FOCUS FINANCIAL PARTNERS INC. Unless otherwise indicated or the context requires, all references to "we,"
"us," "our," the "Company," "
The term "partner firms" refers to our consolidated subsidiaries engaged in wealth management and related services, the businesses of which are typically managed by the principals. The term "principals" refers to the wealth management professionals who manage the businesses of our partner firms pursuant to the relevant management agreement. The term "our partnership" refers to our business and relationship with our partner firms and is not intended to describe a particular form of legal entity or a legal relationship. The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with the accompanying unaudited condensed consolidated financial statements as of and for the three and nine months endedSeptember 30, 2021 and 2022.
Forward-Looking Statements
Some of the information in this Quarterly Report on Form 10-Q may contain forward-looking statements. Forward-looking statements give our current expectations, contain projections of results of operations or of financial condition, or forecasts of future events. Words such as "may," "assume," "forecast," "position," "predict," "strategy," "expect," "intend," "plan," "estimate," "anticipate," "believe," "project," "budget," "potential," "continue," "will" and similar expressions are used to identify forward-looking statements. They can be affected by assumptions used or by known or unknown risks or uncertainties. Consequently, no forward-looking statements can be guaranteed. When considering these forward-looking statements, you should keep in mind the risk factors and other cautionary statements described under "Risk Factors" in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , as filed with theSecurities and Exchange Commission ("SEC") onFebruary 17, 2022 , and in our other filings with theSEC . Actual results may vary materially. You are cautioned not to place undue reliance on any forward-looking statements. You should also understand that it is not possible to predict or identify all such factors and should not consider the following list to be a complete statement of all potential risks and uncertainties. Factors that could cause our actual results to differ materially from the results contemplated by such forward-looking statements include:
? fluctuations in wealth management fees;
? our reliance on our partner firms and the principals who manage their
businesses;
? our ability to make successful acquisitions;
? unknown liabilities of or poor performance by acquired businesses;
? harm to our reputation;
? our inability to facilitate smooth succession planning at our partner firms;
? our inability to compete;
? our reliance on key personnel and principals;
? our inability to attract, develop and retain talented wealth management
professionals;
? our inability to retain clients following an acquisition;
? our reliance on key vendors;
? write down of goodwill and other intangible assets;
? our failure to maintain and properly safeguard an adequate technology
infrastructure;
? cyber-attacks and other disruptions;
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? our inability to recover from business continuity problems;
? inadequate insurance coverage;
? impact of the novel coronavirus ("Covid-19") outbreak on our business;
? the termination of management agreements by management companies;
? our inability to generate sufficient cash to service all of our indebtedness or
our ability to access additional capital;
? the failure of our partner firms to comply with applicable
regulatory requirements and the highly regulated nature of our business;
? worsening economic conditions, including inflation, in
internationally;
? wars or other geopolitical conflict;
? changes to laws and regulations;
? legal proceedings, governmental inquiries; and
? other factors discussed in this Quarterly Report on Form 10-Q, including in
Part II, Item 1A. "Risk Factors".
All forward-looking statements are expressly qualified in their entirety by the foregoing cautionary statements. Our forward-looking statements speak only as of the date of this Quarterly Report or as of the date as of which they are made. Except as required by applicable law, including federal securities laws, we do not intend to update or revise any forward-looking statements.
Overview
We are a leading partnership of independent, fiduciary wealth management firms
operating in the highly fragmented registered investment advisor ("RIA")
industry, with a footprint of over 85 partner firms primarily in the 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.
