Item 7. Management’s Discussion and Analysis
Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to inform the reader about matters affecting the financial condition and results of operations of eXp World Holdings, Inc. and its subsidiaries for the three-year period ended December 31, 2020. The following discussion should be read together with our consolidated financial statements and related notes included elsewhere within this report. This discussion contains forward-looking statements that constitute our estimates, plans, and beliefs. Our actual results could differ materially from those anticipated in these forward-looking statements. See “Forward-Looking Statements” and “Item 1A. – Risk Factors” included elsewhere within this Annual Report on Form 10-K for a discussion of certain risks, uncertainties, and assumptions associated with these statements.
This section generally discusses items pertaining to and comparisons of financial results between 2020 and 2019. Discussions of 2018 items and comparisons between 2019 and 2018 financial results can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (the “2019 MD&A”). The 2019 MD&A is incorporated by reference herein from Part II, Item 7 of our Annual Report on Form 10-K dated March 12, 2020 (Commission File No. 001-38493 ).
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This MD&A is divided into the following sections:
● Overview
● Market Conditions and Industry Trends
● Key Business Metrics
● Recent Business Developments
● Results of Operations
● Liquidity and Capital Resources
● Critical Accounting Policies and Estimates
● Non-U.S. GAAP Financial Measures
All dollar amounts are in USD thousands except share amounts and per share data and as otherwise noted.
OVERVIEW
We operate one of the world’s fastest growing real estate brokerage businesses utilizing a cloud-based model that enables a variety of businesses to operate remotely and supported by a technology platform that allows our independent agents and brokers the ability to provide a suite of more efficient and cost effective services to home buyers and sellers.
While we do not consider acquisitions a critical element of our ongoing business, we seek opportunities to expand and enhance our portfolio of solutions.
Strategy
Our strategy is to grow organically in the North American and certain international markets by increasing our independent agent and broker network. Additionally, we intend to continue our advancement into more international markets. Through our cloud-based operations and technology platform, we strive to achieve customer-focused efficiencies that allow us to increase market share and attain strong returns as we scale our business within the markets in which we operate. By building partnerships and strategically deploying capital, we seek to grow the business and enter into attractive verticals and markets.
During 2020, we believe that we made progress towards achieving our strategic goals, including an increase in our agent count of 63%. The expected outcome of these activities will be to better position us to deliver on our full potential, to provide a platform for future growth opportunities, and to achieve our long-term financial goals.
MARKET CONDITIONS AND INDUSTRY TRENDS
Our business is dependent on the economic conditions within the markets for which we operate. Changes in these conditions can have a positive or negative impact on our business. The economic conditions influencing the housing markets primarily include economic growth, interest rates, unemployment, consumer confidence, mortgage availability and supply and demand.
In periods of economic growth, demand typically increases resulting in increasing home sales transactions and home sales prices. Similarly, a decline in economic growth, increasing interest rates and declining consumer confidence generally decreases demand. Additionally, regulations imposed by local, state, and federal government agencies, and geopolitical instability, can also negatively impact the housing markets for which we operate.
For the year ended December 31, 2020, the COVID-19 pandemic materially and adversely affected businesses worldwide. The magnitude and duration of the impact from COVID-19 are not fully known and cannot be reasonably estimated. While the pandemic has been ongoing for much of the fiscal year, there is still significant volatility and uncertainty surrounding the outlook of the global economy. The impact to the Company for the year ended December 31, 2020 has been less significant than anticipated. We believe that once COVID-19 is further contained the economy will continue to rebound depending on the continued pace, rate, and effectiveness of lifting public health restrictions on businesses and individuals and how quickly people become comfortable engaging in public activities.
According to the National Association of Realtors (“NAR”), the housing market is past the recovery phase from the initial downturn during the beginnings of the COVID-19 pandemic. Current home sales are now at pre-pandemic level, which is due to significant increase in demand. The sizable shift to remote work, which has led to current homeowners looking for larger homes and vacation homes, and the continued historic low interest rates have accelerated housing demand. These low mortgage rates are also allowing more buyers to enter the market. According to the NAR housing statistics, existing home sales, adjusted for seasonality, totaled 6.8 million in 2020, up 22.2% from 2019 and the most annual home sales since the 2008 recession. However, housing inventory declined to 1.07 million and a 1.9-month supply, which are both historic lows. The NAR reported that pending home sales slipped 0.3% in December 2020, indicating a slowing in contract activity, mostly impacted by seasonally activity and inventory levels. The index measures housing
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contract activity and is based on signed real estate contracts for existing single-family homes and condos. However, given the overall uncertainty of the global pandemic, we continue to monitor and assess any potential impacts of the pandemic on our business, results of operations and financial condition as well as recognize the uncertainty inherent in the NAR forecast.
