Crexendo : Management's Discussion and Analysis of Financial Condition and Results of Operations

This section and other parts of this Form 10-Q contain forward-looking
statements that involve risks and uncertainties. Forward-looking statements can
be identified by words such as "anticipates," "expects," "believes," "plans,"
"predicts," and similar terms. Forward-looking statements are not guarantees of
future performance and our Company's actual results may differ significantly
from the results discussed in the forward-looking statements. Factors that might
cause such differences include, but are not limited to, those discussed in Part
II, Item 1A, "Risk Factors," which are incorporated herein by reference. The
following discussion should be read in conjunction with our Annual Report on
Form 10-K for the year ended December 31, 2019 (the "2019 Form 10-K") filed with
the SEC and the Condensed Consolidated Financial Statements and notes thereto
included in the 2019 Form 10-Qs and elsewhere in this Form 10-Q. We assume no
obligation to revise or update any forward-looking statements for any reason,
except as required by law.

OVERVIEW

Crexendo is an award-winning premier provider of cloud communications, UCaaS
(Unified Communications as a Service), call center, collaboration services, and
other cloud business services that are designed to provide enterprise-class
cloud services to any size business at affordable monthly rates. The Company has
two operating segments, which consist of Cloud Telecommunications and Web
Services.

Cloud Telecommunications - Our cloud telecommunications services transmit calls
using IP or cloud technology, which converts voice signals into digital data
packets for transmission over the Internet or cloud. Each of our calling plans
provides a number of basic features typically offered by traditional telephone
service providers, plus a wide range of enhanced features that we believe offer
an attractive value proposition to our customers. This platform enables a user,
via a single "identity" or telephone number, to access and utilize services and
features regardless of how the user is connected to the Internet or cloud,
whether it's from a desktop device or an application on a mobile device.

We generate recurring revenue from our cloud telecommunications and broadband
Internet services. Our cloud telecommunications contracts typically have a
thirty-six to sixty month term. We may also charge activation and flash fees and
the Company generally allocates a portion of the activation fees to the desktop
devices, which is recognized at the time of the installation or customer
acceptance, and a portion to the service, which is recognized over the contract
term using the straight-line method. We also charge other various contracted and
non-contracted fees.

We generate product revenue and equipment financing revenue from the sale and
lease of our cloud telecommunications equipment. Revenues from the sale of
equipment, including those from sales-type leases, are recognized at the time of
sale or at the inception of the lease, as appropriate.

Our Cloud Telecommunications service revenue increased 14% or $425,000 to
$3,525,000 for the three months ended September 30, 2020 as compared to
$3,100,000 for the three months ended September 30, 2019. Cloud
Telecommunications service revenue increased 16% or $1,414,000 to $10,326,000
for the nine months ended September 30, 2020 as compared to $8,912,000 for the
nine months ended September 30, 2019. Our Cloud Telecommunications product
revenue increased 43% or $146,000 to $489,000 for the three months ended
September 30, 2020 as compared to $343,000 for the three months ended September
30, 2019. Cloud Telecommunications product revenue increased 2% or $23,000 to
$1,317,000 for the nine months ended September 30, 2020, as compared to
$1,294,000 for the nine months ended September 30, 2019. As of September 30,
2020 and 2019, our backlog was $28,313,000 and $25,335,000, respectively.

Web Services- We generate recurring revenue from website hosting and other professional services.

Our Web Services revenue decreased 19% or $30,000 to $129,000 for the three
months ended September 30, 2020 as compared to $159,000 for the three months
ended September 30, 2019. Our Web Services revenue decreased 16% or $81,000 to
$421,000 for the nine months ended September 30, 2020 as compared to $502,000
for the nine months ended September 30, 2019.

OUR SERVICES AND PRODUCTS

Our goal is to provide a broad range of cloud-based products and services that
nearly eliminate the cost of a businesses' technology infrastructure and enable
businesses of any size to more efficiently run their business. By providing a
variety of comprehensive and scalable solutions, we are able to cater to
businesses of all sizes on a monthly subscription basis without the need for
expensive capital investments, regardless of where their business is in its
lifecycle. Our products and services can be categorized in the following
offerings:


                                       24


Cloud Telecommunications- Our cloud telecommunications service offering includes
hardware, software, and unified ng IP or cloud technology over any high-speed
Internet connection. These services are rendered through a variety of devices
and communication solutions for businesses using user interfaces such as a
Crexendo branded desktop phones and/or mobile and desktop applications. Some
examples of mobile devices are Android cell phones, iPhones, iPads or Android
tablets. These services enable our customers to seamlessly communicate with
others through phone calls that originate/terminate on our network or PSTN
networks. Our cloud telecommunications services are powered by our proprietary
implementation of standards based Web and VoIP cloud technologies. Our services
use our highly scalable complex infrastructure that we build and manage based on
industry standard best practices to achieve greater efficiencies, better quality
of service (QoS) and customer satisfaction. Our infrastructure comprises of
compute, storage, network technologies, 3rdparty products and vendor
relationships. We also develop end user portals for account management, license
management, billing and customer support and adopt other cloud technologies
through our partnerships.

Crexendo's cloud telecommunication service offers a wide variety of essential and advanced features for businesses of all sizes. Many of these features included in the service offering are:

?
Business Productivity Features such as dial-by extension and name, transfer,
conference, call recording, Unlimited calling to anywhere in the US and Canada,
International calling, Toll free (Inbound and Outbound)

?

Individual Productivity Features such as Caller ID, Call Waiting, Last Call Return, Call Recording, Music/Message-On-Hold, Voicemail, Unified Messaging, Hot-Desking

?

Group Productivity Features such as Call Park, Call Pickup, Interactive Voice Response (IVR), Individual and Universal Paging, Corporate Directory, Multi-Party Conferencing, Group Mailboxes, Web and mobile devices based collaboration applications

?

Call Center Features such as Automated Call Distribution (ACD), Call Monitor, Whisper and Barge, Automatic Call Recording, One way call recording, Analytics

?

