UNITED STATES 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

or

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________________ to ______________________

Commission File Number: 000-53300

EXP WORLD HOLDINGS, INC.
(Exact name of registrant as specified in its charter)



2219 Rimland Drive, Suite 301 
Bellingham, WA 98226 
(Address of principal executive offices and Zip Code)

Registrant’s telephone number, including area code: (360) 685-4206

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]    No [  ]



Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X]    No [   ]



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

Yes [   ]    No [X]

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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act (Check one).





If an emerging growth company, indicate by check mark if the registrant has selected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes [   ]    No [X]



There were 59,036,937 shares of Common Stock, $.00001 par value, of the registrants outstanding as of October 15, 2018.

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TABLE OF CONTENTS





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Statement Regarding Forward-Looking Statements

   

Certain statements contained in this report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements give expectations or forecasts of future events.  Forward-looking statements can be identified by words such as “believe,” “expect,” “anticipate,” “estimate,” “project,” “plan,” “should,” “intend,” “may,” “will,” “would,” “potential” and similar expressions to future periods.  Forward-looking statements are not based on historical facts but rather represent current expectations and assumptions.  Forward-looking statements include statements we make about matters such as: future revenues; future industry market conditions; future changes in our capacity and operations; future operating and overhead costs; operational and management restructuring activities (including implementation of methodologies and changes in the board of directors); future employment and contributions of personnel; tax and interest rates; capital expenditures and their impact on us; productivity, business process, rationalization, investment, acquisition, consulting, operational, tax, financial and capital projects and initiatives; contingencies; changes in the regulatory environment; and future working capital, costs, revenues, business opportunities,  cash flows, margins, earnings and growth.

Forward-looking statements relate to the future and are subject to many risks, assumptions and uncertainties, including those risks set forth in this report and as described in Part I, Item IA Risk Factors of our Annual Report on Form 10-K for our prior fiscal year ended December 31, 2017.  Although we believe the expectations reflected in the forward-looking statements are reasonable, actual results, developments and business decisions could differ materially from those contemplated by such forward-looking statements.  The environment for which we operate in is highly competitive and rapidly changing and it is not possible for our management to predict all risks, as new risks emerge from time to time.  

While no list of uncertainties could be complete, some factors that could cause actual results to differ materially from those in the forward-looking statements include the following, without limitation: current and future business and economic uncertainties may adversely affect our revenues, profitability and financial condition; changes in the residential mortgage markets and housing markets may adversely affect our earnings and financial condition; our earnings may decrease because of increases or decreases in interest rates; we are exposed to capital markets risk related to changes in foreign exchange rates which may adversely affect our results of operations, financial condition and cash flows; our business, financial condition and results of operations could be adversely affected by new government regulations; potential inability to attract and retain skilled personnel, including real estate agents, could harm our business; we may pursue strategic opportunities which could result in operating difficulties or dilution; assertions of claims, lawsuits and proceedings against us could harm our business, results of operations and reputation; changes in the United States or other monetary or fiscal policies and regulations that impact the real estate market; and our potential inability to list our securities on any securities exchange or market. 

All subsequent written and oral forward-looking statements by or attributable to us or persons acting on our behalf are expressly qualified in their entirety by these factors. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future developments or otherwise, except as may be required by law.    



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PART I – FINANCIAL INFORMATION



Item 1. FINANCIAL STATEMENTS





eXp World Holdings, Inc.

(unaudited)

September 30, 2018







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EXP WORLD HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)





 



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EXP WORLD HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)







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EXP WORLD HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)







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EXP WORLD HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)







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eXp World Holdings, Inc.

Notes to the Condensed Consolidated Financial Statements

September 30, 2018

(Expressed in U.S. dollars)

(Unaudited)







eXp World Holdings, Inc. (the “Company” or “we” or “eXp”) was incorporated in the State of Delaware on July 30, 2008.  Through various operating subsidiaries, the Company operates a cloud-based real estate brokerage operating in all U.S. States, the District of Columbia and the provinces of Alberta, British Columbia and Ontario, Canada.  The Company focuses on a number of cloud-based technologies in order to grow an international brokerage without the burden of physical bricks and mortar or redundant staffing costs.

   

The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.



In our opinion, the accompanying unaudited Condensed Consolidated Financial Statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation. Operating results for the three-month and nine-month periods ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.



We have reclassified certain amounts in prior-period financial statements to conform to the current period’s presentation. 





2.SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES



Principles of Consolidation



The accompanying unaudited condensed consolidated financial statements include the accounts of eXp World Holdings, Inc., and its subsidiaries. All inter-company accounts and transactions have been eliminated upon consolidation.

Use of Estimates  

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company regularly evaluates estimates and assumptions related to provisions for doubtful accounts, legal contingencies, income taxes, revenue recognition, stock-based compensation, expense accruals, and deferred income tax asset valuation allowances. The Company bases its estimates and assumptions on current facts, historical experience and various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from the Company’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

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Restricted Cash



The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the condensed consolidated balance sheet that sums to the total of the same such amounts shown in the statement of cash flows.