The Company is positioned to continue to grow in light of a series of fluctuations in economic activity and performed better than expected throughout 2020. However, depending on the continued course of the COVID-19 pandemic, specifically in key areas of operations, it is too early to predict the full extent of the effects the COVID-19 pandemic will have on our Company moving into 2021.
Regardless of whether the housing market continues to grow or slows, we believe that we are positioned to leverage our 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.
National Housing Inventory
Prior to December 31, 2020, increased demand and low mortgage rates caused inventory levels to decline to record lows. With government implemented actions in response to COVID-19, fewer individuals are listing their homes and construction of new homes has slowed. Due to these factors, year over year inventory has decreased further. According to the NAR, inventory of existing homes for sale in the U.S. was 1.1 million as of December 2020 (preliminary) compared to 1.4 million at the end of December 2019. The NAR indicated the need for new home construction due to the high demand of homes and the record-low inventory levels.
Mortgage Rates
According to the NAR, mortgage rates on commitments for 30-year, conventional, fixed-rate mortgages averaged 3.1% for the 2020, compared to 3.9% for 2019. Mortgage rates are forecasted to decrease to 3.0% throughout 2021 and increase minimally to 3.4% in 2022. Mortgage rates are expected to remain low through 2021. Low mortgage rates are expected to continue to contribute to overall high demand for home-buying.
Housing Affordability Index
According to the NAR, the composite housing affordability index increased to 171.8 for December 2020 (preliminary) from 167.2 for December 2019. 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 to favorable mortgage rate conditions. However, as housing prices continue to climb due to low inventory and high demand and in light of the higher unemployment rate and the ongoing COVID-19 pandemic, it is still too early to predict the extent to which the effects of these factors will have on unemployment and housing affordability.
Existing Home Sales Transactions and Prices
According to the NAR, seasonally adjusted existing home sale transactions for the year ended December 2020 (preliminary) increased to 6.8 million compared to 5.5 million for the year ended December 2019. The NAR anticipates transactions to continue with pace however due to low inventory level recovery may not be sustainable.
According to the NAR, nationwide existing home sales average price for December 2020 (preliminary) was $309 compared to $275 in December 2019. Due to low supply and high demand, the average sale price is expected to increase through 2021. However, it is still too early to predict the extent of the effects of the ongoing COVID-19 pandemic will have on home sales prices.
KEY BUSINESS METRICS
Management uses our results of operations, financial condition, cash flows, and key business metrics related to our business and industry to evaluate our performance and make strategic decisions.
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The following table outlines the key business metrics that we periodically review:
Year Ended December 31,
2020
2019
2018
(Dollar amounts in thousands)
Performance:
Agent count
41,313
25,423
15,570
Transactions
238,981
135,322
74,678
Volume
$ 72,206,457
$ 38,215,998
$ 19,799,161
Revenue
$ 1,798,285
$ 979,937
$ 500,148
Gross margin
8.9%
8.6%
8.1%
Adjusted EBITDA
$ 57,841
$ 12,649
$ 2,410
(1) Adjusted EBITDA is not a measurement of our financial performance under U.S. GAAP and should not be considered as an alternative to net income, operating income, or any other measures derived in accordance with U.S. GAAP. For a definition of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, see “Non-U.S. GAAP Financial Measures”.
We periodically evaluate trends in certain metrics to track the Company’s performance.
Our strength is attracting real estate agent and broker professionals that contribute to our growth. Brokerage real estate transactions are recorded when our agents and brokers represent buyer and/or sellers in the purchase or sale, respectively, of a home. The number of real estate transactions are key drivers of our revenue and profitability. Real estate transaction volume represents the total sales value for all homes sold by our agents and brokers and is influenced by several market factors, including, but not limited to, the pricing and quality of our services and market conditions that affect home sales, such as macroeconomic factors, local inventory levels, mortgage interest rates, and seasonality. Real estate transaction revenue represents the commission revenue earned by the Company for closed brokerage real estate transactions.
We continue to increase our agents and brokers significantly in the United States and Canada through the execution of our growth strategies. In the fourth quarter of 2019, we expanded operations to the U.K. and Australia. By the end of 2020, the Company expanded into other countries, including Mexico, South Africa, France, India, and Portugal. The rate of growth of our agent and broker base is difficult to predict and is subject to many factors outside of our control, including actions taken by our competitors and macroeconomic factors affecting the real estate industry in general. The Company’s agent base and transactions have not been significantly impacted throughout the global COVID-19 pandemic, however the full effect on these factors will continue to depend on the duration and severity of the COVID-19 pandemic.