Advanced Unified Communication Features such as Find-Me-Follow-Me, Sequential Ring and Simultaneous Ring, Voicemail transcription

?
Mobile Features such as extension dialing, transfer and conference and seamless
hand-off from WiFi to/from 3G and 4G, LTE, as well as other data services. These
features are also available on CrexMo, an intelligent mobile application for
iPhones and Android smartphones, as well as iPads and Android tablets

?

Traditional PBX Features such as Busy Lamp Fields, System Hold. 16-48 Port density Analog Devices

?

Expanded Desktop Device Selection such as Entry Level Phone, Executive Desktop, DECT Phone for roaming users

?

Advanced Faxing solution such as Cloud Fax (cFax) allowing customers to send and receive Faxes from their Email Clients, Mobile Phones and Desktops without having to use a Fax Machine simply by attaching a file

?

Web based online portal to administer, manage and provision the system.

?

Asynchronous communication tools like SMS/MMS, chat and document sharing to keep in pace with emerging communication trends.

Many of these services are included in our basic offering to our customers for a
monthly recurring fee and do not require a capital expense. Some of the advanced
features such as Automatic Call Recording and Call Center Features require
additional monthly fees. Crexendo continues to invest and develop its technology
and CPaaS offerings to make them more competitive and profitable.

Website Services- Our website services segment allows businesses to host their websites in our data center for a recurring monthly fee.

RESULTS OF OPERATIONS

The following discussion of financial condition and results of operations should
be read in conjunction with our condensed consolidated financial statements and
notes thereto and other financial information included elsewhere in this Form
10-Q.


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Results of Consolidated Operations (in thousands, except for per share amounts):


                                          Three Months Ended  Nine Months Ended
                                          September 30,       September 30,


                                          2020      2019      2020      2019

Service revenue                            $3,654    $3,259    $10,747   $9,414
Product revenue                            489       343       1,317     1,294
 Total revenue                             $4,143    $3,602    $12,064   $10,708
Income before income taxes                 134       334       788       918
Income tax provision                       (3)       -         (9)       (7)
Net income                                 131       334       779       911
Basic earnings per share                   $0.01     $0.02     $0.05     $0.06
Diluted earnings per share                 $0.01     $0.02     $0.05     $0.06

Three months ended September 30, 2020 compared to three months ended September 30, 2019

Service revenue

Service revenue consists primarily of fees collected for cloud
telecommunications services, professional services, interest from sales-type
leases, reselling broadband Internet services, administrative fees, website
hosting, and web management services. Service revenue increased 12% or $395,000,
to $3,654,000 for the three months ended September 30, 2020 as compared to
$3,259,000 for the three months ended September 30, 2019. Cloud
Telecommunications service revenue increased 14% or $425,000, to $3,525,000 for
the three months ended September 30, 2020 as compared to $3,100,000 for the
three months ended September 30, 2019. Web service revenue decreased 19% or
$30,000, to $129,000 for the three months ended September 30, 2020 as compared
to $159,000 for the three months ended September 30, 2019.

Product Revenue

Product revenue consists primarily of fees collected from the sale of desktop
phone devices and third-party equipment. Product revenue increased by 43% or
$146,000, to $489,000 for the three months ended September 30, 2020 as compared
to $343,000 for the three months ended September 30, 2019. Product revenue
fluctuates from one period to the next based on timing of installations. Our
typical customer installation is complete within 30-60 days. However, larger
enterprise customers can take multiple months, depending on size and the number
of locations. Product revenue is recognized when products have been installed
and services commence.

Income Before Income Taxes

Income before income taxes decreased 60% or $200,000, to $134,000 for the three
months ended September 30, 2020 as compared to $334,000 for the three months
ended September 30, 2019. The decrease in income before income tax is primarily
due to an increase in operating expenses of $722,000 and an increase in interest
expense and other expense of $19,000, offset by an increase in revenue of
$541,000.

Income Tax Provision

We had an income tax provision of $3,000 for the three months ended September
30, 2020 compared to an income tax provision of $0 for the three months ended
September 30, 2019. We had pre-tax income for the three months ended September
30, 2020 and 2019 of $134,000 and $334,000, respectively, and a full valuation
allowance on all of our deferred tax assets for the three months ended September
30, 2020 and 2019.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019

Service revenue

Service revenue consists primarily of fees collected for cloud
telecommunications services, professional services, interest from sales-type
leases, broadband Internet services, administrative fees, website hosting, and
web management services. Service revenue increased 14% or $1,333,000, to
$10,747,000 for the nine months ended September 30, 2020 as compared to
$9,414,000 for the nine months ended September 30, 2019. Cloud
Telecommunications service revenue increased 16% or $1,414,000, to $10,326,000
for the nine months ended September 30, 2020 as compared to $8,912,000 for the
nine months ended September 30, 2019. Web service revenue decreased 16% or
$81,000, to $421,000 for the nine months ended September 30, 2020 as compared to
$502,000 for the nine months ended September 30, 2019.


                                       26


Product Revenue

Product revenue consists primarily of fees collected from the sale of desktop
phone devices and third-party equipment. Product revenue increased by 2% or
$23,000, to $1,317,000 for the nine months ended September 30, 2020 as compared
to $1,294,000 for the nine months ended September 30, 2019. Product revenue
fluctuates from one period to the next based on timing of installations. Our
typical customer installation is complete within 30-60 days. However, larger
enterprise customers can take multiple months, depending on size and the number
of locations. Product revenue is recognized when products have been installed
and services commence.

Income Before Income Taxes

Income before income tax decreased 14% or $130,000, to $788,000 for the nine
months ended September 30, 2020 as compared to $918,000 for the nine months
ended September 30, 2019. The decrease in income before income tax is primarily
due to an increase in operating expenses of $1,406,000 and an increase in
interest expense of $45,000 and other expense of $35,000, offset by an increase
in revenue of $1,356,000.

Income Tax Provision

We had an income tax provision of $9,000 for the nine months ended September 30,
2020 compared to an income tax provision of $7,000 for the nine months ended
September 30, 2019. We had pre-tax income for the nine months ended September
30, 2020 and 2019 of $788,000 and $918,000, respectively, and a full valuation
allowance on all of our deferred tax assets for the nine months ended September
30, 2020 and 2019.

