Q2 2023 Fathom Digital Manufacturing Corp Earnings Call
Participants
Michael Cimini; Director, IR; Fathom Digital Manufacturing Corporation
Ryan Martin; CEO & Director; Fathom Digital Manufacturing Corporation
Mark Frost; CFO; Fathom Digital Manufacturing Corporation
Jim Ricchiuti; Analyst; Needham & Company
Greg Palm; Analyst; Craig-Hallum Capital Group
Presentation
Operator
Hello. My name is Carla, and I will be your operator this morning. I would like to welcome everyone to the Fathom Digital Manufacturing earnings conference call. This call is being recorded, and a replay will be available later today. (Operator Instructions)
I would now like to turn the call over to Michael Cimini, Fathom's Director of Investor Relations.
Michael Cimini
Thank you, Carla, and good morning, everyone. Welcome to Fathom's second-quarter 2023 earnings conference call. Before we begin, I'd like to mention that today's presentation and earnings press release are available on Fathom's website at fathommfg.com, where you'll also find links to our SEC filings along with other important information about our company.
Turning to slide 2, we note this presentation contains forward-looking statements within the meaning of the Securities Exchange Act. We encourage you to read the risk factors contained in our filings with the SEC and understand that forward-looking statements are only estimates of future performance and should be taken as such.
We also note today's presentation includes non-GAAP financial measures to describe the way in which we manage and operate our business. We reconcile these measures to its comparable GAAP measures, and you are encouraged to examine those reconciliations, which are found in the appendix to our press release and presentation.
With us today are Ryan Martin, Fathom's CEO; and Mark Frost, our CFO. I will now turn the call over to Ryan.
Ryan Martin
Thanks, Michael, and welcome, everyone, to Fathom's second-quarter 2023 conference call. I'll begin my remarks on slide 3, where we provide our Q2 highlights. Our performance for the quarter was in line with management's expectations as we continue to benefit from the ongoing execution of our optimization plan while further building our orders momentum in a challenging macroenvironment.
In Q2, we generated orders totaling $38 million, up approximately 10% on a sequential basis, contributing to revenue of $34.5 million and expanding our backlog of new business. As a reminder, shipments for new orders, especially on the production side of the business, often extend over several quarters, depending on the size and order type.
Additionally, our adjusted EBITDA totaled $4.8 million, representing a margin of 14%, a notable improvement on a sequential basis. We continue to work closely with enterprise-level customers seeking a unified digital manufacturing partner with comprehensive capabilities and deep technical expertise to help them iterate faster and reduce time to market while creating a more efficient and responsive supply chain.
As discussed on our previous call, we have renewed our focus on strengthening our go-to-market efforts under new leadership. Our Vice President of Sales, Kurt Bork, has been fully onboarded after joining the company in Q1. And I'm excited how our commercial team has steadily ramped up their activities. We continue to focus our commercial efforts on two primary areas: new product innovation or NPI and production to help ensure greater alignment between our processes and resources and boost new orders through more effective and dedicated account teams.
In furthering our commitment to build a proven and experienced management team to drive future results, we recently appointed Doug [Beaden] as Fathom's Chief Operating Officer effective September 5. Doug brings more than 25 years of leadership experience in the global industrials industry, having most recently served as the Chief Operating Officer at a capital equipment manufacturer with multiple businesses -- business units serving the medical, semiconductor, and aerospace markets. Doug also served in leadership capacities at Thermo Fisher Scientific, Danaher Corporation, and GE.
In this newly created position, Doug will serve as a key member of our leadership team responsible for the day-to-day operational aspects of Fathom's national manufacturing footprint and delivering operational excellence throughout the business. He'll play a critical role in supporting our profitable growth objectives. And we're thrilled to welcome someone with Doug's extensive operational expertise and proven track record of driving EBITDA growth while instilling a cohesive, high-performance operating culture.
On slide 4, we highlight some of our key business wins during the second quarter and year to date as we maintain our focus on accelerating customer engagement and increasing our orders momentum. The medical space has remained steady with a $1.8 million order from a new strategic customer that delivers innovative MRI technology for live diagnosis and treatment at the point of care. Additionally, our unique managed services business continues to outperform following a new $2.5 million order from an existing global technology customer.
We also achieved new wins across a diverse range of other key end markets, including EV, semiconductor, and robotics, underscoring our differentiated approach, utilizing 25-plus manufacturing processes, vast engineering services, and support systems to meet our customers' specific needs. And while not on this slide, we secured an initial order of approximately $400,000 following the recent approval as a certified production supplier for a leading manufacturer of thermal solutions for the EV industry, providing an important competitive advantage for Fathom.