Settled home sales transactions and volume resulted from closed real estate transactions and typically change directionally with changes in the market existing home sales transactions as reported by the NAR, as disproportionate variances are representative of company-specific improvements or shortfalls to the norm. Our home sale transactions growth was directly related to the growth of our agent base over the prior comparative period.
We utilize gross margin, a financial statement measures based on generally accepted accounting principles in the U.S. (“U.S. GAAP”) to assess eXp’s financial performance from period to period.
Gross margin is calculated from U.S. GAAP reported amounts and equals the difference between revenue and cost of sales (i.e., gross profit) as a percentage of total revenue. Commissions and other agent-related costs represent the cost of sales for the Company. The cost of sales does not include depreciation or amortization expenses as the Company’s assets are not directly used in the production of revenue. Gross margin is based on the information provided in our results of operations or our consolidated statements of comprehensive income (loss), and is an important measure of our potential profitability and brokerage performance. For the years ended December 31, 2020, 2019, and 2018, gross margin was 8.9%, 8.6%, and 8.1%, respectively. Gross margin has improved each year due to efforts to improve our cost structure, including lower revenue share costs relative to total revenue and the reduction of the discount for shares issued under our agent equity program effective January 1, 2020.
Management also reviews Adjusted EBTIDA, which is a non-U.S. GAAP financial measure, to understand and evaluate our core operating performance. Adjusted EBITDA has grown significantly for the years ended December 31. 2020, 2019, and 2018 due to our revenue growth and improvements in our cost structure.
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RECENT BUSINESS DEVELOPMENTS
Real Estate Brokerage Initiatives
Global Expansion of Our Real Estate Cloud Brokerage
In the fourth quarter of 2019, the Company announced its first international expansion outside of North America into Australia and the U.K. During the fourth quarter of 2020, the Company initiated operations in France, India, Mexico, Portugal, and South Africa. The Company continues to pursue growth opportunities into new global markets. In addition to the international expansion, the Company continues to also focus on growth in the United States and in Canada.
Agent and Employee Experience
The Company has embarked on an initiative to better understand both its agents and employee experience. In doing so, we have adopted many of the principles of the Net Promoter Score® (NPS) across many aspects of our organization. NPS is a measure of customer satisfaction and is measured on a scale between -100 and 100. A NPS above 50 is considered excellent. The Company’s agent NPS was 73 in the fourth quarter of 2020. Whether it be the overall question "How likely are you to recommend eXp to your colleagues, friends, or family?" or more granular inquiries as to specific workflows or service offerings, we believe this will ensure we are delivering on the most important values to our agents and employees. In turn, this often leads to enthusiastic fans of eXp who will promote our Company and continue leading us through strong organic growth.
This also ties into one of our core values of transparency. While we strive for high satisfaction, it is equally important to investigate a low or unfavorable trending of NPS. As NPS scores are often leading indicators to agents and employees’ future actions, we are able to learn quickly what may be a ‘pain point’ or product that is not meeting its desired objective. We then take that information and translate it into action with an effort to remediate the specific root cause(s) driving the lower score. This fast and iterative approach has already led to improvements in such parts of our business such as agent onboarding, commission transaction processing, and employee benefits.
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 our equity incentive program, agents and brokers who qualify are issued shares of the Company’s common stock, and it continues to be another element in creating a culture of agent-ownership.
Our agent compensation plans represent a key lever in our strategy to attract and retain independent agents and brokers. The costs attributable to these plans are also a significant component of our commission structure and results of operations. Agents and brokers can elect to receive 5% of their commission payable in the form of Company common stock. Prior to January 1, 2020, we issued share-based compensation to our agents and brokers at a 20% discount to the market price of our common stock, which changed to a 10% discount for issuances beginning in January 2020 and had a direct and positive impact on gross margin above. Our operational strategy and the importance of the agent compensation plans to our strategy have not changed; however, the financial impact of the change in the discount has had a meaningful effect on our results of operations. Our stock repurchase program and agent growth incentive program are more fully disclosed in Note 11 – Stockholders’ Equity to the consolidated financial statements.
Technology Products and Services
We continue developing the core Virbela software platform and its underlying infrastructure through our subsidiary, eXp World Technologies, LLC (“World Tech”), to accommodate for the increasing use and scale required to support our eXp Realty division. In 2019, we released a new product centered on the concept of an open campus whereby small and independent organizations may utilize sub spaces as part of a larger campus similar to collaborative environments that currently exist in the physical brick and mortar world. In the first quarter of 2020, Virbela began offering virtual events in conjunction with Event Farm. Given the current environment due to the COVID-19 pandemic, there is an acute need for virtual workplace collaboration. For the year ended December 31, 2020, Virbela has seen an increase in demand for virtual events and collaborative spaces for remote teams and as a result has introduced new products and features including, an expo hall, a concert stage for virtual entertainment, VR support for Oculus Rift and HTC VIVE, and screen sharing and video chat capabilities. Lastly, we expect to continue to service existing and new business-to-business enterprise level contracts in the coming year.