USE OF NON-GAAP FINANCIAL MEASURES

To evaluate our business, we consider and use non-generally accepted accounting
principles ("Non-GAAP") net income and Adjusted EBITDA as a supplemental measure
of operating performance. These measures include the same adjustments that
management takes into account when it reviews and assesses operating performance
on a period-to-period basis. We consider Non-GAAP net income to be an important
indicator of overall business performance because it allows us to evaluate
results without the effects of share-based compensation and amortization of
intangibles. We define EBITDA as U.S. GAAP net income before interest income,
interest expense, other income and expense, provision for income taxes, and
depreciation and amortization. We believe EBITDA provides a useful metric to
investors to compare us with other companies within our industry and across
industries. We define Adjusted EBITDA as EBITDA adjusted for share-based
compensation. We use Adjusted EBITDA as a supplemental measure to review and
assess operating performance. We also believe use of Adjusted EBITDA facilitates
investors' use of operating performance comparisons from period to period, as
well as across companies.

In our November 10, 2020 earnings press release, as furnished on Form 8-K, we
included Non-GAAP net income, EBITDA and Adjusted EBITDA. The terms Non-GAAP net
income, EBITDA, and Adjusted EBITDA are not defined under U.S. GAAP, and are not
measures of operating income, operating performance or liquidity presented in
analytical tools, and when assessing our operating performance, Non-GAAP net
income, EBITDA, and Adjusted EBITDA should not be considered in isolation, or as
a substitute for net income or other consolidated income statement data prepared
in accordance with U.S. GAAP. Some of these limitations include, but are not
limited to:

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EBITDA and Adjusted EBITDA do not reflect our cash expenditures or future
requirements for capital expenditures or contractual commitments;
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they do not reflect changes in, or cash requirements for, our working capital
needs;
?
they do not reflect the interest expense, or the cash requirements necessary to
service interest or principal payments, on our debt that we may incur;
?
they do not reflect income taxes or the cash requirements for any tax payments;
?
although depreciation and amortization are non-cash charges, the assets being
depreciated and amortized will be replaced sometime in the future, and EBITDA
and Adjusted EBITDA do not reflect any cash requirements for such replacements;
?
while share-based compensation is a component of operating expense, the impact
on our financial statements compared to other companies can vary significantly
due to such factors as the assumed life of the options and the assumed
volatility of our common stock; and
?
other companies may calculate EBITDA and Adjusted EBITDA differently than we do,
limiting their usefulness as comparative measures.

We compensate for these limitations by relying primarily on our U.S. GAAP
results and using Non-GAAP net income, EBITDA, and Adjusted EBITDA only as
supplemental support for management's analysis of business performance. Non-GAAP
net income, EBITDA and Adjusted EBITDA are calculated as follows for the periods
presented.


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RECONCILIATION OF NON-GAAP FINANCIAL MEASURES

In accordance with the requirements of Regulation G issued by the SEC, we are
presenting the most directly comparable U.S. GAAP financial measures and
reconciling the unaudited Non-GAAP financial metrics to the comparable U.S. GAAP
measures.

         Reconciliation of U.S. GAAP Net Income to Non-GAAP Net Income
                                  (Unaudited)


                                            Three Months Ended September 30,  Nine Months Ended September 30,


                                            2020             2019             2020             2019


                                            (In thousands)                    (In thousands)

U.S. GAAP net income                         $131             $334             $779             $911
Share-based compensation                     136              107              377              293

Amortization of intangible assets            23               13               69               40
Non-GAAP net income                          $290             $454             $1,225           $1,244

Non-GAAP earnings per common share:
Basic                                        $0.02            $0.03            $0.08            $0.09
Diluted                                      $0.02            $0.03            $0.07            $0.08

Weighted-average common shares outstanding:
Basic                                        15,244,804       14,663,151       15,058,192       14,507,696
Diluted                                      17,249,035       15,629,647       16,793,896       15,444,063



      Reconciliation of U.S. GAAP Net Income to EBITDA to Adjusted EBITDA
                                  (Unaudited)


                                          Three Months Ended  Nine Months Ended
                                          September 30,       September 30,


                                          2020      2019      2020      2019


                                          (In thousands)      (In thousands)

U.S. GAAP net income                       $131      $334      $779      $911
Depreciation and amortization              57        25        197       69
Interest expense                           23        1         54        9
Interest and other expense/(income)        (2)       1         25        (10)
Income tax provision                       3         -         9         7
EBITDA                                     212       361       1,064     986
Share-based compensation                   136       107       377       293
Adjusted EBITDA                            $348      $468      $1,441    $1,279

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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. Please see Note 1 of Part I, Item 1 of this
quarterly report on Form 10-Q for a summary of significant accounting policies.
In addition, the estimates, assumptions and judgments involved in our accounting
policies described in critical accounting policies and estimates are disclosed
in our Annual Report on Form 10-K for the year ended December 31, 2019.


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Segment Operating Results

The Company has two operating segments, which consist of Cloud
Telecommunications and Web Services. The information below is organized in
accordance with our two reportable segments. Segment operating income is equal
to segment net revenue less segment cost of service revenue, cost of product
revenue, sales and marketing, research and development, and general and
administrative expenses.

