash, cash equivalence and restricted cash. We received $84,000 in proceeds from stock option exercises offset by repayments made on financing leases and those payable during the quarter. With that, I'll turn it over to Doug Gaylor, our President and COO for additional comments on sales and operations.

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [6]

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Thanks, Ron. I'm pleased with our results for Q1 and how Crexendo was able to react and adapt to the changes brought about by the pandemic. The course of events over the last 3 months has highlighted the importance of businesses utilizing Cloud communications. When the U.S. began enacting stay-at-home measures in March, our customer service lines exploded with existing customers seeking help on how to transform their business to remote functioning organization. Fortunately for Crexendo customers, in most instances, it was as easy as bringing your phone home and plugging it in. Further, the benefits of using Crexendo's platform, our collaboration tools saw a 172% increase in usage in March and our [software] downloads and utilization were up 54% just in March. We're still compiling the total's for April and anticipate even higher utilization of these remote capabilities. I've always stated that it is not a matter of if businesses move their communications to the Cloud, but rather when and the onset of this pandemic I feel will hasten the migration of businesses that were stuck using their old legacy systems to migrate to the Cloud even quicker.

As Ron mentioned, we saw total revenue increase at 11% year-over-year in Q1 and saw even a greater increase in our unified communications as a service, UCaaS revenue, of 18% year-over-year. The increase in revenue led to GAAP net income of $140,000. As mentioned on previous calls, we have committed to reinvesting our profits back into the business and you saw the effects of that in our GAAP numbers for Q1.

We hired a new director of marketing in the quarter and increased our investments in brand building, lead generation and promotions. Although it is still early in our efforts, I am very pleased with the progress we're making in these areas. We continue to add new partners to our reseller channel and I am encouraged by the excitement of our new and existing partners during this pandemic.

For many of our partners, our core business offerings dried up when businesses began shutting down but their interest in sales, success from their Crexendo Cloud communication offering, in many cases, increased. We continue to onboard new partners and we are helping them market remote communication abilities to all of their customers and prospects.

Along those lines, we introduced some significant promotions in the wake of the pandemic to help new and existing customers weather the storm during these unprecedented times. We offered new customers up to 4 free months of service and waived activation fees when signing up for our platform. This allows businesses to implement fast with little to no out-of-pocket costs. We also made our collaboration tool, called Crexconnexe as well as our mobile application called CrexMo and our [soft phone], Cloud Communicator available at no additional charge for new and existing customers for a period of time to help them utilize our technology to enhance their remote communication abilities.

These incentives have been very welcomed by our customers and the amount of positive feedback I have received, personally, during these troubled times has been very rewarding. Our growth for the quarter helped increased our sales backlog to $26.6 million which is a 10% increase year-over-year. And our telecom sector growth margin decreased slightly in Q1 to 59% as a result of some of the incentives and promotions that we instituted during the quarter along with some of the one-time network cost increases that we had previously planned for.

As you are aware, last year was an inflection year for us as we consistently posted GAAP income quarter, every quarter, and I'm very pleased that we are continuing that trend while many in our industry struggled to reach profitability. Despite all of the headwinds in the economy, I expect our success and momentum to continue and results to improve.

As previously mentioned, we have reinvested in our business and that reinvestment did result in lowering our cash position for the quarter while at the same time improving our overall balance sheet. We used cash in the quarter to repurchase, or purchase, our corporate headquarter building here in Tempe which will result in more than $100,000 in annual savings on our facility costs. We also reinvested in our technology and marketing efforts as well as our incentive programs and are proud of the strong balance sheet during these uncertain economic times. We continue to improve and enhance the Crexendo platform and our new phones that have Bluetooth and Wi-Fi capability have been very well received, especially in the remote work environment where people may not have the proper cabling infrastructure in their house. Our Wi-Fi functionality allows them to perform flawlessly.

When we had our last call just 2 months ago, no one would have predicted how quickly our countries economy would shift and how uncertain the business world would become. We believe that we have positioned ourselves extremely well to weather this storm and emerge stronger than ever. Our strong balance sheet, combined with the greater reliance on every business to have a communication infrastructure that will support their needs paints a bright future for Crexendo.

(Inaudible) for our Unified Communications as a service, UCaaS will be stronger than ever and the migration from older premise-based equipment to the Cloud, which was already forecast to have its strongest year ever in 2020 even before the effects of the pandemic, will only intensify as the countries businesses start rebounding.

