Freedom Holding Corp. — Form 10-Q Summary
Business context and period: The unaudited report covers the quarter and six months ended September 30, 2017, the company’s fiscal second quarter and first half of fiscal 2018. Freedom Holding is building a brokerage, banking and financial-services business focused primarily on Russia and Kazakhstan. The September 2017 acquisition of Freedom RU brought its operating subsidiaries, including Freedom KZ, Freedom 24 and FFIN Bank, into the consolidated group. Unless noted, amounts below are in millions of U.S. dollars; financial-statement amounts are reported in thousands.
Key financial metrics
| Metric | Three months ended Sept. 30, 2017 | Six months ended Sept. 30, 2017 |
|---|---|---|
| Total revenue | $34.942 | $48.498 |
| Net income attributable to common shareholders | $27.600 | $35.972 |
| Diluted EPS | $1.22 | $2.12 |
| Net cash from operating activities | Six-month total: $10.499 |
- Revenue composition: Six-month revenue included $39.143 of trading-security gains, $4.403 of fee and commission income, and $3.589 of interest income. Trading-security gains included $28.733 of unrealized gains. The company attributed substantial gains to Kcell and KEGOC share-price increases and to selling Astana Bank shares.
- Expenses and margins: Six-month expenses were $11.539, including $5.009 interest expense and $5.829 operating expense. Net income was unusually high relative to revenue, chiefly reflecting trading gains; conventional operating margin is not presented.
- Balance sheet and liquidity: At September 30, cash and cash equivalents were $37.871, restricted cash $15.255, trading securities $179.020, total assets $245.000, total liabilities $161.704 and equity $83.296. Management reported working capital of $73.167, excluding restricted cash from current assets.
- Funding and debt: Securities repurchase obligations were $130.211, up from $56.289 at March 31. Debt securities issued, net of repurchases and accrued interest, were $7.604. Six-month interest expense rose to $5.009 from $1.352 a year earlier.
- Cash flow: Six-month investing cash outflow was $0.710 and financing cash inflow was $12.348. Cash increased by $18.676 before exchange-rate effects; foreign-exchange movements reduced cash by $3.461. Ending cash and cash equivalents were $37.871 on the balance sheet; the cash-flow statement’s $53.126 ending figure includes restricted cash.
Changes versus the prior comparable period
- Quarterly revenue rose to $34.942 from $5.219 and six-month revenue to $48.498 from $6.260. Six-month net income increased to $35.972 from $1.103; diluted EPS was $2.12 versus $0.10.
- Management attributed the results primarily to larger proprietary trading gains. Quarter trading gains included $27.106 unrealized gains; first-half trading gains included $28.733 unrealized gains. The company cautioned these may not be realized.
- Fees and commissions also increased as FFIN Bank became operational and brokerage, underwriting and market-making activity expanded. Expenses increased with business growth, higher financing costs and custody fees.
- Comparatives were recast because the June 2017 Freedom RU acquisition was treated as an entity under common control. The September 6 reverse stock split was one-for-25; share and per-share data were adjusted retrospectively.
Outlook, risks and unusual items
- Management expects year-over-year growth to continue but said the rapid quarter-over-quarter growth seen in the first half is unsustainable. It does not expect similarly significant trading gains and anticipated lower fee income until additional underwriting engagements are secured. No quantified guidance was provided.
- Trading and liquidity risks are material: securities and cash are used as collateral, and the company warned adverse market moves could harm liquidity, capitalization and operations. Repurchase obligations were largely due within 30 days.
- Other risks include market volatility, currency movements, regulatory compliance across jurisdictions, competition, retaining qualified personnel and the company’s ability to manage proprietary-trading and customer risks. The company relies in part on capital contributions from CEO and controlling shareholder Timur Turlov, who is not obligated to provide further funds.
- Foreign-currency translation reduced comprehensive income by $4.376 in the first half. The company reported a $0.713 loss on currency futures; the contracts had a $25 million notional amount. A related-party call option expired unexercised, generating a $0.490 gain.
- Contractual obligations for the year to September 30, 2018 included $8.534 of deferred distributions to former shareholders and $2.549 of office leases. Management said it had no off-balance-sheet financing arrangements and did not expect ordinary-course legal proceedings to have a material effect.
- After quarter-end, Freedom CY was acquired on November 10 in exchange for 12,758,011 shares; the company also agreed to acquire Freedom UA, subject to regulatory approvals. Management reported disclosure controls were effective and no material change in internal control.
Important facts for investors to verify
- How much of trading income was unrealized, and the company’s exposure to Kcell, KEGOC and other concentrated positions.
- Repurchase-agreement collateral, maturity, funding costs and the liquidity available after customer and other restrictions.
- The basis and effect of the common-control recast, the Freedom RU acquisition accounting, and subsequent share issuance and dilution.
- Whether management’s expectations for lower trading gains and fee income were borne out, and whether the company obtained new underwriting mandates.
- Regulatory status and integration of Freedom CY and the pending Freedom UA acquisition, alongside the company’s capital needs and dependence on shareholder contributions.