Operating Results of our Cloud Telecommunications Segment (in thousands):

                                          Three Months Ended  Nine Months Ended
                                          September 30,       September 30,


                                          2020      2019      2020      2019
Cloud Telecommunications
Service revenue                            $3,525    $3,100    $10,326   $8,912
Product revenue                            489       343       1,317     1,294
Total revenue                              $4,014    $3,443    $11,643   $10,206
Operating expenses:
Cost of service revenue                    $930      $811      $2,758

$2,515

Cost of product revenue                    314       172       797       

664

Research and development                   318       207       816       

600

Selling and marketing                      1,051     1,003     3,151     

2,865

General and administrative                 1,277     974       3,382     2,870
Total operating expenses                   3,890     3,167     10,904    9,514
Operating income                           124       276       739       692
Other income/(expense)                     (20)      2         (47)      (2)
Income before tax provision                $104      $278      $692

$690

Three months ended September 30, 2020 compared to three months ended September 30, 2019

Service Revenue

Cloud Telecommunications service revenue consists primarily of fees collected
for cloud telecommunications services, professional services, interest from
sales-type leases, administrative fees, and reselling broadband Internet
services. Service revenue increased 14% or $425,000, to $3,525,000 for the three
months ended September 30, 2020 as compared to $3,100,000 for the three months
ended September 30, 2019. The increase in service revenue is due to an increase
in contracted service revenue and usage charges of $369,000, an increase in
fees, commissions, and other, recognized over time of $68,000, and an increase
in sales-type lease interest of $29,000, offset by a decrease in one time fees,
commissions and other of $41,000. A substantial portion of Cloud
Telecommunications service revenue is generated through thirty-six to sixty
month service contracts.

Product Revenue

Product revenue consists primarily of fees collected from the sale of desktop
phone devices and third-party equipment. Product revenue increased 43% or
$146,000, to $489,000 for the three months ended September 30, 2020 as compared
to $343,000 for the three months ended September 30, 2019. Product revenue
fluctuates from one period to the next based on timing of installations. Our
typical customer installation is complete within 30-60 days. However, larger
enterprise customers can take multiple months, depending on size and the number
of locations. Product revenue is recognized when products have been installed
and services commence. Additionally, product revenue can fluctuate due to the
allocation of discounts across the performance obligations, primarily due to
sales promos.

Backlog

Backlog represents the total contract value of all contracts signed, less
revenue recognized from those contracts as of September 30, 2020 and 2019.
Backlog increased 12% or $2,978,000 to $28,313,000 as of September 30, 2020 as
compared to $25,335,000 as of September 30, 2019. Below is a table which
displays the Cloud Telecommunications segment revenue backlog as of July 1, 2020
and 2019, and September 30, 2020 and 2019, which we expect to recognize as
revenue within the next thirty-six to sixty months (in thousands):

Cloud Telecommunications backlog as of July 1, 2020 $27,349 Cloud Telecommunications backlog as of September 30, 2020 $28,313

Cloud Telecommunications backlog as of July 1, 2019 $24,772 Cloud Telecommunications backlog as of September 30, 2019 $25,335

                                       29


Cost of Service Revenue

Cost of service revenue consists primarily of fees we pay to third-party
telecommunications carriers, broadband Internet providers, software providers,
costs related to installations, credit card processing fees, shipping charges,
customer support salaries and benefits, and share-based compensation. Cost of
service revenue increased 15% or $119,000, to $930,000 for the three months
ended September 30, 2020 as compared to $811,000 for the three months ended
September 30, 2019. The increase in cost of service revenue was primarily due to
an increase in salaries and benefits of $55,000 as a result of an increase in
customer support and implementation headcount and temporary labor, an increase
in bandwidth costs of $38,000 from an increase in service revenue, an increase
in credit card processing fees of $8,000, an increase in share-based
compensation of $5,000, an increase in shipping charges of $4,000, an increase
in costs related to professional installation services of $4,000, and an
increase in other cost of service revenue of $5,000. These increases are
directly related to the growth in monthly recurring revenue.

Cost of Product Revenue

Cost of product revenue consists of the costs associated with desktop phone devices and third-party equipment. Cost of product revenue increased 83% or $142,000, to $314,000 for the three months ended September 30, 2020 as compared to $172,000 for the three months ended September 30, 2019. The increase is primarily due to the increase in product revenue, offset by an increase in device costs and an increase in product warranty costs.

Research and Development

Research and development expenses primarily consist of salaries and benefits,
share-based compensation, and outsourced engineering services related to the
development of new cloud telecommunications features and products. Research and
development expenses increased 54% or $111,000, to $318,000 for the three months
ended September 30, 2020 as compared to $207,000 for the three months ended
September 30, 2019. There was an increase in salaries and benefits of $82,000 as
a result of an increase in headcount as we continue to invest in our solution,
an increase in costs for maintenance on our customer user interface, our Android
and iPhone mobile phone applications, and Java development of $23,000, and an
increase in share-based compensation of $6,000.

Selling and Marketing

Selling and marketing expenses consist primarily of direct and channel sales
representative salaries and benefits, share-based compensation, partner channel
commissions, amortization of costs to acquire contracts, travel expenses, lead
generation services, trade shows, internal and third-party marketing costs, the
production of marketing materials, and sales support software. Selling and
marketing expenses increased 5% or $48,000, to $1,051,000 for the three months
ended September 30, 2020 as compared to $1,003,000 for the three months ended
September 30, 2019. The increase in selling and marketing expense is due to an
increase in commission expense of $50,000 directly related to an increase in
revenue, an increase in salaries and benefits of $38,000 primarily related to
the addition of one sales rep and a new director of marketing, and an increase
in share-based compensation of $2,000, offset by a decrease in travel related
expenses of $27,000, a decrease in bad debt expense of $8,000, and a decrease in
other sales and marketing expense of $7,000.

General and Administrative

General and administrative expenses consist of salaries and benefits for
executives, administrative personnel, legal, rent, equipment, accounting and
other professional services, investor relations, and other administrative
corporate expenses. General and administrative expenses increased 31% or
$303,000, to $1,277,000 for the three months ended September 30, 2020 as
compared to $974,000 for the three months ended September 30, 2019. Consolidated
general and administrative expenses increased 30% or $311,000, to $1,351,000 for
the three months ended September 30, 2020 as compared to $1,040,000 for the
three months ended September 30, 2019. As Web Services segment revenue has
decreased and Cloud Telecommunications segment revenue has increased, a higher
percentage of general and administrative costs are being allocated to the Cloud
Telecommunications segment. Therefore, we will discuss changes in our
consolidated general and administrative expenses. The increase in consolidated
general and administrative expenses is primarily due to an increase in stock
exchange uplisting and annual fees of $89,000 related to our uplisting from the
OTCQX marketplace to the Nasdaq Capital Markets, an increase in administrative
salaries and benefits of $73,000, an increase in recruiting fees of $55,000, an
increase in legal fees of $37,000, an increase in contractor costs of $33,000,
an increase in telecommunication fees of $20,000, an increase in depreciation
expense of $20,000, an increase in share-based compensation of $17,000, an
increase in software expense of $14,000, an increase in computer, office
equipment, and data center maintenance costs of $11,000, an increase in
intangible amortization expense of $10,000 related to the DoubleHorn asset
acquisition, and an increase in other administrative corporate expenses of
$7,000, offset by a decrease in rent expense of $75,000 related to the purchase
of our corporate office building.


