Focus Financial Partners Inc.

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's 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. With that, I will turn it over to our founder and CEO, Rudy Adolph. Rudy?

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 the market correction, we delivered excellent revenue growth and improved margins, demonstrating the continued strength of our fundamentals. Our results again show the resiliency of our business, reflecting the benefits of our revenue diversification and variable cost base combined with our structural earnings preference, which helped mitigate the market exposure of our earnings and cash flows. Our results also reflect 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 clients' financial lives beyond just investment management. Volatile market conditions are when prudent fiduciary advice 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 RIA list, almost 20% of the total, which nearly half of those also being named to the Barron's 2022 list of Top 100 RIA 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 Cerulli, RAs outperform in post-crisis periods, increasing industry-managed asset growth rates by 60% to 70%. versus their compound annual growth rate of approximately 10% per year in normalized markets, and substantially outpacing the wire houses in broker dealers. We saw this phenomenon in 2008 and 2009, and again in 2020 and 2021, 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 we execute the transactions that deliver some of the greatest upside, and our partners experience elevated client referrals. Collectively, we believe these dynamics position us to outperform as markets recover. The strength of our quarterly performance was enhanced by our strong M&A activities. Year-to-date, we have closed or announced five new partner firms and 19 mergers, bringing our year-to-date transaction total to 24 deals. We closed on Forethought Private Wealth on November 1st. Forethought, 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-positioned to benefit from our value-add programs, particularly our client solutions. In addition, we announced the acquisition of Baumont 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 Devo research. Devo also notes that while year-to-date sales of larger RIAs have moderated compared to the same period in 21, M&A activity among RIAs 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. DeWall also highlights that 52% of RAs seek to become a buyer of other RAs as part 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 gross capital and access to our value-added programs to accelerate their growth, and mergers are an economically attractive form of 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 catalysts of consolidation, succession, and the need for scale are not market dependent. Even extreme market volatility, like what we saw in 2008 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 partnerships. We continue to add high quality new partners and make 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 the 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. 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 an 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, and we do not see the excesses of 2021. This environment is also allowing for greater flexibility in aligning buyer and seller interest, enabling us to structure transactions to be supportive of our targeted 3.5 times 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, structuring, 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 partnerships. 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 in 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 our partner CEO 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 year's downturn within a multi-year context. With the S&P 500 up over 75% from the beginning of 2016 to the end of Q3 2022, there is no capitulation on long-term financial plans. As another of our partner CEOs 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, we anticipate that we will achieve a full-year revenue growth rate for 2022 of approximately 17% and adjusted EBITDA growth rate for 2022 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. Our decentralized approach to partnering with entrepreneurs enables us to remain nimble in how we 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 derive 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? 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, geopolitical 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, increasing 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 about 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 help 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 UK, and Switzerland, which represented a new country for revenue diversification in Q3 with the closing of our partner firm, Octagon. Third, our billing structure 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 built 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. And fifth, the client of our partner firms are high and ultra-high net worth individuals and families, whose approach to investment is fundamentally different than that of the typical client of an asset manager. They are investors who are generally focused on multi-generational capital preservation and wealth creation. This mindset is reflected in how they invest their assets and in turn in our market correlated revenues. The combination of these elements plus the variable nature of our management fees and earnings preference is why our revenue and earnings performance has been so resilient this year. As a result of our strong Q3 revenues, our adjusted EBITDA was $128.7 million, reflecting year-over-year growth of 13.4%, and our adjusted EBITDA margin was 24.8%, above our guidance of approximately 24%. Year-to-date, our margin was 25.1%, reflecting the stability of our business despite market condition. Additionally, our earnings preference provides an important structural protection to our earnings and cash flows. To help investors better understand the structural protections in our financial model, we have included slides 24 to 26 in our earnings supplement. On the M&A front, we recently closed on one new partner firm, Forethought, on November 1st, and we expect to close an additional new partner firm this quarter, Beaumont Financial Partners. Based on mid-quarter closings, we anticipate these firms will add estimated revenues approximately $3 million and adjusted EBITDA of approximately $1 million in the fourth quarter and more than $21 million in annualized revenue and $7.3 million in annualized adjusted EBITDA. As Rudy highlighted, our pipeline is strong with a high-quality transaction mix. Joining an international partnership of 87 like-minded firms led by dynamic