Good day, ladies and gentlemen, and welcome to the Crexendo First Quarter 2019 Earnings Call. [Operator Instructions] At this time, it's my pleasure to hand the floor over to Mr. Steven G. Mihaylo, Chairman of the Board and CEO. Sir, the floor is yours.

Thank you, Tom. Good afternoon, everyone. I'm Steve Mihaylo, the Chairman and CEO of Crexendo. I want to welcome all of you to the Crexendo First Quarter 2009 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, and 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 provide the safe harbor statement.

Yes, sir. 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 Litigation Reform Act of 1995 provides a safe harbor for such forward-looking statements. All statements made in this conference call, other than the 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 that are subject to risks and uncertainties that could cause actual results to differ materially from those discussed here today. The risk factors are explained in detail in the company's filings with the Securities and Exchange Commission, including the Form 10-K for fiscal year ended December 31, 2018, and the Form 10-Qs 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. And now I'd like to turn the call back to Steve. Steve?

Thank you, Jeff. Obviously, this was a great quarter for Crexendo if you've had a chance to look at our press release. We are now leading the UCaaS industry. We have, what I believe is, the best UCaaS services in the industry with award-winning products, top engineering and customer service. We have continued to work to improve sales and marketing. And these results shall mean that we are on the right track. Crexendo's engineers are currently working to be able to provide our platform to telephone companies and international parties -- partners early next year. We returned our first substantial GAAP profit as a UCaaS provider. We reported net income of $239,000 for the first quarter of 2019 or $.02 per diluted common share. That result compares very favorably to our net loss of $63,000 or breakeven per diluted common share for the first quarter of 2018. We continued strong growth in the Cloud Telecommunications segment, UCaaS service revenue. The first quarter increased by 28% from the first quarter of 2018, which shows the organic business continues to be highly impressive. Our costs have gone up slightly, particularly when compared with our strong growth. We managed costs very carefully and we continue to do that, we will continue to do that. We will very strategically and surgically continue to invest in the business to increase our growth and to make certain our customers continue to have the best products and services in the industry. As you also know, we watch our balance sheet very carefully and that has continued to improve, which is also very important, is a very important metric. Another important substantially improving metric is cash provided by operating activities. The first quarter of 2019, cash increased $294,000 compared to a net loss of $127,000 for the first quarter of 2018. I invite everyone listening to Crexendo's ride the cloud service to give it a try. You will find that you should save substantial amounts of money while having the best quality service that we provide. I have said many times, I believe we have the right team and right products and services. I believe the results that we announced today show my confidence was not misplaced, but was right on the mark. I'm convinced that we can -- we'll continue to grow the business and continue to provide shareholder value. With that, I'd like to turn the call over to Ron Vincent. Ron...

Thanks, Steve.

Give us some -- upgrade on the numbers please.

Well, consolidated revenue for the first quarter of 2019 increased 24% to $3.5 million compared to 28 -- $2.8 million for the first quarter of the prior year. Service revenue for the first quarter increased 23% to $3 million compared to $2.4 million reported for the first quarter of the prior year. Our Cloud Telecommunications segment service revenue for the quarter increased 28% or $613,000 to $2.8 million compared to $2.2 million reported for the first quarter of the prior year. Our Web Services segment revenue for the quarter decreased 21% or $47,278,000 compared to $225,000 reported for the first quarter of the prior year. Our product revenue for the first quarter of 2019 increased 32% to $484,000 compared to $366,000 for the first quarter of the prior year. Our consolidated operating expenses for the first quarter of 2019 increased 13% to $3.3 million compared to $2.9 million for the first quarter of the prior year. As Steve mentioned, the company reported a net income of $239,000 or $0.02 per diluted common share compared to a net loss of $63,000 or breakeven per diluted common share for the first quarter of the prior year. On a non-GAAP basis, net income for the first quarter was $343,000 or $0.02 per diluted common share as compared to $17,000 or breakeven per diluted common share for the same period of the prior year. EBITDA for the first quarter was $263,000 compared to a loss of $44,000 for the same period of the prior year. Adjusted EBITDA for the quarter was $354,000 compared to $18,000 for the same period of the prior year. Cash, cash equivalents and restricted cash at March 31, 2019 was $2.2 million compared to $1.9 million at December 31, 2018. Operating activities provided $294,000 of cash, cash equivalents and restricted cash. Our financing activity has used $49,000 of cash, cash equivalents and restricted cash. And with that, I'll turn it over to Doug Gaylor, our President and COO, for additional comments on our operations.