                                       30


Other Income/(Expense)

Other income/(expense) primarily relates to the allocated portions of interest
expense offset by credit card cash back rewards. Other expenses increased
1,100%, or $22,000, to $(20,000) for the three months ended September 30, 2020
as compared to $2,000 of net other income for the three months ended September
30, 2019. The increase in other expenses is related to our increase in interest
expense from our outstanding notes payables and a decrease in credit card cash
back rewards of $2,000.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019

Service Revenue

Cloud Telecommunications service revenue consists primarily of fees collected
for cloud telecommunications services, professional services, interest from
sales-type leases, administrative fees, and broadband Internet services. Service
revenue increased 16% or $1,414,000, to $10,326,000 for the nine months ended
September 30, 2020 as compared to $8,912,000 for the nine months ended September
30, 2019. The increase in service revenue is due to an increase in contracted
service revenue and usage charges of $1,372,000, an increase in fees,
commissions, and other, recognized over time of $151,000, and an increase in
sales-type lease interest of $77,000, offset by a decrease in one time fees,
commissions and other of $186,000 related to a higher volume of site surveys and
installation service revenue in the first quarter of 2019. A substantial portion
of Cloud Telecommunications service revenue is generated through thirty-six to
sixty month service contracts.

Product Revenue

Product revenue consists primarily of fees collected from the sale of desktop
phone devices and third-party equipment. Product revenue increased 2% or
$23,000, to $1,317,000 for the nine months ended September 30, 2020 as compared
to $1,294,000 for the nine months ended September 30, 2019. Product revenue
fluctuates from one period to the next based on timing of installations. Our
typical customer installation is complete within 30-60 days. However, larger
enterprise customers can take multiple months, depending on size and the number
of locations. Product revenue is recognized when products have been installed
and services commence. Additionally, product revenue can fluctuate due to the
allocation of discounts across the performance obligations, primarily due to
sales promos.

Backlog

Backlog represents the total contract value of all contracts signed, less
revenue recognized from those contracts as of September 30, 2020 and 2019.
Backlog increased 12% or $2,978,000 to $28,313,000 as of September 30, 2020 as
compared to $25,335,000 as of September 30, 2019. Below is a table which
displays the Cloud Telecommunications segment revenue backlog as of January 1,
2020 and 2019, and September 30, 2020 and 2019, which we expect to recognize as
revenue within the next thirty-six to sixty months (in thousands):

Cloud Telecommunications backlog as of January 1, 2020 $26,110 Cloud Telecommunications backlog as of September 30, 2020 $28,313

Cloud Telecommunications backlog as of January 1, 2019 $23,029 Cloud Telecommunications backlog as of September 30, 2019 $25,335

Cost of Service Revenue

Cost of service revenue consists primarily of fees we pay to third-party
telecommunications carriers, broadband Internet providers, software providers,
costs related to installations, credit card processing fees, shipping charges,
customer support salaries and benefits, and share-based compensation. Cost of
service revenue increased 10% or $243,000, to $2,758,000 for the nine months
ended September 30, 2020 as compared to $2,515,000 for the nine months ended
September 30, 2019. The increase in cost of service revenue is primarily due to
an increase in bandwidth costs of $136,000, an increase in salaries and benefits
of $123,000 as a result of an increase in customer support and implementation
headcount and temporary labor, an increase in profit sharing costs of $33,000,
an increase in credit card processing fees of $30,000, an increase in
share-based compensation of $20,000, an increase in shipping charges of $9,000,
an increase in other cost of service revenue of $6,000, and an increase in
project management software costs of $4,000, offset by a decrease in costs
related to professional installation services of $118,000. These increases are
directly related to the growth in monthly recurring revenue.


                                       31


Cost of Product Revenue

Cost of product revenue consists of the costs associated with desktop phone devices and third-party equipment. Cost of product revenue increased 20% or $133,000, to $797,000 for the nine months ended September 30, 2020 as compared to $664,000 for the nine months ended September 30, 2019. The increase is primarily due to the increase in product revenue, offset by an increase in device costs and an increase in product warranty costs.

Research and Development

Research and development expenses primarily consist of salaries and benefits,
share-based compensation, and outsourced engineering services, related to the
development of new cloud telecommunications features and products. Research and
development expenses increased 36% or $216,000, to $816,000 for the nine months
ended September 30, 2020 as compared to $600,000 for the nine months ended
September 30, 2019. The increase is primarily due to an increase in costs for
maintenance on our customer user interface, our Android and iPhone mobile phone
applications, and Java development of $98,000, an increase of $97,000 in
salaries and benefits as a result of an increase in headcount as we continue to
invest in our solution, an increase in share-based compensation of $14,000, and
an increase in allocated profit sharing costs of $7,000.

Selling and Marketing

Selling and marketing expenses consist primarily of direct and channel sales
representative salaries and benefits, share-based compensation, partner channel
commissions, amortization of costs to acquire contracts, travel expenses, lead
generation services, trade shows, third-party marketing services, the production
of marketing materials, and sales support software. Selling and marketing
expenses increased 10% or $286,000, to $3,151,000 for the nine months ended
September 30, 2020 as compared to $2,865,000 for the nine months ended September
30, 2019. The increase in selling and marketing expense is due to an increase in
commission expense of $155,000 directly related to an increase in revenue, an
increase in salaries and benefits of $147,000 primarily related to the addition
of one sales rep and a new director of marketing, an increase in bad debt
expense of $19,000, an increase in tradeshow related expense of $18,000, and an
increase in share-based compensation of $14,000, offset by a decrease in travel
related expenses of $56,000 and a decrease in other sales and marketing expenses
of $11,000.