We have to date, with limited exceptions, acquired substantially all of the
assets of the firms we chose to partner with but only a portion of the
underlying economics in order to align the principals' interests with our own
objectives. To determine the acquisition price, we first estimate the operating
cash flow of the business based on current and projected levels of revenue and
expense, before compensation and benefits to the selling principals or other
individuals who become principals. We refer to the operating cash flow of the
business as Earnings Before Partner Compensation ("EBPC") and to this EBPC
estimate as Target Earnings ("Target Earnings"). In economic terms, we typically
purchase only 40% to 60% of the partner firm's EBPC. The purchase price is a
multiple of the corresponding percentage of Target Earnings and may consist of
cash or a combination of cash and equity, and the right to receive contingent
consideration. We refer to the corresponding percentage of Target Earnings on
which we base the purchase price as Base Earnings ("Base Earnings"). Under a
management agreement between our operating subsidiary and the
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management company and the principals, the management company is entitled to management fees typically consisting of all future EBPC of the acquired wealth management firm in excess of Base Earnings up to Target Earnings, plus a percentage of any EBPC in excess of Target Earnings. Through the management agreement, we create downside protection for ourselves by retaining a preferred position in Base Earnings. For mergers on behalf of our partner firms, including mergers forConnectus Wealth Advisers ("Connectus"), one of our partner firms, we typically purchase all of the target firms' EBPC and principals and other personnel of the target firm join our partner firm as employees or may join the related management company as a principal in some instances. There typically is an adjustment to Target Earnings and Base Earnings in the related management agreement if applicable based on the economics of the transaction. Since 2006, when we began revenue-generating and acquisition activities, 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 of approximately$1.8 billion for the year endedDecember 31, 2021 and approximately$1.6 billion for the nine months endedSeptember 30, 2022 . For the year endedDecember 31, 2021 and the nine months endedSeptember 30, 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 footprint 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 comprised 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:
Three Months Ended September 30, Nine Months Ended September 30,
2021 2022 2021 2022
% of Total % of Total % of Total % of Total
Revenues Revenues Revenues Revenues Revenues Revenues Revenues Revenues
(dollars in thousands)
Wealth
management
fees $ 433,967 95.5 % $ 499,017 96.0 % $ 1,213,782 95.3 % $ 1,531,617 96.0 %
Other 20,568 4.5 % 20,847 4.0 % 60,283 4.7 % 64,025 4.0 %
Total
revenues $ 454,535 100.0 % $ 519,864 100.0 % $ 1,274,065 100.0 % $ 1,595,642 100.0 %
During the three and nine months ended September 30, 2022 , our wealth management
fees were impacted by the acquisition of new partner firms and the growth of
existing partner firms, which includes the acquisitions of wealth management
practices by our existing partner firms. During the three and nine months ended
September 30, 2022 , we completed the acquisition of two and three partner firms,
respectively. During the three months ended September 30, 2022 , the new partner
firms were Octogone Holding and Icon Wealth Partners . During the nine months
ended September 30, 2022 , the new partner firms were Azimuth Capital Investment
Management , Octogone Holding and Icon Wealth Partners . During the three and nine
months ended September 30, 2022 , our partner firms completed 7 and 12
acquisitions, respectively, consisting of business acquisitions accounted for in
accordance with Financial Accounting Standards Board Accounting Standard
Codification ("ASC") Topic 805: Business Combinations and asset acquisitions.
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See Note 4 to our unaudited condensed consolidated financial statements for additional information about our acquisitions.
For the nine months endedSeptember 30, 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. Additionally, we estimate that approximately 24% and 23% of our revenues for the three and nine months endedSeptember 30, 2022 , respectively, were not directly correlated to the financial markets. Of the approximately 76% and 77% of our revenues that were directly correlated to the financial markets, primarily equities and fixed income, for the three and nine months endedSeptember 30, 2022 , respectively, we estimate that approximately 66% 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 66% 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.
Operating Expenses
Our operating expenses consist of compensation and related expenses, management fees, selling, general and administrative expenses, 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. 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 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 new 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 generally 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.
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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.
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 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
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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 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 11 business acquisitions during the nine months endedSeptember 30, 2022 , consisting of both new partner firms and acquisitions by 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 typically consists of an upfront cash payment 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, typically annually. 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.
