Fathom Digital Manufacturing Corporation (NYSE:FATH) Q1 2023 Earnings Call Transcript May 15, 2023

Fathom Digital Manufacturing Corporation beats earnings expectations. Reported EPS is $-0.04, expectations were $-0.05.

Operator: Hello, ladies and gentlemen. My name is Glenn, and I will be the operator this morning. I’d 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. After the company’s presentation, there will be a Q&A session with instructions to follow at that time. I would now like to turn the call over to Michael Cimini, Fathom’s Director of Investor Relations.

Michael Cimini: Thank you, Glenn, and good morning, everyone. Welcome to Fathom’s First 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 Web site at fathommfg.com, where you will also find links to our SEC filings, along with other important information about our company. Turning to slide two, we note that 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, become aware of the risk and uncertainties in our business, and understand that forward-looking statements are only estimates. 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 the most comparable GAAP measure. And you are encouraged to examine those reconciliations. With us today are Ryan Martin, Fathom’s CEO; and Mark Frost, the CFO. I will now hand it over to Ryan.

Ryan Martin: Thanks, Michael, and welcome, everyone, to Fathom’s first quarter 2023 conference call. Our performance for the quarter was above management’s expectations as we extended Fathom’s track record of profitability and cash generation. During the quarter, we executed well against our expanded optimization plan, while taking active measures to strengthen our go-to-market strategies. As discussed on our previous call, we took advantage of the temporary softness in the macro environment in Q1 to expand our original optimization plan and further right-size our business. Of the current $19.5 million in projected annualized cost savings, we realized approximately $3.5 million in the first quarter, bringing the cumulative amount to $5.3 million.

In Q1, we continued to optimize our national footprint with the integration of our two Texas-based facilities that we acquired prior to going public. This follows the consolidation of our Oakland facility, in Q4 2022. We also reduced our workforce by an additional 14% while prioritizing our investments and operations in line with the near-term revenue generation. We expect to complete our cost reduction initiatives in the current second quarter, and realize the benefits of the remaining $14.2 million in savings throughout the remainder of 2023. While Mark will discuss our financials in more detail, the ongoing execution of our restructuring efforts contributed to a Q1 gross margin improvement of 810 basis points on a sequential basis. We remain committed to ensuring an efficient cost structure, and we’ll take additional steps, as appropriate, so that our production levels match our customer commitments.

During the first quarter, we also opened our new Silicon Valley Technology Center, in Freemont, California. This state of the art hub provides a unique opportunity to introduce corporate enterprise customers to some of the latest advancements in additive and traditional manufacturing, while enabling Fathom to maintain a strategic presence in the Bay Area. Our new evolved additive solution is among the innovative technologies currently featured at the new tech center. We are now producing customer parts of the new STEP technology, while continuing to build the pipeline. The feedback we’ve received to date from customers reaffirms how Evolve is poised to leave the transition from prototyping to additive production by dramatically reducing lead times for parts across various applications without compromising quality, throughput, scalability or cost.

In maintaining our focus on accelerating customer engagement, we bolstered our commercial leadership in Q1 with the appointment of Kurt Bork as Fathom’s Vice President of Sales and Marketing. We believe his considerable experience in enterprise sales and strategic growth management will add considerable value in this newly created position as we renew our efforts to expand our share of wallet with strategic customers and add new corporate accounts. In the brief period since Kurt joined Fathom, we have built positive momentum advancing these critical objectives. Recently, we received formal approval as a production supplier for a leading semiconductor capital equipment provider, and a manufacturer of thermal solutions for the EV industry that we believe has the potential to deliver $10 million to $15 million annually in aggregate incremental new business for Fathom.

With these two large strategic customers, we expect to strengthen our pipeline with more stable and predictable revenue streams while further enhancing our ability to leverage our extensive low-to-mid volume production capabilities. Notably, the approval to become an approved production supplier for the semiconductor company took over a year to secure, and creates a significant barrier to entry for competitors and underscores the importance of Fathom as a critical supplier to our customers in the current market. Additionally, we continue to optimize our commercial structure with our new product innovation, or NPI teams, and our production teams, while also implementing other initiatives aimed at taking greater advantage of our expansive manufacturing platform to boost new orders and provide a more streamlined customer experience.