We have reclassified certain amounts in prior-period financial statements to conform to the current period’s presentation.  In November 2016, the FASB issued ASU No. 2016-18 – Statement of Cash Flows (Topic 240) which changed the classification and presentation of restricted cash on the statement of cash flows.  The Company adopted the new standard on January 1, 2018.  As a result, restricted cash was reclassified from cash provided from operating activities to cash, cash equivalents and restricted cash on the condensed consolidated statement of cash flows. 



For the nine months ended September 30, 2017, the change in restricted cash of $652,405 was reclassified.



Restricted cash consists of cash held in escrow by the Company’s brokers and agents on behalf of real estate buyers.  The Company recognizes a corresponding customer deposit liability until the funds are released.  Restricted cash totaled $2,717,187 and $923,193 at September 30, 2018 and December 31, 2017, respectively.



Revenue Recognition



Effective January 1, 2018, the Company adopted the new revenue standard using the modified retrospective application in which the cumulative effect of initially applying the revenue standard is recognized as an adjustment to the opening balance of retained earnings.  Adoption of the new standard did not require the Company to make an adjustment to the opening balance.   



The Company serves as a licensed broker in the areas in which it operates for the purpose of processing real estate transactions.  The Company is contractually obligated to provide for the fulfillment of transfers of real estate between buyers and sellers.  The Company provides these services itself and controls the service necessary to legally transfer the real estate.  Correspondingly, the Company is defined as the Principal.  The Company, as Principal, satisfies its obligation upon the closing of a real estate transaction.  As Principal, and upon satisfaction of our obligation, the Company recognized revenue in the gross amount of consideration to which we expect to be entitled to.



Revenue is derived from assisting buyers and sellers in listing, marketing, selling and finding real estate.  Commissions earned on real estate transactions are recognized at the completion of a real estate transaction. 



Stock Compensation



The Company accounts for all stock‑based compensation granted to employees and non‑employees using a fair value method. Stock‑based compensation awarded to employees is measured at the grant date fair value and is recognized over the requisite service period of the awards, usually the vesting period, on a straight‑line basis, net of forfeitures. Prior to the adoption of ASU 2018-07 on July 1, 2018 described below in "Recently Adopted Accounting Pronouncements", stock‑based compensation awarded to non‑employees under our Real Estate Agent Growth Program and Stock Option Awards Plan was subject to revaluation over its vesting term. Subsequent to the adoption of ASU 2018-07, non-employee share-based payment awards are measured on the date of grant, similar to share-based payment awards granted to employees. The Company reduces recorded stock‑based compensation for forfeitures when they occur. 



The Company early adopted ASU 2018-07 on July 1, 2018, using the modified retrospective method.  The reported results for 2018 reflect the application of ASC 718 guidance for non-employee share-based awards while the reported results for 2017 were prepared under the guidance of ASC 505 for non-employee stock-based compensation.  The adoption of ASU 2018-07 for non-employee stock-based compensation represents a change in accounting principle that more closely aligns the accounting for stock-based compensation for employee and non-employee share-based payment awards.

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The cumulative effect of applying the new guidance to all non-employee share-based payment awards was recorded as an adjustment to accumulated deficit as of the adoption date.  As a result of applying the modified retrospective method to adopt the new stock-based compensation guidance, an adjustment of $5.7 million was made to the opening balance of accumulated deficit and additional paid-in capital as of January 1, 2018.



Recently Issued Accounting Pronouncements



In February 2016, the FASB issued ASU No. 2016-02 - Leases (Topic 842).  Under the new guidance, a lessee is required to recognize lease liabilities and corresponding right-of-use assets, initially measured at the present value of lease payments, on the balance sheet for operating leases with terms greater than one year.  Lessor accounting remains largely unchanged from existing lease accounting.  For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities.  If the lessee makes the election, the lessee would recognize lease expense on a straight-line basis over the lease term.  This ASU is effective in annual reporting periods beginning after December 15, 2018 and the interim periods within that fiscal year.  The Company is still evaluating the potential impacts that the implementation of ASU 2016-02 may have on its financial position, operational results, or cash flows.



Recently Adopted Accounting Pronouncements



In June 2018, the FASB issued ASU No. 2018-07 – Compensation – Stock Compensation (Topic) 718.  The ASU was issued as part of its Simplification Initiative to reduce costs and complexities of financial reporting.  ASU No. 2018-07 simplifies the accounting for share-based payments granted to nonemployees for goods and services.  Under the ASU, most of the guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees.  Currently, share-based payments transactions to nonemployees are measured at fair value and remeasured at each reporting date through the date of final vesting.  This ASU changes the guidance related to the determination of the measurement date.  Under the new guidance, equity-classified awards would be measured at the grant date.  This ASU is effective for fiscal years beginning after December 15, 2018 including interim periods within those fiscal years.  Early adoption is permitted if financial statements have not yet been issued.  The Company elected to early-adopt ASU No. 2018-07 effective July 1, 2018 using the modified retrospective application with a cumulative-effect adjustment to the opening balance of accumulated deficit and additional paid-in-capital as of the beginning of the fiscal year.