Thanks, Ron. I'm very pleased with the results that we delivered to start of the year and Q1. We had substantial increases in total revenue, telecom revenue, sales bookings, backlog, GAAP income and cash balances, which highlight that we are executing very well on our business plan. We continue to see strong sales bookings in both our partner and direct channels. We have seen a nice increase in larger size transactions with a 550,000 TCD or total contract daily sale of 250,000 TCD sale and multiple other 100,000 K-plus TCD sales during the quarter. Our solution is a perfect fit for multi-location and larger footprint organizations, and our strong larger partners are making good inroads with their existing customers that took these descriptions and converted them over to Crexendos' platform. The success we have seen consistently over the last few quarters is helping to increase the excitement level with our partners as they continue to see their monthly residual income to increase from their sales contributions. Our strong sales bookings for the quarter helped to increase our sales backlog 5% quarter-over-quarter to $24.23 million as well as help fuel a nice cash balance increase to $2.2 million. Our strong GAAP net income of $239,000 is a culmination of consistently managing our plan to grow profitably. With a recurring revenue model, with a relatively fixed cost structure, we are able to manage very close to our budget and thus our confidence in reaching the recent inflection points of non-GAAP and GAAP profitability. We continue to manage our costs well and we saw a 5% increase in operating expenses for the quarter, while posting a 13% increase in revenue for the quarter, highlighting management's constant focus on improving our efficiencies. Our increases in revenues are driven from our sales efforts and the large 28% year-over-year increase in our telecom revenue was a positive indicator on the traction we are making in the market. As I've highlighted multiple times on previous calls, the fact that approximately 70% of the SMB and small enterprise market is still using older legacy premise-based equipment. It means that there's still a tremendous amount of growth opportunity in front of us. It's not a matter of if these businesses will migrate to the cloud, but when. And when they're ready, Crexendo will be at the top of the list of the providers to help them with their migration. We're also excited about expanding our white label program that allows our partners to sell the Crexendo platform as their own platform while branding -- with branding ability and the label powered by Crexendo model. The program allows interested partners to make significantly more selling our solution, as they treat it more as a wholesale resale model as opposed to a revenue share model. We have added additional partners to this program, and we're extremely excited about the future prospects in this offering. We've been focused on getting the GAAP profitability now through growth in managing expenses. And now that we have reached some successful inflection points in our growth, we'll be working even harder to keep these trends and momentum continuing in the same direction. I'm proud of the efforts of the entire Crexendo team and our partners, and I'm very excited and confident on our ability to continue executing on our plans in 2019 and beyond. Now I'll turn it back over to Steve for any additional comments.

Thanks, Doug. Tom, we're ready to open this up to questions, if there are any.

[Operator Instructions] We'll take our first question from Michael Kaufman with MK Investments.

Steve, it's Mike Kaufman. I think you and the team and Doug did an incredible job bringing this home basically within budget with good growth rates. The one thing that people may not understand, which you might want to convey to people in conferences and literature is what is the dollar value of the served market that you're going after? You talk that 70% of the market isn't penetrated yet, but nobody has a feel as to how big this animal can get. And if there's a way to do that, then I think the value of what you're doing will be rewarded more greatly when we open the stock market.