The following table summarizes our business acquisitions for the nine months
ended
Number of business acquisitions closed 11
Consideration:
Cash due at closing$ 356,854 Estimated working capital adjustment and other 889 Cash due subsequent to closing at net present value 9,611
Fair market value of
$ 419,655
During the nine months ended
Recent Developments
From
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Acquired Base Earnings associated with the acquisition of the new partner firm during this period is$2.0 million . Furthermore, we have signed a definitive purchase agreement to acquire an additional partner firm with Acquired Base Earnings of approximately$5.3 million . This pending transaction is generally on terms and in a structure consistent with past transactions, and the closing is subject to customary closing conditions. Among other risks and uncertainties, there can be no guarantee that this pending acquisition will be completed. For additional information regarding Acquired Base Earnings, please see "-How We Evaluate Our Business." 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 for the three and nine months ended
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Three Months Ended Nine Months Ended
September 30, September 30,
2021 2022 2021 2022
(dollars in thousands, except per share data)
Revenue Metrics:
Revenues $ 454,535 $ 519,864 $ 1,274,065 $ 1,595,642
Revenue growth (1) from prior
period 37.1 % 14.4 % 29.8 % 25.2 %
Organic revenue growth (2) from
prior period 28.8 % 3.4 % 23.1 % 13.3 %
Management Fees Metrics (operating
expense):
Management fees $ 127,166 $ 122,971 $ 345,443 $ 397,612
Management fees growth (3) from
prior period 47.2 % (3.3) % 39.8 % 15.1 %
Organic management fees growth (4)
from prior period 38.7 % (11.6) % 32.5 % 5.1 %
Net Income Metrics:
Net income $ 1,849 $ 38,289 $ 9,505 $ 126,689
Net income growth from prior
period (53.1) % * (77.0) % *
Income per share of Class A common
stock:
Basic $ 0.01 $ 0.45 $ 0.05 $ 1.40
Diluted $ 0.01 $ 0.44 $ 0.05 $ 1.39
Income per share of Class A common
stock growth from prior period:
Basic (66.7) % * (90.2) % *
Diluted (66.7) % * (90.2) % *
Adjusted EBITDA Metrics:
Adjusted EBITDA (5) $ 113,512 $ 128,689 $ 322,296 $ 400,790
Adjusted EBITDA growth (5) from
prior period 45.0 % 13.4 % 39.5 % 24.4 %
Adjusted Net Income Excluding Tax
Adjustments Metrics:
Adjusted Net Income Excluding Tax
Adjustments (5) $ 68,521 $ 70,052 $ 199,770 $ 234,804
Adjusted Net Income Excluding Tax
Adjustments growth (5) from prior
period 42.9 % 2.2 % 44.2 % 17.5 %
Tax Adjustments
Tax Adjustments (5)(6) $ 11,835 $ 16,664 $ 33,365 $ 47,454
Tax Adjustments growth from prior
period (5)(6) 27.4 % 40.8 % 21.8 % 42.2 %
Adjusted Net Income Excluding Tax
Adjustments Per Share and Tax
Adjustments Per Share Metrics:
Adjusted Net Income Excluding Tax
Adjustments Per Share (5) $ 0.84 $ 0.86 $ 2.44 $ 2.88
Tax Adjustments Per Share (5)(6) $ 0.14 $ 0.20 $ 0.41 $ 0.58
Adjusted Net Income Excluding Tax
Adjustments Per Share growth (5)
from prior period 33.3 % 2.4 % 34.1 % 18.0 %
Tax Adjustments Per Share growth
from prior period (5)(6) 16.7 % 42.9 % 13.9 % 41.5 %
Adjusted Shares Outstanding
Adjusted Shares Outstanding (5) 81,829,784 81,597,322 81,708,469 81,509,075
Other Metrics:
Net Leverage Ratio (7) at period
end 3.54x 3.98x 3.54x 3.98x
Acquired Base Earnings (8) $ 10,950 $ 7,849 $ 21,913 $ 19,299
Number of partner firms at period
end (9) 76 87 76 87
* Not meaningful
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(1) Represents period-over-period growth in our GAAP revenue.
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 period 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 September
30, 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 (7) First Lien Term Loan and First Lien Revolver plus other outstanding debt
obligations secured by a lien on the assets of
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 collective preferred position in Base Earnings or comparable (8) measures. We are entitled to 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
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and the principals is amended to adjust Base Earnings and Target Earnings to
reflect the projected post-acquisition earnings of the partner firm.
(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, other
income (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.
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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 relying also on the GAAP results and using Adjusted
EBITDA as supplemental information.