Crexendo has positioned itself well to help these businesses make the transition to the Cloud and we are still very excited about the year ahead and the opportunities that exist. I am confident that we will continue to execute on our plans for revenue and income growth and that we are in a strong position to deliver. I will not turn it over to Steve for any additional comments.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [7]

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I don't have any additional comments, Doug. [Kristie], if you'd open the call up to questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Aman Gulani with B. Riley FBR.

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Aman Raj Gulani, B. Riley FBR, Inc., Research Division - Associate Analyst [2]

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Just calling in on behalf of [Josh], and 2 questions I wanted to ask. Have you noticed any change in trends or regarding customer’s phone usage during the lockdown?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [3]

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Interesting, so we have noticed quite a change. So when we looked at -- everybody moving remotely, we actually saw an increase in talk time. So, I think that was because of inter-office communications when people were in the office, they would just talk to the person next to them in the cubical. When all of the sudden everybody was working remote, we did see a spike in traffic. So in March and in April, we have seen a significant increase in [calling] traffic and that's because I think people working remotely now have to pick up and use the phone as opposed to in the past where if they were in the office maybe just walking over to somebody's office or cubical. So, I think a lot of it is more internal calling than external calling but we have seen an increase of traffic on our network.

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Aman Raj Gulani, B. Riley FBR, Inc., Research Division - Associate Analyst [4]

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Got it. And then what about an uptick in small business churns that might be attributable to the economic shutdown measures?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [5]

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Yes, Aman, great question. Still a little too early to tell on that. You know, we have seen some customers reaching out to us asking us for forbearance or allowances on their payment terms. So, we have seen some of that but we haven't seen the full effect, I feel. I think that over the next month or 2 we'll see how businesses respond. Fortunately we weren't heavily, heavily positioned in the restaurant or the hotel or the travel markets so, in some of the markets that we're most hit hardest we didn't have a heavy concentration there. So, if there's a silver lining to our business concentration is that some of the businesses that were most drastically affected, we don't have a high concentration of those type of customers.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [6]

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So, there's one other thing, our attrition rate is less than 1% per quarter which is extremely low and it remains in that range.

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Aman Raj Gulani, B. Riley FBR, Inc., Research Division - Associate Analyst [7]

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I'll jump back in the queue --

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Ronald Vincent, Crexendo, Inc. - CFO [8]

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-- [a month].

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Operator [9]

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And our next question comes from the Andrew King with Dougherty & Company.

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Andrew King, Dougherty & Company LLC, Research Division - Research Analyst [10]

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Good quarter. Just looking at the different product segments and everything, seeing that Web services actually came up quarter-over-quarter for this quarter and then product revenue is obviously down fairly heavily. How much of this is attributed to COVID-19 versus customer spending habits?

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [11]

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I think it's probably mostly due to COVID-19 but I'm going to let Doug or Ron answer that.

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Ronald Vincent, Crexendo, Inc. - CFO [12]

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Thanks, Steve. So, one thing to point out is we had very high product revenue in Q1 of 2019 and that was related to a big [rush] install that we had done during Q1 of 2019. And so that resulted in a much higher product revenue in the prior year. So, if you look at our product revenue for the quarter, if you look at our average for the last 4 quarters we're trending about the same. When you look at the Web services revenue, there's not much that can attribute to that 2000 increase other than a few customers caught up on their payments from not paying their Website hosting fees.

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Andrew King, Dougherty & Company LLC, Research Division - Research Analyst [13]

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Great, and then just -- if you had any comments on the difference in sales cycles since the pandemics really hit, since really basically since the beginning of March, that would be great, if you've seen a shift in that?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [14]

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Sure, Andrew, this is Doug. I'll answer that one. So we have seen a little bit of a slowdown so heading through mid-March, we didn't see much of a slowdown in decision-making process at all. Once the stay-at-home order started taking effect across the country, we saw a little bit of a delay in decision making. That's starting to come back as we speak but I think for a good 4-week period there, businesses did slow down in making decisions; especially when decision makers might have been removed from the office and getting people pinned down. But no shortage of discussions or excitement about people moving to the Cloud but we did see a little bit of a slowdown for about a 4-week period there.

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Operator [15]

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And next we go to Allen Klee with National Securities.

