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Item 2.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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The following discussion should be read together with
our consolidated financial statements and related notes included elsewhere within this report. The 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 “Item
1 A. – Risk Factors” for a discussion of certain risks, uncertainties and assumptions associated with these statements.
OVERVIEW
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”) operating across the United States
and in the provinces of Alberta and Ontario, 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 three-month period ended March 31, 2018, we
increased our net real estate brokerage agent and broker base by 42.7%, from 6,511 at December 31, 2017 to 9,290 at March 31, 2018.
These increases occurred in both new and existing geographical markets and contributed to our revenue increases of 37.0% and
187.8% as compared to the quarter ended December 31, 2017 and the quarter ended March 31, 2017, respectively.
Agent Ownership
The Company maintains equity incentive programs 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.
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. During this period, 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 restate 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 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.
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:
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reduce individual federal tax brackets at most income levels;
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increase the standard deduction from $12,700 to $24,000 for married
taxpayers filing a joint tax return;
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caps the amount of property, sales and state and local income tax
deductions at $10,000;
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reduce the limit on deductible mortgage debt to $750,000, from $1
million on mortgage loans entered into after December 15, 2017, while entirely suspending interest deductibility of home equity
loans; and
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suspend the deductibility of certain home moving expenses.
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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 NAR, home sale transactions of single
family homes volume decreased 1.5% in the first quarter of 2018 due to inventory constraints as compared to levels one year ago.
Also, according to NAR,
the housing affordability index has continued 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 composite housing affordability index decreased
to
159.6 for February (preliminary) 2018 from 163.4
for February 2017.
The favorable housing affordability index is due in part
to favorable mortgage rate conditions. Mortgage rates increased approximately 10 basis points from March 31, 2017 to March 31,
2018 but continue to be at historically low levels. While any increase to mortgage rates can adversely impact housing affordability,
we believe that rising wages, improving consumer confidence and continued low inventory levels will result in favorable demand
conditions and existing home sale volume growth.
According to the Federal Housing Finance
Agency, mortgage rates on commitments for 30-year, conventional, fixed-rate first mortgages averaged 4.0% for 2017 and the rate
rose to 4.3% in March 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.
Partially offsetting the positive impact of
low mortgage rates are low housing inventory levels. According to NAR, the inventory of existing homes for sale in the U.S. decreased
to 1.5 million (preliminary) as of March 31, 2018, from 1.6 million at three months ended March 31, 2017. The inventory represents
a national average supply of 3.5 (preliminary) months, as of April 30, 2018, at the current home sales pace which is down from
3.9 months for 2017.
Additional factors offsetting the positive impact of
low mortgage rates include the ongoing rise in home prices,
less than favorable mortgage underwriting
standards and some would-be home sellers having limited or negative equity in homes.
Mortgage credit conditions tightened
significantly during the housing downturn, with banks limiting credit availability to more creditworthy borrowers and requiring
larger down payments, stricter appraisal standards, and more extensive mortgage documentation. Although mortgage credit conditions
appear to be easing, mortgages remain less available to some borrowers and it frequently takes longer to close a residential transaction
due to current mortgage and underwriting requirements.
The Company continues to monitor developments in our
regulatory environment. Currently, federal officials are discussing various potential changes to laws and regulations that could
impact the Company’s businesses, including tax reform that could affect the mortgage interest deductions and state and local
tax deductions. Changes in these tax incentives for homeownership, and more generally in the regulatory environment in which the
Company and our customers operate could impact the volume of mortgage originations in the United States and the Company’s
competitive position and results of operations. At this time, the nature and impact of any future changes is unknown.
Existing Home Sales
For the quarter ended March 31, 2018, NAR existing
home sale transactions increased to 5.0 million (preliminary) but decreased 1.0% compared to the same period of 2017.
During
the same period, eXp Realty home sale transactions increased 202% compared to the same period in 2017. Our home sale transactions
were impacted by the growth of our agent base which grew from approximately 6,500 at the end of 2017 to over 9,200 by the end of
the first quarter of 2018.
As of their most recent releases, NAR is forecasting
existing home sales to increase 1.8% in 2018 and another 1.4% 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 March 31, 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, eXp Realty expects
to adhere to its low-cost, high-engagement model, affording a growing number of agents and brokers increased income and ownership
opportunities while offering a scalable solution to brokerage owners looking to survive and thrive in a wide range of economic
conditions.
Results of Operations
Revenues
During the three-month period ended March 31, 2018 revenues increased $40.4 million to $62.0 million as compared to the three-month period ended March 31, 2017, or 187.8%. The increase
as compared to the prior period is a direct result of the increase in our sales agent base by approximately 166% to over 9,200.
Operating Expenses
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Three Months Ended
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March 31,
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2018
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2017
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Change
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Operating expenses:
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Cost of revenues
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$
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55,701,516
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$
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18,960,135
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$
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36,741,381
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General and administrative
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15,688,748
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4,775,881
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10,912,868
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Professional fees
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592,365
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364,460
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|
|
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227,905
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Sales and marketing
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645,797
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301,222
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344,575
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Total operating expenses
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$
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72,628,426
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$
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24,401,698
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$
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48,226,729
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Cost of revenues was $55.7 million for the three-months
ended March 31, 2018 compared to $19.0 million for the three-months ended March 31, 2017, an increase of $36.7 million, or 193.8%.
