FOCUS FINANCIAL PARTNERS INC. You should read this discussion and analysis of our financial condition and results of operations in conjunction with the historical financial statements and related notes included elsewhere in this Annual Report. The information in this section contains forward-looking statements. Please read "Cautionary Statement Regarding Forward-Looking Statements." Our actual results may differ significantly from the results suggested by these forward-looking statements and from our historical results. Some factors that may cause our results to differ are described in "Part I, Item 1A, Risk Factors."
Overview
We are a leading partnership of independent, fiduciary wealth management firms operating in the highly fragmented RIA industry, with a footprint of over 85 partner firms primarily inthe United States . We have achieved this market leadership by positioning ourselves as the partner of choice for many firms in an industry where a number of secular trends are driving consolidation. Our partner firms primarily service ultra-high net worth and high net worth individuals and families by providing highly differentiated and comprehensive wealth management services. Our partner firms benefit from our intellectual and financial resources, operating as part of a scaled business model with aligned economic interests, while retaining their entrepreneurial culture and independence. Our partnership is comprised of trusted professionals providing comprehensive wealth management services through a largely recurring, fee-based model, which differentiates our partner firms from the traditional brokerage platforms whose revenues are largely derived from commissions. We derive a substantial majority of our revenues from wealth management fees for investment advice, financial and tax planning, consulting, tax return preparation, family office services and other services. We also generate other revenues primarily from recordkeeping and administration service fees, commissions and distribution fees and outsourced services. Since we began revenue-generating and acquisition activities in 2006, we have created a partnership of over 85 partner firms, the substantial majority of which are RIAs registered with theSEC and built a business with revenues in excess of$2.1 billion for the year endedDecember 31, 2022 . For the year endedDecember 31, 2022 , in excess of 95% of our revenues were fee-based and recurring in nature. We have established a national footprint acrossthe United States and primarily expanded our international presence intoAustralia ,Canada ,Switzerland and theUnited Kingdom .
Sources of Revenue
Our partner firms provide comprehensive wealth management services through a
largely recurring, fee-based model. We derive a substantial majority of our
revenue from wealth management fees, which are composed of fees earned from
wealth management services, including investment advice, financial and tax
planning, consulting, tax return preparation, family office services and other
services. Fees are primarily based either on a contractual percentage of the
client's assets based on the market value of the client's assets on the
predetermined billing date, a flat fee, an hourly rate based on predetermined
billing rates or a combination of such fees and are billed either in advance or
arrears on a monthly, quarterly or semiannual basis. In certain cases, such
wealth management fees may be subject to minimum fee levels depending on the
services performed. We also generate other revenues, which primarily include
recordkeeping and administration service fees, commissions and distribution fees
and outsourced services. The following table summarizes our sources of revenue:
Year Ended December 31,
2020 2021 2022
% of Total % of Total % of Total
Revenues Revenues Revenues Revenues Revenues Revenues
(dollars in thousands)
Wealth management fees $ 1,286,130 94.5 % $ 1,717,365 95.5 % $ 2,056,328 95.9 %
Other 75,189 5.5 % 80,586 4.5 % 86,993 4.1 %
Total revenues $ 1,361,319 100.0 % $ 1,797,951 100.0 % $ 2,143,321 100.0 %
40
Table of Contents
During the years ended December 31, 2020 , 2021 and 2022, our wealth management
fees were impacted by the acquisitions of new partner firms and the growth of
existing partner firms, which includes the acquisitions of wealth management
practices and customer relationships by our existing partner firms. In 2020,
2021 and 2022, we completed acquisitions of 7, 14 and 5 partner firms,
respectively. In 2020, the new partner firms were Nexus Investment Management ,
MEDIQ Financial Services , InterOcean Capital , Seasons of Advice, CornerStone
Partners , Fairway Wealth Management and Kavar Capital Partners . In 2021, the new
partner firms were Hill Investment Group , Prairie Capital Management , Rollins
Financial, ARS Wealth Advisors , Badgley Phelps Wealth Managers, Ancora Holdings ,
Sonora Investment Management , Cardinal Point , Ullmann Wealth Partners , Mosaic
Family Wealth, Alley Company , Cassaday & Company , Provident Financial Management
and London & Co. The new partner firms Provident Financial Management and London
& Co. combined their respective businesses in December 2021 and operate as
Provident Financial Management. In 2022, the new partner firms were Azimuth
Capital Investment Management , Octogone Holding , Icon Wealth Partners ,
FourThought Private Wealth and Beaumont Financial Partners .
In 2020, 2021 and 2022, our partner firms completed 18, 24 and 19 transactions,
respectively, consisting of business acquisitions accounted for in accordance
with Accounting Standard Codification ("ASC") Topic 805: Business Combinations
and asset acquisitions, including, 4, 8 and 1 transactions completed by
Connectus in 2020, 2021 and 2022, respectively.
See Note 4 to our consolidated financial statements for additional information about our acquisitions.
For the year endedDecember 31, 2022 , in excess of 95% of our revenues were fee-based and recurring in nature. Although the substantial majority of our revenues are fee-based and recurring, our revenues can fluctuate due to macroeconomic factors and the overall state of the financial markets, particularly inthe United States . Our partner firms' wealth management fees are primarily based either on a contractual percentage of the client's assets based on the market value of the client's assets on the predetermined billing date, a flat fee, an hourly rate based on predetermined billing rates or a combination of such fees and are billed either in advance or arrears on a monthly, quarterly or semiannual basis. We estimate that approximately 24% of our revenues for the year endedDecember 31, 2022 were not directly correlated to the financial markets. Of the 76% of our revenues that were directly correlated to the financial markets, primarily equities and fixed income, for the year endedDecember 31, 2022 , we estimate that approximately 66% of such revenues were generated from advance billings. We estimate that approximately 28% of our revenues for the three months endedDecember 31, 2022 were not directly correlated to the financial markets. Of the 72% of our revenues that were directly correlated to the financial markets, primarily equities and fixed income, for the three months endedDecember 31, 2022 , we estimate that approximately 65% of such revenues were generated from advance billings. These revenues are impacted by market movements as a result of contractual provisions with clients that entitle our partner firms to bill for their services either in advance or arrears based on the value of client assets at such time. Since approximately 65% of our market correlated revenues are set based on the market value of client assets in advance of the respective service period, this generally results in a one quarter lagged effect of any market movements on our revenues. Longer term trends in the financial markets may favorably or unfavorably impact our total revenues, but not in a linear relationship. For example, during 2020, 2021 and 2022, theStandard & Poor's 500 Index had a total return of 18.4%, 28.7% and (18.1)%, respectively, and the BarclaysU.S. Aggregate Bond Index had a total return for the same periods of 7.5%, (1.5)% and (13.0)% respectively. By comparison, for the same periods our organic revenue growth was 7.0%, 24.0% and 8.5%, respectively. For additional information, please read "-How We Evaluate our Business."
Operating Expenses
Our operating expenses consist of compensation and related expenses, management fees, selling, general and administrative expenses, management contract buyout, intangible amortization, non-cash changes in fair value of estimated contingent consideration and depreciation and other amortization expense.
Compensation and Related Expenses
Compensation and related expenses include salaries and wages, including variable compensation, related employee benefits and taxes for employees at our partner firms and employees at theFocus LLC company level. 41
Table of Contents
Compensation and related expenses also include non-cash compensation expense, associated with bothFocus Inc.'s andFocus LLC's equity grants to employees and non-employees, including management company principals.