Set forth below is a reconciliation of net income to Adjusted EBITDA for the
three and nine months ended
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2022 2021 2022
(in thousands)
Net income $ 1,849 $ 38,289 $ 9,505 $ 126,689
Interest income (206) (126) (310) (146)
Interest expense 16,543 26,491 37,893 63,999
Income tax expense 2,678 12,120 6,038 59,965Amortization of debt financing costs 1,102 949 2,856 2,999 Intangible amortization 46,055 67,331 133,041 192,256 Depreciation and other amortization 3,622 4,016 10,835 11,454 Noncash equity compensation expense 5,938 7,980 24,569 22,190 Noncash changes in fair value of estimated contingent consideration 36,243 (30,708) 96,241 (82,450) Other (income) expense-net (312) 2,347 219 3,834 Secondary offering expenses - - 1,409 - Adjusted EBITDA$ 113,512 $ 128,689 $ 322,296 $ 400,790
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 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. 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 and restricted stock units outstanding during the periods, (iii) 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), (iv) 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 (v) 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). 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 35
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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
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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 for the three and nine months ended
Three Months Ended September 30, Nine Months Ended September 30,
2021 2022 2021 2022
(dollars in thousands, except per share data)
Net income $ 1,849 $ 38,289 $ 9,505 $ 126,689
Income tax expense 2,678 12,120 6,038 59,965
Amortization of debt financing costs 1,102 949 2,856 2,999
Intangible amortization 46,055 67,331 133,041 192,256
Noncash equity compensation expense 5,938 7,980 24,569 22,190
Noncash changes in fair value of
estimated contingent consideration 36,243 (30,708) 96,241 (82,450)
Secondary offering expenses (1) - - 1,409 -
Subtotal 93,865 95,961 273,659 321,649
Pro forma income tax expense (27%)
(2) (25,344) (25,909) (73,889) (86,845)
Adjusted Net Income Excluding Tax
Adjustments $ 68,521 $ 70,052 $ 199,770 $ 234,804
Tax Adjustments (3) $ 11,835 $ 16,664 $ 33,365 $ 47,454
Adjusted Net Income Excluding Tax
Adjustments Per Share $ 0.84 $ 0.86 $ 2.44 $ 2.88
Tax Adjustments Per Share (3) $ 0.14 $ 0.20 $ 0.41 $ 0.58
Adjusted Shares Outstanding 81,829,784 81,597,322 81,708,469 81,509,075
Calculation of Adjusted Shares
Outstanding:
Weighted average shares of Class A
common stock outstanding-basic (4) 59,940,166 65,599,493 55,978,639 65,441,151
Adjustments:
Weighted average incremental shares of Class A common stock related to stock options and restricted stock units (5) 498,344 221,735 468,431 288,188 Weighted averageFocus LLC common units outstanding (6) 12,609,173 11,898,233 16,263,935 11,899,456 Weighted averageFocus LLC restricted common units outstanding (7) 71,374 192,627 71,374 193,289 Weighted average common unit equivalent ofFocus LLC incentive units outstanding (8) 8,710,727 3,685,234 8,926,090 3,686,991 Adjusted Shares Outstanding 81,829,784 81,597,322 81,708,469 81,509,075
(1) Relates to offering expenses associated with the
secondary equity offerings.
The pro forma income tax rate of 27% reflects the estimated
jurisdictions we conduct business.
Tax Adjustments represent the tax benefits of intangible assets, including
goodwill, associated with deductions allowed for tax amortization of (3) 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
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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
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
(4) Represents our GAAP weighted average Class A common stock outstanding-basic.
(5) Represents the incremental shares related to stock options and restricted
stock units as calculated under the treasury stock method.
Assumes that 100% of the
stock.
(7) Assumes that 100% of the
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.