General and Administrative

General and administrative expenses consist of salaries and benefits for
executives, administrative personnel, legal, rent, equipment, accounting and
other professional services, investor relations, and other administrative
corporate expenses. General and administrative expenses increased 18% or
$512,000, to $3,382,000 for the nine months ended September 30, 2020 as compared
to $2,870,000 for the nine months ended September 30, 2019. Consolidated general
and administrative expenses increased 18%, or $534,000 to $3,585,000 for the
nine months ended September 30, 2020 as compared to $3,051,000 for the nine
months ended September 30, 2019. As Web Services segment revenue has decreased
and Cloud Telecommunications segment revenue has increased, a higher percentage
of general and administrative costs are being allocated to the Cloud
Telecommunications segment. Therefore, we will discuss changes in our
consolidated general and administrative expenses. The increase in consolidated
general and administrative expenses is primarily due to an increase in
administrative salaries and benefits of $143,000, an increase in depreciation
expense of $98,000 from an acceleration of leasehold improvements amortization
and depreciation of the corporate office building directly related to the
purchase of the corporate office building and from depreciation of additional
datacenter related licenses, an increase in stock exchange uplisting and annual
fees of $94,000 related to our uplisting from the OTCQX marketplace to the
Nasdaq Capital Markets, an increase in recruiting fees of $70,000, an increase
in telecommunication fees of $55,000, an increase in contractor costs of
$54,000, an increase in software expense of $48,000, an increase in legal fees
of $43,000, an increase in share-based compensation of $36,000, an increase in
computer, office equipment, and data center maintenance costs of $35,000, an
increase in intangible amortization expense of $29,000 related to the DoubleHorn
asset acquisition, an increase in profit sharing costs of $12,000, an increase
in corporate insurance costs of $8,000, an increase in other administrative
corporate expenses of $8,000, an increase in board of director fees of $6,000,
an increase in closing and inspection fees related to the building purchase of
$5,000, offset by a decrease in rent expense of $200,000 related to the purchase
of our corporate office building and a decrease in accounting fees of $10,000.

Other Expense

Other expense primarily relates to the allocated portions of interest expense
offset by credit card cash back rewards. Net other expense increased 2,250%, or
$45,000, to $47,000 for the nine months ended September 30, 2020 as compared to
$2,000 for the nine months ended September 30, 2019. The increase in other
expense is due to an increase in allocated interest expense of $43,000 for
interest paid on finance agreements and a decrease in credit card cash back

rewards of $2,000.


                                       32

Operating Results of Web Services segment (in thousands):

                                          Three Months Ended  Nine Months Ended
                                          September 30,       September 30,


                                          2020      2019      2020      2019
Web Services
Service revenue                            $129      $159      $421      $502
Operating expenses:
Cost of service revenue                    16        25        66        72
Research and development                   8         8         24        24
General and administrative                 74        66        203       181
Total operating expenses                   98        99        293       277
Operating income                           31        60        128       225
Other income/(expense)                     (1)       (4)       (32)      3
Income before tax provision                $30       $56       $96       $228

Three months ended September 30, 2020 compared to three months ended September 30, 2019

Service Revenue

Service revenue is generated primarily through website hosting and professional
web management services. Web Services segment revenue decreased 19% or $30,000,
to $129,000 for the three months ended September 30, 2020 as compared to
$159,000 for the three months ended September 30, 2019. The decrease in service
revenue is primarily due to a decrease in hosting revenue of $30,000.

Cost of Service Revenue

Cost of service revenue consists primarily of bandwidth, web domain registration
fees, customer service salaries and benefits, temporary labor cost, and credit
card processing fees. Cost of service revenue decreased 36% or $9,000, to
$16,000 for the three months ended September 30, 2020 as compared to $25,000 for
the three months ended September 30, 2019. The decrease in cost of service
revenue is primarily related to a decrease in customer service salaries and
benefits and temporary labor of $7,000, a decrease in web domain registration
fees of $1,000, and a decrease in credit card fees of $1,000, directly related
to the decrease in revenue.

 Research and Development

Research and development expenses primarily consist of salaries and benefits,
and related expenses which are attributable to the development of our website
development software products. Research and development expenses were $8,000 for
the three months ended September 30, 2020 as compared to $8,000 for the three
months ended September 30, 2019.

General and Administrative

General and administrative expenses consist of salaries and benefits for
executives, administrative personnel, legal, rent, equipment, accounting and
other professional services, investor relations, and other administrative
corporate expenses. General and administrative expenses increased 12% or $8,000,
to $74,000 for the three months ended September 30, 2020 as compared to $66,000
for the three months ended September 30, 2019. Consolidated general and
administrative expenses increased 30% or $311,000, to $1,351,000 for the three
months ended September 30, 2020 as compared to $1,040,000 for the three months
ended September 30, 2019. As Web Services segment revenue has decreased and
Cloud Telecommunications segment revenue has increased, a higher percentage of
general and administrative costs are being allocated to the Cloud
Telecommunications segment. Therefore, we will discuss changes in our
consolidated general and administrative expenses. The increase in consolidated
general and administrative expenses is primarily due to an increase in stock
exchange uplisting and annual fees of $89,000 related to our uplisting from the
OTCQX marketplace to the Nasdaq Capital Markets, an increase in administrative
salaries and benefits of $73,000, an increase in recruiting fees of $55,000, an
increase in legal fees of $37,000, an increase in contractor costs of $33,000,
an increase in telecommunication fees of $20,000, an increase in depreciation
expense of $20,000, an increase in share-based compensation of $17,000, an
increase in software expense of $14,000, an increase in computer, office
equipment, and data center maintenance costs of $11,000, an increase in
intangible amortization expense of $10,000 related to the DoubleHorn asset
acquisition, and an increase in other administrative corporate expenses of
$7,000, offset by a decrease in rent expense of $75,000 related to the purchase
of our corporate office building.