Management Fees
While we have to date, with limited exceptions, acquired substantially all of the assets or equity of a target firm, following our acquisition of a new partner firm, the partner firm continues to be primarily managed by its principals through their 100% ownership of a management company formed by them concurrently with the acquisition. Our operating subsidiary, the management company and the principals enter into a management agreement that provides for the payment of ongoing management fees to the management company. The terms of the management agreements are generally six years subject to automatic renewals for consecutive one-year terms, unless earlier terminated by either the management company or us in certain limited situations. Under the management agreement, the management company is entitled to management fees typically consisting of all EBPC in excess of Base Earnings up to Target Earnings, plus a percentage of EBPC in excess of Target Earnings. We retain a preferred position in Base Earnings. To the extent earnings of an acquired business in any year are less than Base Earnings, in the following year we are entitled to receive Base Earnings together with the prior years' shortfall before any management fees are earned by the management company. The following table provides an illustrative example of our economics, including management fees earned by the management company, for periods of projected revenues, +10% growth in revenues and -10% growth in revenues. This example assumes (i) Target Earnings of$3.0 million ; (ii) Base Earnings acquired of 60% of Target Earnings or$1.8 million ; and (iii) a percentage of earnings in excess of Target Earnings retained by the management company of 40%. Projected +10% Growth in -10% Growth Revenues Revenues in Revenues (in thousands) New Partner Firm New partner firm revenues$ 5,000 $ 5,500$ 4,500 Less: Operating expenses (excluding management fees) (2,000) (2,000) (2,000) EBPC$ 3,000 $ 3,500$ 2,500 Base Earnings to Focus Inc. (60%) 1,800 1,800 1,800 Management fees to management company (40%) 1,200 1,200 700 EBPC in excess of Target Earnings: To Focus Inc. (60%) - 300 - To management company as management fees (40%) - 200 - Focus Inc. Focus Inc. revenues$ 5,000 $ 5,500$ 4,500 Less: Operating expenses (excluding management fees) (2,000) (2,000) (2,000) Less: Management fees to management company (1,200) (1,400) (700) Operating income$ 1,800 $ 2,100$ 1,800
As a result of our economic arrangements with the various management company entities, 100% of management fees are variable expenses.
42
Table of Contents
Selling, General and Administrative
Selling, general and administrative expenses include rent, insurance premiums, professional fees, travel and entertainment and other costs.
Intangible Amortization
Amortization of intangibles consists primarily of the amortization of intangibles we acquired through our various acquisitions of new partner firms and acquisitions by our partner firms.
Non-Cash Changes in Fair Value of Estimated Contingent Consideration
We have typically incorporated into our acquisition structure contingent
consideration paid to the sellers upon the satisfaction of specified financial
thresholds, and the purchase price for a typical acquisition is comprised of a
base purchase price and the right to receive such contingent consideration in
the form of earn out payments. The contingent consideration for acquisitions of
new partner firms is generally paid over a six-year period upon the satisfaction
of specified growth thresholds, in years three and six. These growth thresholds
are typically tied to the compound annual growth rate ("CAGR") of the partner
firm's earnings. Such growth thresholds can be set annually or for different
time frames as well, for example, annually over a six-year period. The
contingent consideration for acquisitions made by our partner firms is paid upon
the satisfaction of specified financial thresholds. These thresholds are
generally tied to revenue as adjusted for certain criteria or other operating
metrics based on the retention or growth of the business acquired. These
arrangements may result in the payment of additional purchase price
consideration to the sellers for periods following the closing of an
acquisition. Contingent consideration payments are typically payable in cash
and, in some cases, equity.
For business acquisitions, we recognize the fair value of estimated contingent
consideration at the acquisition date as part of the consideration transferred
in exchange for substantially all of the assets or equity of the wealth
management firm. The contingent consideration is remeasured to fair value at
each reporting date until the contingency is resolved. Any changes in fair value
are recognized each reporting period in non-cash changes in fair value of
estimated contingent consideration in our consolidated statements of operations.
Depreciation and Other Amortization
Depreciation and other amortization expense primarily represents the benefits we received from using long-lived assets such as computers and equipment, leasehold improvements and furniture and fixtures. Those assets primarily consist of purchased fixed assets as well as fixed assets acquired through our acquisitions.
Business Acquisitions
We completed 21, 36 and 18 business acquisitions during the years endedDecember 31, 2020 , 2021 and 2022, respectively, consisting of both new partner firms and acquisitions by our partner firms. Such business acquisitions were accounted for in accordance with ASC Topic 805: Business Combinations. The purchase price is comprised of a base purchase price and a right to receive contingent consideration in the form of earn out payments. The base purchase price can consist of an upfront cash payment, deferred cash consideration and may include equity. The contingent consideration for acquisitions of new partner firms generally consists of earn outs over a six year period following the closing, with payment upon the satisfaction of specified growth thresholds in years three and six. The growth thresholds are typically tied to the CAGR of the partner firm's earnings. Such growth thresholds can be set annually or for different time frames as well, for example, annually over a six-year period. The contingent consideration for acquisitions made by our partner firms generally is earned upon the satisfaction of specified financial thresholds. These thresholds are generally tied to revenue as adjusted for certain criteria or other operating metrics based on the retention or growth of the business acquired. The contingent consideration is typically payable in cash and, in some cases, equity. 43 Table of Contents
The following table summarizes our business acquisitions for the years ended
2020 2021 2022
Number of business acquisitions closed 21 36 18
Consideration:
Cash due at closing$ 327,722 $ 983,240 $ 450,943 Estimated working capital adjustment and other (174) (577) 1,127 Cash due subsequent to closing at net present value - 86,778 9,611 Fair market value of Focus LLC common units issued - 23,118 28,992 Fair market value of Class A common stock issued - 3,515 - Fair market value of estimated contingent consideration 46,918 212,074 56,604 Total consideration$ 374,466 $ 1,308,148 $ 547,277 In addition, we completed four, two and six acquisitions during the years endedDecember 31, 2020 , 2021 and 2022, respectively, that did not meet the definition of a business under ASC Topic 805: Business Combinations. These acquisitions primarily related to the acquisition of customer relationships. Our acquisitions have been paid for with a combination of cash on hand, cash generated by our operations, borrowings under the Credit Facility,Focus LLC common units or our Class A common stock.
2023 Acquisition Developments
FromJanuary 1, 2023 toFebruary 16, 2023 , we completed seven business acquisitions (accounted for in accordance with ASC Topic 805: Business Combinations), consisting of the acquisition of one new partner firm and six acquisitions by partner firms. The Acquired Base Earnings associated with the acquisition of the new partner firm during this period is approximately$1.7 million . For additional information regarding Acquired Base Earnings, please see "-How We Evaluate Our Business." 44 Table of Contents How We Evaluate Our Business
We focus on several key financial metrics in evaluating the success of our business, the success of our partner firms and our resulting financial position and operating performance. Key metrics include the following:
Year Ended December 31,
2020 2021 2022
(dollars in thousands, except per share data)
Revenue Metrics:
Revenues $ 1,361,319 $ 1,797,951 $ 2,143,321
Revenue growth (1) from prior period 11.7 % 32.1 % 19.2 %
Organic revenue growth (2) from prior period 7.0 % 24.0 % 8.5 %
Management Fees Metrics (operating expense):
Management fees $ 349,475 $ 491,433 $ 530,329
Management fees growth (3) from prior period 14.7 % 40.6 % 7.9 %
Organic management fees growth (4) from prior
period 7.8 % 32.1 % (0.4) %
Net Income Metrics:
Net income $ 48,965 $ 24,440 $ 125,278 Net income growth from prior period * (50.1) % * Income per share of Class A common stock: Basic $ 0.58 $ 0.18$ 1.40 Diluted $ 0.57 $ 0.18$ 1.39 Income per share of Class A common stock growth from prior period: Basic * (69.0) % * Diluted * (68.4) % * Adjusted EBITDA Metrics: Adjusted EBITDA (5)$ 321,763 $ 451,296 $ 537,456
Adjusted EBITDA growth (5) from prior period 19.2 % 40.3 % 19.1 % Adjusted Net Income Excluding Tax Adjustments Metrics: Adjusted Net Income Excluding Tax Adjustments (5)$ 195,562 $ 278,681 $ 300,548 Adjusted Net Income Excluding Tax Adjustments growth (5) from prior period 33.3 % 42.5 % 7.8 % Tax Adjustments Tax Adjustments (5)(6) $ 37,254 $ 46,805$ 64,359 Tax Adjustments growth from prior period (5)(6) 16.9 % 25.6 % 37.5 % Adjusted Net Income Excluding Tax Adjustments Per Share and Tax Adjustments Per Share Metrics: Adjusted Net Income Excluding Tax Adjustments Per Share (5) $ 2.46 $ 3.36$ 3.62 Tax Adjustments Per Share (5)(6) $ 0.47 $ 0.56$ 0.77 Adjusted Net Income Excluding Tax Adjustments Per Share growth (5) from prior period 25.5 % 36.6 % 7.7 % Tax Adjustments Per Share growth from prior period (5)(6) 11.9 % 19.1 % 37.5 % Adjusted Shares Outstanding Adjusted Shares Outstanding (5) 79,397,568 82,893,928 83,093,073 Other Metrics: Net Leverage Ratio (7) at period end 3.89x 3.85x 4.19x Acquired Base Earnings (8) $ 22,121 $ 71,400$ 26,568 Number of partner firms at period end (9) 71
84 88
* Not meaningful
(1) Represents period-over-period growth in our GAAP revenue.