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Results of Operations
Three Months Ended
The following discussion presents an analysis of our results of operations for the three months endedSeptember 30, 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. Three Months Ended September 30, 2021 2022 $ Change % Change (dollars in thousands) Revenues: Wealth management fees$ 433,967 $ 499,017 $ 65,050 15.0 % Other 20,568 20,847 279 1.4 % Total revenues 454,535 519,864 65,329 14.4 % Operating expenses:
Compensation and related expenses 144,249 186,320 42,071 29.2 % Management fees 127,166 122,971 (4,195) (3.3) % Selling, general and administrative 75,637 89,915 14,278 18.9 % Intangible amortization 46,055 67,331 21,276 46.2 % Noncash changes in fair value of estimated contingent consideration 36,243 (30,708) (66,951) * Depreciation and other amortization 3,622 4,016
394 10.9 %
Total operating expenses 432,972 439,845 6,873 1.6 %
Income from operations 21,563 80,019 58,456 *
Other income (expense):
Interest income 206 126 (80) (38.8) %
Interest expense (16,543) (26,491) (9,948) (60.1) %Amortization of debt financing costs (1,102) (949) 153 13.9 % Other income (expense)-net 312 (2,347) (2,659) * Income from equity method investments 91 51
(40) (44.0) %
Total other expense-net (17,036) (29,610) (12,574) (73.8) %
Income before income tax 4,527 50,409 45,882 *
Income tax expense 2,678 12,120 9,442 *
Net income $ 1,849 $ 38,289 $ 36,440 *
* Not meaningful
Revenues
Wealth management fees increased $65.1 million , or 15.0%, for the three months
ended September 30, 2022 compared to the three months ended September 30, 2021 .
New partner firms added subsequent to the three months ended September 30, 2021
that are included in our results of operations for the three months ended
September 30, 2022 include Ancora Holdings , Sonora Investment Management ,
Cardinal Point , Ullmann Wealth Partners , Mosaic Family Wealth, Alley Company ,
Cassaday & Company , Provident Financial Management, Azimuth Capital Investment
Management , Octogone Holding and Icon Wealth Partners . Additionally, our partner
firms completed 25 acquisitions subsequent to the three months ended September
30, 2021 . The new partner firms contributed approximately $47.5 million in
revenue during the three months ended September 30, 2022 . The balance of the
increase of $17.6 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.
Other revenues increased
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Operating Expenses
Compensation and related expenses increased $42.1 million , or 29.2%, for the
three months ended September 30, 2022 compared to the three months ended
September 30, 2021 . The increase related to new partner firms was approximately
$13.5 million . Non-cash equity compensation increased $2.0 million primarily
from equity grants in 2021 and incremental non-cash equity compensation expense
from the modification of certain equity awards in 2022. The balance of the
increase of $26.6 million was due primarily to an increase in salaries and
related expense due to the growth of existing partner firms, including
Connectus , and partner firm-level acquisitions.
Management fees decreased $4.2 million , or 3.3%, for the three months ended
September 30, 2022 compared to the three months ended September 30, 2021 . This
reflects an increase related to new partner firms of approximately $10.3
million . Management fees are variable and a function of earnings during the
period. This increase was offset by a $14.5 million decrease in profitability
splits with the management companies during the three months ended September 30,
2022 compared to the three months ended September 30, 2021 .
Selling, general and administrative expenses increased $14.3 million , or 18.9%,
for the three months ended September 30, 2022 compared to the three months ended
September 30, 2021 . New partner firms added approximately $8.2 million . The
balance of the increase of $6.1 million was due primarily to an increase in
expenses related to travel and entertainment and information technology expenses
related to the growth of our existing partner firms, including Connectus , and
partner firm-level acquisitions.
Intangible amortization increased $21.3 million , or 46.2%, for the three months
ended September 30, 2022 compared to the three months ended September 30, 2021 .
The increase related to new partner firms was approximately $12.2 million . The
balance of the increase of $9.1 million was due primarily to partner firm-level
acquisitions.
Non-cash changes in fair value of estimated contingent consideration decreased
$67.0 million for the three months ended September 30, 2022 compared to the
three months ended September 30, 2021 . During the three months ended September
30, 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.
Other income (expense)
Interest expense increased$9.9 million , or 60.1%, for the three months endedSeptember 30, 2022 compared to the three months endedSeptember 30, 2021 . The increase was due primarily to higher average outstanding borrowings and higher average interest rates during the three months endedSeptember 30, 2022 compared to the three months endedSeptember 30, 2021 .