                                       33


Other Expense

Other expense primarily relates to interest income, foreign exchange gains or
losses, the allocated portions of interest expense, and credit card cash back
rewards. Net other expense decreased 75% or $3,000, to $1,000 for the three
months ended September 30, 2020 as compared to $4,000 for the three months ended
September 30, 2019. The decrease in net other expense is due to a $5,000
decrease in foreign exchange losses offset by an increase in allocated interest
expense of $1,000 for interest on finance agreements and a $1,000 decrease in
interest income.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019

Service Revenue

Service revenue is generated primarily through website hosting and professional
web management services. Web Services segment revenue decreased 16% or $81,000,
to $421,000 for the nine months ended September 30, 2020 as compared to $502,000
for the nine months ended September 30, 2019. The decrease in service revenue is
primarily due to a decrease in hosting revenue of $88,000 offset by an increase
in professional web management services of $7,000.

Cost of Service Revenue

Cost of service revenue consists primarily of bandwidth, web domain registration
fees, customer service salaries and benefits, temporary labor cost, and credit
card processing fees. Cost of service revenue decreased 8% or $6,000, to $66,000
for the nine months ended September 30, 2020 as compared to $72,000 for the nine
months ended September 30, 2019. The decrease in cost of service revenue is
primarily related to a decrease in web domain registration fees of $3,000 and a
decrease in credit card fees of $3,000, directly related to the decrease in
revenue.

Research and Development

Research and development expenses primarily consist of salaries and benefits,
and related expenses which are attributable to the development of our website
development software products. Research and development expenses were $24,000
for the nine months ended September 30, 2020 as compared to $24,000 for the nine
months ended September 30, 2019.

General and Administrative

General and administrative expenses consist of salaries and benefits for
executives, administrative personnel, legal, rent, equipment, accounting and
other professional services, investor relations, and other administrative
corporate expenses. General and administrative expenses increased 12% or
$22,000, to $203,000 for the nine months ended September 30, 2020 as compared to
$181,000 for the nine months ended September 30, 2019. Consolidated general and
administrative expenses increased 18%, or $534,000 to $3,585,000 for the nine
months ended September 30, 2020 as compared to $3,051,000 for the nine months
ended September 30, 2019. As Web Services segment revenue has decreased and
Cloud Telecommunications segment revenue has increased, a higher percentage of
general and administrative costs are being allocated to the Cloud
Telecommunications segment. Therefore, we will discuss changes in our
consolidated general and administrative expenses. The increase in consolidated
general and administrative expenses is primarily due to an increase in
administrative salaries and benefits of $143,000, an increase in depreciation
expense of $98,000 from an acceleration of leasehold improvements amortization
and depreciation of the corporate office building directly related to the
purchase of the corporate office building and from depreciation of additional
datacenter related licenses, an increase in stock exchange uplisting and annual
fees of $94,000 related to our uplisting from the OTCQX marketplace to the
Nasdaq Capital Markets, an increase in recruiting fees of $70,000, an increase
in telecommunication fees of $55,000, an increase in contractor costs of
$54,000, an increase in software expense of $48,000, an increase in legal fees
of $43,000, an increase in share-based compensation of $36,000, an increase in
computer, office equipment, and data center maintenance costs of $35,000, an
increase in intangible amortization expense of $29,000 related to the DoubleHorn
asset acquisition, an increase in profit sharing costs of $12,000, an increase
in corporate insurance costs of $8,000, an increase in other administrative
corporate expenses of $8,000, an increase in board of director fees of $6,000,
an increase in closing and inspection fees related to the building purchase of
$5,000, offset by a decrease in rent expense of $200,000 related to the purchase
of our corporate office building and a decrease in accounting fees of $10,000.


                                       34


Other Income/(Expense)

Other income/(expense) primarily relates to interest income, foreign exchange
gains or losses, the allocated portions of interest expense, and credit card
cash back rewards. Net other income decreased 1,167% or $35,000, to $(32,000) of
net other expense for the nine months ended September 30, 2020 as compared to
$3,000 of net other income for the nine months ended September 30, 2019. The
decrease in net other income is due to an increase in net foreign exchange
losses of $32,000 and an increase in allocated interest expense of $3,000 for
interest on finance agreements.

Liquidity and Capital Resources

As of September 30, 2020 and December 31, 2019, we had cash and cash equivalents
of $15,453,000 and $4,280,000, respectively. Changes in cash and cash
equivalents are dependent upon changes in, among other things, working capital
items such as contract liabilities, contract costs, accounts payable, accounts
receivable, prepaid expenses, and various accrued expenses, as well as purchases
of property and equipment, asset acquisitions, and changes in our capital and
financial structure due to debt repayments and issuances, stock option
exercises, sales of equity investments and similar events. We believe that our
operations along with existing liquidity sources will satisfy our cash
requirements for at least the next 12 months.

Working Capital

Working capital increased 384% or $10,911,000 to $13,756,000 as of September 30,
2020 as compared to $2,845,000 at December 31, 2019. The increase in working
capital was primarily related to an increase in cash and cash equivalents of
$11,173,000, an increase in trade receivables, net of allowance for doubtful
accounts of $252,000, an increase in contract assets of $72,000, an increase in
equipment financing receivables of $110,000, an increase in contract costs of
$24,000, an increase in prepaid expenses of $191,000, a decrease in accrued
expenses of $184,000, a decrease in operating lease liabilities of $50,000, a
decrease in contingent consideration of $175,000, and a decrease in contract
liabilities of $8,000, offset by a decrease in inventories of $119,000, a
decrease in income tax receivable of $4,000, an increase in accounts payable of
$128,000, an increase in finance leases of $1,000, an increase in notes payable
of $1,071,000, and an increase in income tax payable of $5,000 during the nine
months ended September 30, 2020.