As a result, we believe this account has the opportunity to grow orders volumes into the multimillions over the long term. As we have mentioned in the past, a core strength of the Fathom platform is its entrenched relationships with enterprise-level customers, which provide attractive recurring revenue streams given our strong retention rate of approximately 90%. By partnering with Fortune 500 tier companies, working with them across multiple sites and developing multiple contacts within each company, we have shown a consistent ability to grow our revenues from strategic accounts since going public despite overall lower volumes.
During this time, we have also increased the number of strategic customers by approximately 8% as our performance among our strategic enterprise-level accounts continues to remain stable. As our commercial activities continued to gain traction based on these positive indicators, we held a customer event last month at our new Silicon Valley technology center, which opened in Q1. The event focused on our new Evolve STEP technology and was attended by approximately 20 existing and prospective customers, representing a premier group of the world's class companies in consumer electronics, technology, EV, autonomous vehicles, alternate energy, and more.
Attendees were able to learn firsthand how this disruptive additive solution produces high-quality thermoplastic ABS parts with broad application from prototyping all through to production at high speeds, dramatically reducing lead times compared to traditional injection molding tools and parts. We're encouraged by the positive orders momentum from this event as we maintain our focus on expanding our share of wallet with strategic customers and aligning new corporate accounts.
I will now turn the call over to Mark.
Mark Frost
Thank you, Ryan, and good morning, everyone. I'll begin my remarks for our quarter-two revenue results on slide 5. Our revenues for the fourth quarter totaled $34.5 million, which exceeded the high end of our forecast of $34 million, but down from $42 million in quarter two 2022.
Now, as Ryan mentioned earlier, we continue to make progress ramping our new commercial activities and strengthening our go-to-market strategies. However, near-term demand remains soft as the US manufacturing PMI index has remained in contraction territory for nine straight months and customer spending continues to be tightly managed.
Our revenue by product line for the quarter was as follows: CNC machining totaled $13.2 million or 38.4% of revenue, reflecting the overall challenging macroenvironment. Precision sheet metal was $10.2 million or 29.5% of total revenue, as this business was essentially flat on a sequential basis but was the major source of our quarterly decline. Injection molding was $6.1 million or 17.6% of total revenue.
Additive manufacturing totaled $3.3 million or 9.5% of total revenue. We believe our new technology center will strengthen our prospects in this segment as we continue to build a pipeline of new orders for Evolve. And finally, ancillary technology, our smallest product line increased year over year to $1.7 million, representing 5% of total revenue.
We continue to focus on growing our strategic accounts by fully leveraging our extensive prototyping and low- to mid-volume production capabilities, empowering our customers to accelerate and differentiate their new product development and production manufacturing.
Now turning to slide 6, we provide our adjusted EBITDA performance for the second quarter. In quarter two, our adjusted EBITDA totaled $4.8 million, representing a margin of 14%. This was toward the high end of our forecast of $4 million to $5 million.
In Q2 2022, we reported adjusted EBITDA of $9 million for a margin of 21.4%. On a sequential basis, adjusted EBITDA increased 17.5% with a margin improvement of 230 basis points. Now our performance reflects reduced volumes and the related impact from lower absorption. We remain focused on taking steps to ensure, though, a more efficient cost structure and generate significant operating leverage as revenue expands.
During the quarter, we realized additional cost savings of approximately $4.3 million from the continued execution of our optimization plan, up from $3.5 million in quarter one, bringing the cumulative amount to approximately $9.6 million. The recent consolidation of our facilities in Austin, Texas has further strength --streamlined our operations and increased economies of scale as this region remains a key driver for future growth.
For the second half of the year, we adjusted slightly the remaining expected savings to approximately $8.9 million for total savings of approximately $18.5 million under our current plan. Going forward, we will maintain our focus on identifying new productivity initiatives, ensuring our operational activities match our customer commitments.
Now for quarter two, our SG&A totaled $9.4 million, a year-over-year decline of approximately 19% due to the impact of lower sales, combined with our restructuring efforts. Now as a percentage of revenue, SG&A decreased to 27.4% from 27.7% in quarter two 2022. Compared to the previous first quarter, SG&A declined approximately 12%, and SG&A as a percentage of revenue declined 340 basis points. Excluding stock compensation, our recurring public company expenses in quarter two decreased to approximately $1 million compared to $1.5 million in quarter one as these costs have now declined in each full quarter since going public.
Now on slide 7, we show our liquidity and cash flow. We ended the second quarter with available liquidity of $18.7 million. This includes $10.7 million in cash and cash equivalents and $8 million of undrawn commitments under our $50 million revolving credit facility. As of June 30, our total gross debt, excluding cash, was $160.8 million, and the net debt totaled $150.1 million with no debt maturities before December 2026.