Income Tax Expense
Income tax expense increased$9.4 million for the three months endedSeptember 30, 2022 compared to the three months endedSeptember 30, 2021 . For the three months endedSeptember 30, 2022 , we recorded tax expense based on an estimated annual effective tax rate of 32.1%. The estimated 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 and reflects an estimated valuation allowance of$9.3 million for deferred tax assets relating to business interest carryforwards. 40
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Nine Months Ended
The following discussion presents an analysis of our results of operations for the nine months endedSeptember 30, 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. Nine Months Ended September 30, 2021 2022 $ Change % Change (dollars in thousands) Revenues: Wealth management fees$ 1,213,782 $ 1,531,617 $ 317,835 26.2 % Other 60,283 64,025 3,742 6.2 % Total revenues 1,274,065 1,595,642 321,577 25.2 % Operating expenses:
Compensation and related expenses 424,337 546,251 121,914 28.7 % Management fees 345,443 397,612 52,169 15.1 % Selling, general and administrative 208,481 273,336 64,855 31.1 % Intangible amortization 133,041 192,256 59,215 44.5 % Noncash changes in fair value of estimated contingent consideration 96,241 (82,450) (178,691) * Depreciation and other amortization 10,835 11,454
619 5.7 %
Total operating expenses 1,218,378 1,338,459 120,081 9.9 %
Income from operations 55,687 257,183 201,496 *
Other income (expense):
Interest income 310 146 (164) (52.9) %
Interest expense (37,893) (63,999) (26,106) (68.9) %Amortization of debt financing costs (2,856) (2,999) (143) (5.0) % Other expense-net (219) (3,834) (3,615) * Income from equity method investments 514 157
(357) (69.5) %
Total other expense-net (40,144) (70,529) (30,385) (75.7) %
Income before income tax 15,543 186,654 171,111 *
Income tax expense 6,038 59,965 53,927 *
Net income $ 9,505 $ 126,689 $ 117,184 *
Revenues
Wealth management fees increased $317.8 million , or 26.2%, for the nine months
ended September 30, 2022 compared to the nine months ended September 30, 2021 .
New partner firms added subsequent to the nine months ended September 30, 2021
that are included in our results of operations for the nine months ended
September 30, 2022 include Ancora Holdings , Sonora Investment Management ,
Cardinal Point , Ullmann Wealth Partners , Mosaic Family Wealth, Alley Company ,
Cassaday & Company , Provident Financial Management, Azimuth Capital Investment
Management , Octogone Holding and Icon Wealth Partners . Additionally, our partner
firms completed 25 acquisitions subsequent to the nine months ended September
30, 2021 . The new partner firms contributed approximately $127.1 million in
revenue during the nine months ended September 30, 2022 . The balance of the
increase of $190.7 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 nine months ended September 30, 2022 for partner firms
that were acquired during the nine months ended September 30, 2021 .
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Other revenues increased$3.7 million , or 6.2%, for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . Other revenues from new partner firms was approximately$2.4 million . The balance of the increase of$1.3 million was due primarily to an increase in recordkeeping and administration fees. Operating Expenses Compensation and related expenses increased$121.9 million , or 28.7%, for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . The increase related to new partner firms was approximately$34.3 million . The balance of the increase of$87.6 million was due primarily to an increase in salaries and related expense due to the growth of existing partner firms, includingConnectus , and partner firm-level acquisitions offset in part by a decrease in non-cash equity compensation expense of$2.4 million . Management fees increased$52.2 million , or 15.1%, for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . The increase related to new partner firms was approximately$30.0 million . Management fees are variable and a function of earnings during the period. The balance of the increase of$22.2 million was primarily due to partner firm-level acquisitions as well as a full period of management fees during the nine months endedSeptember 30, 2022 for partner firms that were acquired during the nine months endedSeptember 30, 2021 . Selling, general and administrative expenses increased$64.9 million , or 31.1%, for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . New partner firms added approximately$20.4 million . The balance of the increase of$44.5 million was due primarily to an increase in expenses related to travel and entertainment, professional fees, information technology expenses and referral fees related to the growth of our existing partner firms, includingConnectus , and partner firm-level acquisitions. Intangible amortization increased$59.2 million , or 44.5%, for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . The increase related to new partner firms was approximately$31.9 million . The balance of the increase of$27.3 million was due primarily to partner firm-level acquisitions. Non-cash changes in fair value of estimated contingent consideration decreased$178.7 million for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . During the nine months endedSeptember 30, 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.