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Allen Robert Klee, National Securities Corporation, Research Division - Research Analyst [16]

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You talk about adding some new partners, I was wondering if maybe you could just give us a little, maybe add a little to that and kind of what you're hearing from your partners, any feedback on how things are going?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [17]

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Sure, yes, we continue to add new partners quarter-after-quarter and that's a main focus for our channel managers that are out there. So, adding new partners to our existing fleet of partners is critical for us every quarter. And so the new partners that we're adding obviously are looking for products that fit their portfolio and so a lot of our partners didn't have a telecom offering in their portfolio before and so for us, when we talked about managed service providers and data providers and B2B providers that are non-telecom related, adding a Crexendo product to their portfolio is perfect for them.

And I will tell you that we've got quite a few partners that we've added in the last 6 or 9 months that their businesses have slowed dramatically and so having the Crexendo product in their portfolio has helped out tremendously. I'll use an example, we've got quite a few copier companies that are Crexendo resellers and partners. Those copier companies are challenged right now because nobody is buying copy machines but all of their customers that they have out there are desperately looking for ways to communicate remotely and so having Crexendo in their portfolio has helped them out tremendously. I can't tell you how many of my copier partners have called to thank us about having Crexendo in our portfolio because their sales staff would have been dead in the water with selling copiers and the fact that they've got other solutions in their portfolio to sell now in these troubled times has helped them out tremendously. So, our partner sales are critical for us and we're always looking for new and enhanced partners to add to our portfolio.

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Allen Robert Klee, National Securities Corporation, Research Division - Research Analyst [18]

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That's very interesting. Doug, I know one of your -- one of your focuses is looking at M&A and I'm just wondering how you're kind of thinking about it of -- you know, what would be generically kind of a nice fit?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [19]

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Yes, so if you think about M&A opportunities, we've always stated the fact that we're looking for accretive acquisitions mostly customer-based type acquisitions and revenue type acquisitions; not as much as technology fit unless it fills a void that we've got in our portfolio. So, obviously there's a few areas that would be a good technology fit. For the most part it's a revenue and a customer acquisition strategy and so those opportunities would range anywhere from, you know, a million dollars or so up to $10 million or $15 million opportunity and so there's a lot of opportunities out there. You know, I use the old adage that we kiss a lot of frogs out there trying to find the right prince or princess and so there's a lot of opportunities and I think that the pandemic is going to create more M&A opportunities. We're in a really, really strong position with a great balance sheet and really positioned well to weather this storm. I can't say that for a lot of a companies in the industry so, you know, this is going to be a challenging time for a lot of companies right now and so that may raise the opportunities a little bit from an M&A perceptive, as Steve mentioned in his comments that we have seen a little bit of a spike in some of the conversations we're having out there.

So, again, we're looking for something that's accretive to our efforts and there's plenty of opportunities out there that we're talking to and that we're ready to disclose yet but, you know, we're hopeful that we'll have something that will be ready before the end of the year.

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Allen Robert Klee, National Securities Corporation, Research Division - Research Analyst [20]

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That's great. My next question is, on the last earnings call, you guys talked about interest in ramping up a little bit your marketing type of efforts. So, maybe just an update on that. Thank you very much.

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [21]

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Yes, so again, great question. Our marketing efforts have seen a dramatic focus for us because we hired a new director of marketing that started in March and so been extremely, extremely pleased with her contributions thus far. It's been a short road but obviously with everything that's gone on since she started on the first week of March and the second week of March we were telling her that she had to work at home and set her up remotely and so -- but the contributions that she's been able to contribute have been sensational and that will result in -- you'll see a new Website presence from us, you'll see new investor [decks] from us, you'll see a lot of marketing pieces and our partners will see a lot of marketing pieces that we've already delivered for them. We've got a lot of promotions out there around the pandemic and what we're doing to help businesses and customers out there and so we've put that out on social media and so we've got just a tremendous effort compared to what we used to have. Our market efforts before were weak in comparison and so we're very pleased with the results that we've gotten out of a short period of time. And we'll continue reinvesting in those marketing efforts because we're a big believer in the fact that people are going to be looking for our services and they've got to be able to find this and so our efforts right now are concentrated on getting our name out there.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [22]

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Yes. Yes, and Allen, I'd like -- I'd like to add just a little to that especially your first question. Your first question had to do with acquisitions. As you can imagine, we have a pretty tight gate that everyone has to get through in order to become a candidate for acquisition. In addition to that, as Doug mentioned, we're not looking for technology acquisitions but, you know, if one is a real close fit we would be interested in that for 2 reasons; number one, or 3 actually, we gain another leg in the product line. Number two, we gain another sales leg in the product line and number three, we gain the engineering expertise of the technology.

So we're looking at all of those things but primarily we're looking at acquisitions that can be highly accretive and ones that add customer base; plain and simple. And that's what I wanted to add.

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Allen Robert Klee, National Securities Corporation, Research Division - Research Analyst [23]

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Thank you so much, it's very helpful and congratulations on your continued track record of execution and discipline.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [24]

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Yes, and we do have probably as much discipline as anybody out there. We've looked at every single penny, as I said in my opening statement, we look at every expense and we could have had a, you know, a much bigger profit than we did but we're reinvesting in this business and you're going to be pleased with the results going down the road.

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Operator [25]

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And our next question comes from Kevin Dede with HCW.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [26]

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Steve, Doug -- Doug, you touched on this a little bit in discussing the M&A side of things but could you just talk a little bit more about the competitive environment and specifically how you see that changing maybe over the past 2 months and you also touched on, you know, your customer exposure and I'm wondering if, just given your financial footing, how you might be able to leverage not just M&A but competitive posturing and whether or not that might lead to promotional efforts?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [27]

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Sure, yes. From competitive perspective, you know, I think it's not just us that realized this is a perfect storm for our industry, so if you think about the massive need or remote communications and collaboration and the tools that we offer, you know, it's a very competitive market as you're well aware. Companies like RingCentral and Vonage and 8x8, they're also in the space, you know, they're just as aggressive as we are right now during these times to get their message out there. So it's still a very competitive environment.

I don't think the competitive environment has changed the M&A landscape that much because the opportunities that we would be looking for are different than the opportunities that the bigger guys might be looking for. We're looking for, you know, a smaller accretive acquisition where the bigger guys might be looking for a much bigger type acquisition. So, you know, think for us I think we're positioned extremely well in that respect against our competition. I think our offering is still fantastic compared to our competition. I think our price points are very well positioned against our competition. So when I think about where we are and the process today, yes it's a competitive environment we are very well represented against our competition and staying very well against our competition so, you know, it's -- to me it's always been about who gets in the door first and so right now think about all the businesses that have legacy premise-based systems when they come back to the office they're going to be trying to figure out, you know, hey, it's time for us to make a change and move to the Cloud and if we're the first ones in there, we're going to stand the chance of winning that business over any of our competition. It's when we try and compete against, you know, 8 others and the customers are trying to compare 8 different products, that gets a little bit more complicated but with our partner relationships hopefully we get walked in the door and it's an easy opportunity for us to sell somebody without them going out and looking at a lot of competitors.

When it gets back to marketing against our competition, I was just sharing on our board call earlier that, you know, if I look at what we spend on digital marketing and advertising right now versus what somebody like a RingCentral spends on digital marketing and advertising, they probably spend more in a day than we spend in a year. So, you know, it's -- we're not going to be able to compete in the same arena but we've got very specific things that we're going to be doing with our marketing dollars to go after our customer bases with our partners and go out there and be very selective about our messaging.

So, you're not going to see us trying to go out there and pull the Super Bowl [ahead] but we're going to be out there spending our marketing dollars very focused and very diligently on our partners and getting a nice return on investment and reinvesting in our partners marketing efforts to their customer bases.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [28]

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And, Kevin, I'd like to add just 2 things. Number one, we will be investing a lot of money comparatively speaking in marketing for a company of our size and we expect to get much better results than we've had in the past. So, from a marketing standpoint I think we get a lot more bang for the buck than our competitors do. The other thing I wanted to touch on is the M&A point just a little bit. Most of our competitors have very, very established customer bases and they also have a not invented here type attitude. Their products are what they are, good, bad or otherwise. Whereas we don't have a not invented here attitude. If somebody has a better technology, we want it. And they should be part of our organization; and it's just that simple. We are going to do what's right for the shareholders every single time. And that's what I wanted to add.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [29]

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Okay. One last question for Ron. Ron, can you just run through the metrics that you evaluated when you decided to buy your office building, especially in light of Steve's comments and wanting to -- and what I remember from the year-end call and wanting to devote more resources to marketing?

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Ronald Vincent, Crexendo, Inc. - CFO [30]

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Yes, the board and management evaluated the decision carefully because they had to weigh the current operating lease environment at the time and market prices as well as the rates in the environment. So we were able to secure a debt at a low interest rate and we thought that based on the amount we would save in op expense would far outweigh the opportunity for utilizing that cash flow in marketing. We deployed $500,000 of our cash reserves. Two million was used from a bank financing term loan and so the cost of that use of capital is low when compared -- in comparison to marketing spend.

So, I think we're going to have a net positive on an annual basis from that decision because we're going to have less -- although we'll have depreciation and you'll see an increase in depreciation from the depreciation (inaudible), our actual operating cost, the interest, is much lower than we were paying in rent.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [31]

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What about the tax implications?

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [32]

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Pardon me?

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [33]

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Yes, I was just curious too, Ron, about the tax implications?

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Ronald Vincent, Crexendo, Inc. - CFO [34]

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Yes, so we were at -- our lease agreement, we were paying property taxes as it was. So, we're really not saving much. We were already paying the property tax as part of our lease agreement so paying property tax is part of the -- on the asset is no different.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [35]

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I'm sorry, Steve, just one last little thing. Do you get a benefit on account of carrying that $2 million in debt?

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [36]

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Well, it's at a very low interest rate, so --

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Ronald Vincent, Crexendo, Inc. - CFO [37]

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Not from an effective tax rate. So, we're currently in net non-tax position because of our deferred tax assets, our NOL's from the previous years. The loss of --

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [38]

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Right, right, right. Okay. Yes, yes, yes. Okay. I'm sorry, Steve, sincere apologies.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [39]

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Yes. There's another thing too. This building houses our datacenter which if we were to go into a [colo] it would increase our cost tremendously. And we have the ability to probably go to 2 to 3 million desk comps in our datacenter without having to go into a colo . We currently back up with AWS but the cost is tremendously lower by securing that asset.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [40]

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Steve, on that point, have you considered, I mean -- if I remember, when I was there a bunch of years ago, you had another facility that you -- sort of redundant operation center and I'm wondering -- Yes, so I'm wondering is that still up and running and are you thinking about buying that too?

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [41]

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No, we're not thinking about buying it, it's part of Amazon Web Services but it is up and running and it's running quite well.

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Kevin Darryl Dede, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [42]

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Okay, so I -- I guess the question is, would you consider owning and operating your own as you decided to do in Phoenix?

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [43]

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No. This is our main location for datacenter. If we were to do another datacenter, and I'd have to confer with our VP of engineering, we'd probably do it on the East Coast in a [colo].

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Operator [44]

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And our next question comes from Michael Kaufman with MK Investments.

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Michael D. Kaufman, MK Investments I LLC - President [45]

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Steve and Doug, great job in steering the ship through very troubled waters. Congratulations. Question I had is, you were going to focus on trying to get larger customers. Where do you stand and -- that asset. The other thing is, when you were brought in by a reseller, what happens if that reseller kind of falls on hard times and goes out of business. Do you inherit the customer and service it yourself?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [46]

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Yes, both great questions. So, one, on the focus on larger customers, obviously that's a goal for us to continue to increase our size of our average customer. We're kind of at the mercy since 70%, approximately, of our sales come from our partner channel. You know, it's what they're concentrating on, it's what's in their customer base. So, you know, every quarter we see a nice percentage of our deals that are larger sized opportunities but the majority of our deals are still in the small and mid-sized businesses but, you know, we continue to bring on bigger partners and bigger partners tend to have bigger customers out there. So, I'm confident that we'll continue to see our average size system sale increase as we continue to concentrate on bigger partners with bigger customers.

On the second question, lost my train of thought, what was the second question again, Michael?

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [47]

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The question was --

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Michael D. Kaufman, MK Investments I LLC - President [48]

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Yes, for some reason, the people who bring you into an account --

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [49]

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Yes, our -- our --

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Michael D. Kaufman, MK Investments I LLC - President [50]

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-- go out of business, do you acquire and service that location yourself?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [51]

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We do. So, you know, when our partners sell a Crexendo opportunity it's still on Crexendo's paper and we are the billing and receivables and service and support team for that customer. So, our relationship with our partners is just added partner relationship, so they're bringing their customer to us but the relationship with the customer from a billing and support perspective is direct. So even if a partner fell on hard times and unfortunately didn't make it and went out of business, that customer, end user customer, is still a Crexendo customer for all intents and purposes and so we actually do all the service and billing and support on them.

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Michael D. Kaufman, MK Investments I LLC - President [52]

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Just a pass through and you give them commission based on what you get.

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [53]

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Exactly. It's a revenue share so they get a percentage of the revenue that we're bringing in as a revenue commission chair.

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Michael D. Kaufman, MK Investments I LLC - President [54]

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And you indicated that usage was up like 75% because this is so important. Is there any longer-term where you would have a --

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [55]

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[70] percent --

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Michael D. Kaufman, MK Investments I LLC - President [56]

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-- some activity variable in there that says, you know, you get -- for this price you get a certain amount of stuff and after something else there's a slight up-charge?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [57]

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We do have fair usage policies on all of our services; most customers don't ever get to the point of where they would exceed their fair usage policy but if somebody did have a tremendous amount of usage over and above what is typically normal. So that's very standard on most plans out there but it's rare that that would occur. So, customers, when they come on board with us have unlimited plans that allow them to have basically unlimited usage as long as they don't exceed a fair usage policy that we have in place and that rarely, rarely occurs.

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Michael D. Kaufman, MK Investments I LLC - President [58]

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And I guess, the last question, if you have -- kind of what would be a perfect kind of customer? Are you going after some of these larger customers directly?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [59]

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We do, so we've got a direct staff and we've got our partner channel. Sorry, direct staff does concentrate on larger opportunities and more major type accounts but our partners bring in probably just as many larger type accounts as well.

So, you know, our focus, Michael, is that it's like fishing, if I want to go and catch a trophy fish, I'm not going into the stream, I'm going where the trophy fish are. So, it's all about prospecting. So, if I want to go catch a marlin I know I've got to go offshore to catch a marlin but if I want to catch a trout, I got into a stream. Most of our salespeople, most of our partners realize that you get a lot more commissionable dollars if you're going out and catching marlin; a little bit diff -- more difficult to catch a marlin so you've got to really plan accordingly but with the right marketing strategies, that's what it's all about is finding out where the big fish are and then going to those spots and making sure that we've got a good strategy.

So, you know, we will take any size opportunity that comes along but obviously we want our partners and our direct people to focus on bringing in larger opportunities because they're much more lucrative for us.

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Operator [60]

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And next we move to [Brian Hoff], an investor.

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Unidentified Participant, [61]

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Congratulations on another great quarter. My question -- I was wondering, you're welcome. Wondering if the sales were affected at all by our changed world and if maybe, Doug, if you got feedback from salespeople regarding maybe businesses more reluctant to scale back or not renew?

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [62]

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Yes, so we have noticed a little bit of a change in the sale environment out there over the last 4 weeks, as I mentioned earlier. So, you know, I think when all of the sudden businesses started shutting down and working remotely and having stay-at-home orders, businesses were in kind of a state of what happens next? And so I think we did see some delays in decision making. Obviously those opportunities are still out there and now that the country appears to be reopening slowly but surely, you know, we anticipate that those opportunities will come to the front burner pretty quickly.

So, I think our biggest challenge over the course of the last couple of weeks, especially from a prospecting perspective is actually reaching people. You know, if you think about the statistics out there, you know, 60% or 70% of the businesses out there are not on the Cloud today and so those businesses that aren't on the Cloud, if I were to call into a main number at a business that has an old premise-based system, you know, maybe I'm just getting a voicemail or an auto-attendant and I don't have the capability to reach a decision maker and so I'm leaving voicemail messages and hoping they call me back. And quite frankly, if people are working at home and they've got other fires to put out, they're probably not jumping at the opportunity to go do something in the office that may not be high on the priority list.

But I think once they all come back to the office and realize that their phone system let them down during this unprecedented time, I think they're going to be jumping on the opportunity to replace it and get something that allows them to function remotely.

So I think that salespeople's reactions that I get out of there and I'm a big driver on the sales side, is that they've got to work harder and smarter. So before when you're prospecting, you know, you could go knock on doors at businesses and see what kind of phone system they have. Well, with stay-at-home orders and social distancing, you're not walking into a business unsolicited right now and asking who handles their phones and if we could give them a no-cost obligation quote to see if we can save them some money. So that's not happening right now. So everything is being done remotely. Everything is being done on the phone.

So I would say it's a little bit more challenging getting people on the phone but once we do get them on the phone the engagement is extremely high because the people that need the service now it's high priority as opposed to before where their phone system maybe was okay, now they're realizing their phone system was really inferior.

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Unidentified Participant, [63]

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Okay. That was a great answer. So we're thinking maybe it would have been even better but this is just pent up and we'll get people later on, once this is over, or slows down anyway. And --

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [64]

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Yes, I'm confident -- I'm confident that this is going to hopefully open up the flood gates. Now, it may not happen immediately but, you know, I think that this is -- we had talked about the fact that it's not a matter of if businesses move to the Cloud but when and so when is based on their needs and before this pandemic, you know, businesses were migrating to the Cloud in pretty high percentages but it was still the high majority of customers that weren't on the Cloud.

I think this is going to really, really hasten that to where we see a lot more businesses moving to the Cloud much more rapidly. So where the statistics are showing that 70% going to 50%, down to 30%, down to 15% over the course of the next 4 or 5 years. I wouldn't be surprised to see that migration to the Cloud, you know, maybe even double.

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Unidentified Participant, [65]

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Yes, I agree too.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [66]

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I -- Brian, I think that people have delayed a decision and they're going to be forced into making a decision because the Cloud is so much better than what they currently have. It gives them a lot more flexibility, productivity, it reduces their costs, all of the above. So it's -- as Doug said, it's -- and I think the pandemic has really pointed out the need for the Cloud more than anything.

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Unidentified Participant, [67]

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I think you're right. Okay, thank you guys. Congratulations again. You should be very proud.

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [68]

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Thanks, [Brian], appreciate it.

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Operator [69]

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And our next question comes from [Wyatt Carr] with Western International.

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Unidentified Analyst, [70]

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The first one I have is basically, in the last call you mentioned that there was a potential up-listing and I was wondering if there's been any movement on that and then the second question is to do with your 8-K filing that came out recently after your quarter and you -- you took on about a million dollars and I was just wondering how that's going to impact your operating expense line. Was there any in compensation that you had to do and did that change your headcount at all?

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Ronald Vincent, Crexendo, Inc. - CFO [71]

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Thanks for your questions, Wyatt. So, on the uplifting, we're working with NASDAQ through the application process and so we're in that comment letter process, they've submitted comments and we've responded and so we're in a [voiding] pattern at the moment so hopefully we'll get some clarity on that in the coming weeks as it relates to the loan that we took.

You know, there weren't any changes in compensation. It does allow us to retain our employees and keep our employees afloat. We did take the pledge to continue to provide services to all customers and not cut any customers off either businesses or residential for a period of time so that it would allow customers to receive services without paying. That definitely puts a stress point on businesses as the receivables increase and so those -- the ability to get that loan will help us continue to make payroll and not reduce staff and would actually increase staff and customer service and fulfillment to help the demand that was coming from our customer base and new customers as they needed to move from the office to home and get their systems set up at home or new systems set up in an emergency situation.

So --

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [72]

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The PPP that the government offered to companies like ours is exactly what it was intended to do and that's to keep employees on the payroll, using every bit of that money for payroll and we haven't cut a single person. And we are a regulated utility, even though we're very small.

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Unidentified Analyst, [73]

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Great. Also the NASDAQ would probably be helpful in your M&A activities too.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [74]

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I think that's a good observation.

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Operator [75]

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And with that, I will turn the call back over to Steve Mihaylo for any closing remarks.

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Steven G. Mihaylo, Crexendo, Inc. - Chairman of the Board & CEO [76]

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Thank you, Kristie. Well, thank you for all of you taking time out of your day to be here. We're excited about the future. It's unfortunate that the pain of the coronavirus, the COVID-19, has caused our country but we think it's a wakeup call and that more and more companies will realize they need to be on the Cloud so that they can access communication and data anywhere in the world. And we're very excited about the future for this company and we look forward to being with you next quarter and the quarter after that and so on. And we appreciate the fact that most of you are shareholders and we look forward to the future.

With that, I'll say good evening to those of you that are on the East Coast and on the West Coast, good afternoon, and we'll talk to you next quarter. Thank you.

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Douglas Walter Gaylor, Crexendo, Inc. - COO & President [77]

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Thanks, everybody.

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Operator [78]

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And that does conclude today's teleconference. We appreciate your participation. You may now disconnect your lines and have a great day.