Focus Financial Partners Inc (FOCS) 2018 Q2 法說會逐字稿

Good morning. At this time I would like to welcome everyone to the Focus Financial Partners second-quarter 2018 earnings teleconference. Our host for today's call will be Chairman and Chief Executive Officer Rudy Adolf; Chief Financial Officer Jim Shanahan; and General Counsel Rusty McGranahan. (Operator Instructions). As a reminder, this conference call may be recorded. I would now like to hand the call over to Mr. McGranahan. You may begin the conference.

Thank you and good morning, everyone. I am Rusty McGranahan, the General Counsel at Focus Financial Partners. 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. With that I will turn it over to our founder, Rudy.

Thank you, Rusty and good morning, everyone. And thank you for joining us today for our first quarterly earnings call as a public company. We appreciate your interest in learning more about Focus and our business.

I would like to thank and congratulate our partners on our successful initial public offering. There certainly would be Focus without our partners. And we appreciate the trust and confidence you have had in us along our journey.

I'm also proud that our IPO has been seen not just as a milestone for Focus, but as an important moment in the independent fiduciary wealth management industry. We take our responsibility as a market leader in the $56 billion revenue financial planning and advice market seriously; and are confident that we are well positioned to continue to take advantage of the tectonic shifts defining this industry. We believe we are in the right industry with the right model at the right time.

When my co-founders, Rajini and Lenny and I started Focus over 12 years ago on our kitchen tables, we observed three challenges Focus could address to make an already highly successful industry even more successful.

Our first objective was to enhance our partners' results by bringing economies of expertise, the sharing of best practices and process and technology enhancements to the firms all while supporting their compliance programs and introducing a high level of purchasing power previously unavailable in this industry.

Second, we observed that this industry historically had very limited access to capital. Banks rarely lent to this industry and private equity rarely invests and is at best a provider of temporary capital. In addition, private equity is not a good match given the culture of RIAs.

Also, bank transactions rarely succeed in cultural conflicts in the fundamental differences in the mindset of RIAs versus banks. RIAs want to offer objective advice but traditional banks are incentivized to distribute product.

Finally, we felt we could offer a unique solution to the only true threat facing the industry, succession planning. But most importantly we felt we could help the industry meet these challenges by adhering to article one of the Focus Constitution: never turning a successful entrepreneur into an employee. Our whole business model in practice has been organized around this principle.

These are the reasons Focus has been successful over its 12-plus year history. Accordingly, Focus is now one of the largest dedicated conduits of capital into this space and helps industry participants address the very important needs I just described. Focus provides an attractive alternative to entrepreneurs by providing fair value to the founding generation and help transitioning leadership to the next generation all while enhancing the operating environment of their fiduciary businesses.

Today, we have 58 partner firms and our business achieved $663 million in revenue last year. Over the past five calendar years we have grown revenue by a compounded annual growth rate of over 25%. However, it's not just the growth that makes our model attractive. Over 90% of our revenues are fee-based and recurring, resulting in more stability and predictability.

In addition, our average organic growth over the last five calendar years has been 10%. So, while we are an acquisition oriented firm, we have generated gross both organically and inorganically.

In addition to top-line growth in business development, we are committed to operational excellence and leveraging our strengths to achieve economies of scale. This was evidenced by our adjusted net income per share growth, which was up 37.6% in the second quarter 2018 compared to the same period last year.

It is critical to understand that our economics are very different from that of an asset manager. Our partner firms are providing holistic advice to clients. They become deeply and intimately ingrained in their financial lives and in personal lives.

Our partner firms do not manage assets against the performance of a particular benchmark, but rather provide advice on everything from financial planning to major life events impacting a family. As a result we are less exposed to the volatility of any given market. Just another reason that RIAs and hybrid are growing year after year.

Clients need this independent client centric holistic advice. And they need partners for the long run and over multiple generations. The fiduciary advice model continues to grow every year versus the conflicted wirehouse and bank models. The wirehouse channel continues to do significant assets in clients through the independent channel and we expect these trends to continue.

We also have regulatory tailwinds at our back. While the DOL fiduciary role was vacated it raised client awareness that some called advisors are legally permitted to operate in a manner that is short of the client's best interest. The SEC has recently proposed other rules that would raise the standard of conduct of certain competitors moving in further to the model we already adopted. We are seeing this trend towards independent fiduciary advice all over the world and believe we are well positioned to capitalize on it in the US and abroad.

