Freedom Holding Corp. annual report, FY2018

Freedom Holding Corp. — FY2018 Form 10-K

Reporting period: Fiscal year ended March 31, 2018, compared with fiscal 2017. Although the request refers to “2017 Q4,” this filing is an annual report for FY2018, not a standalone quarterly filing. Financial statement amounts below are in U.S. dollars; unless noted, amounts are in millions.

Business context

Freedom Holding provides retail securities brokerage, banking, investment banking, underwriting, market-making and proprietary trading services, principally in Kazakhstan and Russia, with operations also in Ukraine, Uzbekistan, Kyrgyzstan and Cyprus. At year-end, it reported more than 46,000 client accounts, over $14 billion in client transaction volume, and 55 retail offices. Management attributed growth to expanded operations and acquisitions. The FY2017 comparative figures were recast to include entities acquired from controlling shareholder Timur Turlov under common control.

Financial performance and liquidity

Metric	FY2018	FY2017, recast
Net revenue	$55.224	$19.386
Total expenses	$35.512	$13.614
Income before taxes	$19.712	$5.772
Net income attributable to common shareholders	$19.233	$6.287
Basic and diluted EPS	$0.58	$0.56
Net cash from/(used in) operating activities	$(19.191)	$4.802

Revenue increased 185%. Trading securities gains were $33.746 million, including $16.432 million of unrealized gains; fee and commission income was $10.796 million, and interest income was $8.184 million. Trading gains were the largest revenue source.
Net income rose substantially, while EPS increased modestly. The company completed a 1-for-25 reverse stock split and issued substantial shares during the year, including in private placements and acquisitions.
Total expenses rose 161%. Interest expense increased to $14.244 million, primarily because of greater repo financing; operating expense rose to $18.927 million as the company expanded. Net interest expense was $6.060 million.
At March 31, 2018, cash and cash equivalents were $64.531 million, restricted cash was $13.671 million, and working capital was $98.696 million. Total assets were $330.086 million, total liabilities $214.986 million, and stockholders’ equity $115.100 million.
Trading securities were $212.319 million. Securities repurchase obligations were $154.775 million; loans received were $7.143 million and issued debt securities were $10.840 million. Management reported $209.088 million of trading securities subject to repo obligations or pledge loans. A single company represented about $105 million, or 49%, of the proprietary portfolio; the position was highly leveraged and remained open at the report date.
Financing cash flow was $64.777 million, including $40.444 million of private-placement proceeds, $11.933 million from bond issuance, and $8.594 million of shareholder capital contributions. Investing cash flow was $(0.869) million. The company reported no off-balance-sheet financing arrangements.

Material changes and unusual items

FY2018 net revenue growth reflected higher brokerage and banking fees, trading gains, interest income and foreign-exchange gains. Four securities—Kcell, Astana Bank, Kazakhtelecom and KEGOC—contributed $16.132 million, $8.186 million, $3.980 million and $1.847 million, respectively, to trading gains.
Operating cash flow turned negative despite higher net income, principally reflecting increased trading securities, receivables and loans issued; repo obligations and customer liabilities also increased.
In December 2017 and March 2018, the company raised approximately $40.444 million net through common-stock placements. A one-year credit line permitted borrowing up to $9 million at 7%; approximately $7 million was drawn at year-end. Kazakhstan subsidiary bonds carried fixed coupons of 8% to 11.5% and maturities in 2019 and 2020.
After year-end, the company acquired Asyl Invest for approximately $2.25 million and Nettrader for approximately $3.816 million. Both had been controlled by Mr. Turlov; the stated consideration equaled fair value of net assets acquired. A further $29.4 million bond placement at an 8% coupon, maturing in 2021, was completed in June 2018.
Management stated that existing cash, expected operating cash flows and forecast proprietary-trading returns were expected to cover working capital needs for the next 12 months. No numerical earnings or revenue guidance was provided.

Risks, contingencies and governance

Principal financial risks include highly leveraged proprietary trading, portfolio concentration, securities-price and liquidity risk, repo funding and collateral exposure, counterparty and margin-credit risk, and foreign-exchange movements. The company warns that adverse market moves or difficulty liquidating positions could materially affect liquidity, capital and earnings.
Other material risks include changing regulatory and capital requirements across operating countries, political and economic conditions, cybersecurity and service disruptions, cross-border fund transfers, FATCA compliance, and anti-corruption compliance. The filing notes potential conflicts between Russian data-sharing rules and FATCA requirements.
Mr. Turlov beneficially owned approximately 73.1% of outstanding common stock and controlled key decisions. The filing also identifies related-party transactions, including acquisitions, shareholder contributions, related-party brokerage activity and receivables.
The company did not intend to pay common-stock dividends in the foreseeable future. Its shares traded on the OTC Pink Market, which the filing describes as having a limited public market.
Management said routine legal proceedings, claims and regulatory inquiries were not expected to materially affect financial condition or operations, but it could not estimate related future legal fees. The independent auditor gave an unqualified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor did not attest to internal control.

Important facts for investors to verify

How much of FY2018 trading profit was realized versus unrealized, and whether the concentrated, leveraged single-company position has since been reduced or changed.
The terms, collateral, maturities and refinancing requirements of repo funding, loans and issued bonds, and the amount of liquid assets actually available after restrictions and pledges.
Why operating cash flow was negative and whether trading-asset growth and working-capital demands can be funded without repeated external financing.
The terms, approvals, valuation support and integration outcomes for acquisitions from Mr. Turlov, and the extent of other related-party balances and activity.
The effects of the FY2017 recast and reverse stock split on comparability, share count and per-share results; also review subsequent dilution and equity compensation.
Whether post-year-end acquisitions and the June 2018 bond issuance changed liquidity, leverage, client-account totals or the stated 12-month funding outlook.