In May 2017, the FASB issued ASU No. 2017-09 - Compensation (Topic 718): Scope of Modification Accounting. The FASB issued guidance to clarify when to account for a change in the terms or conditions of share-based payments awards as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The general model for modifications of share-based payment awards is to record the incremental value arising from the change as additional compensation costs. Previously, judgments about whether certain changes to an award were substantive may have impacted whether or not modification accounting was applied in these situations. The Company adopted the new standard on January 1, 2018.  The standard did not have an impact on the Company’s financial position, operational results or cash flows.

 

In November 2016, the FASB issued ASU No. 2016-18 – Statement of Cash Flows (Topic 240). The FASB issued guidance to address the diversity in the classification and presentation of changes in restricted cash on the statement of cash flows under Topic 230, Statement of Cash Flows. The amendments require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cashflows. The Company adopted the new standard on January 1, 2018.  The standard did not have a material impact on the Company’s financial position, operational results or cash flows.

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In May 2014, the FASB issued ASU No. 2014-09 - Revenue from Contracts with Customers (Topic 606). The objective of the revenue standard is to provide a single, comprehensive revenue recognition model for all contracts with customers to remove inconsistencies in requirements, provide a robust framework, improve comparability across entities and industries, provide more useful information to users and simplify the preparation of financial statements. The core principle of the revenue standard is that revenue be recognized upon the transfer of goods or services to customers in an amount that reflects the consideration to which we expect to receive in exchange for those goods or services. The new standard permits for two alternative implementation methods, the use of either (1) full retrospective application to each prior reporting presented or (2) modified retrospective application in which the cumulative effect of initially applying the revenue standard is recognized as an adjustment to the opting balance of retained earnings in the period of adoption. The Company adopted the new standard effective January 1, 2018 using the modified retrospective method. Since the Company currently recognizes revenue on a gross basis acting as a principal, upon completion of its performance obligations in the form of a completed residential real estate sale, the new standard did not have a material impact on the Company’s financial position, operational results or cash flows.





3.FIXED ASSETS, NET



Fixed assets, net consisted of the following:





Depreciation expense for the nine months ended September 30, 2018 and 2017 was $570,910 and $207,189, respectively.



Depreciation expense for the three months ended September 30, 2018 and 2017 was $240,031 and $112,487, respectively.



4.STOCKHOLDERS’ EQUITY



As of September 30, 2018, the Company had 58,968,762 shares of common stock issued and outstanding. 



The following provides a detailed description of the stock-based transactions completed during the nine months ended September 30, 2018:



During the nine months ended September 30, 2018, the Company issued 2,256,550 shares of common stock upon the exercise of stock options and received cash consideration totaling $1,749,896 upon payment of the exercise price for the options.



During the nine months ended September 30, 2018, the Company issued 989,098 shares of common stock in exchange for services totaling $14,746,702, which includes the expense activity in our 2015 Agent Equity Program.

 

During the nine months ended September 30, 2018, the Company issued 742,842 shares of common stock in exchange for services totaling $16,507,378, which included the expense activity for Real Estate Agent Growth and Other Incentive Programs.

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Agent Equity Program



The Company provides agents and brokers the opportunity to elect to receive 5% of commissions earned from each completed residential real estate transaction in the form of common stock.  If agents and brokers elect to receive portions of their commissions in common stock, they are entitled to receive the equivalent number of shares of common stock, based on the fixed monetary value of the commission payable. The shares are issued at a 20% discount to market on the date of issuance. We recognize this 20% discount as an additional cost of sales charge during the periods presented.



All agents and brokers in good standing with the Company are eligible to participate in the Agent Equity Program.  To be considered in good standing, agents and brokers must be current in their financial obligations, including all fees, to the Company.  In addition, all required licenses, local, state and national dues and subscriptions which are required to conduct real estate business in their state must be current and in effect.



During the nine months ended September 30, 2018 and 2017, the Company issued 989,098 and 1,197,422 shares of common stock, respectively, to agents and brokers for total consideration of $14,746,702 and $3,968,505 respectively, for the settlement of commissions payable inclusive of the 20% non-cash charge for the discount.



Real Estate Agent Growth Incentive Program



The Company administers an equity incentive program whereby agents and brokers become eligible to receive awards of the Company’s common stock through agent attraction and performance benchmarks. Agents who qualify are awarded common stock based on achievement of performance milestones.



Under this program, the Company awards common stock to our agents and brokers that become issuable upon the achievement of certain milestones for both the individual and the recruited agents.

   

The following table illustrates the Company’s stock activity for the Real Estate Agent Growth Incentive Program for the following periods:







As of September 30, 2018, the Company had 2,064,468 unvested stock awards and 4,165,339 expected to vest, respectively, with unrecognized compensation costs totaling $24,531,203.



Stock Option Awards



During the nine months ended September 30, 2018, the Company granted 345,000 stock options with an estimated grant date fair value of $3,318,089.  The assumptions used to estimate the grant date fair value of the awards issued for the nine months ended September 30, 2018 include: expected volatility based on historical stock prices ranging from 131.3% to 153.7%; an average expected term between 6.25 and 10 years; risk free rates based on U.S. Treasury instruments for the expected term of approximately 2.6%; and no dividend payments. 