On July 31, 2020, the Company acquired all of the equity ownership interests in Showcase Web Sites, L.L.C. (“Showcase”) for cash consideration of $1.5 million and promissory notes in the aggregate principal amount of $1.5 million (the “Showcase Acquisition”). Showcase is a technology company focused on agent website and consumer real estate portal technology. With this acquisition, the Company will be able to strategically focus on creating consumer home-search technology for utilization by our independent agents and brokers, as well as continued services offerings to third party clients of Showcase.
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Affiliated Services
Recent acquisitions and partnerships have allowed us to begin offering to customers more products and services complementary to our real estate brokerage business. These affiliated services include mortgage origination, title, escrow, and settlement services, which we can now provide as a more inclusive offering in addition to our brokerage services. We anticipate continued growth and investment in these service offerings through 2021; however, actual performance will depend directly on utilization by eXp Realty agents and brokers and the on-going and fluctuating government implemented restrictions due to the COVID-19 pandemic.
On December 4, 2020, the Company acquired all of the equity ownership interests in Success Enterprises LLC (“Success”) and its related media properties, including SUCCESS ® print magazine, SUCCESS.com, SUCCESS ® newsletters, podcasts, digital training courses and affiliated social media accounts across platforms for cash consideration of $8.0 million. With the addition of Success, eXp intends to blend its technology and content to enhance the personal development platform for entrepreneurs and sales professionals.
RESULTS OF OPERATIONS
Year ended December 31, 2020 vs. Year ended December 31, 2019
Year Ended
% of
Year Ended
% of
Change
2020 vs. 2019
December 31, 2020
Revenue
December 31, 2019
Revenue
$
%
(In thousands, except share amounts and per share data)
Statement of Operations Data:
Revenues
$ 1,798,285
100%
$ 979,937
100%
$ 818,348
84%
Operating expenses
Commissions and other agent-related costs
1,638,674
91%
895,882
91%
742,792
83%
General and administrative expenses
122,801
7%
89,035
9%
33,766
38%
Sales and marketing expenses
5,223
-%
3,799
-%
1,424
37%
Total operating expenses
1,766,698
98%
988,716
101%
777,982
79%
Operating income (loss)
31,587
2%
(8,779)
(1)%
40,366
460%
Other expense, net
184
-%
281
-%
(97)
(35)%
Income (loss) before income tax expense
31,403
2%
(9,060)
(1)%
40,463
447%
Income tax expense
413
-%
497
-%
(84)
(17)%
Net income (loss)
30,990
2%
(9,557)
(1)%
40,547
424%
Add back: Net loss attributable to noncontrolling interest
141
-%
29
-%
112
386%
Net income (loss) attributable to eXp World Holdings, Inc.
$ 31,131
2%
($ 9,528)
(1)%
$ 40,659
427%
Adjusted EBITDA (1)
$ 57,841
3%
$ 12,649
1%
$ 45,192
357%
Earnings (loss) per share (2)
Basic
$ 0.22
($ 0.08)
$ 0.30
397%
Diluted
$ 0.21
($ 0.08)
$ 0.28
373%
Weighted average shares outstanding (2)
Basic
138,572,358
126,256,407
Diluted
151,550,075
126,256,407
(1) Adjusted EBITDA is not a measurement of our financial performance under U.S. GAAP and should not be considered as an alternative to net income, operating income, or any other measures derived in accordance with U.S. GAAP. For a definition of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, see “Non-U.S. GAAP Financial Measures”.
(2) Earnings per share and weighted average shares outstanding have been adjusted for the impact of the two-for-one stock split in the form of a stock dividend effected on February 12, 2021 (the “Stock Split”) for all periods presented.
Revenue
Our total revenues were $1,798.3 million in 2020 compared to $979.9 million in 2019, an increase of $818.3 million, or 84%. Total revenues increased primarily as a result of higher volume of real estate brokerage commissions, which is directly related to our increase in agent count of 63% compared to 2019. Higher average home sales price also contributed to the increase of revenue marginally.
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Commission and Other Agent Related Costs
Commission and other agent-related costs were $1,638.7 million in 2020 compared to $895.9 million in 2019, an increase of $742.8 million, or 83%. Commission and other agent related costs include sales commissions paid and are reduced by agent related fees. Commission and other agent related costs increased primarily as a result of an increase in settled real estate transactions and growth in our agent base.