Cash, Cash Equivalents, and Restricted Cash

Cash, cash equivalents, and restricted cash increased 261% or $11,173,000 to
$15,453,000 at September 30, 2020 as compared to $4,280,000 at December 31,
2019. During the nine months ended September 30, 2020, cash provided by
operating activities was $423,000. Cash used for investing activities was
$921,000, primarily for the purchase of our corporate office building,
datacenter related assets, and a redesigned company website of $745,000 and an
initial asset acquisition payment of $176,000 for customer relationships. Cash
provided by financing activities was $11,671,000, primarily related to proceeds
from notes payable of $1,001,000, proceeds from the exercise of options of
$2,007,000, and proceeds from the issuance of common stock in connection with
our public offering of $8,778,000, offset by $54,000 in contingent consideration
payments for a customer relationship asset acquisition, repayments made on notes
payable of $39,000, and repayments on finance leases of $22,000 during the
period.

Inventories

Inventories decreased 31% or $119,000 to $263,000 at September 30, 2020 as
compared to $382,000 at December 31, 2019. Inventory balances fluctuate based on
timing of installations and inventory shipments. The decrease is primarily due
to the timing of inventory shipments. We feel our inventory balance at September
30, 2020 is sufficient to fulfill future installations.

Prepaid Expenses

Prepaid expenses increased 135% or $191,000 to $332,000 at September 30, 2020 as
compared to $141,000 at December 31, 2019. The increase is related to a $90,000
increase in inventory deposits, $53,000 increase in software services and
support, a $39,000 increase in corporate insurance policies, and a $9,000
increase in other prepaid expense accounts.


                                       35


Trade Receivables

Current and long-term trade receivables, net of allowance for doubtful accounts,
increased 64% or $248,000, to $634,000 as of September 30, 2020 as compared to
$386,000 as of December 31, 2019. Current trade receivables, net of allowance
for doubtful accounts, increased 66% or $252,000, to $632,000 as of September
30, 2020 as compared to $380,000 as of December 31, 2019. The increase in
current trade receivables can primarily be attributed to a number of customers
carrying a balance as of September 30, 2020 related to a slowdown in collections
resulting from COVID-19. The Company took the FCC's Keep Americans Connected
Pledge in response to the COVID-19 pandemic to not shut off customers for
non-payment. Long-term trade receivables, net of allowance for doubtful
accounts, decreased 67% or $4,000, to $2,000 as of September 30, 2020 as
compared to $6,000 as of December 31, 2019. The decrease is primarily due to the
receipt of monthly installment payments.

Accounts Payable and Accrued Expenses

Accounts payable increased 149% or $128,000 to $214,000 at September 30, 2020 as
compared to $86,000 at December 31, 2019. The aging of accounts payable as of
September 30, 2020 were generally within our vendors' terms of payment. The
increase is primarily related to the timing of check processing schedule.

Accrued expenses decreased 10% or $184,000 to $1,570,000 at September 30, 2020
as compared to $1,754,000 at December 31, 2019. The decrease is related to a
$200,000 decrease in accrued bonuses due to the payout of the 2019 Profit
Sharing Plan, a $176,000 decrease in accrued asset acquisition costs, a $108,000
decrease in accrued telecommunications and sales tax accrual, and a $62,000
decrease in accrued salaries, offset by a $179,000 increase in accrued invoices,
an $89,000 increase in accrued paid time off, a $55,000 increase in partner
commissions, a $12,000 increase in 401k accrued contributions, a $10,000
increase in warranty reserve, and a $17,000 increase in other accrued expenses.

Notes Payable

Notes payables increased $2,962,000 to $2,962,000 at September 30, 2020 as
compared to $0 at December 31, 2019. The increase in notes payable is related to
the $1,961,000 note payable for the purchase of the corporate office building,
and a $1,001,000 note payable related to the Paycheck Protection Program loan.

Finance Lease

Finance lease obligations decreased 19% or $22,000, to $94,000 as of September
30, 2020 as compared to $116,000 at December 31, 2019. The decrease in finance
lease obligations can be attributed to payments made on financing contracts

of
$22,000.

Contingent Consideration

Contingent consideration decreased 100% or $175,000 to $0 at September 30, 2020
as compared to $175,000 at December 31, 2019. The decrease is due to $54,000 in
earn-out payments and a $121,000 adjustment to the total consideration payable
under the customer relationships asset purchase agreement.

Operating Lease Liabilities

Operating lease liabilities decreased 98% or $50,000 to $1,000 at September 30,
2020 as compared to $51,000 at December 31, 2019. The decrease is related to the
expiration of the corporate office lease due to the purchase of the building in
January 2020.

Contract Liabilities

Contract liabilities increased 2% or $19,000 to $1,233,000 at September 30, 2020
as compared to $1,214,000 at December 31, 2019. The increase is from an increase
in the prorated portion of monthly invoices with service dates in future periods
for customers added during the period and an increase in down payments of
uninstalled contracts. Our typical customer installation is complete within
30-60 days. However, larger enterprise customers can take multiple months,
depending on size and the number of locations

Capital

Total stockholders' equity increased 269% or $11,796,000, to $16,183,000 as of
September 30, 2020 as compared to $4,387,000 at December 31, 2019. The increase
in total stockholders' equity was attributable to net income of $779,000, and
increases in additional paid-in capital of $2,007,000 from stock option
exercises, $8,633,000 from the issuance of common stock related to an offering,
and $377,000 in share-based compensation for options issued to employees.


                                       36

Off Balance Sheet Arrangements

As of, September 30, 2020, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

RELATED PARTY TRANSACTIONS

We leased our corporate office building in Tempe, Arizona from a Company that is
owned by the major shareholder and CEO of the Company, a related party. On March
1, 2017, the lease agreement was renewed for a three year term with monthly rent
payments of $25,000. As of December 31, 2019, we initiated the process to
purchase our corporate office building and gave notice that we will not be
exercising our option to renew for another three year term. On January 27, 2020,
the Company entered into an agreement to purchase our corporate office building
located at 1615 S 52nd St, Tempe, AZ 85281 from a Company that is owned by the
major shareholder and CEO of the Company for $2,500,000. The fair value of the
building was established by an independent appraisal.

Impact of Recent Accounting Pronouncements

The information set forth under Note 1 to the condensed consolidated financial
statements under the caption "Recent Accounting Pronouncements" is incorporated
herein by reference.

Item 3.

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