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The following table illustrates the Company’s stock option activity for the following periods:







As of September 30, 2018, the total unrecognized compensation cost associated with options was approximately $7,867,752.





5.DEBT



We have a $1,000,000 line of credit with a variable interest rate computed on a 360-day year. The variable interest rate is the higher of either 1) the Prime Rate in effect on such day, 2) Daily One Month LIBOR plus one and one-half percent (1.5%), or 3) the Federal Funds Rate plus one and one-half percent (1.5%). The line of credit agreement requires us to comply with various financial covenants as well as customary affirmative and negative covenants that restrict our ability to, among other things, incur debt and liens, make significant investments, dispose of assets and make distributions without prior consent. The line of credit is secured by accounts receivable. The line of credit contains certain financial covenants, including a fixed charge coverage ratio and a tangible net worth. At September 30, 2018,  we were in compliance with all of the financial covenants under the line of credit.



As of September 30, 2018, we had no amount outstanding under the line of credit.





6.SUBSEQUENT EVENTS



On October 25, 2018, eXp Realty, LLC, entered into agreement with RealTNow, LLC, whereby eXp Realty, LLC purchased certain technology and intellectual property of the ShowMeNow application to expand our products and service offerings.  ShowMeNow is an on-demand, home tour mobile application that enables home shoppers to request immediate access to properties, giving buyers flexible, real-time access to properties.  The acquisition was not material.  



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Item 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



The following discussion should be read together with our consolidated financial statements and related notes included elsewhere within this report.  Management’s Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements.  Our actual results could differ materially from those anticipated in these forward-looking statements.  See “Forward-Looking Statements” and “Part II, Item 1 A – Risk Factors” for a discussion of certain risks, uncertainties and assumptions associated with these statements.

 

OVERVIEW



Our Company



eXp World Holdings, Inc., (the “Company”, “eXp”, “we”, “us”, “our”), is a holding company with our main operating division being a cloud-based international residential real estate brokerage (“eXp Realty”), the largest single owned residential real estate brokerage by geography in North America.  We operate across the United States and in the provinces of Alberta, Ontario and British Columbia, Canada.  Our operations are focused on the use of cloud-based technologies in order to grow an international brokerage without the burden of physical brick and mortar offices or redundant staffing costs. Our technology focus includes the development of a proprietary cloud based real estate transactional platform.



Continued Accelerated Growth



During the nine-month period ended September 30, 2018, we increased our net real estate brokerage agent and broker base by 112.9%, from 6,511 at December 31, 2017 to 13,859 at September 30, 2018.  These increases occurred in both new and existing geographical markets and contributed to our revenue increases of 224.2% and 231.9% as compared to the nine months and three months ended September 30, 2017, respectively. 

The rate of growth of our agent and broker base cannot be predicted and is subject to many factors outside of our control, including actions taken by our competitors and macroeconomic factors affecting the real estate industry generally.  We cannot assure you that we will be able to maintain our recent agent growth rate or that our agent and broker base will continue to expand in future periods.



 Agent Ownership



The Company maintains an equity incentive program whereby agents and brokers of eXp Realty can become eligible for awards of the Company’s common stock through the achievement of production and agent attraction benchmarks. Under this program, agents and brokers who qualify can be issued shares of the Company’s common stock. 



The Company also administers a program whereby agents and brokers could elect to receive 5% of their commission payable in the form of Company common stock which is issued at a 20% discount to market on the date of issuance. 



Outlook

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As we continue to scale the organization in the coming years and increase market share, we seek to realize gross margins at or near low double digits, resulting in Adjusted EBITDA margins in the lower single digits.  See “Non-GAAP Financial Measures” for additional information and a reconciliation of net loss to Adjusted EBITDA.  The Company aspires to end the current fiscal year with an agent count between 16,000 and 20,000.    

These operating goals are not forecasts and do not reflect our expectations, but rather are aspirational targets for future performance that may never be realized.  These statements involve risks, uncertainties, assumptions and other factors that are difficult to predict and that could cause actual results to vary materially from those expressed in them.  Factors include, among others, (i) changes in demand for the Company’s services and changes in consumer behavior; (ii) macroeconomic conditions beyond our control; (iii) the Company’s ability to effectively maintain its infrastructure to support its operations and initiatives; (iv) the impact of governmental regulations related to the Company’s operations; and other factors, as described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 and in Part II, Item 1A, “Risk Factors,” in this Quarterly Report on Form 10-Q.



RECENT BUSINESS DEVELOPMENTS



Initiatives



As the organization continues to grow, and in an effort to support our rapidly growing agent base, we believe it is important to continue building our culture in alignment with long term goals of the Company.  In the first quarter, we hired an executive director of eXp Realty University’s education and training program to build an even more robust education and training program that the Company offers to all of our agents.  Our goal is to improve agent knowledge while building and enhancing their business skills as well as their productivity.  Our new executive director of eXp Realty University has been a leader in the real estate industry for more than 14 years and is a professional speaker, coach and certified continuing education instructor.