Other income (expense)
Interest expense increased$26.1 million , or 68.9%, for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . The increase was due primarily to higher average outstanding borrowings and higher average interest rates during the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . 42 Table of Contents Income Tax Expense Income tax expense increased$53.9 million for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . For the nine months endedSeptember 30, 2022 , we recorded tax expense based on an estimated annual effective tax rate of 32.1%. The estimated 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 and reflects an estimated valuation allowance of$9.3 million for deferred tax assets relating to business interest carryforwards.
Liquidity and Capital Resources
Sources of Liquidity
During the nine months endedSeptember 30, 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 be met by cash generated by our operations and borrowings under 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 in periods after the initial public offering 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. During the nine months endedSeptember 30, 2022 , payments totaling$3.9 million were made under the Tax Receivable Agreements. As ofSeptember 30, 2022 , we expect that future payments to the TRA holders that have already exchangedFocus LLC units will be$221.2 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 redemption of units, the price of our Class A common stock at the time of each redemption, the extent to which such redemptions are taxable transactions, the amount ofFocus LLC's assets that consist of equity in entities taxed as corporations at the time of each redemption, the amount and timing of the taxable income we generate in the future, theU.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 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 43
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subject to the Tax Receivable Agreements and/or (ii) distributions toFocus Inc. byFocus LLC are not sufficient to permitFocus 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, principals and directors.
Cash Flows
The following table presents information regarding our cash flows and cash and
cash equivalents for the nine months ended
Nine Months Ended
September 30,
2021 2022 $ Change % Change
(dollars in thousands)
Cash provided by (used in):
Operating activities $ 237,848 $ 230,316 $ (7,532) (3.2) %
Investing activities (310,595) (380,059) (69,464) (22.4) %
Financing activities 649,664 (29,889) (679,553) (104.6) % Cash and cash equivalents-end of period 642,207 128,528 (513,679) (80.0) %
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$7.5 million , or 3.2%, for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . The decrease was principally related to changes in working capital including the timing of due to affiliate payments and an increase in interest payments, which were partially offset by an increase in Adjusted EBITDA of$78.5 million during the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 .
Investing Activities
Net cash used in investing activities increased$69.4 million , or 22.4%, for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 . The increase was due primarily to an increase in cash paid for acquisitions and contingent consideration of$74.9 miilion offset in part by a decrease in investment and other, net of$12.0 million during the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 .
Financing Activities
Net cash provided by financing activities for the nine months endedSeptember 30, 2022 decreased$679.6 million , or 104.6%, compared to the nine months endedSeptember 30, 2021 . The decrease was primarily due to a 44
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decrease in net borrowings under our Credit Facility of$718.9 million offset in part by a decrease in contingent consideration paid of$31.8 million during the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 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 acquisition 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 September 30,
2021 2022
(in thousands)Net cash provided by operating activities (1)(2) $ 310,742 $ 306,386 Purchase of fixed assets (13,218) (17,610) Distributions for unitholders (33,083) (26,439) Payments under tax receivable agreements (4,423)
(3,856)
Adjusted Free Cash Flow $ 260,018 $ 258,481
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
cash outflows for each quarter in the trailing 4-quarters ended
2022 was
respectively, totaling
September 30, 2022 . See Note 6 to our unaudited condensed consolidated financial statements for additional information. A portion of deferred acquisition consideration paid is classified as
operating cash outflows in accordance with GAAP, with the balance reflected
(2) in financing cash outflows. Deferred acquisition consideration paid
classified as operating cash outflows was
ended
Credit Facilities
