Futu Holdings Ltd annual report, Q4 FY2019

Futu Holdings Limited — Form 20-F Summary

Business context and reporting period

Futu Holdings Limited is a Cayman Islands holding company operating primarily through Hong Kong subsidiaries and a PRC variable interest entity. It provides online securities brokerage, margin financing, securities lending, wealth management, market-data, investor-community and corporate services, primarily to affluent Chinese investors. The filing covers the fiscal year ended December 31, 2019, rather than a standalone fourth quarter; the filing text does not provide a separate Q4 income statement or cash-flow statement.

The company completed its Nasdaq IPO in March 2019. Each ADS represents eight Class A ordinary shares. At December 31, 2019, the company had 459.1 million Class A shares and 544.6 million Class B shares outstanding.

Financial performance and key metrics

Metric	2018	2019	Change
Total revenue	HK$811.3 million	HK$1,061.6 million	+30.9%
Brokerage commission and handling income	HK$408.0 million	HK$511.4 million	+25.3%
Interest income	HK$360.6 million	HK$464.9 million	+28.9%
Other income	HK$42.8 million	HK$85.3 million	+99.3%
Gross profit	HK$561.7 million	HK$779.9 million	+38.8%
Gross margin	69.2%	73.4%	+4.2 percentage points
Operating expenses	HK$353.0 million	HK$591.9 million	+67.7%
Net income	HK$138.5 million	HK$165.7 million	+19.6%
Net margin	17.1%	15.6%	Declined
Net income attributable to ordinary shareholders	HK$36.9 million	HK$143.2 million	+287.6%

All financial statements are prepared under U.S. GAAP. The filing presents 2019 revenue of US$136.3 million, net income of US$21.3 million and net income attributable to ordinary shareholders of US$18.4 million.

Research and development expense increased 73.6% to HK$262.3 million.
Selling and marketing expense increased 67.9% to HK$164.7 million.
General and administrative expense increased 58.9% to HK$164.9 million.
Share-based compensation increased to HK$16.0 million from HK$10.4 million.
Basic and diluted earnings per share attributable to ordinary shareholders were HK$0.17 and HK$0.16, respectively; basic and diluted earnings per ADS were US$0.18 and US$0.16.

Cash flow, liquidity and debt

Net cash generated from operating activities was HK$1.97 billion in 2019, down from HK$4.47 billion in 2018. The cash generation substantially exceeded reported net income, primarily because of increases in payables to clients and brokers, partly offset by higher loans and advances and receivables.
Net cash used in investing activities was HK$160.1 million, including HK$118.3 million of property, equipment and intangible-asset purchases and HK$285.8 million of purchases of available-for-sale securities.
Net cash generated from financing activities was HK$1.15 billion, including IPO proceeds and short-term borrowings, partly offset by repayment of borrowings.
Cash and cash equivalents were HK$362.6 million at year-end, compared with HK$215.6 million in 2018. Cash, cash equivalents and cash held on behalf of clients totaled HK$14.90 billion, but client cash is segregated and is not generally available for corporate use.
Borrowings were HK$1.47 billion at year-end, down from HK$1.58 billion. The weighted-average borrowing rate was 4.29%, and unused bank facilities totaled HK$3.33 billion; those facilities were uncommitted and could be withdrawn.
Loans and advances increased to HK$4.19 billion, including HK$4.14 billion of margin loans, from HK$3.09 billion in 2018.
Operating lease liabilities were HK$172.5 million following adoption of ASC Topic 842. Contractual operating lease payments totaled HK$188.4 million, primarily due through 2023.
Regulated subsidiaries were in compliance with capital requirements. Reported excess regulatory capital totaled HK$1.32 billion, including HK$1.23 billion for Futu Securities.