General and Administrative Expense
General and administrative expenses were $122.8 million in 2020 compared to $89.0 million in 2019, an increase of $33.8 million, or 38%. General and administrative expenses include costs related to wages, including stock compensation, and other general overhead expenses. General and administrative expenses increased primarily as a result of an increase of $22.7 million in compensation related expenses including salaries, contract labor, employee benefits, and payroll taxes and processing. The Company had an increase in stock compensation expense of $2.8 million. These increases are a direct result of the Company’s increase in employee and agent count. Employees increased from 634 in 2019 to 900 in 2020, representing growth in headcount of 42%. The Company’s agent base increased by 63%. Also, in support of the Company’s business operations, computer and software costs increased $3.6 million compared to prior year, mostly consisting of online subscriptions and security and virus protection. Finally, $2.3 million of the increase in general and administrative expenses is related to professional fees including accounting, legal, and other consulting. These increases are directly related to the Company’s continued revenue growth, international expansion and new business ventures.
Sales and Marketing
Sales and marketing expenses were $5.2 million in 2020 compared to $3.8 million in 2019, an increase of $1.4 million, or 37%. Sales and marketing costs include lead capture costs and promotional materials. Sales and marketing expenses increased primarily as a result of an increase in advertising costs of $0.7 million.
Other Expense, Net
Other expense includes amortization expense of the present value adjustment to our stock payable and start-up costs. There were no significant changes in other expense in 2020 compared to 2019.
Income Tax Benefit (Expense)
The Company’s provision for income taxes amounted to $0.4 million, a decrease of $0.1 million, or 17%, for the year ended December 31, 2020 compared to the same period in 2019. The decrease in income tax expense was primarily attributable to the geographic mix of earnings. Higher deductible share-based compensation expenses represented most of the decrease in effective tax rate, partially offset by the change in valuation allowance on deferred tax assets and higher state taxes incurred in 2020 compared to 2019. Refer to Critical Accounting Policies and Estimates within this MD&A and Note 13 – Income Taxes to the consolidated financial statements for further information.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity are our cash and cash equivalents on hand and cash flows generated from our business operations. Our ability to generate sufficient cash flow from operations or to access certain capital markets, including banks, is necessary to fund our operations and capital expenditures, repurchase our common stock, and meet obligations as they become due. At present, our cash and cash equivalents balances and cash flows from operations have strengthened primarily due to transaction volume growth and improved cost leverage over the prior five years, especially during 2019 and 2020, attributable to the expansion of our independent agent and broker network and, to a lesser extent, increased average prices of home sales.
Currently, our primary use of cash on hand is to sustain and grow our business operations, including, but not limited to, commission and revenue share payments to agents and brokers and cash outflows for operating expenses. Our current capital deployment strategy for 2021 is to utilize excess cash on hand to support our growth initiatives into select markets and enhance our technology platforms and for repurchases of our common stock. As of December 31, 2020, the Company is not party to any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures, or capital resources. In addition, the Company has no known material cash requirements as of December 31, 2020 relating to capital expenditures, commitments, or human capital (except as passthrough commissions to agents and brokers concurrent with settled real estate transactions). The cash requirements for the upcoming fiscal year relate to our leases and our debt associated with acquisitions. For information regarding the Company’s expected cash requirement related to leases, see Note 10 – Leases to the consolidated financial statements. Cash requirements associated with our acquisitions include a $0.5 million cash payment related to the principal amount of promissory notes issued to the previous owners of Showcase and a $1.0 million payment of cash or common stock of the Company to the previous owners of Virbela both due in 2021. A final cash payment of $1.0 million for the settlement of the promissory notes issued to the previous owners of Showcase will be due in 2022.
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We believe that our existing balances of cash and cash equivalents and cash flows expected to be generated from our operations will be sufficient to satisfy our operating requirements for at least the next twelve months. Our future capital requirements will depend on many factors, including our level of investment in technology, our rate of growth into new markets, and cash used to repurchase shares of the Company’s common stock. Our capital requirements may be affected by factors which we cannot control such as the changes in the residential real estate market, interest rates, and other monetary and fiscal policy changes to the manner in which we currently operate. In order to support and achieve our future growth plans, we may need or seek advantageously to obtain additional funding through equity or debt financing. We believe that our current operating structure will facilitate sufficient cash flows from operations to satisfy our expected long-term liquidity requirements beyond the next twelve months.
We currently do not hold any bank debt, nor have we issued any debt instruments through public offerings or private placements. If we are unable to raise additional capital when desired, our business, results of operations, and financial condition would likely suffer. As of December 31, 2020, our cash and cash equivalents totaled $100.1 million. Cash equivalents are comprised of financial instruments with an original maturity of 90 days or less from the date of purchase, primarily money market funds. We currently do not possess any marketable securities.