To foster our agents’ career growth, we have made improvements to our mentoring program which allows the Company to bring on new agents that are newer to the business with less experience and pair them with experienced agents in their local markets.  Additionally, we continue to build our marketing department in an effort to create and design all agent marketing materials to market listings of properties, as well as general marketing for business development.

The Company continues to build out its eXp Enterprise (“Enterprise”) operating platform. Enterprise is a proprietary platform that manages all of the Company’s critical processes and information, including onboarding new agents, transactions, commission payments and other back office processes. It allows for a flow of real time information to eXp agents, while also providing a singular platform for eXp staff to perform a variety of back office functions in a scalable and efficient manner. The platform has already led to improvements in the areas of agent onboarding, transaction processing and financial oversight. This platform will lend itself to constantly enhance and build out capabilities that meet the needs of company stakeholders into the future. 

The Company continues to focus its efforts on our engagement strategy to build a positive employee experience to advance creativity, productivity and service quality to retain top performing talent with the overall goal of growing and improving overall profitability.  We continue to refine our organizational structure and leadership teams to drive our business forward by effectively managing and streamlining business operations, improving decision making and promoting the flow of information by way of monthly “all Company” meetings to update employees on new initiatives and timelines.  Additionally, the Company has implemented a monthly recognition program to recognize employees who exemplify the Company’s core values and a weekly recognition program to award those who take the extra initiative to deliver excellent service.

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Tax Cuts and Jobs Act of 2017



The Tax Cuts and Jobs Act of 2017 became law on December 22, 2017.

The law includes provisions that, among other things:



The provisions of the 2017 Tax Act may cause changes in the residential real estate market, the prices taxpayers are willing to pay for new homes and the terms of their financing.  The effects of the 2017 Tax Act on average home sale prices may be more impactful in states with particularly high state income tax and property values.  The impact of the income tax changes on individuals and potential impact on home sale transactions is difficult to predict.    



MARKET CONDITIONS AND INDUSTRY TRENDS

According to the National Association of Realtors (NAR), existing home sale transactions of single family homes decreased 6.5% during the first three quarters of 2018.  During this same period, the average homesales price increased 4.4%.  Factors that may have contributed to the decline in homesales transactions include mortgage rate increases, continued inventory constraints and income tax reform. 



The inventory of existing homes for sale in the U.S. decreased 1.1% (preliminary) as of September 30, 2018, compared to the same period in 2017.  The inventory represents a national average supply of 4.4 (preliminary) months, as of September 30, 2018, at the current homesales pace which is up from 3.9 months as of December 31, 2017.



Also, according to the NAR, the composite housing affordability index decreased to 141.2 (preliminary) for August 2018 from 158.8 for September 2017.  However, the housing affordability index continues to be at historically favorable levels. When the index is above 100, it indicates that a family earning the median income has sufficient income to purchase a median-priced home, assuming a 20 percent down payment and ability to qualify for a mortgage.  The favorable housing affordability index is due in part to favorable mortgage rate conditions. Although mortgage rates increased approximately 70 basis points from September 30, 2017 to September 30, 2018, the rates continue to be at historically low levels.



According to the Federal Housing Finance Agency, mortgage rates on commitments for 30-year, conventional, fixed-rate first mortgages averaged 4.2% for 2017 and the rate rose to 4.8% (preliminary) in August 2018. To the extent mortgage rates increase further, consumers continue to have financing alternatives such as adjustable rate mortgages or shorter-term mortgages which can be utilized to obtain a mortgage rate that is lower than a comparable 30-year fixed-rate mortgage.



While increasing mortgage rates and higher home prices may negatively impact housing affordability, demand remains favorable by rising wages, availability of alternative mortgage arrangements and improving consumer confidence.



Factors that may negatively affect growth in the housing industry include prolonged periods of slow economic growth, increased prevalence of unemployment, increasing mortgage interest rates, increase in home sales prices, insufficient inventory levels, regulations imposed by local, state and federal government agencies, geopolitical instability, first time home buyers inability to save due to increasing rent prices and adverse shifts in consumer attitudes towards home ownership.

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Existing Home Sales

 

For the nine months ended September 30, 2018, NAR existing home sale transactions decreased 4.1% to 5.2 million (preliminary), compared to the same period in 2017.  During this same period, eXp Realty home sales units increased 205.4% to 52,594 and home sales volume increased 234.7% to $13.9  billion compared to the same period in 2017.  Our home sale transactions growth was directly related to the growth of our agent base.

 

As of their most recent releases, NAR is forecasting existing home sales to decrease 1.6% for the remainder of 2018 and increase 2.0% in 2019.



Existing Home Sale Price 

 

We believe primary drivers to the long-term demand for housing and the growth of our company to support that demand are housing affordability, the general economic health of the U.S. economy, demographic trends such as population growth, the increase in household formation, mortgage rate levels and mortgage availability, job growth, the inherent benefits of owning a home versus renting and the influence of local housing dynamics of supply versus demand. 



