Focus Financial Partners Inc

F:2JE

Earnings Call Analysis

Focus Financial Partners Q1 Earnings

Focus Financial Partners reported Q1 revenues of $557.5 million, slightly missing its target range of $560-$570 million, indicative of a challenging quarter yet showcasing the firm's resilience. Adjusted EBITDA stood at $132.5 million, with margins at 23.8%, marginally below the forecasted 24%. The company's adjusted net income per share, excluding tax adjustments, was $0.69, dropping by 29.6% year-over-year, primarily due to increased borrowing costs. Despite unsettled market conditions, their M&A activities remained robust with 16 deals closed. No future guidance was offered due to an impending merger with Clayton, Dubilier & Rice.

Overview of Company Performance and Strategy

Focus Financial Partners kick-started the earnings call with a forward-looking statement caveat before delving into the first quarter results. CEO Rudy Adolf acknowledged a slight miss in expectations for Q1, with revenues of $557.5 million and adjusted net income, excluding tax adjustments, of $0.69 per share. Despite challenging market conditions, he emphasized the resilience and agility of Focus' partner firms in delivering high-quality, personalized advice. Adolf highlighted the company's robust M&A activities, boasting 16 closed transactions, accentuating Focus' scaling capabilities in sourcing and executing these opportunities. He additionally pointed to the valuable role of their tailored value-add programs in driving organic growth and retention among partners and clients.

M&A Activities and Forward Growth Opportunities

Adolf brought to light the rebound in M&A transaction volumes as reported by Echelon Partners, forecasting an increase in industry activity. He associated Focus' growth prospects with the shift towards comprehensive and unbiased advice stemming from market corrections in the previous year. Their ongoing commitment to value-add programs bespoke of their strategy to remain apace with the growing needs of clients, setting the foundation for long-term, sustainable growth. Such activities were instrumental for Focus' differentiated position in the independent wealth management space.

First Quarter Financials and M&A Transactions

CFO Jim Shanahan fleshed out the financial specifics, noting a 3.9% year-over-year increase in Q1 revenues to $557.5 million, versus the forecasted $560-$570 million range, attributing the shortfall to unexpectedly lower non-market correlated revenues. Adjusted EBITDA dropped slightly to $132.5 million, a 1.9% year-over-year decrease, mainly due to merger-related expenses, with a marginally lower adjusted EBITDA margin of 23.8%. Adjusted net income saw a 29.6% decline to $0.69 per share, primarily attributed to higher interest expenses. On the bright side, Shanahan detailed the closing of 12 M&A transactions in Q1 and 4 so far in Q2, enhancing Focus' market position and profitability.

Cost Management and Balance Sheet Health

Shanahan expanded on cost management, indicating a sequential decrease in management fees, consistent equity compensation expense, and robust cash flow generation of $303.9 million over the last twelve months, reflective of Focus' adaptable business model. Despite a net leverage ratio of 4.41x being slightly above expectations, Focus boasted a strong capital position, with over $850 million of available resources and an additional $500 million in forward starting interest rate swaps to hedge against future interest rate fluctuations. His remarks underscore the financial prudence of the firm amidst market volatility.

Closing Remarks and Long-term Outlook

In his closing address, Adolf reinforced the firm's resilience and leadership position within the wealth management landscape. In the context of 2022's volatile markets, he was bullish on the firm's ability to capitalize on anticipated financial market recoveries. Despite not offering guidance due to the pending merger with Clayton, Dubilier & Rice, Adolf conveyed strong confidence in Focus' future growth trajectory and its ability to leverage the unfolding opportunities in the global wealth management industry.

Earnings Call Transcript 2023-Q1

[John McGranahan, General Counsel & Corporate Secretary]

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 lists 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. In addition, due to our pending merger with Clayton, Dubilier & Rice, we will not be taking questions following Rudy and Jim's prepared remarks and will not be providing earnings guidance for the second quarter of 2023.

With that, I will turn it over to our Founder and CEO, Rudy Adolf. Rudy?

[Rudy Adolf, Founder and CEO]

Thanks, Rusty. Good morning, everyone, and thank you for joining us today. This morning, we announced our first quarter results with $557.5 million of revenues, adjusted net income, excluding tax adjustments per share of $0.69 and tax adjustments per share of $0.20. While slightly below our expectations, our financial performance continued to reflect the resiliency of our business despite the challenging backdrop during the quarter. Our partners continue to deliver excellent service to their clients and manage their business as well, remaining agile during the quarter. Providing highly personalized, integrated advice is extremely valuable to their clients, especially during periods of volatility. According to Echelon Partners, industry M&A transaction volumes rebounded in the first quarter from a slower fourth quarter last year. They noted that buyers' demand and seller supply is strong, and they anticipate activity to increase as the year progresses. Year-to-date, our M&A activity has been strong with 16 closed transactions, including two new partner firms and 14 mergers on behalf of our partners. Our differentiated ability to source, structure and execute these transactions remains a core element of our value proposition to growth-oriented firms. With the largest M&A team in the independent wealth management space, we continue to bring industry-leading scale to benefit our partner firms and their clients through acquisition.