Net Working Capital
Net working capital is calculated as the Company’s total current assets less its total current liabilities. The following table presents our net working capital for the periods presented:
December 31, 2020
December 31, 2019
Current assets
$ 212,225
$ 78,819
Current liabilities
(96,650)
(41,965)
Net working capital
$ 115,575
$ 36,854
As of December 31, 2020, net working capital increased $78.7 million, or 214%, compared to the comparable prior year period, primarily due to an increase in cash and cash equivalents of $60.1 million and accounts receivable of $48.8 million resulting from pending real estate transactions. In correlation to the number of pending real estate transactions, accrued expenses increased $31.7 million, which included higher commissions payable of $20.7 million.
Cash Flows
The following table presents our cash flows for the periods presented:
Year Ended December 31,
2020
2019
2018
Cash provided by operating activities
$ 119,659
$ 55,186
$ 24,311
Cash used in investment activities
(16,963)
(6,690)
(8,859)
Cash used in financing activities
(21,893)
(24,569)
2,015
Effect of changes in exchange rates on cash, cash equivalents and restricted cash
47
106
(21)
Net change in cash, cash equivalents and restricted cash
$ 80,850
$ 24,033
$ 17,446
For the year ended December 31, 2020, cash provided by operating activities increased $64.5 million compared to the same period in 2019. The change resulted primarily from the increased volume in our real estate sales transactions, improved cost leverage, increase in customer deposits, and higher participation by our agents and brokers in our agent stock compensation programs. See Note 11 – Stockholders’ Equity to the consolidated financial statements for further details related to this program.
For the year ended December 31, 2020, cash used in our investing activities increased primarily due to higher cash used for business acquisitions of approximately $9.0 million and an increase of $1.4 million in capital expenditures. As we continue to develop and refine our cloud-based platforms and continue to accelerate our business in innovative ways, we expect to continue to use our existing cash resources on similar expenditures for the next twelve months.
For the year ended December 31, 2020, the decrease in cash flows used in financing activities primarily related to higher proceeds received from the exercise of stock options of $4.6 million, partially offset by higher repurchases of our common stock of $2.3 million compared to the prior year period.
Outlook
As we continue to scale our Company in the future and increase market share, we expect to continue invest in the business and drive strong growth in the U.S. and international markets.
These operating ambitions 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
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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 (v) other factors, as described in this Annual Report on Form 10-K in Part II, Item 1A, “Risk Factors.”
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 – Summary of Significant Accounting Policies to 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.
Stock-based compensation
Our stock-based compensation is comprised of agent growth incentive programs, agent equity program, and stock option awards. The Company accounts for stock-based compensation granted to employees and non-employees using a fair value method. Stock-based compensation awards are measured at the grant date fair value, and the stock-based compensation cost is recognized over the requisite service period of the awards, usually the vesting period, on a straight-line basis, net of forfeitures. The Company reduces recorded stock-based compensation for forfeitures when they occur.
Recognition of compensation cost for an award with a performance condition is based on the probable outcome of that performance condition being met. The Company estimates the share-based liability based on estimated performance probabilities based on our most recent estimates on probable achievement of the performance measures established under our agent growth incentive program. These estimates calculated based on the agent’s historical performance for each award type. Also, the requisite service period at the grant date of performance awards is estimated based on the probability of the period of time it will take an agent to meet the performance metric. The value of the stock award is amortized over this period and recognized as stock compensation expense starting on the grant date.
If factors change causing different assumptions to be made in future periods, estimated compensation expense may differ significantly from that recorded in the current period. See Note 11 – Stockholders’ Equity to the consolidated financial statements for more information regarding the assumptions used in estimating the fair value of our awards.
Revenue recognition
The Company generates substantially all of its revenue from real estate brokerage services and generates a de minimis portion of its revenues from software subscription and professional services.
Real Estate Brokerage Services
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 services for the fulfillment of transfers of real estate between buyers and sellers. The Company provides these services itself and controls the services necessary to legally represent the transfer of 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 recognizes 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 real estate. Commissions earned on real estate transactions are recognized at the completion of a real estate transaction once we have satisfied our performance obligation. Agent related fees are currently recorded as a reduction to commissions and other agent related costs.
At each reporting period, we estimate revenue for closed transactions for which we have not yet received the closing documents due to timing of when a transaction settles. Additionally, provisions for anticipated differences between consideration due and amounts expected to be received are estimated and recorded to revenue. A hypothetical change of 10% in the accrual for estimated revenue would have impacted total revenue by approximately $4.3 million and pre-tax income by approximately $0.5 million for the year ended December 31, 2020. Although all differences in the historical reported amounts (including the most recent fiscal year) have been immaterial, estimated revenue could materially differ from actual results and could have an adverse impact to the Company’s results of operations and financial condition.