Over the last several years Focus has developed significant scale with over 2,800 partners and employees. Yet we believe we have barely scratched the surface of this opportunity. We believe that in the US alone Focus has 500 suitable partners that could join us as a partner and 5,000 firms that could be a good fit for existing partner firms over time.

In addition, through our independence program we support brokers' journey towards a model of fiduciary advice. Today, there are over 47,000 brokers within wirehouses, so Focus has a terrific opportunity to support the transaction of a small but highly qualified group of elite brokers.

Each year, Focus adds quality partner firms. Last year we acquired $44.2 million in recurring cash flow which we refer to as acquired base earnings and we have already acquired $37.8 million to date in 2018.

Now let's turn to the results for the second quarter, which was a record for the Company and consistent with our historical track record of producing double-digit growth in revenues and earnings.

As referred to in the earnings release and page 3 of the supplement, we had revenue growth of 47.2% and adjusted net income per share growth of 37.6%, which were driven by robust organic growth, as well as new partner firm addition since the end of the second quarter 2017.

We added three new partner firms during the quarter: Bartlett Wealth Management, Campbell Deegan Financial and Nigro Karlin Segal Feldstein & Bolno with $23.8 million in combined acquired base earnings.

We have maintained a strong base of M&A activity since the end of the second quarter with the addition of three new partner firms. These three partner firms -- Asset Advisors, Edge Capital Group and Vista Wealth Management, shown on page 4 of the supplement -- represent $11.2 million in combined acquired base earnings. Year to date we have added a total of eight new partner firms representing acquired base earnings of $37.8 million and we expect to maintain a strong pipeline of opportunities through the remainder of the year.

In addition, through our acquisitive growth we also continue to enhance the value added services we provide to our partners during the second quarter by completing a minority investment in New York-based FinTech company known as SmartAsset. SmartAsset connects prospective clients with financial advisors and provides tools to help individuals make financial decisions.

To sum it up, we are very excited to introduce many of you to Focus as a public company. We believe we have a unique and attractive model and we believe we can leverage our strength to continue to lead this industry in the years to come. Now I will hand the call to Jim for a more detailed review of our second-quarter results. Jim?

Thank you, Rudy, and good morning, everybody. I'll begin by spending a few minutes discussing the results of our recent IPO. Then I will review our second-quarter performance, pro forma financials and balance sheet.

On July 30, 2018 we closed our IPO of 18.6 billion shares of Class A common stock at $33 per share. This included 2.4 million shares of Class A common stock sold in connection with the full exercise by the underwriters of their option to purchase additional shares.

Upon closing of the IPO there was a total of 71.8 million adjusted shares outstanding as detailed in our earnings release. We received estimated net proceeds from the offering of approximately $564.8 million including $74.7 million in connection with the overallotment and after deducting underwriter discounts and other estimated IPO expenses.

We used the estimated net proceeds to retire our $207 million second lien term loan, pay down approximately $185.5 million of our first lien term loan to $803 million, and expect to use the remainder for general corporate purposes and acquisitions.

Now moving on to the second-quarter financials. As Rudy mentioned, our second-quarter results presented record financial performance for the Company. We reported total revenues of $231.4 million in the second quarter, an increase of 47.2% or $74.2 million compared to the second quarter of last year. Wealth management fees increased $71.0 million or 48.8% compared to the second quarter of last year.

Additionally, in excess of 90% of our revenues continue to be fee-based and recurrent. Approximately $47.9 million of the revenue growth during the quarter was the result of new partner firm acquisitions completed after the second quarter of last year. Organic revenue growth was 16.7% compared to 11.9% in the second quarter of 2017. Income from operations was $11.7 million, up from $2.5 million in the second quarter of 2017.

Interest expense for the quarter was $18.2 million compared to $7.1 million in the second quarter last year due to the impact of our $1 billion credit facility that was closed in July 2017. The net loss in the second quarter of 2018 was $7.7 million compared to a net loss of $5.2 million in the second quarter of 2017.

In order to reflect what our financials might have looked like if we were a public company during the first two quarters of 2018, our earnings release includes a pro forma analysis as if our IPO and related transactions occurred on January 1, 2018. For the six months ended Q2 2018 pro forma adjusted net income per share was $0.90 per share.