As I have mentioned before, we believe that the flight to comprehensive, unconflicted advice will continue to accelerate due to last year's market correction, leading to substantial growth in client assets managed by the RA industry as experienced in prior cycles. Our partners continue to take advantage of our value-added programs designed to give them an edge in meeting their clients' growing and highly personalized needs. By leveraging our scale and dedicated resources, our partners can deliver ever-increasing value to their advisers and clients, which are essential catalysts for retention, referrals and organic growth. While market conditions remain unsettled, our diverse and growing global partnership creates a number of scale advantages, reinforcing the sustainability of our strong growth over the long term and our differentiated value proposition in this industry.

With that, let me turn the call over to Jim. Jim?

[Jim Shanahan, CFO]

Good morning, everyone. Our business remains resilient, supported by a diverse recurring revenue stream, variable management fee structure and the economic alignment we have with our partners. We are executing well, and we remain confident that we are well-positioned to capitalize on our industry's substantial forward growth opportunity. Now let's turn to our Q1 P&L. Our revenues for the quarter were $557.5 million, up 3.9% year-over-year but slightly below our guidance of $560 million to $570 million. This was primarily due to lower-than-anticipated non-market correlated revenues. Our Q1 results also reflected $9.1 million in real estate-related performance fees, slightly below our $10 million guidance. Our Q1 adjusted EBITDA was $132.5 million, 1.9% lower year-over-year, excluding the expenses associated with the merger process. Our adjusted EBITDA margin was 23.8%, marginally below our estimate of approximately 24%. The revenue shortfall versus expectations that I just mentioned earlier contributed to the variance in our margin. Our Q1 adjusted net income, excluding tax adjustments per share was $0.69, a decline of 29.6% year-over-year. This reduction reflects the effect of higher interest expense on our borrowings. Our Q1 tax adjustments per share was $0.20, 11.1% higher year-over-year, reflecting our tax-efficient acquisition activity associated with the high M&A transaction volume for the period. Our Q1 M&A activity reflected our continued strong momentum. We closed 12 transactions in Q1, including 1 new partner firm and 11 mergers on behalf of our partner firms. So far in Q2, we have closed 3 mergers on behalf of our partner firms and 1 new partner firm. The partner firm we closed on January 1 added revenues of approximately $1.2 million and adjusted EBITDA of approximately $400,000 to our quarterly results. Additionally, Westcourt Capital, the new partner firm that we closed on May 1, is expected to add $11.1 million in annual acquired base earnings.

Now let's turn to our Q1 expenses and cash flow. Management fees were $124.6 million or 22.3% of our revenues, lower sequentially by 1.9%, reflecting the contractual economic arrangements we have with our partners. Our noncash equity compensation expense was 1.4% of our Q1 revenues, in line with our expectations. As of March 31, our LTM cash flow available for capital allocation was $303.9 million, reflecting the resiliency of our cash flows during a volatile market year. We paid cash earn-out obligations of $26.1 million in Q1. We also paid $12.5 million in deferred acquisition consideration in Q1. Now turning to our balance sheet. We ended Q1 with approximately $2.7 billion of debt outstanding and our net leverage ratio was 4.41x, marginally above our estimate of approximately 4.3x due primarily to the modest shortfall in our adjusted EBITDA versus our expectations. As of March 31, our undrawn Term Loan A, together with our undrawn revolver and cash balance, give us over $850 million of available firepower as we anticipate another strong year of M&A activity. Additionally, in April, we entered into $500 million in forward starting interest rate swaps. These swaps fix our 1-month term SOFR for $500 million of borrowings at approximately 3.17% plus a spread of 325 basis points for the April 2024 to April 2028 period. In closing, we continue to navigate the ongoing market challenges well and remain highly disciplined in deploying capital. We remain committed to driving substantial growth, enhancing our value-add programs and position ourselves to take advantage of the secular growth opportunity within the global wealth management industry.

I'll now turn the call back to Rudy for closing remarks.

[Rudy Adolf, Founder and CEO]

Thank you, Jim. In closing, I would like to reiterate the strength and resiliency of our business model, our differentiated competitive position and the value of prudent fiduciary advice in volatile market environments. As I have said before, it is an environment like we experienced last year. Our firm's industry leadership and the value of what they do really shows, positioning them for a solid growth and performance as financial markets recover. Rajini, Lenny and I could not be prouder of our incredible partnership and the quality of the business, the Focus team together with our partners has built over the last 18 years. We look forward to continuing to grow and evolve the company and to capitalizing on the substantial growth opportunities that lie ahead of us. Now as Rusty said, given our pending merger with Clayton, Dubilier & Rice, we won't be opening up the lines for Q&A. However, we want to thank everyone for their time and interest in Focus.