Michael here. First of all, good afternoon. Your question is a very good one. Actually, the worldwide market for what we're doing is probably close to $1 trillion. Just in the U.S., it's probably $100 billion market plus. But we've been reluctant to talk about the size of the market for fear that people would think we're being a little overambitious about the size of the market, but it is absolutely huge. We're doing several things that will get us into the bigger market, with our software licensing program we expect to launch next year some time, that gets us into that market, without the need for investing a lot of money to get into it other than the R&D. It also gets us into a place where we can start charging for, call it, certain areas of the world. And we'll have a little bit lower cost structure than we do now. So that will amount to a good opportunity for us. And we can have multiple partners in each market. That's not to say that we're just going to have 1 or 2. We're going to have multiple partners with some kind of a saturation policy so that we don't get too many partners competing against each other. The other thing we can do with our white label program, which we just started in January or February, is we can private label the phone and put the partner's name on it and allow them to sell under their own brand, which is even less channel conflict than might be available otherwise. So there's a lot of good things happening. Now we haven't really spoken about, but that will allow Crexendo to get really large. I'm going to turn this over to Doug right now so he can talk about the traction we're getting with some of our bigger accounts. In fact, he mentioned some of them when he gave his report, but we're getting accounts that are in the $100,000 range for total contract value routinely and we're getting some that are over $0.5 million. And believe me, as we get bigger, our accounts will get bigger. We have a much lower cost of servicing those accounts, as we might end in smaller ones. And Doug, would you like to add something to that.

Sure, Steve, great comments. And Michael, to Steve's comments, he's exactly right, and the opportunity is still tremendous. If we think about the 70% of the businesses, it still haven't migrated to the cloud and the estimates here in the U.S., it's still about $100 billion market within the next 4, 5 years, just tremendous growth opportunity. And again, from our positioning, we realized that we're one of the smaller players in the market, but with our results today, I can probably say that we're one of the more profitable organizations in the industry. And so we're growing this thing at the right pace right now and growing it profitably. And we're recognizing bigger and better opportunities out there. As Steve said, some of these opportunities that are $0.5 million or $0.25 million total contract value, and they go through a lot of diligence and looking for the right partner. And by far, we stand out above the competition because of our unique aspect of making our own platform, making our own phones, our warranty, our price points and our service and support are second to none. So we really have a unique advantage out there, and we're starting to really accelerate on our partners and our direct sales people taking advantage of the competition because we have a lot of advantages if the competition can hold the candle to.

Thank you, Doug. And 2 other things, Michael. First of all, we have recurring revenue. In other words, we're going to have $14 million, $15 million in revenue this year. And I realized that's a forward statement, so I don't want to get my lawyer. You're excited here. Whether we sell anything or not, we've got a very large backlog of close to $25 million. And last, but not least, we have an attrition rate of 2% or less per year. So we're locked and loaded. I am very optimistic about the future. I hope that answers your question.

It does a long way. And I think, I spent 13 years with Xerox. So the whole idea was to put a new product and have the current base not drift too much. So I think in some of the your presentations, you may talk about the high contract renewal rate or stickiness of the customer. And the fact that this creates an ongoing revenue stream, which is residuals basically that keeps flowing. And so that will build a nice profitable business. The other thing would be to take the elephant and break it down to bite-sized chunks, and say, okay, we're putting our resources to go after these specific submarkets of this giant market, where we see an opportunity because of all benefit statements to do very well. And here's how we're positioning the sales force and whatever else we do for the customer to take these little bites one at a time, and so the investor -- public can understand how this thing is likely to grow without getting scared by the $1 trillion opportunity that would overwhelm any small company.

Yes. You're absolutely right, Michael. Doug Gaylor and Ron Vincent attend most of the conferences that we've been at. And I can assure you that we're doing everything you've mentioned and then some. We're the only company, I think, in the entire industry that adds features, functionality and so on, and we push those out to our customers. When they become a customer, very few things that we charge additional for. We also do nonrecurring engineering for customers in order to get a deal or to retain a deal. And in most cases, we don't charge for it. We make it up in the monthly recurring revenue. In some cases, we do charge for it, but even then, it's a lot less than they could do it by themselves. Do you want to comment...

Yes. the barriers to sell.

Yes, we're doing that and that's why we'll continue to get more and more traction as we go forward here and as we -- as our engineering force and our sales force continue to grow. Doug, do you want to add anything to that?