Now shifting to the reported Q2 balance sheet. As of June 30, 2018 we had cash and cash equivalents of $32.6 million compared to $51.5 million at December 31, 2017. We had $1.2 billion stated value outstanding on our credit facilities at June 30, 2018 compared to $1.0 billion at December 31, 2017.

On July 30, 2018, an amendment to our credit facility became effective in connection with the close of the IPO. The amendment reduced the interest rate margin on our term loan and revolver and increased the borrowing capacity under our revolver from $250 million to $650 million. This revolver will be primarily used for acquisition activity.

While we will not be providing specific revenue or earnings guidance, we remain confident in our ability to execute on our long-term strategy of growing annual revenue and adjusted net income per share 20% on average and over time.

As Rudy mentioned, we have added eight new partner firms year to date with combined acquired base earnings of approximately $37.8 million. And we are confident in our ability to continue growing both organically and through acquisitions through the remainder of the year. Now I'll turn it back over to Rudy to provide some concluding remarks. Rudy?

Thank you, Jim. In summary, we believe the strength of our second-quarter performance demonstrates the value proposition of our unique differentiated partnership model and fiduciary approach to wealth management. Our track record as a public company is off to a tremendous start and we believe Focus has a very bright future.

Let me also thank our partners and employees for all you have done to make Focus what we are. We could not have accomplished any of this without you and we look forward to continuing to build this great company together. With that, I will now open the call for questions. Operator?

(Operator Instructions). Kyle Voigt, KBW.

Hi, good morning. Thanks for taking my question. You noted that there were three partner firms that have joined since the end of 2Q, but I think you've also announced a sizable sub acquisition this quarter. Just wondering if you could talk about those sub acquisitions specifically and how much of those have contributed to that 16.7% organic growth you posted in 2Q and maybe a little bit on the pipeline there. Thank you.

Yes, happy to respond. The deal that we just announced, AFAM Capital, is a merger with Kovitz and, in so many ways, is a perfect microcosm of our business model where we have a very successful partner firm, hands-down one of the market leaders in Chicago Kovitz that has a very robust [off-line] offering.

And then the even more specialized firm, AFAM, has been around for a very long time, with very specific investment strategies that is very complementary to what Kovitz is doing. And by basically bringing them together, deploying our M&A expertise, our capital in the process here, we ultimately really help Kovitz and the combined equity to round up its -- to significantly round up its value proposition to the clients. So it's just a perfect example.

Of course, it's obvious we don't disclose the actual specific terms or financials in the transaction, but AFAM is of course not reflecting the Q2 financials. But it is one of the largest mergers that we have supported for one of our partner firms. So it is a deal we are very, very excited about.

And really in the second quarter, the 16.7% growth, any disclosure on how much of that was coming from your partner firms doing deals via sub acquisitions? Or can you just comment I guess even in qualitative terms how meaningful they've been?

Actually, Jim, do you want to quickly answer that?

Right. So Kyle, as you know, our organic growth is a combination of market and new assets, the tuck-ins as Rudy had mentioned and all the value-added services. We don't break that out. Obviously it was 16.7% for Q2, 16.9% for the first half of 2018. And obviously that's an important statistic towards how we grow our long-term revenue of 20%.

Okay. And then last for me then I'll hop back in the queue is just on the IPO proceeds. You disclosed that $390 million was used to repay debt. I think in the final prospectus you disclosed $137 million would be used for acquisitions and general corporate purposes. Just wondering of that $137 million, has most of that already been utilized for acquisition activity? We're just trying to get a sense of the current net debt as of today. Thanks.

Right, so we've disclosed the base earnings of $11.2 million. Obviously we haven't broken out the components of the cash stock on what that is. But we are comfortable running the business of leverage between 3 and 4 times.

Thank you.

And when we report our Q3 results there will be more visibility on the acquisition activities during Q3.

And just importantly to say we have tremendous firepower. It's not just the cash on the balance sheet. Of course here the cash that we generate, it's our $650 million revolver. We are very well positioned with the capital that we have available to basically continue the execution of our strategy.

Michael Carrier, Bank of America.

Thanks, guys. Maybe just one of the value-added services. So, with your guys' model, the revenue growth is attractive and the adjusted earnings. There's not as much operating leverage just by nature, the model. But it does seem like operationally you guys can provide certain incentives to the partner firms given the scale of the overall focus franchise. And that could potentially maybe over time drive down the cost and maybe Focus could benefit from that.