management teams is highly differentiated in the independent wealth management space. Our value proposition continues to resonate with firms in the industry, and we are a highly sought after partner. Now turn into our Q3 expenses and cash flows. Management fees were $123 million or 23.7% of revenues, which was a lower percentage compared to the second quarter of this year, reflecting the modest sequential decline in revenue and the variable nature of our management fees. Because management fees are our second largest operating expense and are correlated to the profitability of our partner firms quarter to quarter, they provide an important source of earnings and cash flow stability in volatile markets. Non-cash equity compensation expense was approximately 1.5% of revenues in line with our estimate, and we expect this expense will be approximately 1.6% of estimated Q4 revenues. The third quarter was impacted by the change in the estimated fair value of earnouts pursuant to our Monte Carlo simulations under GAAP. Accordingly, we recorded a positive $30.7 million non-cash change in fair value of estimated contingent consideration in our statement of operation. Market conditions drove the reduced estimate of these liabilities as of September 30th. As markets recovered, these estimates typically increase. As of September 30th, our LTM cash flow available for capital allocation was $345.8 million, increasing 15.4% year-over-year, reflecting the strong financial performance of our partnership, despite volatile markets. Our gross unamortized tax yield was over $2.8 billion as of September 30th, which will support our cash flows in future periods. We also paid cash earn-out obligations of $47.9 million, and deferred purchase consideration obligations of $1.5 million, which was in line with our Q3 estimate, and we anticipate that our earn-out payments will be approximately $38 million in Q4. Now for a few words on our Q4 P&L expectations. We estimate that our Q4 revenues will be in the range of $505 to $515 million, a sequential decrease of approximately 1% to 3%. This range does not include an estimate for performance fees. While our guidance reflects the effect of the decline in market conditions in the second half of this year, it also demonstrates the benefits of the revenue diversification I mentioned earlier. We expect that our Q4 organic revenue growth rate will be approximately negative 10% due in part to a comparatively strong Q4 21, which included approximately $20 million of performance fee revenues. The $20 million in performance fees in the prior year has a negative 4% impact on our Q4 2020 organic revenue growth estimate. I also want to remind you that our advanced billing structure, which generally reflects market levels in the prior quarter, also results in a lagged effect of markets on our organic revenue growth rate. The time and amount of our performance fees varies based on the source. For example, one of our partner firms that specializes in alternative investments is working on a real estate fund transaction. We have not included that estimate in our Q4 revenue guidance because the transaction may close in Q1 of next year. As we typically do, we will provide a full year update on our performance fees on our Q4 earnings call. We anticipate that our Q4 adjusted EBITDA margin will be approximately 23%, which we estimate would bring our full year margin to approximately 24.5%. The estimated sequential decline in our margin is due to lower revenues than we anticipate in Q4. Our partner firms continue to take a very thoughtful approach to managing their expenses. They are mindful of the risk of reducing expenses too severely in reaction to current market conditions, limiting their ability to respond as markets recover. While lower market levels have an impact on our revenues, they are not currently making significant adjustments to their operating expenses. Our partners' objectives continue to center on building stable businesses that deliver consistently high levels of client service. Periods like these are also when our partners tend to see higher levels of client referrals. Additionally, talent recruitment and retention remains of paramount importance and it is difficult to find advisors in their 30s and 40s with experience in managing sophisticated high and ultra-high net worth clients. Our partners are focused on ensuring that they deliver superior client experience across cycles and capture the full potential during the recovery. However, should challenging market conditions persist for a long period of time, our partners can adjust their expenses accordingly. Now let me turn to our balance sheet. As of September 30th, we had approximately $2.4 billion in debt outstanding, and we ended the quarter with a net leverage ratio of 3.98 times, which was in line with our guidance. We estimate that our Q4 net leverage ratio will be approximately 4.25 times. I know the impact of rising rates on our interest expense remains a focus for the investment community. As a reminder, $850 million of our $2.4 billion of debt outstanding has LIBOR swapped from a floating rate to a fixed weighted average rate of 62 basis points plus a spread of 200 basis points. We typically use 30-day LIBOR on our term loans. Assuming 30-day LIBOR was 200 basis points higher in Q3 rather than the average LIBOR rate of 221 basis points in effect during the quarter on our term loan borrowings, we would have had incremental quarterly pro forma interest expense of approximately $8.2 million, which is net of our 850 million hedges. This type of pro forma increase, especially when evaluated on an after-tax basis, is a headwind, but manageable for a business with annualized revenues in excess of $2 billion. While we selectively use equity as an acquisition currency from time to time, I would like to reiterate a point Rudy made, which is we do not have to raise equity capital. Given the depressed levels at which our stock is currently trading, such a raise would not be attractive. Additionally, while we have not used our authorized $200 million stock buyback, it does remain available. In closing, the benefits of the diversification of our revenues are once again evident in our financial results during another very challenging period in the markets. Our partners' businesses are built on deep, long-standing client relationships that have withstood the test of time across market cycles. We fully expect that the resiliency and stability of our results will continue to be evident as we navigate the ongoing market turbulence. We and our partner firms are actively planning for when markets recover, which we believe will offer substantial growth opportunities as it has after other major crises. Now let me turn the call over to the operator for Q&A. Operator?