45
Table of Contents
Organic revenue growth represents the period-over-period growth in revenue
related to partner firms, including growth related to acquisitions of wealth
management practices and customer relationships by our partner firms,
including
for each of the entire periods presented. We believe these growth statistics
are useful in that they present full-period revenue growth of partner firms
on a "same store" basis exclusive of the effect of the partial results of
partner firms that are acquired during the comparable periods.
The terms of our management agreements entitle the management companies tomanagement fees typically consisting of all EBPC in excess of Base Earnings
up to Target Earnings, plus a percentage of any EBPC in excess of Target (3) Earnings. Management fees growth represents the period-over-period growth in
GAAP management fees earned by management companies. While an expense, we
believe that growth in management fees reflect the strength of the
partnership.
Organic management fees growth represents the period-over-period growth inmanagement fees earned by management companies related to partner firms,
including growth related to acquisitions of wealth management practices and
customer relationships by our partner firms and partner firms that have (4) merged, that for the entire periods presented, are included in our
consolidated statements of operations for each of the entire periods
presented. We believe that these growth statistics are useful in that they
present full-period growth of management fees on a "same store" basis
exclusive of the effect of the partial period results of partner firms that
are acquired during the comparable periods.
For additional information regarding Adjusted EBITDA, Adjusted Net Income
Excluding Tax Adjustments, Adjusted Net Income Excluding Tax Adjustments Per
Share, Tax Adjustments, Tax Adjustments Per Share and Adjusted Shares (5) Outstanding, including a reconciliation of Adjusted EBITDA, Adjusted Net
Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax
Adjustments Per Share to the most directly comparable GAAP financial measure,
please read "-Adjusted EBITDA" and "-Adjusted Net Income Excluding Tax
Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share."
Tax Adjustments represent the tax benefits of intangible assets, including
goodwill, associated with deductions allowed for tax amortization of
intangible assets in the respective periods based on a pro forma 27% income
tax rate. Such amounts were generated from acquisitions completed where we
received a step-up in basis for tax purposes. Acquired intangible assets may
be amortized for tax purposes, generally over a 15-year period. Due to our (6) acquisitive nature, tax deductions allowed on acquired intangible assets
provide additional significant supplemental economic benefit. The tax benefit
from amortization is included to show the full economic benefit of deductions
for acquired intangible assets with the step-up in tax basis. As of December
31, 2022, estimated Tax Adjustments from intangible asset related income tax
benefits from closed acquisitions based on a pro forma 27% income tax rate
for the next 12 months is
Net Leverage Ratio represents the First Lien Leverage Ratio (as defined in
the Credit Facility), and means the ratio of amounts outstanding under the
first lien term loan A (the "First Lien Term Loan A"), first lien term loan B
(the "First Lien Term Loan B" and together with the "First Lien Term Loan A," (7) the "First Lien Term Loan"), and First Lien Revolver plus other outstanding
debt obligations secured by a lien on the assets of
letters of credit other than unpaid drawings thereunder) minus unrestricted
cash and cash equivalents to Consolidated EBITDA (as defined in the Credit
Facility).
The terms of our management agreements entitle the management companies to
management fees typically consisting of all future EBPC of the acquiredwealth management firm in excess of Base Earnings up to Target Earnings, plus
a percentage of any EBPC in excess of Target Earnings. Acquired Base Earnings
is equal to our preferred position in Base Earnings. We are entitled to (8) receive these earnings notwithstanding any earnings that we are entitled to
receive in excess of Target Earnings. Base Earnings may change in future
periods for various business or contractual matters. For example, from time
to time when a partner firm consummates an acquisition, the management
agreement among the partner firm, the management company and the principals
is amended to adjust Base Earnings and Target Earnings to reflect the
projected post-acquisition earnings of the partner firm.
46
Table of Contents
(9) Represents the number of partner firms on the last day of the period
presented.
Adjusted EBITDA
Adjusted EBITDA is a non-GAAP measure. Adjusted EBITDA is defined as net income
excluding interest income, interest expense, income tax expense, amortization of
debt financing costs, intangible amortization and impairments, if any,
depreciation and other amortization, non-cash equity compensation expense,
non-cash changes in fair value of estimated contingent consideration, loss on
extinguishment of borrowings, other expense-net and secondary offering expenses,
if any. We believe that Adjusted EBITDA, viewed in addition to and not in lieu
of, our reported GAAP results, provides additional useful information to
investors regarding our performance and overall results of operations for
various reasons, including the following:
non-cash equity grants made to employees or non-employees at a certain price
? and point in time do not necessarily reflect how our business is performing at
any particular time; stock-based compensation expense is not a key measure of
our operating performance;
contingent consideration or earn outs can vary substantially from company to
company and depending upon each company's growth metrics and accounting
? assumption methods; the non-cash changes in fair value of estimated contingent
consideration is not considered a key measure in comparing our operating performance; and
amortization expenses can vary substantially from company to company and from
period to period depending upon each company's financing and accounting
? methods, the fair value and average expected life of acquired intangible assets
and the method by which assets were acquired; the amortization of intangible
assets obtained in acquisitions are not considered a key measure in comparing
our operating performance. We use Adjusted EBITDA:
? as a measure of operating performance;
? for planning purposes, including the preparation of budgets and forecasts;
? to allocate resources to enhance the financial performance of our business;
? to evaluate the effectiveness of our business strategies; and
? as a consideration in determining compensation for certain employees.
Adjusted EBITDA does not purport to be an alternative to net income or cash flows from operating activities. The term Adjusted EBITDA is not defined under GAAP, and Adjusted EBITDA is not a measure of net income, operating income or any other performance or liquidity measure derived in accordance with GAAP. Therefore, Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
? Adjusted EBITDA does not reflect all cash expenditures, future requirements for
capital expenditures or contractual commitments;
? Adjusted EBITDA does not reflect changes in, or cash requirements for, working
capital needs; and
? Adjusted EBITDA does not reflect the interest expense on our debt or the cash
requirements necessary to service interest or principal payments.
47
Table of Contents
In addition, Adjusted EBITDA can differ significantly from company to company
depending on strategic decisions regarding capital structure, the tax
jurisdictions in which companies operate and capital investments. We compensate
for these limitations by also relying on the GAAP results and using Adjusted
EBITDA as supplemental information.