Yes, just maybe one comment. So we work on an agile software release process, which means that every 8 weeks or so we're coming out with new software enhancements to our platform as opposed to our competition that may come out with one enhancements annually. We are coming out with on average upwards of 6 to 7 releases annually. And the fact that we make our own platform and the fact that we're in control of our own destiny means that we can really jump on any opportunities that we want to from a customization perspective. So the fact we've got our own in-house engineering that is responsible for designing, developing and supporting our platform gives us unique advantage when it comes to unique applications and customizing our solutions. So again, we're very well positioned to have that continued growth and would be able to outmaneuver and outbox the competition.

We'll take our next question from Kevin Dede with H.C. Wainwright.

Long time, no chat. A couple things for you. I'm going to assume that all the top line growth is organic. I was wondering if you could help explain the difference and service versus product revenue? I know, Steve, you touched on the white label product, and I'm wondering if that's helping.

Well, first of all, good afternoon, Kevin. Secondly, the difference between product revenue and service revenue is quite simple. The product revenue is the telephone's signal on the desktop.

Oh, yes, yes, Steve. No, Steve, I understand that. I was just curious why product revenue outpaced service so greatly. And that's why I was wondering if your private labels contributed to that? Or maybe there's something that missing.

From the private label, it's just now starting to get traction, the white label product. It varies depending on whether an end user wants the most expensive phone or a lot of conference phones and so on and so forth. So that's going to vary and it's going to be up and down. It's still a component of only about 15% of our revenue. But most of our revenue is recurring, that's the 85%. And that's for service revenue. I'm going to let Doug answer more color to that since the sales people all report to him.

Kevin, thanks for calling in. So the product revenue does fluctuate a little bit based on the number of product retrenchments we're moving and the composition of those instruments, so we're moving more of our low end. Obviously, the bad news would be maybe a little bit on the smaller side. We're seeing a higher concentration on our higher-end phones lately. And quite frankly, we had a great quarter from a installation perspective, where we moved just a lot of equipment. And that equipment is the product portion of it, not as much associated with the white label. As Steve said, the white label is still fairly new in its infancy. But I don't anticipate those percentages changing much even with the white label program because we still recognize the revenue in those 2 different tranches. So the white label partners also be buying hardware from us and still have the monthly service expenses. But we have seen the hardware fluctuate a little bit from quarter-to-quarter just based on the makeup of the revenue that we're installing. But again, Q1 was a really strong quarter for us with the amount and the size of the opportunities that we're installing and the composition of the hardware that's been installed during in the quarter.

Just on that point, I guess there -- do you think there's some seasonality? Do you think there might be some shake out given the collapse of fusion? What would you -- I mean, what would you expect as you look out at the next 3 quarters this year? And I know you're not comfortable offering projections, but just in terms of seasonality or cyclicality, what could you offer as sort of the larger industry growth factors that seemed to specifically positively effect your March quarter?

Yes, good question. So I think as you look at our business, I don't see a lot of seasonality to our business. I think our business is fairly consistent. Every business out there has a phone system and most of them need our service, and that's kind of in my philosophy from the get go. So when I think about the amount of businesses that are out there and the amount of businesses that are still using legacy equipment, it doesn't matter if it's December, January or March as to whether that they need new equipment. So it's really a matter of the fact that most of people we're talking to were showing a nice return on investment. So they can see an accretive benefit out of our solution right after that. So when I look at the opportunities out there, I think right now, we're in a really, really key position because we're seeing a lot of momentum, we're seeing a lot of activity. Our pipelines are really full right now. And so the opportunities for continued success on the sales look pretty robust right now. Especially when I look at our competition, our competition is having a lot of challenges out there. So if you think about the impulsion of an organization like Fusion. Windstream just filed for bankruptcy. You've got my Mitel and Avaya now talking about joining forces which helped me. It would just create a lot of uncertainty and challenges for that size organization to try and merge with another organization that just came out of bankruptcy. So I look at right now at our competitive landscape and a lot of our competitors are extremely weak and having major challenges. look at our position right now coming and hitting a great GAAP profitable quarter and our strongest quarter that we've ever had, look at where we are positioned right now compared to our competition. And I put the smile on my face because our competition is having a lot of challenges. And that allows us to go out there and talk to them about becoming Crexendo partners and having some of the Avaya and Mitel and Fusion resellers out there and Windstream resellers out there that are worried about the future of their partnerships with their existing organizations. We look at something like Crexendo that's really a newcomer and say, "Hey, these guys look like the real deal." And I don't have to worry about what's going to happen to them in the future.