As of September 30, 2018, we believe that these factors are generally favorable. However, significant changes to one or more of these drivers could cause the demand for housing to slow, negatively affecting all real estate brokerage firms, including eXp Realty. 



Regardless of whether the housing market continues to grow or slows, the Company is positioned to adhere to its low-cost, high-engagement model, affording agents and brokers increased income and ownership opportunities while offering a scalable solution to brokerage owners looking to survive and thrive in a series of fluctuations in economic activity. 

 

Results of Operations



Three Months Ended September 30, 2018 compared to the Three Months Ended September 30, 2017

Revenues



During the three-month period ended September 30, 2018 revenues increased $109.9 million to $157.2 million as compared to the three-month period ended September 30, 2017, or 231.9%.  The increase as compared to the prior period is a direct result of the 179% increase in our sales agent base to over 13,800 agents. Operating Expenses



Cost of revenues includes costs related to sales agent commissions and revenue sharing. These costs are highly correlated with recognized revenues. As such, the increase in cost of revenues, compared to the comparable prior year period, was primarily attributable to a higher amount of revenues and increase in agent commissions paid. As we continue to attract agents who produce at higher than average levels, these agents typically earn high commission payout rates resulting in a lower margin on their specific production.

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General and administrative expenses include costs related to wages, including stock compensation, dues, operating leases, utilities, travel and other general overhead expenses. The increase in general and administrative costs, compared to the comparable prior year period, was driven primarily by the increase in compensation expenses of $3.1 million, increase in stock compensation expense of $1.9 million as a result of an increase in awards granted and decrease in stock options expense of $.9 million resulting from fewer stock options granted compared to the comparable prior year period.  Stock compensation expense and stock options expense is affected by awards granted, awards exercised and/or awards forfeited throughout the year.  Awards granted, issued and forfeited are more fully disclosed in Note 4, Stockholders’ Equity, of the Consolidated Financial Statements.  Professional fees include costs related to legal, accounting and other consultants.  The increase in professional fees, compared to the comparable prior year period, were primarily driven by an increase of $.07 million in audit costs, $.09 million in legal fees and $.09 million in consulting costs.  

Sales and marketing includes costs related to lead capture, digital and print media, and trade shows, in addition to other promotional materials. The increase in sales and marketing expenses, compared to the comparable prior year period was primarily due to increased cost in lead capture of $0.3 million.



Nine Months Ended September 30, 2018 compared to the Nine Months Ended September 30, 2017

During the nine-month period ended September 30, 2018 revenues increased $241.9 million to $349.7 million as compared to the nine-month period ended September 30, 2017, or 224.2%.  The increase as compared to the prior period is a direct result of the 179% increase in our sales agent base to over 13,800 agents.



Operating Expenses



Cost of revenues includes costs related to sales agent commissions and revenue sharing. These costs are highly correlated with recognized revenues. As such, the increase in cost of revenue, compared to the comparable prior year period, was primarily attributable to a higher amount of revenues and increase in agent commissions paid.  As we continue to attract agents who produce at higher than average levels, these agents typically earn high commission payout rates resulting in a lower margin on their specific production.

General and administrative expenses include costs related to wages, including stock compensation, dues, operating leases, utilities, travel and other general overhead expenses. The increase in general and administrative costs, compared to the comparable prior year period, was driven primarily by the increase in compensation expenses of $8.2 million, increase in stock compensation expense of $12.7 million resulting from an increase in awards granted and decrease in stock options expense of $1.0 million resulting from fewer stock options granted compared to the comparable prior year period.  Stock compensation expense and stock options expense is affected by awards granted, awards exercised and/or awards forfeited throughout the year.  Awards granted, issued and forfeited are more fully disclosed in Note 4, Stockholders’ Equity, of the Consolidated Financial Statements. 

Professional fees include costs related to legal, accounting and other consultants.  The increase in professional fees, compared to the comparable prior year period, were primarily driven by an increase of $.4 million in audit costs, $.1 million in legal fees and $.1 million in stock transfer agent fees.  

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Sales and marketing includes costs related to lead capture, digital and print media, and trade shows, in addition to other promotional materials. The increase in sales and marketing expenses, compared to the comparable prior year period, was primarily due to increased cost in lead capture of $.8 million. 



LIQUIDITY AND CAPITAL RESOURCES





For the nine months ended September 30, 2018, net working capital increased $18.6 million primarily due to an increase in cash of $17.4 million and commissions receivable of $10.0 million resulting from pending real estate transactions.  In correlation to the number of pending real estate transactions, accrued expenses, which include commissions payable, and salaries payable, increased $12.4 million.    

The following table presents our cash flows for the nine months ended September 30, 2018 and 2017:





For the nine months ended September 30, 2018, cash provided by operating activities increased $15.8 million.  The change resulted primarily from the increased volume in our sales transactions and increase in commissions receivable offset by an increase in stock compensation expense.  In correlation with our increased volume in sales transactions, we incurred increased expenses in commissions payable.    

For the nine months ended September 30, 2018, our investing activities consisted of additional expenditures related to the on-going development of our internal use software.  As we continue to develop and refine our cloud-based platforms, we expect to continue to use our existing cash resources on similar expenditures for the next twelve months.