Technology Services and Products
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The Company earns a de minimis amount of subscription revenue that is derived from fees from users to access the Company’s virtual reality software platform. The terms of our subscriptions do not provide customers the right to take possession of the software. Subscription revenue is generally recognized ratably over the contract term.
Professional services revenue is derived from implementation and consulting services. Professional services revenue is typically recognized over time as the services are rendered, using an efforts-expended (labor hours) input method.
Software subscription and professional services revenue accounts for approximately 1% of all revenue for each of the years ended December 31, 2020, 2019, and 2018.
Accounts receivable and expected credit losses
The Company’s accounts receivable includes agent non-commission based fees, agent short-term advances, and commissions receivable for real estate property settlements. The majority of the Company’s accounts receivable is derived primarily from real estate property settlements, which are in-substance guaranteed because they represent commission payments on closed transactions. The accounts receivable are typically unsecured.
The allowance for credit losses is our estimate based on identified potentially uncollectible amounts and consideration of historical experience of losses incurred. We periodically perform detailed reviews to assess the adequacy of the allowance. We exercise significant judgment in estimating the timing, frequency and severity of losses. The Company uses the aging schedule method to estimate current expected credit losses (“CECL”) based on days of delinquency, including information about past events and current economic conditions. The Company’s accounts receivable is separated into the aforementioned three categories to evaluate the allowance under the CECL impairment model. The receivables in each category share similar risk characteristics.
The Company analyzed uncollectable accounts for the three categories of receivables and concluded that only agent non-commission based fees receivables and agent short-term advances carry any risk of expected credit losses. Current economic conditions and forecasts of future economic conditions do not affect expected credit losses on uncollectable real estate property settlements, and the Company has no historical experience or expectation of losses related to these receivables. A hypothetical change of 10% in expected credit losses related to agent non-commission based fees receivables and agent short-term advances would have impacted our pre-tax income by approximately $0.2 million for the year ended December 31, 2020.
Although we experienced higher rates of delinquency on agent fees and advances receivable and recognized greater expected losses during 2020, the Company typically has not experienced material uncollectible accounts (including the most fiscal recent year). However, future experience could materially differ from historical results and could have an adverse impact to the Company’s results of operations, financial condition, and cash flows.
Business combinations and goodwill
The Company accounts for business combinations using the acquisition method of accounting, under which the consideration for the acquisition is allocated to the assets acquired and liabilities assumed. The Company recognizes identifiable assets acquired and liabilities assumed at the fair values as of the acquisition date. Acquisition-related costs, such as due diligence, legal and accounting fees, are expensed as incurred and not considered in determining the fair value of the acquired assets.
Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions, estimates and market factors. Estimating the fair value of individual reporting units requires us to make assumptions and estimates regarding significant changes or planned changes in the use of the assets, as well as industry and economic conditions. These assumptions and estimates include projected revenues and income growth rates, terminal growth rates, competitive and consumer trends, market-based discount rates, and other market factors. Significant assumptions used in determining the allocation of fair value include the following valuation techniques: the cost approach, the income approach, and the market approach, which are determined based on cash flow projections and related discount rates, industry indices, market prices regarding replacement cost and comparable market transactions.
At the acquisition date, the Company recognizes the identifiable acquired assets, liabilities, and contingent liabilities (identifiable net assets) of the subsidiaries on the basis of fair value. Recognized assets and liabilities may be adjusted during a maximum of one year from the acquisition date (the “measurement period”), depending on new information obtained about the facts and circumstances in existence at the acquisition date.
If current expectations of future growth rates are not met or market factors outside of our control change significantly, then our goodwill or intangible assets may become impaired. Additionally, as goodwill and intangible assets associated with recently acquired businesses are recorded on the balance sheet at their estimated acquisition date fair values, those amounts are more susceptible to impairment risk if business operating results or macroeconomic conditions deteriorate.
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Goodwill impairment
We review goodwill for impairment on an annual basis in the fiscal fourth quarter or on an interim basis if an event occurs or circumstances change that would more likely than not indicate that the fair value of the goodwill is below its carrying value. An impairment loss for goodwill would be recognized based on the difference between the carrying value and its estimated fair value, which would be determined based on either discounted future cash flows or another appropriate fair value method. Due to the impacts of the COVID-19 pandemic on the general economy, we performed this assessment at each interim period during 2020 as well. However, based on the Company’s performance, we believed that an impairment was remote during the year.
The evaluation of goodwill for impairment requires management to use significant judgments and estimates in accordance with U.S. GAAP, including, but not limited to, economic, industry, and company-specific qualitative factors, projected future net sales, operating results, and cash flows. Although we currently believe the estimates used in the evaluation of goodwill are reasonable, differences between actual and expected net sales, operating results, and cash flows and/or changes in the discount rates used could cause these assets to be deemed impaired. If this were to occur, we would be required to record a non-cash charge to earnings for the write-down in the value of the goodwill, which could have a material adverse effect on our results of operations and financial position but not our cash flows from operations.