So just wanted to -- I know there's nothing like near-term, but just when you guys think longer-term, are there opportunities to increase maybe the efficiencies at the partners, meaning them driving that? But then that could actually benefit the parent model -- or the parent margin, sorry?

Yes, yes, Michael, absolutely. And as we have disclosed in our -- in the S1 where we looked at this 20 firms that we are partners at Focus, what you saw in the S1 is that initially their growth was 3.8%. Five years later it was 9.4%. So we saw just significant growth that we could prove.

And the Focus model is all about value added. Our model simply wouldn't work if this was purely a financial model. And our value added comes from the just tremendous expertise that we have is a group, having almost 60 partner firms now across the network. And of course all of them operating as entrepreneur of independent units, but we are deeply involved with these partners and basically are deeply helping them throughout the whole business model.

Now what we are also bringing is of course tremendous purchasing power. We are the largest client of just about any provider in this industry and this gives us tremendous access and tremendous ability to quite frankly use our muscle and purchasing power on behalf of our partner firms and of our clients.

A good example here is last night -- yesterday I spent time with one of our most recent firms. We had a session where -- like a 40-page document where we sat down, deal is closed and basically worked through all the leverage points of what we learned in due diligence, what we learned in the client interviews, what observations we have. And then basically develop an agenda with the leadership team of this firm who just joined us in areas they want to address, areas we can address. And together kind of creating this 18 months to two-year agenda of support.

So yes, value-added is at the very core of what we do. We do it in a nontraditional way. We are not a rollup who slaps things together. I would say the rollup is an excuse to overpay for underperforming assets in the hope that you squeeze some synergies out. I think we have a way more sophisticated model and it is much more oriented towards growth.

Mike, just a little clarification on what Rudy mentioned. As you know, during the road show, and it was in the prospectus. So it was year one we had these 20 partner firms that have been with us for five years. So they had grown 5.7% in year one, and then by year five they had grown to 9.5%. So those are the metrics on how we add some value-added services to our partner firms.

Right, okay. And then maybe just a quick follow-up. Jim, just on the -- when you guys -- you have quarters where the revenue growth is coming in maybe slightly less than the management fee growth, like this quarter, just what are some of the nuances that can drive that?

Because I would assume like over time we would expect that to be fairly similar as long as the transactions that are being brought on are kind of the same like economics. But just any details on what can drive those nuances from quarter to quarter.

Right. Now remember, we have a unique model in the respect of the management company and how we split cash flows with our partner firms. And when you look at those changes maybe quarter over quarter or so forth as a percentage, management fees as a pure dollar basis is a lot lower than revenue. So you could have management fee percentage growth greater than revenue. So you have to look at the base dollars, point one.

Point two is, obviously an important thing to our business model is next generation. So, when key employees are now ready for leadership roles in the management company, they leave the operating company where they were a W-2 employee and they join the management company as the next leaders of the partners. So accordingly you can see management fee growth from that as well.

Got it, okay. Thanks a lot.

Chris Shutler, William Blair.

Hey guys, good morning. Maybe just a little bit more color on the pipeline. So specifically can you talk about the -- at least qualitatively the level of acquired base earnings that you see at various stages of the pipeline? And is there anything transformative in the near-term pipeline?

And then lastly, anything in the pipeline that would vary significantly from your typical kind of 45% to 50% of cash flow that you are buying? So would it be anything well north of that or well south of that? Thanks.

So obviously we don't give any specific quarterly guidance and particularly not on the M&A pipeline. Because while in every turnover time of course we have a track record of executing against our financial targets, the 20% of the 20%, this (inaudible) objectives. And of course we are way ahead of these numbers here, as you can see with the earnings announcement here.

Chris, as you know, this is just a perfect industry. We love the space we are in and we have a -- probably the most robust pipeline I have ever seen and some of this is credit to the very successful IPO. One of the themes or one of the thesis that we had was that with the power of the credibility of the public offering and the successful public offering, doors will open and it will add to the, quite frankly, strong track record and reputation we already had and that's exactly what happened.

So, we feel very good about where we are right now. We feel very good that we will be able to keep at a good pace here. Specifically how the next number of deals look like, obviously I couldn't tell you right now. But we are just in a really good spot and we like what we see.

Okay, thanks, Rudy. And then let's see, on the SmartAsset acquisition, maybe just a little bit more detail there. How much did you invest? And more importantly, just talk about your plans to leverage that asset.