Operating and strategic changes versus 2018

Trading volume declined to HK$872.7 billion from HK$907.0 billion, but paying clients increased 49% to 198,382 and total client assets increased to HK$87.1 billion from HK$50.9 billion.
Registered clients increased to 717,842 from 502,452, while users increased to 7.5 million from 5.6 million. December 2019 average daily active users were 208,340, versus 151,700 in December 2018.
Margin financing balances increased to HK$4.14 billion from HK$2.89 billion; securities lending balances increased to HK$655.6 million from HK$297.3 million. Approximately 71.3% of margin financing was funded through financial institution partners.
Interest income from margin financing and securities lending increased 14.5% to HK$258.9 million. Bank-deposit interest income increased 51.2% to HK$187.2 million.
Futu launched its online wealth-management platform in August 2019. More than 17,000 clients held mutual fund positions at year-end, with mutual fund client assets exceeding HK$6.0 billion. Related fund-distribution revenue contributed to the increase in other income.
The company acquired Golden Jade Wealth Management Limited, expanded U.S. operations and participated in 16 U.S. IPOs through Futu Inc. Moomoo had more than 40,000 users at year-end.
Operating leverage improved at the gross-profit level, but substantial investment in technology, personnel, marketing and new products caused operating expenses to grow faster than revenue and reduced net margin.
All 377.9 million preferred shares converted into ordinary shares at the IPO. The company also issued 115.7 million Class A shares in the IPO and concurrent private placement and issued 106.3 million shares upon exercise of employee options.

Guidance, outlook, commentary and risks

The filing does not provide quantitative revenue, earnings or trading-volume guidance. Management states that current cash, operating cash flow and available financing are expected to satisfy anticipated working-capital and capital-expenditure needs for at least the next 12 months. The company expects continued investment in technology, regulatory capital, personnel, client acquisition, wealth management and international expansion.

COVID-19: The filing, dated April 27, 2020, reports higher account sign-ups, trading activity and net asset inflows during early 2020 because of market volatility and migration from offline to online trading. It also reports delayed product launches and increased margin-loan credit risk. Management had not identified a material COVID-19-related contingency, impairment or liquidity deficiency as of the filing date, but stated that the duration and financial impact remained uncertain.
Regulatory inquiries: Futu International Hong Kong was subject to ongoing HK SFC inquiries, including matters concerning client onboarding. The outcome could include reprimands, fines, business restrictions or suspension or revocation of licenses. No accrual was recorded for this contingency in 2018 or 2019 because the outcome was not determinable.
Online onboarding and licensing: The company acknowledged that online onboarding procedures for certain PRC residents did not strictly follow specified Hong Kong methods and that remediation could be costly and disruptive. It also lacks certain PRC licenses potentially relevant to securities brokerage, securities investment consulting, internet audio-visual services, internet news and fund sales activities.
VIE structure: A limited portion of PRC operations is conducted through contractual arrangements with a VIE. Changes in PRC law or enforcement could impair the company’s control of the VIE or prevent consolidation of its financial results.
Market and interest-rate exposure: Revenue depends heavily on trading activity, client assets, commission rates, interest rates and margin balances. Management estimates that a gradual 100-basis-point increase in rates would increase pre-tax income by approximately HK$57.9 million, while a comparable decrease would reduce pre-tax income by approximately the same amount.
Credit and liquidity risk: Margin lending, securities lending, clearing obligations and reliance on external funding partners expose the company to collateral, counterparty and funding risks, particularly during market volatility.
Internal controls: Management concluded that disclosure controls were ineffective at December 31, 2019 because a previously identified material weakness in U.S. GAAP and SEC reporting expertise had not been fully remediated. The filing does not include management’s Section 404 assessment or an auditor attestation because of the applicable emerging-growth-company transition period.
Governance and ownership: The founder controlled approximately 71.1% of voting power as of February 29, 2020. The dual-class structure gives Class B shares 20 votes per share, limiting ADS holders’ influence.
Dividend policy: The company does not expect to pay cash dividends in the foreseeable future and intends to retain earnings for growth.

Most important facts for investors to verify

Verify the separate quarterly results for Q4 2019, because this annual filing reports full-year results and does not clearly provide standalone Q4 financial statements.
Review the status and eventual resolution of the HK SFC inquiries, particularly the client-onboarding matters, and determine whether any penalties, remediation or license restrictions were imposed.
Assess the sustainability of revenue growth given the decline in trading volume, reliance on interest income and sensitivity to market activity and interest rates.
Reconcile operating cash flow with reported earnings and distinguish corporate cash from segregated client cash.
Monitor margin-loan growth, collateral quality, funding concentration, uncommitted credit facilities and potential credit losses during volatile markets.
Evaluate whether the material weakness in financial reporting controls was remediated and whether future filings contain a management Section 404 assessment.
Review the PRC VIE arrangements, required licenses, foreign-exchange restrictions and the effect of the PRC Foreign Investment Law on the operating structure.
Consider dilution from outstanding options and the company’s concentrated founder and dual-class shareholder control.