Freedom Holding Corp. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended December 31, 2017; filed February 14, 2018. Amounts below are in U.S. dollars, generally thousands, unless stated otherwise. The interim statements are unaudited, and comparative periods were recast for businesses under common control.
Business context and reporting period
Freedom Holding is building a financial-services group focused on brokerage, banking, trading and investment services in Russia, Kazakhstan, Cyprus and Ukraine. During the period it completed the acquisitions of Freedom RU and Freedom CY; it acquired Freedom UA in November, with Ukrainian regulatory approval received in January 2018. It formed a wholly owned Uzbekistan subsidiary in February 2018, which planned to seek a brokerage license.
Financial performance and position
| Metric | Three months ended Dec. 31, 2017 | Nine months ended Dec. 31, 2017 | Comparable 2016 period |
|---|---|---|---|
| Net revenue | $(2,159) | $46,331 | $2,866; $9,079 |
| Net income (loss) attributable to common shareholders | $(13,126) | $22,530 | $(572); $383 |
| Basic and diluted earnings (loss) per share | $(0.29) | $0.86 | $(0.05); $0.03 |
| Net cash used in operating activities | Not presented quarterly | $(12,108) | $(6,344) |
| Net cash used in investing activities | Not presented quarterly | $(685) | $(2,763) |
| Net cash from financing activities | Not presented quarterly | $27,043 | $11,135 |
The 2016 figures in the final column are respectively for the three- and nine-month periods. Net revenue is not a conventional sales measure here: it includes trading gains and losses, interest, fees, derivatives and foreign-exchange results. The filing does not present a single operating margin measure.
- Trading and earnings: Nine-month trading-securities gains were $30,825, including $19,562 unrealized gains; management attributed key gains to Kcell and KEGOC share-price increases and $8,373 from selling Astana Bank shares. In the third quarter, trading securities generated an $8,318 loss, including $8,113 unrealized, primarily following a decline in Kcell shares. The quarter’s net revenue was negative and the company recorded a net loss.
- Other income and costs: Nine-month interest income was $6,442; fee and commission income was $6,412. Total expenses were $23,217, including $9,499 interest expense and $12,113 operating expense. Interest costs rose with repurchase-agreement financing and issued debt; operating costs increased amid expansion, including payroll, rent and stock compensation.
- Balance sheet and liquidity: At December 31, total assets were $258,846, liabilities $173,323 and equity $85,523. Cash and cash equivalents were $34,847, with an additional $14,138 restricted. Working capital, calculated by management excluding restricted cash, was $77,551 versus $31,429 at March 31, 2017.
- Borrowing and collateral: Securities repurchase-agreement obligations were $137,436, up from $56,289 at March 31; debt securities issued, net, were $10,625 versus $3,459. Of $199,207 in trading securities, $137,436 was subject to repurchase obligations; $21,674 of cash and cash equivalents was placed under reverse repurchase agreements. Cash-flow statement ending cash and cash equivalents of $48,985 includes restricted cash.
- Cash generation and capital: Operating cash use increased to $12,108, reflecting, among other factors, investment in trading securities. Financing provided $27,043, including $11,045 from a private placement, $8,594 of capital contributions from CEO and controlling shareholder Timur Turlov, and $9,853 of debt-security proceeds, partly offset by debt repurchases.
Changes versus comparable periods
- Third-quarter net revenue moved from $2,866 to a loss of $2,159, and net loss widened to $13,126 from $572, chiefly because trading results reversed from a gain to a substantial loss. Higher interest income and fee income did not offset trading losses and increased expenses.
- For nine months, net revenue rose to $46,331 from $9,079 and net income increased to $22,530 from $383, principally due to higher trading gains, interest income and commissions. These results include significant unrealized trading gains and income associated with the Astana Bank IPO.
- Assets expanded to $258,846 from $121,363 at March 31, 2017, alongside acquisitions, a larger trading portfolio, and increased repurchase financing. The balance sheet and prior comparative results were recast for entities treated as under common control.
- Common shares outstanding rose from 11,213,926 at March 31 to 52,606,600 at December 31, primarily reflecting shares issued for acquisitions and employee awards, as well as the private placement. A one-for-25 reverse split was applied retroactively to share and per-share data.
Outlook, risks and unusual items
- Management expected revenue, expenses and net income to trend higher year over year as the business expanded, while warning that quarter-to-quarter results could vary. It expected fee and commission income to be lower in upcoming periods until additional underwriting engagements are secured; it reported no upcoming underwriting engagements at the time of the filing. No numerical guidance was provided.
- Management highlighted exposure to market volatility and proprietary trading, especially concentrated positions in securities such as Kcell and KEGOC; changes in prices can materially affect reported earnings. It also warned that collateralization of trading securities and cash could worsen liquidity or capitalization if markets move adversely.
- Other stated risks include foreign-exchange movements, regulatory requirements across jurisdictions, competition, ability to retain licensed staff, expansion funding needs, and control by Turlov as majority shareholder. Management said it had no agreement requiring Turlov to provide further capital and that further growth could require external equity or debt financing.
- The Tax Cuts and Jobs Act’s effects were provisional; the company said accounting would be completed in the fourth quarter of 2018 and noted possible incremental U.S. tax under GILTI rules from 2018. The filing lists office-lease commitments of $7,289, including $3,826 due within one year. Management did not expect pending legal proceedings to materially affect financial condition, results or cash flows; it reported no off-balance-sheet financing arrangements.
- Related-party items included $3,103 of commission income from related parties during the nine months and $8,594 in Turlov capital contributions. The company also issued shares to Turlov for acquisitions and a director participated in the private placement.
Important facts for investors to verify
- How much of nine-month profit came from unrealized, concentrated trading gains, and how those positions performed after period-end.
- The composition, liquidity and valuation of pledged trading securities, and the terms, maturities and refinancing risks of repurchase agreements.
- The quality and repeatability of IPO-related and underwriting revenue, given management’s warning of lower near-term commissions without new engagements.
- The financial contribution and integration costs of acquired businesses, and the final accounting for common-control recasts and the Freedom CY and Freedom UA transactions.
- Potential dilution from acquisition shares, employee awards and options, and the economic effect of related-party dealings and any future capital contributions.
- The final tax-reform accounting, potential GILTI exposure, and whether available capital and liquidity meet subsidiaries’ regulatory requirements as expansion continues.