Yes, so SmartAsset, the transaction itself is pretty small, small for -- by our standards, not small for SmartAssets. We are now one of their larger shareholders. But this is of course a nontraditional deal for us and it's all about value added. SmartAsset is obviously a FinTech company that really provides ultimately leads into the RIA space and beyond. And we have tested their capabilities with a number of our partner firms. Quite frankly we are very impressed with the initial results.

They are a very large -- I don't think they disclose it, but their number of unique visitors per month is just tremendous and has further increased since our investment. So it's one of those areas where it's less about the financials but it's much more about the tremendous expertise that by the way goes both ways. We are learning from them and they are learning from us.

My cofounder Rajini is on the Board. Eric Amar, one of our principals, is also an observer of the Board. So this is much more about expertise that ultimately we can help them with and, quite frankly, they can help us with. And we feel that while short-term of course this has no impact on our financials directly. It's a tremendous capability. We have a unique vantage point and over time it will help our value-added program for our partners.

All right, makes sense. And then lastly, Jim, what kind of share count dilution should we model in the back half and into 2019 assuming the deal momentum continues?

Right. So at the close of the IPO we had 71.8 million shares at $33 per unit. And obviously we have a lot of M&A activity going on currently and to the remainder of the year. So we don't have an exact guidance for the number of shares at the end of the year. What I can say is our typical deals are a touch heavier on cash, as you know. And in terms of leverage we're still targeting 3 to 4 times leverage.

Yes, Chris there's always something we are learning ourselves now. We really want to use cash for our deals going forward. Cash at -- you have -- based on our cash generation, based on the -- is very cheap of course. And how this plays out over time we are just going to learn. But our sweet spot deals, as much as we can guide it this way, would be heavily geared if not exclusively geared towards cash.

All right, thanks a lot, guys.

Alex Blostein, Goldman Sachs.

Great. Hey, good morning, guys. Rudy, first question just I guess is a follow-up around the acquisition discussions. I guess looking at the acquisitions by the partner firms, any comments on how the pipeline looks there? It sounds like obviously the pipeline for you guys is robust, but I'm wondering what's going on at the partner firm level.

Yes, so -- good morning, Alex. So, one is clearly -- this is our bread and butter. In a typical year we do 15, 20 of these mergers on behalf of our partner firms. It is -- these are highly accretive deals. This is tremendous value added to our partners. And quite frankly -- and it was disclosed in the S1 -- roughly about two-thirds of our partner firms have done deals and of course some of them are serial acquirers.

Now what's important here is the number -- with the increase of number of partner firms we have simply way more opportunities to do these deals. And the pipeline on the merger side is at least as strong as it is on the holding company transactions. And it is a big part of our value-added program for partners. So both holding company and mergers here we feel very good about.

Got it. Thanks. And then just a second question I guess for Jim. When we look at the adjustments this quarter, the change in fair value of contingent consideration seems quite sizable, about $12 million. Obviously it's a good thing because I'm assuming the business is doing well.

But any more granularity in terms of how many partner firms does that span over? Is it just a handful or is it a bunch and it just kind of happens all in one quarter? And I guess more importantly any update on what the fair value is of the entire contingency and the composition between cash and equity of how that would be paid actually out?

So obviously, as you know, under GAAP we have to fair value all the earn-outs that we have each quarter. So at the end of June, based on the results and the forecast of what we think earn-outs may be in the future -- and remember, a lot of our earn-outs are year three and year six, so they are long-term in nature.

And based on our projections we are more optimistic, so therefore accordingly we had to make that adjustment in our P&L for the likely probability of more earn-outs being achieved. And that's a non-cash item, as you know, at this point flowing through the P&L.

And then in the Q that was filed in footnote 5, we disclosed the estimated fair value at $108 million. And remember, this is a Monte Carlo simulation of what that number may be. And in terms of the cash stock mix, these are long-term awards. We have to basically talk to the partners at that time when the earn-outs are achieved. But obviously if they are earning the earn-outs then the P&L results are coming in and Rudy and the management team are more than happy to pay those earn-outs.

Excellent. So I'm being told there are actually no more questions here. So, this is our inaugural earnings announcement. I want to really thank you all for your interest in Focus. And I guess we are looking forward to speaking with many of you on our third-quarter call. We are very proud of our results that we are showing you. I think it was a great start. And thank you for your confidence and trust in our business. Bye-bye.

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone have a great day.