Set forth below is a reconciliation of net income to Adjusted EBITDA:
Year Ended December 31,
2020 2021 2022
(in thousands)
Net income $ 48,965 $ 24,440 $ 125,278
Interest income (453) (422) (791)
Interest expense 41,658 55,001 99,887
Income tax expense 20,660 20,082 53,077
Amortization of debt financing costs 2,909 3,958 3,999
Intangible amortization 147,783 187,848 261,842
Depreciation and other amortization 12,451 14,625 15,281
Noncash equity compensation expense 22,285 31,602 30,453
Noncash changes in fair value of estimated
contingent consideration 19,197 112,416 (64,747)
Loss on extinguishment of borrowings 6,094 - 1,807 Other expense-net 214 337 11,370 Secondary offering expenses - 1,409 - Adjusted EBITDA$ 321,763 $ 451,296 $ 537,456
Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share
We analyze our performance using Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share. Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share are non GAAP measures. We define Adjusted Net Income Excluding Tax Adjustments as net income excluding income tax expense, amortization of debt financing costs, intangible amortization and impairments, if any, non-cash equity compensation expense, non-cash changes in fair value of estimated contingent consideration, loss on extinguishment of borrowings and secondary offering expenses, if any. The calculation of Adjusted Net Income Excluding Tax Adjustments also includes adjustments to reflect a pro forma 27% income tax rate reflecting the estimatedU.S. federal, state, local and foreign income tax rates applicable to corporations in the jurisdictions we conduct business and is used for comparative purposes. The actual effective income tax rate, in current or future periods, may differ significantly from the pro forma income tax rate of 27%. Adjusted Net Income Excluding Tax Adjustments Per Share is calculated by dividing Adjusted Net Income Excluding Tax Adjustments by the Adjusted Shares Outstanding. Adjusted Shares Outstanding includes: (i) the weighted average shares of Class A common stock outstanding during the periods, (ii) the weighted average incremental shares of Class A common stock related to stock options outstanding during the periods, (iii) the weighted average incremental shares of Class A common stock related to unvested Class A common stock outstanding during the periods, (iv) the weighted average incremental shares of Class A common stock related to restricted stock units outstanding during the periods, (v) the weighted average number ofFocus LLC common units outstanding during the periods (assuming that 100% of suchFocus LLC common units, including contingently issuableFocus LLC common units, if any, have been exchanged for Class A common stock), (vi) the weighted average number ofFocus LLC restricted common units outstanding during the periods (assuming that 100% of suchFocus LLC restricted common units have been exchanged for Class A common stock) and (vii) the weighted average number of common unit equivalents ofFocus LLC vested and unvested incentive units outstanding during the periods based on the closing price of our Class A common stock on the last trading day of the periods (assuming that 100% of suchFocus LLC common units have been exchanged for
Class
A common stock).
48
Table of Contents
We believe that Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share, viewed in addition to and not in lieu of, our reported GAAP results, provide additional useful information to investors regarding our performance and overall results of operations for various reasons, including the following:
non-cash equity grants made to employees or non-employees at a certain price
? and point in time do not necessarily reflect how our business is performing at
any particular time; stock-based compensation expense is not a key measure of
our operating performance;
contingent consideration or earn outs can vary substantially from company to
company and depending upon each company's growth metrics and accounting
? assumption methods; the non-cash changes in fair value of estimated contingent
consideration is not considered a key measure in comparing our operating performance; and
amortization expenses can vary substantially from company to company and from
period to period depending upon each company's financing and accounting
? methods, the fair value and average expected life of acquired intangible assets
and the method by which assets were acquired; the amortization of intangible
assets obtained in acquisitions are not considered a key measure in comparing
our operating performance.
Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share do not purport to be an alternative to net income or cash flows from operating activities. The terms Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share are not defined under GAAP, and Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share are not a measure of net income, operating income or any other performance or liquidity measure derived in accordance with GAAP. Therefore, Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share have limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding
? Tax Adjustments Per Share do not reflect all cash expenditures, future
requirements for capital expenditures or contractual commitments;
Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding
? Tax Adjustments Per Share do not reflect changes in, or cash requirements for,
working capital needs; and
Other companies in the financial services industry may calculate Adjusted Net
? Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax
Adjustments Per Share differently than we do, limiting its usefulness as a
comparative measure.
In addition, Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share can differ significantly from company to company depending on strategic decisions regarding capital structure, the tax jurisdictions in which companies operate and capital investments. We compensate for these limitations by relying also on the GAAP results and use Adjusted Net Income Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per Share as supplemental information.
Tax Adjustments and Tax Adjustments Per Share
Tax Adjustments represent the tax benefits of intangible assets, including
goodwill, associated with deductions allowed for tax amortization of intangible
assets in the respective periods based on a pro forma 27% income tax rate. Such
amounts were generated from acquisitions completed where we received a step-up
in basis for tax purposes. Acquired intangible assets may be amortized for tax
purposes, generally over a 15-year period. Due to our acquisitive nature, tax
deductions allowed on acquired intangible assets provide additional significant
supplemental economic
49
Table of Contents
benefit. The tax benefit from amortization is included to show the full economic
benefit of deductions for acquired intangible assets with the step-up in tax
basis.
Tax Adjustments Per Share is calculated by dividing Tax Adjustments by the Adjusted Shares Outstanding.
Set forth below is a reconciliation of net income to Adjusted Net Income
Excluding Tax Adjustments and Adjusted Net Income Excluding Tax Adjustments Per
Share:
Year Ended December 31,
2020 2021 2022
(dollars in thousands, except per share data)
Net income $ 48,965 $ 24,440 $ 125,278
Income tax expense 20,660 20,082 53,077
Amortization of debt financing costs 2,909 3,958 3,999
Intangible amortization 147,783 187,848 261,842
Noncash equity compensation expense 22,285 31,602 30,453
Noncash changes in fair value of estimated
contingent consideration 19,197 112,416 (64,747)
Loss on extinguishment of borrowings 6,094 - 1,807
Secondary offering expenses (1) - 1,409 -
Subtotal 267,893 381,755 411,709
Pro forma income tax expense (27%) (2) (72,331) (103,074) (111,161)
Adjusted Net Income Excluding Tax Adjustments $ 195,562 $ 278,681 $ 300,548
Tax Adjustments (2)(3) $ 37,254 $ 46,805 $ 64,359
Adjusted Net Income Excluding Tax Adjustments Per
Share $ 2.46 $ 3.36 $ 3.62
Tax Adjustments Per Share (3) $ 0.47 $ 0.56 $ 0.77
Adjusted Shares Outstanding 79,397,568 82,893,928 83,093,073
Calculation of Adjusted Shares Outstanding: Weighted average shares of Class A common stock outstanding-basic (4) 48,678,584 57,317,477 65,552,592 Adjustments: Weighted average incremental shares of Class A common stock related to stock options, unvested Class A common stock and restricted stock units (5) 118,029 513,674 257,623 Weighted averageFocus LLC common units outstanding (6) 21,461,080 15,200,900 11,857,164 Weighted averageFocus LLC restricted common units outstanding (7) 5,005 73,983 199,495 Weighted average common unit equivalent of Focus LLC incentive units outstanding (8) 9,134,870
9,787,894 5,226,199
Adjusted Shares Outstanding 79,397,568 82,893,928 83,093,073
(1) Relates to offering expenses associated with the
secondary equity offerings.
The pro forma income tax rate of 27% reflects the estimated
state, local and foreign income tax rates applicable to corporations in the
jurisdictions we conduct business and is used for comparative purposes. The
actual effective income tax rate, in current or future periods, may differ
significantly from the pro forma income tax rate of 27%. The actual effective (2) income tax rate is the percentage of income tax after taking into
consideration various tax deductions, credits and limitations. Among other
things, periods of increased interest expense and limits on our ability to
deduct interest expense may, in current or future periods, contribute to an
actual effective income tax rate that is less than or greater than the pro
forma income tax rate of 27%.
Tax Adjustments represent the tax benefits of intangible assets, including
goodwill, associated with deductions allowed for tax amortization of
intangible assets in the respective periods based on a pro forma 27% income (3) tax rate. Such amounts were generated from acquisitions completed where we
received a step-up in basis for tax purposes. Acquired intangible assets may
be amortized for tax purposes, generally over a 15-year period. Due to our
acquisitive nature, tax deductions allowed on acquired intangible assets
provide additional significant
50
Table of Contents
supplemental economic benefit. The tax benefit from amortization is included to
show the full economic benefit of deductions for acquired intangible assets with
the step-up in tax basis. As of
from intangible asset related income tax benefits from closed acquisitions based
on a pro forma 27% income tax rate for the next 12 months is
(4) Represents our GAAP weighted average Class A common stock outstanding-basic.