During the fourth quarter of 2020, we performed an assessment of the fair value of goodwill related to World Tech. Due to the timing of the recent acquisitions of Showcase and Success, management did not identify any new events or changes in circumstances that would more likely than not indicate that the fair value of the goodwill acquired for each business combination is below its carrying value. To perform these assessments, we identified and analyzed macroeconomic conditions, industry and market conditions, and company-specific factors. Taking into consideration these factors, we estimated the potential change in the fair value of goodwill compared with our most recent quantitative impairment test for World Tech. As a result of the analysis performed, management believes the estimated fair value of the reporting units continue to exceed their carrying values by a substantial margin and does not represent a more likely than not possibility of potential impairment. The goodwill analysis did not result in an impairment charge. Also, a reasonable hypothetical change in assumptions, such as a 1% change in the discount rate or a 10% change in the projected cash flows, would not have resulted in an impairment charge for the year ended December 31, 2020.
Income taxes
We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis 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. As of December 31, 2020, based on our assessment of the realizability of the net deferred tax assets, we continue to maintain a full valuation allowance against all of our federal and state net deferred tax assets. If our valuation allowance were released due to a change in the likelihood of our deferred tax assets as of December 31, 2020, our income tax benefit and net income would have increased by up to $22.1 million. Management has evaluated our recent profitability trends and believes that, if current trends persist, there is a reasonable possibility that within the next 12 months, sufficient positive evidence may become available to allow us to reach the conclusion that a significant portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain DTAs and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance to be released are subject to change based on the positive evidence, including, but not limited to, the level of expected profitability, that we are able to actually achieve in future periods.
Although management believes that the judgment and estimates involved are reasonable and that the necessary provisions related to income taxes have been recorded, changes in circumstances or unexpected events could adversely affect our financial position, results of operations, and cash flows.
See Note 13 – Income Taxes to the consolidated financial statements for further information related to our income tax positions.
Litigation
We recognize expense for legal claims when payments associated with the claims become probable and can be reasonably estimated. Due to the difficulty in estimating costs of resolving legal claims, actual costs could have a material adverse impact on our results of operations and cash flow, if we were to become a party to a material legal action.
NON-U.S. GAAP FINANCIAL MEASURES
To supplement our consolidated financial statements, which are prepared and presented in accordance with U.S. GAAP, we use Adjusted EBITDA, a non-U.S. 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’ overall
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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 U.S.GAAP.
We define the non-U.S. GAAP financial measure of Adjusted EBITDA to mean net income (loss), excluding other income (expense), income tax benefit (expense), depreciation, amortization, and impairment charges, 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 underlying operations and provides better transparency into our results of operations.
We are presenting the non-U.S. 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 U.S. GAAP. There are a number of limitations related to the use of Adjusted EBITDA compared to Net Income (Loss), the closest comparable U.S. GAAP measure. Some of these limitations are that:
● Adjusted EBITDA excludes stock-based compensation expense related to our agent growth incentive program and stock option expense, which have been, and will continue to be for the foreseeable future, significant recurring expenses in our business and an important part of our compensation strategy; and
● Adjusted EBITDA excludes certain recurring, non-cash charges such as depreciation of fixed assets, amortization of intangible assets, and impairment charges related to these long-lived assets, and, although these are non-cash charges, the assets being depreciated, amortized, or impaired may have to be replaced in the future.
The following tables present a reconciliation of Adjusted EBITDA to net loss, the most comparable U.S. GAAP financial measure, for each of the periods presented:
Year Ended December 31,
2020
2019
2018
Net income (loss)
$ 30,990
($ 9,557)
($ 22,430)
Other expense (income), net
184
281
(32)
Income tax expense
413
497
78
Depreciation, amortization, and impairment expenses (1)
4,214
2,384
894
Stock compensation expense (2)
15,239
13,959
19,053
Stock option expense
6,801
5,085
4,847
Adjusted EBITDA
$ 57,841
$ 12,649
$ 2,410
(1) Stock payable amortization is included in other expense (income). Impairment expense relates to 2020 write off of an intangible asset related to a discontinued internally developed software project. There were no impairment charges recognized during 2019 or 2018.
(2) This includes agent growth incentive stock compensation expense and stock compensation expense related to non-controlling interest.
The primary driver for the changes in Adjusted EBITDA was improved net income attributable to the increase in revenue from the higher volume of real estate sales transactions. During the years ended December 31, 2020 and 2019, net income increased by $40.5 million and net losses decreased by $12.9 million, respectively.