Okay. So just to take that, just one layer deeper, have you -- I mean have you had or engaged in conversations with partners or potential partners that are trying to shy away from their pre-existing relationships? Can you give us some insight on -- yes, okay, can you give us some insight on how your partnership relationships have grown over the past 12 months?

Yes. We continue to add new partners to our partner base. And so when we talk about what our existing partners consist of, our existing partners and our new partners really fall into 3 different tranches. We've got our traditional interconnect telecom vendors that are selling existing telecom products. We've got managed services and beta bars that would be the second tranche, which are really MSPs and beta bars that don't really have a telecom offering. We're looking at adding telecom offerings into their portfolio. And then we've got third tranche which is business-to-business type organizations that are selling other business services, if you're looking at adding a complementary product or offering to their platform. So when I think about the traditional telecom vendors out there, a lot of them already have long-term relationships. And once they have long-term relationships with Avaya and Mitel and Windstream and Fusion. They've had those relationships in some cases for dozens of years, in other cases for shorter periods of time. But whenever there is change and challenges with the organization, those partners are looking for a true symbiotic relationship. And I could tell you that a lot of the partners, that we bring on that are traditional telecom partners, have had prior relationships with all of the above, whether it's Fusion or Windstream or Mitel or Avaya or ShoreTel, you name it. There's been so many changes in our industry over the last few years, but a lot of these folks are looking for stability. And when we go in there and talk to an existing partner of one of these other vendors, we talked about stability, we talked about our growth plans and our focus. And we're not distracted right now. A lot of our competitors are distracted. So it is helping. We did increase our partner account marginally in Q1, but we are seeing a lot more traction from our existing partners and contingency, great success there. So I couldn't be more pleased with the partner contributions that we're having and the excitement that we're getting out as the partner channel is really starting to catapult as I mentioned in my statements. These partners make bigger and bigger monthly residual commission checks because they keep selling more of our services, and that just tightens the bond that we have with them, where a lot of these traditional telecom vendors, it's won and done, and so they don't have that residual stream. So when they start their relationship with Crexendo, it's all about that residual relationship that Mr. Kaufman asked about earlier when they start making that residual monthly commission month after month after month. Even if they have a poor month, they are still getting a nice commission check from us. Where with the relationship they may have with Avaya and Mitel, if they're not selling anything, they're not making anything.

Okay. Fair enough. Just two other quick ones, Doug. First on backlog, $24 million number, pretty big. I'm wondering how you guys calculate that? And then over what period of time you expect to recognize it?

Yes, great question. So I'll give the opening statement and I'll have -- Ron may add a little color to it. So our backlog consist of all of our contracted obligations. So if we go out and we sell -- just to use an easy example, we sell $8,000 month bill around a 48-month agreement. That's $48,000 worth of total contract value for that account. We only take revenue on that $1,000 at a time on a monthly basis. And so if we sell that account today and we take revenue for the month of April for $4,000, we have $47,000 worth of backlog. So that number continues to grow as we add more contracted value than we're actually taking for revenues. So that number has consistently grown quarter over quarter over quarter for us. A nice increase from Q4 to Q1 of over $1.2 million. So that's a nice increase in backlog. And that number is, hopefully, going to continue to grow nicely. Ron, any color you want to add to that?

Kevin, we present in our footnotes, we actually present a -- the allocation of our remaining performance obligations under our backlog. And so see in there a schedule that shows 2019 of $6.5 million of the backlog will be utilized, $7 million in 2020, $5.3 million in 2021 and so on. And so we really gave a picture of what that backlog means to future periods, and then we make up the difference with new sales. Did that answer your question?

Yes, yes. No, great. Last one before I turn the floor over, sort of two-parts. One is, perhaps options you might consider to, I guess, accelerate growth? And a subset of that is an M&A pipeline. I know that you gentlemen have spoken to considering that and I'm just wondering if your cash flow generation and the shakiness of your competitors has changed your thinking about the -- granted you're very wise conservative financial managers, but I was just curious, as if you thought the industry picture had maybe changed your thinking about how to stimulate growth, particularly with regard to M&A?