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 was primarily attributable to a higher amount of revenues
and increase in agent commissions paid.
General and administrative expenses were $15.7 million
for the three-months ended March 31, 2018 compared to $4.8 million for the three-months ended March 31, 2017, an increase of $10.9
million, or 228.5%. 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 was driven primarily
by the increase in compensation expenses of $2.0 million and increase in stock compensation expense of $7.6 million. The increase
in stock options and 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 the increase in stock compensation expense was the increase in our stock price 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.
Professional fees were $0.6 million for the three-months
ended March 31, 2018 compared to $0.4 million for the three-months ended March 31, 2017, an increase of $0.2 million, or 62.5%.
Professional fees include costs related to legal, accounting and other consultants. The increase in professional fees were primarily
driven by an increase in audit costs of $0.2 million.
Sales and marking expenses were $0.6 million for the
three-months ended March 31, 2018 compared to $0.3 million for the three-months ended March 31, 2017, an increase of $0.3 million,
or 114.4%. 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 was primarily due to increased cost in lead capture of
$0.2 million and other internet marketing of $0.5 million related to our growth in agent and broker headcount.
LIQUIDITY AND CAPITAL RESOURCES
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March 31,
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December 31,
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2018
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2017
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Change
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Current assets
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$
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19,904,749
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$
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13,098,918
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$
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6,805,831
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Current liabilities
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(15,994,940
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)
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(10,376,460
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)
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(5,618,480
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)
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Net working capital
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$
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3,909,809
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$
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2,722,458
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$
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1,187,351
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For the three-months ended March 31, 2018, net working
capital increased $1.2 million, to $3.9 million, primarily due to an increase in cash of $3.7 million and commissions receivable
of $3.2 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 $4.7 million.
The following table presents our cash flows for the three-months
ended March 31, 2018 and 2017:
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Three-Months ended
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March 31,
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2018
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2017
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Change
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Cash provided by operating activities
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$
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4,788,421
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$
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461,828
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$
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4,326,594
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Cash used in investment activities
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(513,521
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)
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(213,625
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)
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(299,896
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Cash provided by financing activities
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264,355
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148,354
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116,001
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For the three-months ended March 31, 2018, cash provided
by operating activities increased $4.3 compared to the same period in 2017. The change resulted primarily from the increased volume
in our sales transactions and higher commissions receivable. In correlation with our increased volume in sales transactions, we
incurred higher expenses, specifically commissions payable.
For the three-months ended March 31, 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 three-months ended March, 31, 2018, we generated
approximately $0.3 million in cash flows from financing activities primarily related to the exercise of options to purchase 1,071,407
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 $500,000. 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.
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 states
in which it operates for the purpose of processing residential real estate transactions. The Company is contractually obligated
to provide 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 transactions with non-employees are measured at the fair value
which requires estimates to determine fair value in association with U.S. GAAP.
We measure expense associated with stock-based
awards (usually stock options) to our employees and directors on the date of grant and recognize the corresponding compensation
expense of those awards over the requisite service period, which is generally the vesting period of the respective award.
We account for stock-based compensation
arrangements with non-employees using a fair value approach. The estimated fair value of unvested awards granted to non-employee
consultants is remeasured at each reporting date through the date of final vesting. As a result, the non-cash charge to operations
for non-employee awards with vesting conditions is affected in each reporting period by changes in the fair value of the Company’s
common stock.
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.
Item 4.
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CONTROLS AND PROCEDURES
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Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as defined in
Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”),
that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that
such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure.
As of the end of the period covered by this report, our Chief
Executive Officer and our Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures. Based
on this evaluation, due to the material weaknesses in our internal control over financial reporting discussed below, our Chief
Executive and Chief Financial Officers each concluded that our disclosure controls and procedures were not effective to ensure
that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the SEC’s rules and forms, and that such information was not accumulated
and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding
required disclosure.
Management’s Report on Internal Control Over Financial
Reporting
Our management is responsible for establishing and maintaining
adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our management,
including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal
control over financial reporting as of December 31, 2017. In making its evaluation, management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control — Integrated Framework
(2013).
Based on this evaluation, management concluded that the Company’s
internal control over financial reporting was not effective as of March 31, 2018.
Our management determined that our internal control over financial
reporting was not effective based on the identification of certain material weaknesses. 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.
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:
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Failure to properly recognize and measure the fair value of equity
and equity-linked awards issued to employees and non-employees. Our policies and procedures failed to identify the need to consider
certain areas of US GAAP applicable to stock awards issued to employees and non-employees.
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Our internal controls failed to identify the need to consider certain
areas of U.S. GAAP applicable to the classification of certain agent fees. Our agent fees are no longer classified as revenue,
rather they are offset against costs of revenue.
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During 2018, Management has been actively engaged in remediation
efforts to address the material weaknesses summarized above, including the following:
To address the above
material weaknesses, management has implemented additional training programs associated with accounting for equity-based payments
to employees and non-employees. The Company plans to engage the services of a
third-party software
servicer to ensure consistency in the identification and classification of share-based payments of current 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
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. We continue to hire qualified personnel who
have a greater understanding of accounting principles. 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.