Freedom Holding Corp. — Form 10-Q Summary
Business context and period. Freedom Holding Corp. provides retail brokerage, banking-related services, investment banking, market making and proprietary securities trading, primarily in Eastern Europe and Central Asia. This report covers the fiscal third quarter and nine months ended December 31, 2018; financial statements are unaudited. Unless noted, dollar amounts below are in thousands. Prior-year comparisons are recast.
Financial results and condition
- Quarter: Net revenue was $26,393, versus a net revenue loss of $1,430 in the prior-year quarter. Net income was $8,900, versus a net loss of $13,468; diluted EPS was $0.15 versus a loss of $0.30. Comprehensive income was $3,304, including a $5,596 foreign-currency translation loss.
- Nine months: Net revenue increased 7% to $51,779, while net income fell to $4,276 from $21,934; diluted EPS was $0.07 versus $0.83. Comprehensive loss was $13,538, principally reflecting $17,836 of foreign-currency translation losses.
- Revenue mix and margins: Nine-month fee and commission income rose to $31,033 from $7,526; trading-securities gains declined to $12,669 from $31,408; interest income increased to $11,823 from $6,778. Foreign-exchange operations moved from a $1,989 gain to a $3,746 loss. Net income was about 8% of net revenue for the nine months, versus about 45% in the prior-year period; for the quarter, net income was about 34% of net revenue.
- Expenses: Nine-month total expenses increased 79% to $46,494, including operating expenses of $31,272 versus $14,149. Management attributed much of the increase to expansion, with higher payroll, advertising, rent and stock-based compensation. Interest expense rose 17% to $11,471.
- Cash flow: Nine-month operating cash flow was $45,879, compared with cash used of $90,235 in the prior-year period. Investing used $6,048 and financing used $48,808. Cash, cash equivalents and restricted cash declined by $19,165 to $68,528; cash and cash equivalents alone were $41,425 at December 31.
- Liquidity and balance sheet: Working capital was $95,591, largely unchanged from $95,376 at March 31, 2018. Total assets were $295,361 versus $350,902; total liabilities were $183,918 versus $223,870; stockholders’ equity was $111,443 versus $127,032. Cash and cash equivalents were not insured. Restricted cash was $27,103.
- Debt and financing: Securities repurchase agreement obligations declined to $68,181 from $154,775. Debt securities issued increased to $26,573 from $11,222; loans received declined to $3,967 from $7,143. The company issued Freedom KZ bonds with fixed coupons of 8% or 11.5%. On January 23, 2019, it announced retirement of KZT-denominated debt with a December 31 carrying value of $8,105, including accrued interest.
Changes, outlook and risks
- Management attributed revenue growth to a larger customer base, increased transaction volume and growth in brokerage-related banking. The company reported more than 110,000 client accounts, over 65% with positive cash or asset balances, and transaction volume exceeding $39 billion for the nine months.
- Growth included the April 2018 Asyl merger, which added approximately 16,000 Kazakhstan client accounts, and the May 2018 Nettrader merger, which added approximately 16,000 Russian accounts and completed the acquisition of the Tradernet platform. First Stock Store was disposed of for $7, producing a $15 loss.
- Management stated that available cash, expected operating cash flows and forecast returns from proprietary trading should meet working-capital needs for the next 12 months. Further expansion may require external financing, which may not be available on acceptable terms.
- Material exposures include market and leverage risk, collateralized funding, and currency risk. Approximately $59 million of the proprietary trading account was invested in a single company at December 31 and remained open at the report date. Management warned that an adverse investment or market outcome, or inability to liquidate the position, could significantly affect liquidity, capital and results. The company also reported that a significant portion of its trading securities and cash was subject to collateralization agreements.
- Related-party commission income was $26,723 for the nine months, compared with $3,103 in the prior-year period; the filing describes it primarily as brokerage commissions, referral agency fees and money-transfer commissions. Investors should consider the scale of this related-party activity.
- Other notable items: the company announced approval for listing its common stock on the KASE Alternative Market in February 2019. It reported no off-balance-sheet financing arrangements, no additions to the risk factors in its prior annual report, and no material effect expected from routine legal matters, while noting legal costs cannot be estimated. Management concluded disclosure controls were effective.
- Comparative figures were revised following acquisitions and mergers of entities deemed under common control, and certain reclassifications were made. The company cautioned that interim results are not necessarily indicative of full-year results. It provided no specific earnings or revenue guidance.
Key facts for investors to verify
- How much of commission income is recurring and economically dependent on related parties, and what are the terms of those arrangements?
- What are the identity, valuation, liquidity and concentration risks of the approximately $59 million single-company position, and how much leverage supports it?
- How sensitive are earnings, comprehensive income, capital and liquidity to further ruble and tenge depreciation and to trading-security price movements?
- What are the maturity, refinancing and collateral terms of repurchase obligations and issued bonds, including the subsequent $8.1 million debt retirement?
- Can client growth and revenue gains sustainably offset sharply higher operating costs, and will expansion require additional financing?
- What impacts will adoption of the new lease accounting standard have? The company expected significant right-of-use assets and lease liabilities but was still assessing the effects.