Well, this is Steve, Kevin. First of all, some of the -- I would say 99% of the deals we've looked at were way overpriced. We can go out and stimulate growth organically a lot cheaper than we can by acquiring somebody. In a lot of cases, we're just acquiring somebody else's headaches, but there may be some opportunities out there and we'll continue to look. As you may know, the previous company I ran, we did 65 or 70 acquisitions over a period of about 20 years. So that was 3 or 4 a year and 1 a quarter. I'm not suggesting that's going to hold true in this case, but the industry is consolidating and it'll take another year or 2 to firm up and then people have a much more realistic deal of how this is done. However, our white label program is designed to generate acquisition candidates, and this would be for anybody that is a white label customer of ours that doesn't have a family member or a successor in their business and they want a liquidity event. To begin with, they're going to be getting higher margins than just a contract sales person or a contract sales organization. So they're getting a much higher amount of revenue, gross profit margin than an average person would be getting with an average product. And they have relatively little cost involved other than the fact that they have to offload a lot of the expenses that we would normally cover like customer service billing, all of those things, implementation, et cetera, et cetera, but they get a much, much higher gross margin, usually double what the contract sales organizations are getting or maybe even a little bit better than double. So we can afford to acquire something like that for 1 or 1.5x revenue when, in effect, we're having to pay 2 or 3x revenue for an organization that we might not even know, a complete stranger. So I looked at that as something that will kick in probably starting in the end of next year or even the beginning of the following year. Well, we're going to keep looking. We're going to keep checking in the tires, but we're not going overpay for anything. I don't care how great the opportunity looks. We're just not going to spend shareholder money on making foolish decisions. Did you want to add anything to that, Doug?

No, perfectly said, Steve. And Kevin, we talked a lot at some of these conferences. And we're always looking for opportunities, but we're looking for the right opportunities. And so if the right opportunity doesn't come along, we're easily okay with passing on opportunities until we find the right fit. So we're just going to keep looking for the right opportunities. And then in the same time, focus on that organic growth, and that's been working well for us over the last few quarters. And so if we can continue that growth and if we find the right opportunity that layers in there, that's great. If not, you'll continue to see nice organic growth on public organization.

So Doug, just what do you think the implications have been? I mean Steve mentioned that things are -- people are just demanding too much in prices. What do you think the implications are in valuation, given some of the meltdowns that you've seen from the larger companies in the space? And then if we haven't seen them yet, how long do you think before thinking becomes more commonsensical?

Yes, I think it's a matter of what you're leveraging. And so when you look at the acquisition targets that we're looking at, yes, they're obviously smaller in size until we're looking for something that's going to be accretive and profitable right from the get go. If you look at some of the challenges that some of the bigger players have been facing in the industry, they bite off way more than they can chew. And so the amount of debt that they're carrying on their balance sheet is just overwhelming. And so that's the challenge that you got with some of these organizations like the Mitels and the Avayas and the Fusions and the Windstreams of the world, is it -- they just have an overwhelming amount of debt. And as Steve said, we've managed our books extremely well. And so if you look at us today being debt free and profitable, we're going to manage the business. So we're not about to go out there and do an acquisition, it's going to put us with a ton of debt out there that's hard to manage. That's the recipe for disaster that these other organizations have fallen into. We're not going to fall into that same trap. So if we look at the small acquisition, our focus is really finding organizations that are already profitable, that already have an accretive revenue stream that can easily be merged in our organization and grow. We're not going to go out and buy somebody that's 3x our size and leverage the heck of a company and put us in jeopardy of having a Fusion like type impulsion. That's not our MO.

[Operator Instructions] We'll go next to Kevin Walsh, private investor.

I got a question. I have one on seasonality that was well answered. Next question I've got is on backlog. The $25 million you've got, which is great. Typically, what happens when a contract period ends? You go month to month and not add the backlog again? What do you typically renew for another 3 or 4 years?

We technically renew. Every now and then, we get a customer that just wants to be on a month to month, but I believe and Doug can answer this one, we typically renew at a lower rate than a month to month. Is that correct, Doug?