As ofSeptember 30, 2022 , our credit facility (the "Credit Facility") consisted of a$2.4 billion first lien term loan (the "First Lien Term Loan"), consisting of a tranche A ("Tranche A") and tranche B ("Tranche B"), and a$650.0 million first lien revolving credit facility (the "First Lien Revolver"). Tranche A bears interest (at our option) at: (i) the London Interbank Offering Rate ("LIBOR") plus a margin of 2.00% or (ii) the lender's Base Rate (as defined in the Credit Facility) plus a margin of 1.00%. Tranche A requires quarterly installment repayments of$4.2 million and has a maturity date ofJuly 2024 . 45 Table of Contents Tranche B bears interest (at our option) at: (i) LIBOR plus a margin of 2.50% with a 0.50% LIBOR floor or (ii) the lender's Base Rate plus a margin of 1.50%. Tranche B requires quarterly installment repayments of$2.0 million and has a maturity date ofJune 2028 . InApril 2022 , we amended the First Lien Revolver to extend the maturity date toJune 2024 and change the benchmark interest rate from LIBOR to the Secured Overnight Financing Rate ("SOFR"). As amended, the First Lien Revolver bears interest (at our option) at SOFR, including a credit adjustment spread, plus a margin of 2.00% with step downs to 1.75%, 1.50% and 1.25% or the lender's Base Rate plus a margin of 1.00% with step downs to 0.75%, 0.50% and 0.25%, 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. 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. AtSeptember 30, 2022 , our First Lien Leverage Ratio was 3.98:1.00, which satisfied the maximum ratio of 6.25:1.00. First Lien Leverage Ratio means the ratio of amounts outstanding under the First Lien Term Loan and First Lien Revolver plus other outstanding debt obligations secured by a lien on the assets ofFocus LLC (excluding letters 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$579.9 million atSeptember 30, 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 2021. Based on the excess cash flow calculation for the year endedDecember 31, 2021 , no contingent principal payments are required to be made in 2022. We defer and amortize our debt financing costs over the respective terms and tranches of the First Lien Term Loan and First Lien Revolver. The debt financing costs related to the First Lien Term Loan are recorded as a reduction of the carrying amount of the First Lien Term Loan in the unaudited condensed consolidated balance sheets. The debt financing costs related to the First Lien Revolver are recorded in debt financing costs-net in the unaudited condensed consolidated balance sheets. AtSeptember 30, 2022 , outstanding stated value borrowings under the First Lien Term Loan and First Lien Revolver were approximately$2.4 billion . The weighted-average interest rate for outstanding borrowings was approximately 3% for the nine months endedSeptember 30, 2022 . As ofSeptember 30, 2022 , the First Lien Revolver available unused commitment line was$590.1 million . AtSeptember 30, 2022 , we had outstanding letters of credit in the amount of$9.9 million bearing interest at an annual rate of approximately 2%. InMarch 2020 , we entered into a 4 year floating to fixed interest rate swap with a notional amount of$400.0 million . The interest rate swap effectively fixes the variable interest rate applicable to$400.0 million of borrowings outstanding on the First Lien Term Loan. The terms of the interest rate swap provide that we pay interest to the counterparty each month at a rate of 0.713% and receive interest from the counterparty each month at the 1 month USD LIBOR rate, subject to a 0% floor. InApril 2020 , we entered into two 4 year floating to fixed interest rate swap agreements with notional amounts of$250.0 million and$200.0 million . These swaps effectively fix the variable interest rate applicable to associated amount of borrowings outstanding on the First Lien Term Loan. The terms of these swaps provide that we pay interest to the counterparty each month at a rate of 0.537% and 0.5315%, respectively, and receive interest from the counterparty each month at the 1 month USD LIBOR rate, subject to a 0% floor. 46
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The interest rate swaps effectively fix the variable interest rate applicable to$850.0 million or approximately 36% of the First Lien Term Loan borrowings outstanding, resulting in a weighted average interest rate on these borrowings of approximately 0.62% plus a margin of 2%. Our First Lien Term Loan uses LIBOR as a benchmark for establishing the interest rate. 1-, 3-, 6- and 12-month LIBOR are expected to be replaced by SOFR in 2023. We expect SOFR to be a reasonable replacement for LIBOR and do not expect any material impact on the interest rates we pay.
Critical Accounting Policies
As ofSeptember 30, 2022 , there have been no significant changes to our critical accounting policies previously disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2021 .
Recent Accounting Pronouncements
The effects of new accounting pronouncements are discussed in the notes to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
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