Cash provided by operations in quarter two totaled $1.7 million, up from $0.5 million in quarter one reflecting continued improvement in our working capital management. In Q2, our CapEx was reduced to $1.1 million or 3.2% of revenue, which was consistent with our expectations as we limit nonessential capital expenditures to optimize our cash position and focus only on growth addition.
During the quarter, we successfully launched our cloud-based ERP system at our second site and intend to leverage our learnings to speed up the implementation at our remaining sites and further boost productivity. We also recently launched our first enterprise data platform or EDP to automate company-wide the collection and standardization of key performance indicators in real-time as we remain committed to upgrading the additional thread of our business.
Finally, on this slide, our free operating cash flow in quarter two totaled $0.6 million and was positive for the first time since we became public. We remain focused on maintaining this trend and generating positive free operating cash flow for the full year 2023.
Now turning to slide 8, we provide our forecast for the third quarter of 2023. We expect continued benefits from our previous actions that consolidate our national footprint, lowered our expense base, increase the scalability of our broad on-demand platform. For the third quarter, we anticipate realized cost savings of approximately $4.8 million from our optimization plan, up from $4.3 million in quarter two.
Although we have taken steps to rightsize our business and achieve our growth objectives with greater efficiency, the near-term economic uncertainty has pushed out demand for our manufacturing services as customers in general remain cautious. We believe market conditions will improve as customer inventories return to more normalized levels.
We're also seeing a trend with our orders taking longer to convert to revenue due to a relatively higher production contribution, which can lead to a conversion over two to three quarters. This has impacted our quarter three expectations. We currently expect quarter three revenue to range between $31.5 million and $33.5 million and adjusted EBITDA to range between $3.5 million and $4.5 million. This represents an implied adjusted EBITDA margin of 11.1% to 13.4%.
Now based on our current projections, we expect we will not be able to comply with our financial covenants under our amended credit agreement relating to year-to-date adjusted EBITDA for the nine months ending September 30, 2023. We expect to remain compliant with the current minimum liquidity requirements.
We are in active discussions with our lenders on an amendment and/or waiver to our credit facility to increase our financial flexibility. We are optimistic that a positive resolution can be reached in the coming weeks. And we'll provide an update regarding any changes to our credit agreement once finalized with our lending group.
I'll now turn the call back over to Ryan. Ryan?
Ryan Martin
Thank you, Mark. I will provide some closing comments on slide 9. Our results for the second quarter reflect continued progress in further solidifying the company's commercial and operational foundation while enhancing our position to drive sustainable and profitable growth over the long term.
Our commercial actions continue to take hold under new leadership as demonstrated by the sequential growth in orders volume of approximately 10%. We remain focused on further strengthening the breadth of our leading offerings to meet the high-mix, low-volume production needs of blue-chip customers and accelerating Fathom's digital thread as the positive long-term fundamentals in our industry remain intact.
We also took steps to further bolster our executive team with the appointment of our first Chief Operating Officer, while further executing against our optimization plan, which contributed to a sequential improvement in our adjusted EBITDA and adjusted EBITDA margin. Although the macroenvironment remains challenging, Fathom is well positioned to capitalize on its increased scalability as market conditions improve. We are also committed to strengthening our financial flexibility and improving our company's capital structure.
I want to share my appreciation for our highly talented workforce, which has demonstrated tremendous resilience and dedication under trying conditions and remain confident the best is yet to come for Fathom. This concludes our prepared remarks, and we'll now open the call for questions.
Question and Answer Session
Operator
(Operator Instructions) Jim Ricchiuti, Needham & Co.
Jim Ricchiuti
Hi. Thank you. Good morning. Just a question on gross margins. I'm sure mix underutilization and possibly pricing contributed to the sequential decline. But I'm wondering if you could give us a little bit more color on what's driving that and maybe how we should think about gross margins in the current quarter?
Mark Frost
Sure, Jim. It's a good question. We were hit with a couple issues related to freight and material on certain orders where the cost came in higher. Particularly, we had orders where we had a significant amount of freight. And when we price freight, usually, it's not -- there's no margin on the freight; it's a pass through. So that caused some dilution in the quarter.
We don't expect that to continue. We thought that was unusual. We -- actually, I should say we think that was unusual and expect that as we move forward, we will see further improvement in the gross margins. As we've discussed on previous calls that we get back into the mid-30s and high-30s as we enter into next year. So that's still our expectation.
So we think it was a bit of an anomaly, Jim, and expect that should pass as we go into the second half.