Yes. So it depends on what kind of agreement there are on, but most of our agreements at the end of the term. We'll contact them before the end of the term, try and negotiate the extended renewal agreement with it. They do have the option to go month to month. If they don't do anything, the term will auto renew at 12 months. If it auto renews at 12 months, we'll put 12 months into our backlog. If they go month to month, then we don't obviously put everything into our backlog. And then if they renew for a 2-, 3- or 4-year agreement, we'll put that 2-, 3-, or 4-year agreement into our backlog.

And not to worry, something that I meant to mention earlier is all of our product revenue is usually taken one they paid for the equipment, which is right upfront. So most of the revenue on the backlog is actually recurring revenue that we're going to get as times goes on. Is that correct, Ron?

Yes, mostly correct. There is a short period of time, maybe 2 to 3 weeks where we're installing as we do not recognize the revenue until the install is complete. And so we have a pretty short time frame. Sometimes it's a week, sometimes it's 2 to 3 weeks depending on the size of the organization, but yes, the majority of the revenue -- majority of the backlog is recurring revenue.

So the nice thing on our quarterly calls like this and our quarterly reports were reporting a mix of service revenue and product revenue, whereas the backlog is about 95% or 99% recurring opportunities that we have. So it's a small difference, but it makes a difference. And the other thing and I know you didn't asked us, nobody asked it, but I'm going to offer it is the fact that we're continually working on our P&L to get our cost down and to get our margins up. And Doug told me earlier today that he expects us to exit the year with about 70% or 71% margins. Now you might want to think that's a big deal, but it is a big deal. And it's only 2% or 3%, but 2% or 3% every bit of that falls to the bottom line.

All right. That's wonderful. I have a question on your pricing. Is your product priced as a commodity? Or are you able to sort of value both your competitors because you have features that maybe inequivalent or that you are willing to tailor the product and help them installations?

Look, I'm going to let Doug answer that, but I'm going to give you a quick answer also. We are not a commodity where somebody like level 3 or one of broadband suppliers getting into the commodity business because there is 4 or 5 other competitors that offer the same thing, and it's going to start boiling down to price. But we're adding functionality with every single release over 6 or 8 weeks. And that is value added. And Doug, do you want to add something to that?

Yes, it's truly a value-added play, Kevin. When we look at what we're offering out there, our pricing is very competitive. We tend to have a lot of our basic functionality included as a standard offering, where a lot of our competition charges extra. So applications like call center are standard offerings on our platform, where many of our competitors charge that as an optional feature, features like ACD and paging and call recording are standard application than ours, where many of our competitors may charge that on a higher license fee. So when we look at where our price point is, we're very competitive out of the gates compared to our competition. And we tend to have more functionality in our basic package than our competition does. So I think we're positioned extremely well compared to a lot of our competitors.

Perfect. Last question, and I'm not quite sure how to ask it, but I'm curious about the fixed costs based and how to ask a question, there is a fixed cost, there's a percentage of sales and fixed costs, how long it will last before you need to make a sizable investment to, let's say, double the capacity or whatever. So if you could help me about with that, I'd love it.

Yes. I'm just going to -- but the only thing that's [inaudible] is step that we depreciate and we're leasing our building, but it's a 3-year lease, so that's pretty well defined.

And on the balance sheet, I see.

Pardon me. Yes, we have...

…the balance sheet I see.

Well, it is on the balance sheet, the 3 years of lease payments is on the balance sheet as of this quarter, they just changed the accounting pronouncements and added that to it. But the other thing where we're going to have to invest in infrastructure is in our data center. And most of our data center is there. The only thing we have to add customers is servers. And we're upgrading not all the time. We just upgraded the memory in the data center. And we have to add more memory as we get bigger, but it's all solid state. We went from spending this solid state memory and we went from about 40 terabytes to close to 100 stuff like that. But it's the prices keep coming down for servers and stuff. If were to spend $50,000 or $100,000 for servers next year, I'd be surprised, maybe 150 at the very most. It's not a lot of money. We're going to start generating so much cash there that I think it's going to surprise folks. And that's because we're not interested in just being a flash in the pan, more in this for the long run. We're not going to be in the business to go through our role of strategy or anything else. We're only going to do acquisitions if they make sense and our organic growth is going to inch up a point or 2 every quarter, hopefully, and I don't know where it's going to level off, but it has to level off at some point in time. We don't want to get out of control on our growth. And then last, but not least, we're always going to be whittling away at our cost structure. And even 0.5% is meaningful when you're making money because it all falls to the bottom line. And I don't know if you want to add anything to that, Doug or Ron, but feel free to.