And finally on this slide, we took steps during the quarter to increase our financial flexibility. Specifically, we amended our existing credit facility under favorable terms, providing for extended covenant relief through Q1 2024. These modifications strengthened our ability to withstand the ongoing uncertainty in the global economy as we maintain our focus on preserving Fathom’s long-term financial health, while investing in the growth of our business. Additionally, the execution of our $19.5 million optimization plan contributed to notable improvements in our net cash provided by operations, adjusted EBITDA, and adjusted EBITDA margin on a sequential basis. By actively managing our cost structure and preserving capital, we expect to further improve our profitability and leading margin profile over the remainder of the year, and generate positive free cash flow in 2023.

I’m pleased by our company’s ability to adapt to persisting macroeconomic headwinds, and believe our resilient workforce, combined with our diverse enterprise-level customer base and comprehensive manufacturing services and deep technical expertise positions our company well, to not only navigate the near-term macro challenges, but benefit from our increased scalability as market conditions continue to improve. I will now turn the call over to Mark.

Mark Frost: Thank you, Ryan, and good morning everyone. I’ll begin our remarks for our Q1 revenue results on slide four. Our revenue for the fourth quarter totaled $35 million, which exceeded the high end of our forecast of $34 million, but down from $40.5 million in Q1 2022. In Q1, the macroeconomic headwinds persisted as certain production customers, particularly in the capital goods and building industries, have delayed new purchase orders amid the ongoing market uncertainty. We remain optimistic the bulk of these pending orders will eventually close most likely in the second-half of the year. Now, although near-term demand remained soft, we continue to make steady progress ramping up our new commercial activities and strengthening our go-to-market strategies under new senior leadership as Ryan mentioned earlier.

Our revenue by product line was as follows. CNC machining increased approximately 7% to $14.2 million or 40.6% of total revenue as this business continues to perform well among our strategic accounts. Precision sheet metal was $10.4 million or 29.7% of total revenue, reflecting the ongoing softness in the macro environment. Injection molding was $4.7 million or 13.4% of total revenue. Although our outsource business has shown signs of improvement, we continue to focus on new tooling orders to generate more reorders for production of parts along with new tooling. Additive manufacturing totaled $3.6 million or 10.2% of total revenue. We believe our new technology center combined with the rollout of new additive technologies, including Evolve, will strength our prospects in this segment as we continue to benefit from our consolidation efforts.

And finally, ancillary technologies, our smallest product line, increased to $2.1 million, representing 6.1% of total revenue. Now, despite current market uncertainties, we believe the secular drivers in our business remain sound, including the condensing of product development cycles, consolidation of supplier partnerships and near shoring of U.S. manufacturing to ensure a more agile and local supply chain. We will continue to monitor the market landscape and remain committed to providing global product driven companies with timely value-added solutions that leverage our robust on-demand digital manufacturing pipeline. Now, turning to slide five, we provide our adjusted EBITDA performance for the first quarter. In quarter one, our adjusted EBITDA totaled $4.1 million, representing a margin of 11.7%.

This was above the high end of forecast of $3.5 million with a sequential margin improvement of 380 basis points despite lower sales. In quarter one 2022, we reported adjusted EBITDA of $6.2 million for a margin of 15.2%. Now, our performance for the quarter was primarily driven by lower sales volumes and the associated overhead absorption impacts. We partially offset the absorption impact by achieving notable progress in lowering our cost structure based on the continued execution of our $19.5 million optimization plan which contributed to a gross margin of 34.1%, up from 26% in quarter four, 2022. We also benefited in the quarter from strategic price increases which should have a positive impact for the remainder of the year and into 2024.

In the prior year period, our gross margin was 37.5% when excluding the $3.2 million in onetime non-cash purchase accounting adjustments. Now, looking ahead, we anticipate further improvement in our gross margin which is expected to be in the high 30s for the full-year 2023 as our restructuring efforts continue to take effect. And following the launch of our plan last year, we remain on track to realize approximately 90% of the anticipated $19.5 million in cost savings throughout 2023 where two-thirds of the total benefiting our gross margin with the remaining one-third resulting in lower SG&A expenses. Now, for quarter one, our SG&A totaled $10.8 million. A year-over-year decline of 27% due to the impact of lower sales combined with reduction in people-related expenses, stock compensation, and public professional fees.