Jim Ricchiuti
Mark, is this a couple of hundred basis points impact? Or I'm just trying to get a sense what you just outlined --
Mark Frost
Yeah. It was about a couple of hundred basis points of hit that we took in quarter two.
Jim Ricchiuti
Okay. And Ryan, maybe a question for you, just curious about this other order you alluded to, called it out from EV customer. Can you -- you may have mentioned it, what service line does that relate to? And of how long have you been working with this customer? It sounds like you see potential to grow this over the intermediate to longer term.
Ryan Martin
Yeah. It's part of our -- it's a smaller customer that we've worked with on the prototyping side of things in the past. But this is a production opportunity in our sheet metal side of our business. And so they saw really some of the unique capabilities that we have within that high-mix, low-volume sheet metal production side of things. And so that's the area.
So we're taking on a couple of new products for them. But there's a lot of opportunity to further ramp with that. And so that would primarily go through our production of sheet metal facility in Denver.
Jim Ricchiuti
Got it. And the last question for me, just on that slide you had on some good new business wins. For the most part, are these existing customers? Any new customers you're calling out?
Ryan Martin
Yeah. The -- it's a combination of new and existing. The CNC, the sort of $1.2 million in nanotechnology, which is in the medical space, is actually a new customer for us. The rest of them are expansion of existing customers. But what's really intriguing for us is a lot of these are new contacts within larger existing customers.
So although it's been a customer have worked with, it is new business lines, new product business units, segments within those, and new contacts within those accounts. So continuing to go a lot deeper and wider within our existing accounts, which we believe is real differentiator of the Fathom platform is our ability to serve these larger strategic customers and to really be able to leverage multiple manufacturing processes to help them from that product development all the way through to their low- to mid-volume production, Jim.
Jim Ricchiuti
Got it. Thanks a lot.
Operator
(Operator Instructions) Greg Palm, Craig-Hallum Capital Group.
Greg Palm
Thanks. Good morning, everyone. I just wanted to start by asking maybe the cadence of orders throughout the quarter. And if you can comment at all what you've seen quarter to date in just in terms of visibility levels. Have things now changed versus several months ago, better, worse, same? Just curious what your overall thoughts are there.
Ryan Martin
Yes. As we talked about in our prepared remarks, there's still continues to remain some uncertainty from a macroenvironment, but we remain optimistic that the orders growth will continue. Right now, our orders in Q3 are trending near Q2 levels. We're continuing to maintain really a focus on the customer.
I've spent over the last couple of months, a tremendous amount of time meeting with some of our largest strategic customers and really understanding where they see their business going and demand on that. I would say we continue to remain optimistic in the second half of this year.
I would say, within the medical device, EV, consumer electronics defense, we still see the demand there to be really strong. I would say some of the capital goods industries where there's interest rate implications, we've seen a little bit of softness in some of those end markets that we serve as well some building supply.
Semiconductor, we remain very, very optimistic long term on that, especially as the money from the CHIPS Act and AI continues to and become more integrated. We think we're really well positioned there. But there still is some short-term softness there that we've seen, although we've seen month over month with some of our key semiconductor industries, orders starting to pick back up, which has been a positive sign.
So as I mentioned in the remarks, we feel really good about the leadership team that we have in place and Kurt Bork really now being fully integrated into the business and the momentum that we're starting to pick up from a commercial side of things, as you saw with the 10% orders growth versus Q1. And we anticipate at this point to see that continuing into Q3.
Greg Palm
Yeah. Okay. And then just on the financial flexibility comment, you mentioned that based on what the guidance is, you're not going to be able to comply with the covenants. What would a -- it sounds like you're in active dialogue right now with the lender, but what sort of a good outcome look like in your opinion?
Mark Frost
Sure, Greg. Now just to point out, we're obviously not in -- we're in compliance right now at June 30. So this is a forward view that we took. And we then -- as soon as we had seen that, we initiated discussions. We've had a good relationship with our lenders. We've been able in the past to agree amendments that did provide us more flexibility.
Our hope -- our focus would be try to get an agreement that takes us through the end of 2024. So we're having this conversation not on a couple of quarter basis. That has happened in the past quarter. So we'll focus -- as I indicated in my comments, liquidity is fine. It's the EBITDA covenant where we need to work with our lending group to figure out on a better path forward on that subject. So that's where the focus would be, Greg, would be on the minimum EBITDA aspect of the covenant.
Greg Palm
Understood. Okay. I'll leave it there. Thanks.
Operator
Thanks, Greg. We have no further questions at this time. So with that, we can conclude today's call. Thank you for your participation. You may now disconnect your lines.
