Focus Financial Partners : Q3 2022 Earnings Transcript

Focus Financial Partners

Third Quarter 2022 Earnings

November 3, 2022

Presenters

Rudy Adolf - Founder, Chief Executive Officer, Chairman Jim Shanahan - Chief Financial Officer

Rusty McGranahan - General Counsel

Tina Madon - Head of Investor Relations & Corporate Communications

Q&A Participants

Craig Siegenthaler - Bank of America

Michael - Goldman Sachs

Ryan Kenny - Morgan Stanley

Gerald O'Hara - Jeffries

Matt Moon - KBW

Owen Lau - Oppenheimer

Patrick O'Shaughnessy - Raymond James

Operator

Good morning. I would like welcome everyone to the Focus Financial Partners 2022 third quarter earnings call. Joining today's call are Rudy Adolf, Founder and CEO; Jim Shanahan, Chief Financial Officer; Rusty McGranahan, General Counsel; and Tina Madon, Head of Investor Relations and Corporate Communications.

At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press *0 on your telephone keypad. Please note this conference is being recorded. And with that, Mr. McGranahan, please go ahead.

Rusty McGranahan

Good morning, everyone. Before we begin, let me remind you that during the course of this call, we may make a number of forward-looking statements. We call your attention to the fact that Focus' results may, of course, differ from these statements. These statements are based on assumptions made by and information currently available to Focus Financial Partners and involve risks and uncertainties that could cause the results of Focus to materially differ from these statements.

Focus' has made filings with the SEC, which list some of the factors that may cause its results to differ materially from these statements. And finally, Focus assumes no duty and does not undertake to update any such forward-looking statements. With that, I will turn it over to our Founder and CEO, Rudy Adolf. Rudy?

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Rudy Adolf

Thanks, Rusty. Good morning, everyone and welcome to our call. This morning, we announced another quarter of strong results, which again exceed our guidance on all measures despite an exceptionally volatile period in the capital markets. We generated revenues of $519.9 million in the third quarter, up 14.4% versus the prior year. And our year-over-year organic growth rate was 3.4%.

Our adjusted EBITDA was $128.7 million, up 13.4% versus the prior year. And our adjusted EBITDA margin was 24.8%. Our adjusted net income, excluding tax adjustments per share, was $0.86 and tax adjustments per share was $0.20. Despite a market correction, we did have excellent revenue growth and improved margins, demonstrating the continued strength of our fundamentals. Our results, again, showed the resiliency of our business, reflecting the benefits of our revenue diversification and variable cost base, combined without our structural earnings preference, which helped mitigate the market exposure of our earnings and cash flows.

Our results are also reflect (ph) the value of trusted advice, particularly in this environment. Our partner firms deliver comprehensive wealth management services to high- and ultra-high net worth clients who take a long-term view on structuring their wealth and they are engaged in every element of their client's financial lives, beyond just investment management. Volatile market conditions, are when prudent, fiduciary device is of the utmost importance, reinforcing the loyalty and long-term retention of these client relationships.

In fact, 18 Focus partner firms were recently named to the 2022 Forbes/SHOOK Top 100 RA list, almost 20% of the total, which nearly half of those also being named to the Barron's 2022 list of top 100 RA firms. This level of recognition reflects the exceptional client service these firms, and all of our partners, are delivering during the current period. Looking forward, we expect the same industry pattern as in prior times of volatility.

According to Cerulean, RAs outperform in post-crisis periods, increasing industry managed asset growth rates by 60 to 70% versus their compound annual growth of approximately 10% per year in normalized markets and substantially outpacing the wire houses in broker dealers. We saw this phenomenon in 2008 and '09, and again in 2020-21, two of the most significant market crises in recent history, and we believe that we will see it again, once current markets recover.

I've mentioned these statistics before, but they bear repeating because it is during periods like this that the executed transactions that deliver some of the greatest upside and our partners experience elevated client referrals. Collectively, we believe these dynamics position us to outperform if markets recover. The strength of our quarterly performance was enhanced by our strong M&A activity. Year-to-day, we have closed or announced five new partner firms and 19 mergers, bringing our year-to-day transaction total to 24 deals.

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We closed on FourThought Private Wealth on November 1st. FourThought, which manages approximately $1.1 billion in client assets, will deepen our presence in the rapidly-growing Florida wealth management market. The team is well position to benefit from our value-add programs, particularly our client solutions. In addition, we announced the acquisition of Beaumont Financial Partners, a premier, independent wealth manager, that will augment our extensive presence in and around Boston, by benefiting from our value-added resources and its proximity to other leading Focus partners in the Northeast.

Industry M&A deal volume remained strong during the third quarter, with year-to-date transaction volumes up 23%, compared to the first nine months in '21, and with '22 on pace to be another record year, according to Devot (ph) Research. Devot also notes that while year-to- date sales of larger RIAs have moderated, compared to the same period in '21, M&A activity among RAs with less than $1 billion in client assets has increased 54%, year-over-year.

The flexibility of our model, which enables us to acquire on a direct basis, on behalf of our partner firms, in the form of mergers, positions us to benefit not only from strong industry volumes, but also from changing seller dynamics. Devot also highlights that 52% of RAs seek to become a buyer of other RAs as parts of their growth strategy, which was a driving force behind the merger activity that we have completed, year-to-date. This dynamic further reinforces our value proposition of providing entrepreneurs with permanent growth capital, in excess to our value- added programs to accelerate their growth and mergers are an economically attractive form on acquisition for us.

We are frequently asked by investors whether current market conditions are impacting M&A activity. Our experience is that M&A in this business is secular, not cyclical, because the primary capitalists of consolidation, succession, and the need for scale are not market dependent. Even extreme market volatility, like what we saw in '08 and 2020, tends to only delay transactions, leading to catch-up periods of high-deal activity. This industry continues to under-consolidate, which is amplified by current conditions.