Now, as a percentage of revenue, SG&A decreased to 30.8% from 36.4% in quarter one, 2022. Compared to the previous fourth quarter, SG&A declined 6.6% notwithstanding the higher cost in quarter one related to the publication of our annual report and other SEC filings. Excluding stock compensation, our recurring public company cost declined again on sequential basis to $1.5 million in quarter one compared to $1.8 million in quarter four. In quarter one 2022, our recurring public company expenses totaled $2.3 million reflecting the significant gains we have achieved over the past year in rationalizing our public company infrastructure. Now, on slide six, we show our liquidity and cash flow. We ended the first quarter with available liquidity of $20.1 million.

This includes $12.1 million in cash and cash equivalents, and $8 million of undrawn commitments under our $50 million revolving credit facility. As of March 31, our total gross debt excluding cash was $162.3 million. And net debt totaled $150.2 million with no debt maturities before December 2026. The amortization of our term debt was offset by increase in the usage of our revolver. Now, cash provided by operations in quarter one totaled $0.5 million, which reflects an improvement in our working capital balance. This compares to cash used in operation of $3.4 million in quarter four, a sequential swing of just under $4 million. In quarter one, our CapEx was reduced to $1.9 million or 5.4% of revenue which was consistent with our expectations and includes payments from some previous commitments made in 2022.

Our focus remains on limiting non-essential capital expenditures to generate additional cash savings with only focused CapEx investments critical to near-term growth. Now, finally as Ryan mentioned earlier, we reached an agreement in quarter one with our senior lenders to amend our existing credit agreement providing for extended covenant relief, specifically, the minimum net leverage ratio and interest covered ratio have been suspended through 2023 and replaced with a minimum adjusted EBITDA and available liquidity requirement. Both covenants will be reinstated in quarter one, 2024 beginning at 5x for net leverage and 2x for interest coverage. We appreciate the support of our lending group in further enhancing our financial flexibility as we continue to reduce cost and optimize our cash position.

Now, turn to slide seven, and we provide our forecast for the second quarter of 2023. For the second quarter, we anticipate further benefits from the execution of our $19.5 million optimization plan, with realized savings, approximately $4.5 million, up from $3.5 million in quarter 1. As we seek to maintain attractive levels of profitability in line with our backlog, the challenging macro environment continues to weigh on our sales outlook. As discussed previously, the near-term economic uncertainty has led to lower customer inventories and extended sales cycles for new orders. We are cautiously optimistic these trends will begin to improve in the second-half of the year as manufacturing activity recovers and our commercial actions continue to take hold.

Currently, we expect quarter two revenue to range between $32 million and $34 million, and adjusted EBITDA range between $4 million and $5 million. This represents an implied adjusted EBITDA margin of 12.5% to 14.7%, up 80 to 380 basis points from quarter 1 ’23. Additionally, we remain on track to achieve positive free cash flow for the full-year 2023, and expect to achieve a year-over-year increase in adjusted EBITDA, while enhancing our ability to generate significant operating leverage once the overall market recovers. I’ll now turn the call back over to Ryan. Ryan?

Ryan Martin: Thank you, Mark. I will provide some closing comments on slide eight. Our results for the first quarter demonstrate management’s commitment to take aggressive actions aimed at driving future performance in a challenging macro environment. The ongoing execution of our $19.5 million optimization plan will help ensure we maintain attractive levels of profitability as well as cash generation, while our commercial enhancements continue to gain more traction. By strengthening our go-to-market efforts, we intend to focus more on our strategic relations within the Fortune 500-tier companies, and return to market outgrowth for our additive and traditional manufacturing technologies. We believe the positive long-term fundamentals in our industry remain intact, and that our flexible hybridized approach integrating speed, quality, technical ingenuity, and problem solving positions Fathom well to continue to meet the high mix, low-to-mid volume production needs of companies in a manner that supports customization.

Our focus remains on leveraging our profitable business model, including an extensive and entrenched blue chip customer base across diverse end markets and a breadth of leading offerings, driving long-term scalable growth. This concludes our prepared remarks. And we’ll now open the call for questions.

Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Jim Ricchiuti from Needham & Company. Jim, your line is now open.

Operator: Thank you, Jim. We have our next question coming from Greg Palm from Craig-Hallum Capital Group. Greg, your line is now open.

Operator: Thank you, Greg. [Operator Instructions] We have our next question comes from Paul Chung from JP Morgan. Paul, your line is now open.

Operator: Thank you, Paul. We have a follow-up question from Jim Ricchiuti from Needham & Company. Jim, your line is now open.

Operator: Thank you. We have no further questions on the line. Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines.