Greetings, and welcome to the Crexendo First Quarter 2018 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Steve Mihaylo, Chief Executive Officer. Please go ahead.

Thank you, Hector. Good afternoon, everyone. I'm Steve Mihaylo, Chairman and CEO of Crexendo. I want to welcome all of you to the Crexendo First Quarter 2018 Conference Call. With me today are Doug Gaylor, our President and COO; Ron Vincent, our CFO; and Jeff Korn, our General Counsel. I'm going to ask Jeff to read the safe harbor statement. After that, I will give some brief general comments relative to the quarter. Ron will then provide granularity to the numbers, and Doug will give a business and sales update. And then we will open the call up to questions. Jeff, would you please read the safe harbor statement?

Thank you, Steve. I want to take this opportunity to remind listeners that this call will contain forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. The Private Securities and 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 like believe, expect, anticipate, estimate, will and other similar statements of expectation identifying forward-looking statements. Investors should be aware that any forward-looking statements are based on assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from those discussed here today. 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, 2017, and the Forms 10-Q for 2018 as filed. Crexendo does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. I'd now like to turn the call back to Steve. Steve?

Thank you, Jeff. Crexendo had a great quarter. We had a very impressive 28% increase on our UCaaS service revenue for the first quarter of 2018 over the first quarter of 2017. The growth in this segment is what is going to provide our shareholders good value in the future. I am also very encouraged that for the third quarter in a row, we achieved non-GAAP net income. For the second quarter in a row, we had breakeven per diluted common share on a GAAP basis. We are working diligently on reaching GAAP profitability. We still do an excellent job of keeping costs in line even with our substantial growth. We will continue to build on our success and continue to work through increased sales and profitability. We continue to receive industry awards, and our customers are highly satisfied. We will continue to provide what I believe is the best UCaaS products and services in the industry. I continue to believe very strongly in the company and the Crexendo team. I am convinced we will continue to grow the business organically. We are regularly reviewing potential accretive acquisitions. And I believe if the right opportunities come along that they will be a way to further accelerate our growth. With this, I'm going to turn the call over to Ron Vincent. Ron?

Thanks, Steve. First, let me say that during the quarter, we adopted Accounting Standard Update 2014-09 which relates to revenue from contracts with customers, Topic 606, on January 1, 2018, using the full retrospect application. Financial results for the prior periods have been adjusted by our adoption of Topic 606 to be comparable with current period financial results. Our consolidated revenue for the first quarter 2018 increased 22% to $2.8 million compared to $2.3 million for the first quarter of the prior year. Approximately 92% of our revenue was derived from our Cloud Telecommunications segment which contributed $2.6 million for the quarter. That's an increase of 28% compared to $2.0 million contributed in the first quarter of the prior year. Our service revenue for the first quarter of '18 increased 21% to $2.4 million compared to $2.0 million reported for the first quarter of the prior year. Product revenue for the first quarter of 2018 increased 31% to $366,000 compared to $279,000 for the first quarter of the prior year. Operating expenses on a consolidated basis for the first quarter of 2018 increased slightly by $96,000 to $2.9 million compared to $2.8 million for the first quarter of the prior year. On a GAAP basis, the company reported a net loss of only $63,000 or a breakeven diluted per common share compared to a net loss of $515,000 or a $0.04 loss per diluted common share for the first quarter of the prior year. On a non-GAAP basis, net income for the first quarter was $17,000 or breakeven per diluted common share compared to a non-GAAP net loss of $160,000 or a $0.01 loss per diluted common share for the same period of the prior year. EBITDA for the first quarter was a loss of $44,000 compared to a loss of $454,000 for the same period of the prior year. Adjusted EBITDA for the quarter was $18,000 compared to a loss of $156,000 for the same period of the prior year. Our cash, cash equivalents and restricted cash at March 31, 2018, was $1.2 million compared to $1.1 million at the end of the first quarter of 2017. During the quarter, operating activities used $127,000 of cash, cash equivalents and restricted cash. Investing activities had no impact on cash, cash equivalents and restricted cash. And our financing activity has used $38,000 of our cash, cash equivalents and restricted cash. With that, I'll turn it over to Doug Gaylor, our President and COO, for additional comments.

Thanks, Ron. We continue to see nice growth on our telecom revenue and backlog numbers. We've now had non-GAAP profitability for 3 straight quarters and GAAP EPS breakeven for 2 consecutive quarters and are right on the cusp of GAAP net income. The 22% total revenue growth and 28% telecom revenue growth year-over-year were significant, but I believe we can do even better with the platform and offerings we have in place. We had some great success during the quarter that continues to highlight our offerings and our capabilities. We were awarded a phone system agreement for a large 1,200-phone school district as well as phone systems for multiple smaller schools and municipalities during the quarter. In addition, we won multiple 6-figure total contract value contracts during the quarter. We had a very successful kickoff with U.S. Cellular after the formal launch of our partnership during Q1. We secured sales contracts through that partnership and have very high expectations going forward with our partnership with U.S. Cellular. We were proud to be awarded the 2018 INTERNET TELEPHONY Product of the Year Award presented by TMC, a global integrated media company covering the telecom industry, in recognition of our strong and powerful communications platform. Our sales backlog increased 23% year-over-year to $20.7 million at the end of Q1, and our telecom segment gross margins improved to 66% for the quarter as we continue to manage our phone manufacturing and network costs to improve margins. We introduced a phone rental program during the quarter which has been well received by the end-user customers who prefer an operating expense option as opposed to a capital expense option to acquire their initial phone hardware. We continue to add larger and stronger partners to our partner channel and have strong sales bookings during the quarter…

Thank you, Doug. At this time, Hector, we'll open it up to questions if there are any.

[Operator Instructions] Our first question comes from the line of [ Greg Hellman ], a private investor.

Yes, I had 2 questions. Number one, the practicality of your system, are -- well, let me back up. First of all, let's talk about SG&A. In terms of SG&A, what percentage is fixed? What percentage is variable? Or what's the dollar amount per quarter or per year you expect? And what was the other part that you would say would be variable?

The majority of our operating...

Did you have something else, [ Greg ]?

Yes, just about the [indiscernible] system. What's -- yes, I was wondering, what's the name of that really big company in Silicon Valley that provides telephony systems? I think it starts with C.

There's a RingCentral. There's a Cisco. There's a...

Cisco, Cisco, yes. Do you have the same functionality as Cisco?

We have the same -- well, we have the same functionality as the company they acquired, BroadSoft, but they manufacture a lot of gear that's not in our wheelhouse like switches and routers and that sort of thing. Doug, did you have something to add to that?

No, I think the competitive nature continues to change out there. I think we are one of the stronger organizations, although much smaller, we've got one of the stronger financial positions out there as you look at the competitive landscape. But to get back to the financial question, I'll have Ron just highlight the SG&A and how that [ is ] as far as fixed versus nonfixed.

Thanks, Doug. Yes, so the majority of our general and administrative costs are relatively fixed. We do have some variable costs within those -- in that category, primarily stock option expense. So when we grant stock options and have executive vesting, that has a variable in that number. With the majority of our options outstanding for the executive group having been vested over the last 5 years, so that number has dropped down considerably from Q1 of 2017 to Q4 and into Q1. Outside of that, the majority of those, we watch our costs very closely, and those are -- have been adjusted to the lowest possible amount they can be. So we consider those to be pretty fixed at the minimum we need to operate our business.

One of the things we did, [ Greg ], we've designed this business to be a much larger business, so we have some infrastructure that a company that, say, of our size wouldn't have if they're not planning on achieving significant growth.

Okay. And just for the sales and marketing portion, what percentage of that is variable?

I mean, I'm not sure of the exact percentage, but our sales and marketing expenses obviously are the salaries for our salespeople, the commissions for our partners and the commissions for our salespeople. So that'll vary based on bookings. As we continue to increase bookings, we'll continue to see the sales and marketing expenses increase.

And it's running about 30%.

30%?

Yes.

30% revenue.

Yes. So if you take the SG&A, the R&D and the sales and marketing, that's about 70%. And then [ loss ] are about 10% or 15%, so we should be able to start showing numbers that are quite significant on a GAAP income here in the next 3 to 4 quarters because we are at breakeven right now. And assuming most of our customers re-up because we are seeing customers who have been with us now 4 and 5 years, and about 95% or 98% of those are signing new agreements. So the long and the short of it is, we should start dropping some nice numbers to the bottom line.

Okay. And finally, the length of your sales cycle between your first contacting the customer and getting the order, either for your channel partners or for your own salespeople, how is that changing over time? And what was it, I don't know, 3 years ago versus what it is today?

We're selling larger systems. Our average is, what, about 22 phones?

Yes, our average size transaction, Steve, is about 20 phones. Our average time from start to finish on a sale is about 4 weeks. But we see opportunities, [ Greg ], that happen in 1 or 2 days, we see opportunities that take 6 months. I would say our average transaction time from start to finish is typically 4 weeks.

Yes, but that's going to creep up a little bit as we start selling larger and larger opportunities.

But getting back to my point, just for -- so for some of the best value-added resellers here in the country, the safe bet would go -- to go to Cisco or somebody like that, would that be correct?

Not necessarily at all. If we look at Cisco, Cisco is probably the most expensive option out there. And Cisco really has, until they bought BroadSoft at the end of last year, had really taken a backseat on telecom. So buying BroadSoft is really putting them back into full mode on telecom. But up until they bought BroadSoft, Cisco had really taken a backseat on their telecom offerings and enhancing their product offerings out there. So if we look at our competition out there, as I said, the landscape is changing dramatically. So with Cisco coming in and others going out, we see that landscape changing dramatically, and we're taking advantage of it. We've got BroadSoft resellers that are contacting us to look at our product and our platform. So when we look at the opportunities that are existent out there, I don't look at Cisco being a competitor, in fact, I look at Cisco buying BroadSoft as a true advantage for us.

Okay. And do you expect to make major inroads in affiliate marketing, in other words like to have like a church group sell things for you? I mean, do you expect headway with major affiliate relationships this year?

Major headway. But some headway, we do have some nice relationships today that are affiliate-related with different associations. That's been a fairly stable sales avenue for us. It hasn't seen a dramatic increase, and I don't anticipate seeing a dramatic increase. Our main focus today is growing our partner channel. The affiliate programs that we have in place today for associations and groups, as you associated with, we're going to continue working that, but our main focus going out there and getting partners that are a perfect fit for reselling our solution.

Which should be any kind of VAR.

Yes, beta VARs, managed service providers, business-to-business resellers and telecommunication VARs.

[Operator Instructions] Our next question comes from the line of [ Michael Kaufman ], a private investor.

A question I had -- I was interested in you mentioning that you have some expenses in your operating activities that really would allow you to get to a much bigger level. And the question is, what is your longer-term expense to revenue model? And at what kind of revenue level you have to get to make it reasonable in terms of kind of moving forward? And when do you think you can hit the knee in the curve in terms of product adoption? Because right now you're kind of feeding the food chain and then, I guess, you have to get enough early investors or early takers to start getting a ramp and start getting notoriety in the field. So where do you see that shaking out?

Well, I'm going to get -- give you my off-the-cuff answer to that one. Obviously, as we get bigger, we allow some leverage with our suppliers on the cost side, so that's going to come down a little. It's not going to be huge, but it will probably be in the 1% or 2% or 3% price range. The SG&A or the G&A, I should say, is going to increase at a much slower rate. We grew at 28% last quarter in the UCaaS segment of our business, which, as Ron mentioned, is 92%, and that's going to increase as we go forward here. Probably next quarter, it'll be 93% and then 94% and so on. But we've had a little bit of an increase in our general and administrative, but it's a lot lower than what the increase has been in sales. So I would suspect, if that's running about 35% now, maybe by the first quarter of next year it could be down to 31% or 32%. Do you have anything to add to that, Doug or Ron?

No. I think as Steve mentioned, I mean, we're constantly managing our costs, and that's a critical eye for all of our management team here. So as we continue to grow our sales, we reinvest where we need to, to make sure we have the marketing programs and the incentives out there for our partners and for our sales opportunities, but we need to make sure that we're managing that because our goal is to increase the revenues and decrease the cost.

You indicated you had a backlog of $20.7 million. When does -- how long does that take to flow into revenue?

Yes, that's based on our contracted obligations. And so that's -- typically, majority of our contracts are 60-month contracts. Second highest percentage is 36-month contracts. So we have contracts ranging anywhere from 12 to 60 months. You'll see that information detailed into our 10-Q that will be released today. So we actually break that down with the new revenue recognition standards. We actually have that breakdown on the backlog into the different segments.

Yes, you'll find that in footnote 3. We lay out the runout of that $20 million.

All right. I look forward to getting up to speed on the company. It sounds like an interesting opportunity and, hopefully, it will be much bigger than a breadbox pretty soon.

Thank you. It's just about bigger than a breadbox now where things stands...

At least 10x Inter-Tel.

Yes, there you go. Well, here's the thing, at $100 million in revenue, this company would be equivalent to what Inter-Tel was at $460 million. That's the difference of a software company and a hardware company. So we're pretty excited.

That's with contribution margin to the bottom line.

Even contribution to the bottom line, we could expect net margins of 18% to 20% where, at Inter-Tel, we were lucky if we got 5% or 6% after taxes.

I had a lot of experience in this business, that sounds good. Look forward to hearing from you in the future, and keep up the good work.

Thank you.

Our next question comes from the line of [ Chris Barber ], a private investor.

Listen, just one quick question. I was a little concerned because you were not operating cash flow-positive this quarter. If you could just expand on the reasons behind that a little bit to help me get more comfortable there.

I'm going to give you a short answer. We changed suppliers and -- or I should say we consolidated suppliers in China, and we had to order additional inventory. That's the bulk of it. And Ron Vincent will give you some color on the rest of it.

Yes, you're right, Steve, that was the majority of that change. We had to make some advance purchases on inventory while we were transferring our molds. We didn't want to be without inventory during the transition period, so that was a big part of it. And the other was just changes in our operating accounts on the balance sheet, collection of receivables and changes in prepaid inventory balances.

And an example, the large deal that we mentioned in my comments, the 1,200-phone deal is a school district. Their payment terms are different than typical payment terms where we would typically have a deposit when we get agreements signed. Their payment terms are payment upon delivery of the equipment, so that was a huge deposit that would have typically applied to cash in the first quarter but has been deferred to second quarter as we install the opportunity as we speak.

Yes. And the consolidation of manufacturers in China will ultimately bring the cost -- stabilize them and may even bring them down a little bit. But for sure, they'll expedite the supply chain.

Our next question comes from the line of [ Roy Knutsen ], a private investor.

My name is [ Roy Knutsen ], a 15-year holder of the security of this company. And I...

You've got more time on this rock than I do.

I do, I do. One, Steve, we're about the same age, maybe I'm a year or so older. One, how is your health? And I worry about somebody who's been -- you've been so good in running a business. I worry at some point that if you happen to leave the company, what happens? And my second -- for whatever reasons, health or whatever. And my second question would be, you continue to buy shares in the company and you're a very large owner, around 65%. I always wonder, I don't want to lose my position because after 15 years, I have a sizable loss, and I hate to lose the stock at a price at where it is now. So...

Well, let me -- you asked quite a few questions there, Roy. Let me see if I can answer them as I recall them, and you may have to help me out here. But first of all, my health is excellent. To say I'm healthier than a horse would probably be an understatement, but I think I'm healthier than a horse unless I slip on a banana peel or my wife pushes me down the stairs or something, but I don't expect either to happen. So I think you're safe there. From a stock ownership position, all of my stock goes into a foundation when I die, which I hope is at least 20 more years from now. And pardon me?

Good for you.

Yes, good for you, too. I wish you the same. And when it goes into the foundation, the managers of this company are also board members of the foundation, so I think there's plenty of continuity there. As for buying more stock, I actually stopped buying stock, Ron, how long ago?

At least 9 months.

Yes, it's been at least 9 or 12 months. I have exercised some options. As they get close to the money, I exercise them because I don't want the tax that I have to pay to kick in. And like you, I'm getting a little antsy here. I want to get this thing into high gear. So we're beating the bushes, and I'm beating the team. It's -- so we're all committed, everyone. Go ahead.

You are here for the long term.

I -- that's the only way I know how to operate.

That's all I want to know.

Yes, sir. You bet.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Mr. Steve Mihaylo for closing remarks.

All right. Well, thank you, Hector. And the one thing that I want to add to Roy's questions and my comments, obviously, we have a great team here with Doug at the helm and Ron and Jeff and Joe and others that are involved in this business. Theresa Weitzel, Darren Johnson. Nishith Chudasama and others that make this company go. And I'll tell you what, I am more impressed with this team than any I've seen out there. So I think we're in very good shape going forward. And I want to thank everyone for being on the call today, and we look forward to reporting our second quarter probably in early -- well, actually early August, late July, if maybe we kick them real hard. Okay, thank you, everyone, and have a good evening. Good night.

Thank you.

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