We remain beneficiaries of these dynamics, as is evidenced by our transaction volume, year-to- date. This year will be one of our strongest for M&A activity, overall, as well as one of our most active years for mergers, on behalf of our partner firms. We anticipate that full-year 2022 will also mark a strong year for acquisition capital deployment, with over $500 million invested to grow and enhance our partnership. We continue to add high-quality new partners and match good progress in executing our strategy to expand our international footprint.

Our value-add programs remain a significant differentiator for us, both within our partnership and as an important part of our value proposition to other firms who decide to join us. These programs are an important source of organic growth and revenue diversification for our partners. We are very pleased with the progress in both our business and client solutions, with a number of our teams expanding, as our partners increasingly take advantage of these programs.

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We have a robust pipeline, including further international expansion. Our partners remain very active in pursuing mergers to accelerate their growth and expand their geographic reach and enhance their client service capabilities. Additionally, there continues to be a focus on talent in this industry. Mergers are often a attractive conduit for adding strong advisory teams, where there is a cultural and organizational fit. Our ability to source and execute these complex transactions is a valuable competitive edge for our partner firms.

We remain disciplined in our capital deployment and return criteria. We have no need to raise equity capital and our business continues to generate a substantial amount of cash flow. Multiples are softening (ph) and we do not see the excesses of 2021. This environment is also allowing for greater flexibility in aligning buyer and seller interests, enabling us to structure transactions to be supportive of our targeted, 3.5 to 4.5 times net leverage ratio. Our M&A team is the largest and most experienced in the industry and has deep expertise in the complexities surrounding deal sourcing, structure, and pricing, as well as in navigating the nuances of transacting in such a relationship-based industry.

There are key competitive advantages, as we execute on our acquisition pipeline, going into 2023, and as we build additional scale and grow our partnership. In recent conversations with many of our partner firms, they continue to navigate the challenges of the macro environment well. The feedback remains unchanged, despite the third quarter decline in markets and bearish outlook for many. The concept of the experienced, trusted advisor, proactive and consistent client communications, and well-balanced portfolios, structured for the long-term remain central themes.

These are the times that create numerous opportunities to engage with clients, further solidifying those relationships. More than ever, clients seek stability and advice by advisors who have served them for long periods of time, advisors whose advice proves itself in the outcomes and who have seen many market cycles who, as one of partner CO describes, have been there and done that. The other element of what we hear, which was also a theme last quarter, is that our partner clients are evaluating this years' downturn within a multi-year context.

With the S&P 500 up over 75% from the beginning of 2016 to the end of Q3 '22, there is no capitulation on long-term financial plans. As another of our partner CO says, this won't be the last downturn we'll see in our lifetimes. We have to play the long game. As the fourth quarter gets underway, it remains challenging to determine how the macro environment will evolve, but we anticipate that market conditions will remain volatile for several additional quarters, at least.

Against this backdrop, with anticipate that we will achieve a full-year revenue growth rate for 2022, of approximately 17% in adjusted EBIDTA growth rate of '22, of 15%. As we have demonstrated throughout this year, we continue to weather the storm well and use it as an opportunity to position ourselves to accelerate growth, as markets and economies recover. A decentralized approach to partnering with entrepreneurs enables us to remain nimble in how we

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manage our business and positions us and our partners to take advantage of the opportunities on the horizon.

We believe these attributes, together with our embedded operating leverage, will drive sustained outperformance, if markets stabilize. It is for these reasons, that we are confident that Focus will generate substantial growth and deliver superior value to its shareholders, over the long term. With that, let me turn the call over to Jim. Jim?

Jim Shanahan

Good morning, everyone. We delivered strong results this quarter, again demonstrating the stability and resiliency of our business against a challenging macro backdrop. The performance of our partner firms was strong, and while current conditions raise the obvious questions around inflation, monetary policy, geo-political risk, and the economic impact of a recession, their clients continue to remain focused on their long-term financial objectives.

We are executing well against our M&A pipeline and we remain confident that we will navigate the current challenges and emerge well positioned to capitalize on the forward-growth opportunity within our industry. Now for a few comments on the key elements of our Q3 P&L. Our revenues were $519.9 million, increase in 14.4%, year-over-year, and above the top-end of our guidance range of $505 to $515 million. The resiliency of our revenue in this market environment is, again, notable.

Our Q3, year-over-year organic revenue growth rate was 3.4%, also above the top end of our 0 to 2% guidance, primarily due to better-than-expected revenue growth across our partnership of 87 firms. I want to take a moment again to reinforce five, key elements of our revenue diversification, which helped mitigate the impact of declining markets, as you saw this quarter. I mentioned these on our call in August, but believe they bear repeating.

First, approximately 23.9% of our Q3 revenues come from non-market correlated sources, which is a significant percentage of our total revenues. Unlike during COVID, in 2020, when these revenues were impacted by the lockdowns, our non-market correlated revenues are providing a valuable hedge in this environment. Second, a growing percentage of our revenues come from international sources. Approximately 6.4% of our Q3 revenues were generated by our partner firms in Australia, Canada, the U.K., and Switzerland, which represented a new country for revenue diversification in Q3, with the closing of our partner firm, Octagon.

Third, our billing structures reduces the impact of volatile markets in any given quarter. Approximately 65.6% of our Q3 market correlated revenues were billed in advance, while 34.4% were billed in arrears. This structure also gives us good visibility into our revenues in the upcoming quarter. Fourth, our partner firms each manage their own investment processes. Each respective partner firm has its own investment committee and investment philosophy and follows its individual asset allocation methodology.

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