For the nine months ended September 30, 2018, we generated approximately $1.7 million in cash flows from financing activities primarily related to the exercise of options to purchase 2,256,550 shares of common stock. 

Our future capital requirements will depend on many factors, including our level of investment in technology and our rate of growth into new markets. Our capital requirements may be affected by factors which we cannot control such as the residential real estate market, interest rates, and other monetary and fiscal policy changes to the manner in which we currently operate. We anticipate that between our current cash position and cash flow from ongoing operations we have the necessary resources to continue operating our business over the next 12 months. In order to support and achieve our future growth plans, however, we may need or seek advantageously to obtain additional funding through equity or debt financing.

We have a line of credit which provides the Company may borrow up to $1,000,000.  We currently have no borrowings against the line of credit facility or any other term loan bank debt. In the event that additional financing is required in the future, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business and results of operations will likely suffer.



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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in accordance with U.S. GAAP requires us to make certain judgments and assumptions, based on information available at the time of our preparation of the financial statements, in determining accounting estimates used in the preparation of the statements.  Our significant accounting policies are described in Note 2 of the Consolidated Financial Statements.



Accounting estimates are considered critical if the estimate requires us to use judgments and/or make assumptions about matters that were uncertain at the time the accounting estimate was made and if different accounting estimates could have been used in the reporting period or changes in the accounting estimates are likely to occur that would have a material impact on our financial condition, results of operations or cash flows.



Revenue Recognition



The Company serves as a licensed broker in the areas in which it operates for the purpose of processing residential real estate transactions.  The Company is contractually obligated to provide services for the fulfillment of transfers of residential real estate between buyers and sellers.  The Company provides these services itself and controls the service necessary to legally transfer the residential real estate.  Correspondingly, the Company is defined as the Principal.  The Company, as Principal, satisfies its obligation upon the closing of a residential real estate transaction.  As Principal, and upon satisfaction of our obligation, the Company recognized revenue in the gross amount of consideration to which we expect to be entitled to.



Revenue is derived from assisting home buyers and sellers in listing, marketing, selling and finding residential real estate.  Commissions earned on real estate transactions are recognized at the completion of a residential real estate transaction. 



Income Taxes



We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. A valuation allowance against deferred tax assets would be established if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50%) that some or all of the deferred tax assets are not expected to be realized.  Our assumptions, judgments, and estimates relative to the value of our deferred tax assets take into account predictions of the amount and category of future taxable income. 



Since inception, we have incurred operating losses, and accordingly, we have generally not recorded a provision for income taxes. We generally do not expect any significant changes in the amount of our income tax provision until we are no longer incurring operating losses. 



Stock Based Compensation



The Company issues equity and equity linked instruments to employees and non-employees. Share-based payment awards are measured at the grant date fair value with compensation costs associated with those awards recognized over the requisite service period, which is generally the vesting period of the respective award.



OFF-BALANCE SHEET ARRANGEMENTS

We have no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our stockholders.



NON-GAAP FINANCIAL MEASURES

To supplement our condensed consolidated financial statements, which are prepared and presented in accordance with GAAP, we use Adjusted EBITDA, a non-GAAP financial measure, to understand and evaluate our core operating performance. This non-GAAP financial measure, which may be different than similarly titled measures used by other companies, is presented to enhance investors’

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overall understanding of our financial performance and should not be considered a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP.

We define the non-GAAP financial measure of Adjusted EBITDA to mean net income (loss), excluding interest income (expense), income tax benefit (expense), depreciation and amortization; stock-based compensation expense, and stock option expense.  

We believe that Adjusted EBITDA provides useful information about our financial performance, enhances the overall understanding of our past performance and future prospects, and allows for greater transparency with respect to a key metric used by our management for financial and operational decision-making. We believe that Adjusted EBITDA helps identify underlying trends in our business that otherwise could be masked by the effect of the expenses that we exclude in Adjusted EBITDA.  In particular, we believe the exclusion of stock and stock option expenses, provides a useful supplemental measure in evaluating the performance of our operations and provides better transparency into our results of operations. 

We are presenting the non-GAAP measure of Adjusted EBITDA to assist investors in seeing our financial performance through the eyes of management, and because we believe this measure provides an additional tool for investors to use in comparing our core financial performance over multiple periods with other companies in our industry.

Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. There are a number of limitations related to the use of Adjusted EBITDA compared to Net Income (Loss), the closest comparable GAAP measure. Some of these limitations are that:



The following tables present a reconciliation of Adjusted EBITDA to net loss, the most comparable GAAP financial measure, for each of the periods presented:





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The primary impact on Adjusted EBIDTA is stock compensation expense.  Stock compensation expense increased $12.7 million and $1.9 million for the nine months ended and three months ended September 30, 2018, respectively, compared to the same period in 2017.  Stock compensation expense is affected by awards granted, awards exercised and/or awards forfeited throughout the year.  Awards granted, issued and forfeited are more fully disclosed in Note 4, Stockholders’ Equity, of the Consolidated Financial Statements.  Also impacting stock compensation expense was the adoption of ASU 2018-07 disclosed in Note 2, Summary of Significant Accounting Principles and the increase in shares granted for our equity incentive program whereby agents and brokers of eXp Realty become eligible for awards of the Company’s common stock through the achievement of production and agent attraction benchmarks.