Represents the incremental shares related to stock options, unvested Class A (5) common stock and restricted stock units as calculated under the treasury
stock method.
(6) Assumes that 100% of
(7) Assumes that 100% of
Class A common stock.
Assumes that 100% of the vested and unvested
Class A common stock at the end of the respective period and such
common units were exchanged for Class A common stock.
Factors Affecting Comparability
Our future results of operations may not be comparable to our historical results of operations, principally for the following reasons:
Tax Treatment
As a flow-through entity,Focus LLC is generally not and has not been subject toU.S. federal and certain state income taxes at the entity level, although it has been subject to the New York City Unincorporated Business Tax. Instead, forU.S. federal and certain state income tax purposes, taxable income was and is passed through to its unitholders, includingFocus Inc. Focus Inc. is subject toU.S. federal and certain state income taxes applicable to corporations.
Results of Operations
Year Ended
For a comparison of the years endedDecember 31, 2020 and 2021, see Part II. Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in our Form 10-K for the year endedDecember 31, 2021 . 51
Table of Contents
Year Ended
The following discussion presents an analysis of our results of operations for the years endedDecember 31, 2021 and 2022. Where appropriate, we have identified specific events and changes that affect comparability or trends and, where possible and practical, have quantified the impact of such items. Year Ended December 31, 2021 2022 $ Change % Change (dollars in thousands) Revenues: Wealth management fees$ 1,717,365 $ 2,056,328 $ 338,963 19.7 % Other 80,586 86,993 6,407 8.0 % Total revenues 1,797,951 2,143,321 345,370 19.2 % Operating expenses:
Compensation and related expenses 591,121 729,891 138,770 23.5 % Management fees 491,433 530,329 38,896 7.9 % Selling, general and administrative 297,636 376,417 78,781 26.5 % Intangible amortization 187,848 261,842 73,994 39.4 % Noncash changes in fair value of estimated contingent consideration 112,416 (64,747) (177,163) * Depreciation and other amortization 14,625 15,281
656 4.5 %
Total operating expenses 1,695,079 1,849,013 153,934 9.1 %
Income from operations 102,872 294,308 191,436 186.1 %
Other income (expense):
Interest income 422 791 369 87.4 %
Interest expense (55,001) (99,887) (44,886) (81.6) %Amortization of debt financing costs (3,958) (3,999) (41) (1.0) % Loss on extinguishment of borrowings - (1,807) (1,807) * Other expense-net (337) (11,370) (11,033) * Income from equity method investments 524 319
(205) (39.1) %
Total other expense-net (58,350) (115,953) (57,603) (98.7) %
Income before income tax 44,522 178,355 133,833 300.6 %
Income tax expense 20,082 53,077 32,995 164.3 %
Net income $ 24,440 $ 125,278 $ 100,838 412.6 %
* Not meaningful
Revenues
Wealth management fees increased $339.0 million , or 19.7%, for the year ended
December 31, 2022 compared to the year ended December 31, 2021 . New partner
firms added subsequent to the year ended December 31, 2021 that are included in
our results of operations for the year ended December 31, 2022 include Azimuth
Capital Investment Management , Octogone Holding , Icon Wealth Partners ,
FourThought Private Wealth and Beaumont Financial Partners . Additionally, our
partner firms completed 19 acquisitions subsequent to the year ended December
31, 2021 . The new partner firms contributed approximately $27.5 million in
wealth management fees during the year ended December 31, 2022 . The balance of
the increase of $311.5 million was due to the revenue growth at our existing
partner firms, including Connectus , associated with wealth management services,
which includes partner firm-level acquisitions, as well as a full period of
revenue recognized during the year ended December 31, 2022 for partner firms
that were acquired during the year ended December 31, 2021 . Six partner firms,
which closed in the prior year on December 31, 2021 , contributed $90.9 million
of the increase.
Other revenues increased $6.4 million , or 8.0%, for the year ended December 31,
2022 compared to the year ended December 31, 2021 . The increase related to new
partner firms was approximately $2.4 million .
52
Table of Contents
Operating Expenses
Compensation and related expenses increased $138.8 million , or 23.5%, for
the year ended December 31, 2022 compared to the year ended December 31, 2021 .
The increase related to new partner firms was approximately $9.0 million . The
balance of the increase of $129.8 million was due to an increase in salaries and
related expense due to growth of our existing partner firms including Connectus ,
partner firm-level acquisitions and a full period of expense during the year
ended December 31, 2022 for partner firms acquired during the year ended
December 31, 2021 , offset in part by a decrease in non-cash equity compensation
of $1.1 million . Six partner firms, which closed in the prior year on December
31, 2021 , contributed $27.9 million of the increase.
Management fees increased $38.9 million , or 7.9%, for the year ended
December 31, 2022 compared to the year ended December 31, 2021 . The increase
related to new partner firms was approximately $3.2 million . Management fees are
variable and a function of earnings during the period. The balance of the
increase of $35.7 million was due to partner firm-level acquisitions as well as
a full year of earnings recognized during the year ended December 31, 2022 for
partner firms acquired during the year ended December 31, 2021 . Six partner
firms, which closed in the prior year on December 31, 2021 , contributed $20.5
million of the increase.
Selling, general and administrative expenses increased $78.8 million , or 26.5%,
for the year ended December 31, 2022 compared to the year ended December 31,
2021 . New partner firms added approximately $7.2 million . The balance of the
increase of $71.6 million was due primarily to an increase in expenses related
to professional fees and information technology expenses related to the growth
of our existing partner firms, including Connectus , and partner firm-level
acquisitions.
Intangible amortization increased $74.0 million , or 39.4%, for the year ended
December 31, 2022 compared to the year ended December 31, 2021 . The increase
related to new partner firms was approximately $9.2 million . The balance of the
increase of $64.8 million was due to partner firm-level acquisitions as well as
a full year of amortization recognized during the year ended December 31, 2022
for partner firms acquired during the year ended December 31, 2021 . Six partner
firms, which closed in the prior year on December 31, 2021 , contributed $20.6
million of the increase.
Non-cash changes in fair value of estimated contingent consideration decreased
$177.2 million for the year ended December 31, 2022 compared to the year ended
December 31, 2021 . During the year ended December 31, 2022 , the probability that
certain contingent consideration payments would be achieved decreased due to
Monte Carlo Simulation changes associated with market conditions and forecasts,
resulting in a decrease in the fair value of the contingent consideration
liability.
Depreciation and other amortization expense increased $0.7 million , or 4.5%, for
the year ended December 31, 2022 compared to the year ended December 31, 2021 .
The increase related to new partner firms was approximately $0.3 million .
53
Table of Contents
Other income (expense)
Interest expense increased $44.9 million , or 81.6%, for the year ended December
31, 2022 compared to the year ended December 31, 2021 . The increase was due
primarily to higher average interest rates on outstanding borrowings during the
year ended December 31, 2022 compared to the year ended December 31, 2021 .
During the year ended
Other expense-net increased$11.0 million for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 . The increase was due primarily to a 2022 partial write-off of an insurance receivable that was initially recorded during the year endedDecember 31, 2021 .
Income Tax Expense
Income tax expense increased$33.0 million , or 164.3%, for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 . For the year endedDecember 31, 2022 , we recorded a tax expense of approximately$53.1 million resulting in an annual effective tax rate of 29.8%. The annual effective tax rate is primarily related to federal, state and local income taxes imposed onFocus Inc.'s allocable portion of taxable income fromFocus LLC .
Liquidity and Capital Resources
Sources of Liquidity
During the year endedDecember 31, 2022 , we met our cash and liquidity needs primarily through cash on hand, cash generated by our operations and borrowings under our Credit Facility. Over the next twelve months, and in the longer term, we expect that our cash and liquidity needs will continue to be met by cash generated by our ongoing operations and our Credit Facility, especially for acquisition activities. If our acquisition activity continues at an accelerated pace, or for larger acquisition opportunities, we may decide to issue equity either as consideration or, if market conditions are favorable, in an offering. For information regarding the Credit Facility, please read "-Credit Facilities."
Tax Receivable Agreements
Our Tax Receivable Agreements with the TRA holders generally provide for the payment byFocus Inc. to each TRA holder of 85% of the net cash savings, if any, inU.S. federal, state and local income and franchise tax thatFocus Inc. actually realizes (computed using simplifying assumptions to address the impact of state and local taxes) or is deemed to realize in certain circumstances as a result of certain increases in tax basis and certain tax benefits attributable to imputed interest.Focus Inc. will retain the benefit of the remaining 15% of these cash savings. The payment obligations under the Tax Receivable Agreements areFocus Inc.'s obligations and not obligations ofFocus LLC , and we expect that such payments required to be made under the Tax Receivable Agreements will be substantial. Estimating the amount and timing of payments that may become due under the Tax Receivable Agreements is by its nature imprecise. For purposes of the Tax Receivable Agreements, cash savings in tax generally are calculated by comparingFocus Inc.'s actual tax liability (determined by using the actual applicableU.S. federal income tax rate and an assumed combined state and local income and franchise tax rate) to the amountFocus Inc. would have been required to pay had it not been able to utilize any of the tax benefits subject to the Tax Receivable Agreements. As ofDecember 31, 2022 , we expect that future payments to the TRA holders will be$224.6 million , in aggregate. Future payments under the Tax Receivable Agreements in respect of subsequent exchanges will be in addition to this amount.
The actual increases in tax basis, as well as the amount and timing of any
payments under the Tax Receivable Agreements, will vary depending upon a number
of factors, including the timing of any exchange of units, the price of our
Class A common stock at the time of each exchange, the extent to which such
exchanges are taxable transactions, the amount of
54
Table of Contents
amount and timing of the taxable income we generate in the future, the U.S.
federal income tax rates then applicable and the portion of the payments under
the Tax Receivable Agreements that constitute imputed interest or give rise to
depreciable or amortizable tax basis.
The foregoing amount of expected future payments to TRA holders is merely an
estimate and the actual payments could differ materially. It is possible that
future transactions or events could increase or decrease the actual tax benefits
realized and the corresponding payments under the Tax Receivable Agreements as
compared to the foregoing estimates. Moreover, there may be a negative impact on
our liquidity if, as a result of timing discrepancies or otherwise, (i) the
payments under the Tax Receivable Agreements exceed the actual benefits realized
in respect of the tax attributes subject to the Tax Receivable Agreements and/or
(ii) distributions to Focus Inc. by Focus LLC are not sufficient to permit
Focus Inc. to make payments under the Tax Receivable Agreements after it has
paid its taxes and other obligations.
The payments under the Tax Receivable Agreements will not be conditioned upon a
TRA holder's having a continued ownership interest in either
We expect that future unitholders may become party to one or more Tax Receivable Agreements entered into in connection with future acquisitions byFocus LLC or issuances of units ofFocus LLC to employees, partners and directors.
Cash Flows
The following table presents information regarding our cash flows and cash and cash equivalents for the year endedDecember 31, 2021 compared to the year endedDecember 31, 2022 . For information regarding our cash flows and cash and cash equivalents for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2021 , see Part II. Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in our Form 10-K for the year endedDecember 31, 2021 : Year Ended December 31, 2021 2022 $ Change % Change (dollars in thousands) Cash provided by (used in): Operating activities$ 313,918 $ 288,599 $ (25,319) (8.1) % Investing activities (1,007,312) (475,181) 532,131 52.8 % Financing activities 938,797 16,992 (921,805) (98.2) %
Cash and cash equivalents-end of period 310,684 139,973
(170,711) (54.9) % Operating Activities
Net cash provided by operating activities includes net income adjusted for non-cash expenses such as intangible amortization, depreciation and other amortization, amortization of debt financing costs, non-cash equity compensation expense, non-cash changes in fair value of estimated contingent consideration, other non-cash items and changes in cash resulting from changes in operating assets and liabilities. Operating assets and liabilities include receivables from our clients, prepaid expenses and other assets, accounts payable and accrued expenses, deferred revenues and other assets and liabilities. Net cash provided by operating activities decreased$25.3 million , or 8.1%, for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 . The decrease was primarily related to the timing of management fee payments which resulted in an increase of payments to affiliates, an increase in payments of interest and other working capital changes, which were offset, in part, by an increase in Adjusted EBITDA. 55 Table of Contents Investing Activities Net cash used in investing activities decreased$532.1 million , or 52.8%, for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 . The decrease was due primarily to a decrease of$517.5 million in cash paid for acquisitions and contingent consideration.
Financing Activities
Net cash provided by financing activities for the year endedDecember 31, 2022 decreased$921.8 million , or 98.2%, compared to the year endedDecember 31, 2021 . The decrease was primarily due to a reduction in net borrowings from credit facilities of$767.5 million and a decrease in proceeds from issuance of common stock of$219.6 million , which were offset, in part, by reduced unit redemptions and distributions of$67.1 million and, to a lesser extent, a decrease in contingent consideration paid of$16.1 million in the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 .
Adjusted Free Cash Flow
To supplement our statements of cash flows presented on a GAAP basis, we use a non-GAAP liquidity measure on a trailing 4-quarter basis to analyze cash flows generated from our operations. We consider Adjusted Free Cash Flow to be a liquidity measure that provides useful information to investors about the amount of cash generated by the business and is one factor in evaluating the amount of cash available to pay contingent consideration and deferred cash consideration, make strategic acquisitions and repay outstanding borrowings. Adjusted Free Cash Flow does not represent our residual cash flow available for discretionary expenditures as it does not deduct our mandatory debt service requirements and other non-discretionary expenditures. We define Adjusted Free Cash Flow as net cash provided by operating activities, less purchase of fixed assets, distributions forFocus LLC unitholders and payments under Tax Receivable Agreements (if any). Adjusted Free Cash Flow is not defined under GAAP and should not be considered as an alternative to net cash from operating, investing or financing activities. Adjusted free cash flow may not be calculated the same for us as for other companies. The table below reconciles net cash provided by operating activities, as reflected on our cash flow statement, to our adjusted free cash flow. Trailing
4-Quarters Ended
2021 2022
(in thousands)Net cash provided by operating activities (1)(2) $ 313,918 $ 288,599 Purchase of fixed assets (11,018) (21,017) Distributions for unitholders (32,311) (22,984) Payments under tax receivable agreements (4,423)
(3,856)
Adjusted Free Cash Flow $ 266,166 $ 240,742
A portion of contingent consideration paid is classified as operating cash
outflows in accordance with GAAP, with the balance reflected in investing and
financing cash flows. Contingent consideration paid classified as operating
cash outflows for each quarter in the trailing 4-quarters ended
2021 was
(1) respectively, totaling
outflows for each quarter in the trailing 4-quarters ended
was
totaling
See Note 7 to our consolidated financial statements for additional
information.
A portion of deferred cash consideration paid is classified as operating cash
outflows in accordance with GAAP, with the balance reflected in financing
(2) cash outflows. Deferred cash consideration paid classified as operating cash
outflows was
2022. No deferred consideration was paid in the year ended December 31, 2021 .
56
Table of Contents
Credit Facilities
As of December 31, 2022 , our Credit Facility consisted of a $2.5 billion First
Lien Term Loan B, consisting of a $1.75 billion tranche A ("First Lien Term Loan
B - Tranche A") and $788.4 million tranche B ("First Lien Term Loan B - Tranche
B"), a $240.0 million delayed draw First Lien Term Loan A, and a $650.0 million
First Lien Revolver.
In
InNovember 2022 , we amended the Credit Facility to, among other things, (i) repay the then existing$1.6 billion First Lien Term Loan B - Tranche A and issue approximately$1.8 billion stated value First Lien Term Loan B - Tranche A with a maturity date ofJune 2028 , (ii) change the First Lien Term Loan B - Tranche B benchmark interest rate from LIBOR to SOFR, (iii) issue$240.0 million delayed draw First Lien Term Loan A with a maturity date ofNovember 2027 and (iv) change the maturity date of the First Lien Revolver toNovember 2027 . The First Lien Term Loan B - Tranche A bears interest (at our option) at: (i) SOFR plus a margin of 3.25% with a 0.50% SOFR floor or (ii) the lender's Base Rate (as defined in the Credit Facility) plus a margin of 2.25%. The First Lien Term Loan B - Tranche A requires quarterly installment repayments of$4.4 million and has a maturity date ofJune 2028 . The debt was issued at a discount of 1.75% or$30.8 million . The First Lien Term Loan B - Tranche A also requires a prepayment penalty of 1%, of the then outstanding principal amount of the First Lien Term Loan B - Tranche A if repaid prior toMay 2023 . The First Lien Term Loan B - Tranche B bears interest (at our option) at: (i) SOFR plus a margin of 2.50% with a 0.50% SOFR floor or (ii) the lender's Base Rate plus a margin of 1.50%. The First Lien Term Loan B - Tranche B requires quarterly installment repayments of$2.0 million and has a maturity date ofJune 2028 . The First Lien Term Loan A bears interest (at our option) at: (i) SOFR plus a margin of 2.50% with a 0.50% SOFR floor or (ii) the lender's Base Rate plus a margin of 1.50%. The First Lien Term Loan A has a nine month delayed draw feature, which expires inAugust 2023 . The delayed draw feature has a ticking fee with respect to the undrawn commitments with (i) no fee from 0-60 days from the closing date, (ii) 50% of the interest rate margin for the First Lien Term Loan A from 61-120 days of the closing date and (iii) 100% of the interest rate margin for the First Lien Term Loan A after 121 days of the closing date. The First Lien Term Loan A, when drawn, will be issued at a discount of 1.50%. When drawn, the First Lien Term Loan A will require quarterly amortization equal to 0.25% in 2023, 0.50% in 2024 and 2025, 1.25% in 2026 and 1.875% in 2027. InDecember 2022 ,$20.0 million was borrowed under the First Lien Term Loan A at a discount of$300.0 thousand with quarterly installment repayments of$50.0 thousand . The First Lien Term Loan A has a maturity date ofNovember 2027 . As amended, the First Lien Revolver bears interest (at our option) at SOFR plus a margin of 2.25% with step downs to 2.00% and 1.75% or the lender's Base Rate plus a margin of 1.25% with step downs to 1.00% and 0.75%, based on achievement of a specified First Lien Leverage Ratio. The First Lien Revolver unused commitment fee is 0.50% with step downs to 0.375% and 0.25% based on achievement of a specified First Lien Leverage Ratio. Up to$30.0 million of the First Lien Revolver is available for the issuance of letters of credit, subject to certain limitations. The First Lien Revolver has a maturity date ofNovember 2027 . Our obligations under the Credit Facility are collateralized by the majority of our assets. The Credit Facility contains various customary covenants, including, but not limited to: (i) incurring additional indebtedness or guarantees, (ii) creating liens or other encumbrances on property or granting negative pledges, (iii) entering into a merger or similar transaction, (iv) selling or transferring certain property and (v) declaring dividends or making other restricted payments. We are required to maintain a First Lien Leverage Ratio (as defined in the Credit Facility) of not more than 6.25:1.00 as of the last day of each fiscal quarter. AtDecember 31, 2022 , our First Lien Leverage Ratio was 4.19:1.00, which satisfied the maximum ratio of 6.25:1.00. First Lien Leverage Ratio means the ratio of amounts outstanding under the Credit Facility plus other outstanding debt obligations secured by a lien on the assets ofFocus LLC (excluding letters 57 Table of Contents of credit other than unpaid drawings thereunder) minus unrestricted cash and cash equivalents to Consolidated EBITDA (as defined in the Credit Facility). Consolidated EBITDA for purposes of the Credit Facility was$578.4 million atDecember 31, 2022 .Focus LLC is also subject on an annual basis to contingent principal payments based on an excess cash flow calculation (as defined in the Credit Facility) for any fiscal year if the First Lien Leverage Ratio exceeds 3.75:1.00. No contingent principal payments were required to be made in 2022. Based on the excess cash flow calculation for the year endedDecember 31, 2022 , no contingent principal payments are required to be made in 2023. AtDecember 31, 2022 , outstanding stated value borrowings under the Credit Facility were approximately$2.6 billion . The weighted-average interest rate for outstanding borrowings was approximately 4% for the year endedDecember 31, 2022 . As ofDecember 31, 2022 , the First Lien Revolver available unused commitment line was$640.0 million . AtDecember 31, 2022 , we had outstanding letters of credit in the amount of$10.0 million bearing interest at an annual rate of approximately 2%. In connection with theNovember 2022 amendment to the Credit Facility, we terminated our three then existing interest rate swaps, with notional amounts of$400.0 million ,$250.0 million and$200.0 million , which provided we pay interest to the counterparty each month at a rate of 0.713%, 0.537% and 0.5315%, respectively, and receive interest from each of the counterparties each month at the 1 month LIBOR rate, subject to a 0.0% floor, and entered into the SOFR Swaps (as defined below) with the same notional amounts. AtDecember 31, 2022 , we have three floating to fixed interest rate swap agreements with notional amounts of$400.0 million ,$250.0 million and$200.0 million , the terms of which provide that we pay interest to the counterparty each month at a rate of 0.619%, 0.447% and 0.440%, respectively, and receive interest from each of the counterparties each month at the 1 month USD Term SOFR rate, subject to a 0.50% floor (the "SOFR Swaps"). The interest rate swaps effectively fix the variable interest rate applicable to$850.0 million or approximately 33% of the First Lien Term Loan borrowings outstanding, resulting in a weighted average interest rate on these borrowings of approximately 0.53% plus a margin of 3.25%.
Critical Accounting Policies
Our financial statements are prepared in accordance with GAAP. Our financial statements include the accounts ofFocus Inc. and our subsidiaries. Intercompany transactions and balances are eliminated in consolidation. Critical accounting policies are those that are the most important to the preparation of our financial condition and results of operations and that require our most difficult, subjective and complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. While our significant accounting policies are described in more detail in the Note 2 to our financial statements, our most critical accounting policies are discussed below. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in our financial statements and the accompanying notes. Management believes that the estimates utilized in preparing the financial statements are reasonable and prudent. Actual results could differ from those estimates. Revenue Recognition Wealth Management Fees We recognize revenue from wealth management fees, which are primarily composed of fees earned for advising on the assets of clients, financial and tax planning fees, consulting fees, tax return preparation fees, fees for family office services, and fees for wealth management and operational support services provided to third-party wealth management firms. Client arrangements may contain one of the services or multiple services, resulting in either a single or multiple performance obligations within the same client arrangement, each of which are separately identifiable and priced, and accounted for as the related services are provided and consumed over time. Fees are primarily based either on a contractual percentage of the client's assets based on the market value of the client's assets on the predetermined billing date, a flat fee, an hourly rate based on predetermined billing rates or a combination of such fees and are billed either in advance or arrears on a monthly, quarterly, or semiannual basis. Revenue is recognized over the respective service 58
Table of Contents
period based on time elapsed or hours expended, as the case may be, which is deemed to be the most faithful depiction of the transfer of services as clients benefit from services over the respective period. Revenue for wealth management and operational support services provided to third party wealth management firms is presented net since these services are performed in an agent capacity. Client agreements typically do not have a specified term and may be terminated at any time by either party subject to the respective termination and notification provisions in each agreement. A majority of our wealth management fees are correlated to the markets, and therefore are considered variable consideration. Our market-correlated fees are dependent on the market and, thus, are susceptible to factors outside our control. Therefore, at inception of the contractual service period for fees which are based on the market values at the end of the service period, we cannot conclude that it is probable that a reversal in the cumulative revenue recognized would not occur if the estimate was included in the transaction price at that time. However, at each quarterly reporting date, we update our estimate of the transaction price as the market uncertainty is typically resolved. We can then reasonably conclude that a reversal of the variable consideration will not occur for those services already provided. Wealth management fees are recorded when: (i) an arrangement with a client has been identified; (ii) the performance obligations have been identified; (iii) the fee or other transaction price has been determined; (iv) the fee or other transaction price has been allocated to each performance obligation based on standalone fee rates; and (v) we have satisfied the applicable performance obligation. Other Other revenue primarily includes recordkeeping and administration service fees, commissions and distribution fees and outsourced services. Client arrangements may contain a single or multiple performance obligations, each of which are separately identifiable and accounted for as the related services are provided and consumed over time. Recordkeeping and administration and outsourced services revenue, in accordance with the same five criteria above, are recognized over the period in which services are provided. Commissions and distribution fees are recognized when earned. Business Acquisitions Business acquisitions are accounted for in accordance with ASC Topic 805: Business Combinations. Business acquisitions are accounted for by allocating the purchase price consideration to the fair value of assets acquired and liabilities assumed. The purchase price allocations are based upon preliminary valuations, and our estimates and assumptions are subject to change within the measurement period as valuations are finalized. Any change in the estimated fair value of the net assets, prior to the finalization of the more detailed analyses, but not to exceed one year from the dates of acquisition, will change the amount of the purchase price allocations.Goodwill is recognized as the excess of the purchase price consideration over the fair value of net assets of the business acquired. All transaction costs are expensed as incurred. We have incorporated contingent consideration into the structure of our partner firm acquisitions. These arrangements may result in the payment of additional purchase price consideration to the sellers based on the growth of certain financial thresholds for periods following the closing of the respective acquisition. The additional purchase price consideration is payable in the form of cash and, in some cases, equity. For business acquisitions, we recognize the fair value of estimated contingent consideration at the acquisition date as part of the consideration transferred in exchange for the acquired wealth management firm. The contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved. Any changes in fair value are recognized each reporting period in non-cash changes in fair value of estimated contingent consideration in the consolidated statements of operations.
The results of the acquired wealth management firms are included in our consolidated financial statements from the respective dates of acquisition.
59
Table of Contents
Goodwill is tested annually for impairment as ofOctober 1 , or more frequently if events and circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We compare the fair value of the reporting unit to the carrying value of the net assets of the reporting unit. The fair value of the reporting unit is determined using a market approach. If the fair value of the reporting unit exceeds the carrying value of the net assets of the reporting unit no further consideration is necessary. If the carrying value exceeds the fair value of the reporting unit, we would record an impairment charge for the amount that the carrying value exceeds the fair value of the reporting unit. Intangible assets and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the asset might be impaired or that the estimated useful life should be changed prospectively. If impairment indicators are present, the recoverability of these assets is measured by a comparison of the carrying amount of the asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset, which is determined using a discounted cash flow approach.
Income Taxes and Tax Receivable Agreements
Focus Inc. is a holding company whose most significant asset is a membership interest inFocus LLC .Focus Inc. is subject toU.S. federal, state and local income taxes onFocus Inc.'s allocable portion of taxable income fromFocus LLC .Focus LLC is treated as a partnership forU.S. federal income tax purposes. Accordingly,Focus LLC is generally not and has not been subject toU.S. federal and certain state income taxes at the entity level, although it has been subject to the New York City Unincorporated Business Tax and certain of its subsidiaries have been subject toU.S. federal and certain state and local or foreign income taxes. Instead, forU.S. federal and certain state income tax purposes, the income, deductions, losses and credits ofFocus LLC are passed through to its unitholders, includingFocus Inc. Focus LLC makes tax distribution payments to the extent of available cash, in accordance with the Fourth Amended and Restated Focus LLC Agreement.Focus Inc. files income tax returns with theU.S. federal government as well as various state and local jurisdictions. We apply the asset and liability method for deferred income taxes. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. Valuation allowances, if any, are recorded to reduce the deferred tax assets to an amount that is more likely than not to be realized.
We review and evaluate tax positions in our major tax jurisdictions and
determine whether or not there are uncertain tax positions that require
financial statement recognition. Based on this review, we have recorded no
reserves for uncertain tax positions at
Focus Inc. entered into Tax Receivable Agreements with the TRA holders. The agreements generally provide for the payment by us to each TRA holder of 85% of the net cash savings, if any, inU.S. federal, state and local income and franchise tax thatFocus Inc. actually realizes (computed using simplifying assumptions to address the impact of state and local taxes) or is deemed to realize in certain circumstances as a result of certain increases in tax bases and certain tax benefits attributable to imputed interest.Focus Inc. will retain the benefit of the remaining 15% of these cash savings. As ofDecember 31, 2022 ,Focus Inc. had a liability of$224.6 million relating to its obligations under the Tax Receivable Agreements. The foregoing amount of expected future payments to TRA holders is merely an estimate and the actual payments could differ materially. It is possible that future transactions or events could increase or decrease the 60
Table of Contents
actual tax benefits realized and the corresponding payments under the Tax Receivable Agreements as compared to the foregoing estimates.
Consolidation Considerations
ASC Topic 810, Consolidation, requires an entity to perform a qualitative
analysis to determine whether its variable interests give it a controlling
financial interest in a variable interest entity ("VIE"). Under the standard, an
enterprise has a controlling financial interest when it has (a) the power to
direct the activities of a VIE that most significantly impact the entity's
economic performance and (b) the obligation to absorb losses of the entity or
the right to receive benefits from the entity that could potentially be
significant to the VIE. An enterprise that holds a controlling financial
interest is deemed to be the primary beneficiary and is required to consolidate
the VIE.
Certain of our subsidiaries have management agreements with the respective
management company, which causes these operating subsidiaries to be VIEs. We
have assessed whether or not we are the primary beneficiary for these operating
subsidiaries and have concluded that we are the primary beneficiary.
Accordingly, the results of these subsidiaries have been consolidated.
Certain of our subsidiaries have variable interests in certain investment funds
that are deemed voting interest entities. Due to substantive kick-out rights
possessed by the limited partners of these funds, we do not consolidate the
investment funds.
From time to time, we enter into option agreements with wealth management firms
(each, an "Optionee") and their owners. In exchange for payment of an option
premium, the option agreement allows us, at our sole discretion, to acquire
substantially all of the assets of the Optionee at a predetermined time and at a
predetermined purchase price formula. If we choose to exercise our option, the
acquisition and the corresponding management agreement would be executed in
accordance with our typical acquisition structure. We have determined that the
respective option agreements with the Optionees qualify the Optionees as VIEs.
We have determined that we are not the primary beneficiary of the Optionees and
do not consolidate the results of the Optionees.
Stock Based Compensation Costs
Compensation cost forFocus LLC incentive units andFocus Inc. stock option awards is measured based on the fair value of awards determined by the Black-Scholes option pricing model or the Monte Carlo Simulation Model on the date that the awards are granted or modified, and is adjusted for the estimated number of awards that are expected to be forfeited. Compensation cost for unvested Class A common stock and restricted stock units, as well asFocus LLC restricted common units, is measured based on the market value of the Class A common stock on the date that the awards are granted and is adjusted for the estimated number of awards that are expected to be forfeited. The compensation cost is recognized on a straight-line basis over the requisite service period. Non-cash equity compensation expense, associated with employees and non-employees, including principals in the management companies, is included in compensation and related expenses in the consolidated statements of operations. We estimate forfeitures at the time of the respective grant and revise those estimates in subsequent periods if actual forfeitures differ materially from those estimates. We use historical data to estimate forfeitures and record non-cash equity compensation expense only for those awards that are expected to vest.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements.
© Edgar Online, source