Yes. Good color, Steve, and again, I think as we look at our growth strategy, our cost, as we talk about today, we have a very stable cost structure. It doesn't require much infrastructure for us to add customers. And that's why we know as we talked about in my comments that we've budgeted this thing out and we are very deadly with our budget. I mean, we are always tracking right to it. We know with certain bookings that we're going to be at certain results. And so it's because our cost structure is very stable. I can add customers now and we have a very high percentage of our new customers with that flowing right to the bottom line. That question was asked last quarter, and Ron actually ran some calculations. Ron, I don't know if you has that handy. But from the revenue that we added, we can give you a pretty good idea of what flows through to the bottom line.

Yes, approximately 60% of the increased revenue over Q4 dropped to the bottom line.

So that gives you a good idea just from Q4 to Q1 that additional revenue, how much fell to the bottom line. And so that's because that cost structure is very stable.

You got a great team there, Steve, and it's really terrific when a guy with your character leaving us.

Thank you, Kevin. Thanks for that comment and I agree 100%, in fact 200%.

We do have a follow-up question from Michael Kaufman with MK Investments.

Just quickly, I know that a lot of the existing companies, if you want to cancel so you have to -- they charge a hefty cancellation fee, but the venture community and the real estate community is putting together these turnkey offices for all these internet companies that are being formed, where they want to outfit it with all the telephone capability and your response would be well suited for that. So it might pave for your salespeople to contact some of these companies that are providing turnkey leasing and also the venture community in general or people who bank them like Silicon Valley Bank because this is all greenfield new companies that are being supported by venture people who don't want to spend a lot of money on capital. So there might be an opportunity here where you don't have -- since it's a brand new deal, you don't have any cancellation charges. This is all new stuff.

Right. Well, I'm going to let Doug handle that one, but I will say, we have our mobile app, it's called CrexMo. It's offered with every desk telephone, you get a CrexMo mobile app to go with it. And that's exactly what you're talking about. Doug, do you want to add some color to that?

Yes, your comment Michael is well heated. We have had discussions and are currently working with some similar type organizations, maybe not on the large scale that you are mentioning, but I know some of the organizations we've had initial discussions with that are fairly large if they haven't resulted in a tremendous [inaudible]. But we do have a lot of building base organizations that include our services as part of their offering for lease customers. So something moves into the facility and they're providing the phones as part of the rent service for the space that they're renting. So there is a great opportunity for us. Trust me when I say that we don't leave many stones unturned. So if there is a business opportunity out there, as I mentioned at the beginning of the call, every business has a phone system and most of them need our service. So we're out there looking for every opportunity. So more than glad, I know, Michael, we talked in the past, if you've got any connections or any people that you want to point me in the right direction to, I'm more than glad to make a introductory call to him and see if it is a good partnership opportunity.

Anyone else that has a question?

There is not, sir. I will turn the call back over to you for any closing comments.

All right. Thank you very much, everyone, for being on the call this quarter. And we look forward to being with you next quarter. I think we've demonstrated that we know how to build the business and I'm convinced that we're starting to lift off the launching pad if not already lifted off here. I'm very, very proud of the people that make this happen. I'm just a small cog in the wheel. They do the heavy lifting and they make my job really easy. We have appreciated the fact that you guys have been on the call and that you're going to continue on the call. And we look forward to talking to you next quarter. Did you have anything to add to that, Doug?

No. Thanks. Many thanks for great questions, and thanks for having the confidence to follow us and hopefully you will see great results in the future. Thanks.

Thanks, everyone. We'll talk to you next -- probably in July for the second quarter results. So long, and have a good evening.