Item 3.                   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



As a “smaller reporting company”, we are not required to provide the information required by this Item.



Item 4.                   CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2018 pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.



Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined by Rule 13a-15(f) under the Exchange Act). In assessing the effectiveness of our internal control over financial reporting as of September 30, 2018, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework).



Based on the evaluation of our disclosure controls and procedures as of September 30, 2018, our Chief Executive Officer and Chief Financial Officer concluded that, as a result of material weaknesses in our internal control over financial reporting as disclosed in our annual report on Form 10-K for the year ended December 31, 2017 and discussed below, our disclosure controls and procedures were not effective as of September 30, 2018.

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Management’s Report on Internal Control Over Financial Reporting

Our management determined that our internal control over financial reporting was not effective based on the identification of certain material weaknesses in connection with the preparation and d audit of our consolidated financial statements as of the and for the year ended December 31, 2017. Under standards established by the Public Company Accounting Oversight Board of the United States, a material weakness is a significant deficiency, or combination of significant deficiencies, that results in there being a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

The determination that our disclosure controls and procedures were not effective was based on the following material weaknesses in our internal control over financial reporting, which were identified and described in detail in our Annual Report on Form 10-K for the year ended December 31, 2017, and summarized below:



During the third quarter of fiscal 2018,



During 2018, management has been actively engaged in remediation efforts to address the underlying causes of the material weaknesses summarized above, including the following:



To address the above material weaknesses, we have hired and continue to hire qualified personnel who have a greater understanding of accounting principles. The Company has engaged the services of a third-party software servicer to ensure consistency in the identification and classification of current share-based payments as well as future share-based payment arrangements. It will also ensure proper and consistent U.S. GAAP reporting for our equity instruments.  The Company has engaged third-party consultants to assist us with the evaluation of complex technical accounting matters and advise us on making further improvements to our internal controls over financial reporting.  We believe these additional resources will enable us to broaden the scope of our controls relating to the oversight and review of financial statements and our application of relevant accounting policies.  The Company completed an analysis of the historical option grants to ensure that they have been correctly recorded. The Company has also reviewed its revenue recognition policies and trained staff to ensure compliance with US GAAP. The Company will test the continued effectiveness of the new controls over stock compensation and revenue subsequent to implementation and consider the material weaknesses remediated after the applicable remedial controls operate effectively for a sufficient period of time. 



Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal controls will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with associated policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. 

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the period covered by this quarterly report on Form 10-Q that has materially affected or, are reasonably likely to materially affect, our internal control over financial reporting.



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PART II – OTHER INFORMATION

Item 1.LEGAL PROCEEDINGS

From time to time, we are subject to potential liability under laws and government regulations and various claims and legal actions that may be asserted against us that could have a material adverse effect on our business, reputation, results of operations or financial condition. 



There are no matters pending or, to our knowledge, threatened that we expect to have a material adverse impact on our business, reputation, results of operations or financial condition.

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Item 1A.RISK FACTORS



 As a smaller reporting company, we are not required to provide the information required by this Item. We note, however, that an investment in our common stock involves a number of very significant risks. Investors should carefully consider the risk factors included in the “Risk Factors” section of our Annual Report on Form 10-K for our fiscal year ended December 31, 2017, as filed with SEC on April 17, 2018, in addition to other information contained in such Annual Report and in this Quarterly Report on Form 10-Q, in evaluating the Company and our business before purchasing shares of our common stock. The Company’s business, operating results and financial condition could be adversely affected due to any of those risks. 

We may be unable to maintain our agent growth rate, which would adversely affect our revenue growth and results of operations.

We have experienced rapid and accelerating growth in our real estate broker and agent base. During the year ended December 31, 2017, our net agent and broker base grew by 171%, from 2,401 agents and brokers at December 31, 2016, to 6,511 agents and brokers at December 31, 2017. During the first nine months of 2018, our net agent and broker base has grown by 112.9% to 13,859 agents and brokers at September 30, 2018.  Because we derive revenue from real estate transactions in which our brokers and agents receive commissions, increases in our agent and broker base correlate to increases in revenues, and the rate of growth of our revenue correlates to the rate of growth of our agent and broker base.  The rate of growth of our agent and broker base cannot be predicted and is subject to many factors outside of our control, including actions taken by our competitors and macroeconomic factors affecting the real estate industry generally.  We cannot assure you that we will be able to maintain our recent agent growth rate or that our agent and broker base will continue to expand in future periods. A slowdown in our agent growth rate would have a material adverse effect on revenue growth and could adversely affect our results of operations.



Item 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS



None.



Item 3.DEFAULTS UPON SENIOR SECURITIES



None.



Item 4.MINE SAFETY DISCLOSURES



Not applicable.



Item 5.OTHER INFORMATION



None.

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Item 6.EXHIBITS



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SIGNATURES

Pursuant to the requirements of the Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



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