Fathom Digital Manufacturing Corporation
Q2 2022 Earnings Call Transcript

Published: 15 Aug 2022

[Operator:]

Hello. My name is Charlie and I'll be the operator for this call this morning. I'd like to welcome everyone to Fathom Digital Manufacturing's 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 the instructions to follow at the time. I'd now like to turn the call over to Michael Cimini, Fathom’s Director of Investor Relations. Michael, please go ahead.

[Michael Cimini:]

Thanks, Charlie, and good morning, everyone. Welcome to Fathom Second Quarter 2022 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 will also find links to our SEC filings, along with other important information about our company. Turning to Slide 2, 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 risks and uncertainties in our business and understand that forward-looking statements are only estimates of future performance and should be taken as such. The forward-looking statements represent management's expectations only as of today, and the company disclaims any obligation to update them. 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, which are found in the appendix to both the press release and the slide presentation. With us today are Ryan Martin, Fathom’s Chief Executive Officer; and Mark Frost, our Chief Financial Officer. I will now hand it over to Ryan.

[Ryan Martin:]

Thanks, Michael, and welcome, everyone to Fathom's Second Quarter two022 Conference Call. I'd like to begin my remarks on Slide 3, where we will provide our Q2 highlights. During the second quarter, Fathom furthered its history of growth and profitability as we delivered positive results consistent with our expectations. In Q2, we posted revenue of $42 million, representing an increase of 17% compared to the year earlier period. On an organic basis, excluding the impact of acquisitions, revenue was up 9.4% in the quarter, including growth in all four of our key manufacturing technology line, and adjusted EBITDA increased 16.1% to $8.7 million, representing an industry-leading margin. We continue to benefit from our comprehensive manufacturing services by providing enterprise-level customers with timely, value-added solutions across both additive manufacturing and traditional manufacturing. During the quarter, we entered into a new $1.2 million managed services agreement with a Fortune 50 multinational technology company, where we will lend our engineering expertise and serve as an extension of their R&D and manufacturing teams. We also secured a large order for just under $1 million with a global leader in health care technology to produce parts utilizing our hybridized model by leveraging our injection molding, additive manufacturing and ancillary technologies as well. We also saw continued additive orders growth within our key EV and robotics end markets with two strategic customers placing more than $1 million in additive orders in the first half of 2022. We believe our technology-agnostic approach, integrating speed, flexibility, quality control, technical expertise and problem solving continues to position Fathom well to meet the rapid prototyping and low to mid-volume production needs for some of the largest and most innovative companies in the world. Many Fortune 500 companies remain highly focused on both diversifying their supply base through onshore and consolidating their supplier partnerships to create greater efficiencies, increased responsiveness and speed to market. We are particularly seeing this trend in the medical and industry sectors ensuring a more agile and local supply chain to protect against the rising number of global uncertainties provides a competitive edge for product-driven companies seeking to get ahead and stay ahead. At Fathom, we continue to work closely with our customers to help them iterate faster and accelerate their manufacturing innovation. Although the positive secular drivers in our business remain intact, including the condensing of product development life cycles, reshoring of U.S. manufacturing, consolidation of supplier partnerships and the digitization of manufacturing, our second quarter orders of approximately $40 million were slightly below our expectations. Outside of the macro environment, one key factor that impacted orders was the speed we were able to build our platform-based strategic sales team. This effort was primarily impacted by the tight labor markets. And it is key to point out that we will always be building and working to build a larger, more concise sales team. We've made tremendous progress on this, and we continue to build the very best team in the industry. As I sit here today, we have significantly strengthened our commercial team and expect it to be in a stronger position to achieve our go-forward growth targets. In addition to continuing to improve our overseas supply chain, which is a key part of our value proposition. We are investing more in our resources for our outsourced business, including new software support system, we expect to further aid the sales process and increase throughput, which will improve our margins. In further in our efforts to accelerate profitable growth, we continue to optimize our operations and our most recent announcement is outlined on Slide 4. These steps are a natural progression in Fathom's growth trajectory as we have built one of the largest and most profitable platforms in the digital manufacturing sector. Our team is continually evaluating opportunities to promote operational excellence across the entire organization, which led to the creation of the multipronged plan aimed at optimizing our national footprint, increasing operational efficiencies and fully leveraging our scale as we continue to pursue both organic and inorganic growth opportunities. Key steps in our current plan include the following

[Mark Frost:]

Thank you, Ryan, and good morning, everyone. I'll begin my remarks on our Q2 results on Slide 5. Our revenue for the second quarter totaled $42 million for a year-over-year increase of 17%, of which $3.6 million was organic and $2.5 million was from acquisitions. Early in the second quarter of 2021, we completed four additional acquisitions, which focused primarily on CNC machining. Now excluding the impact of these acquisitions, our organic revenue in the second quarter increased approximately 9.4% as we achieved growth in all four of our main technologies with double-digit growth in both precision sheet metal and CNC mainly due to our cross-selling activities. Now for quarter two, our reported revenue by product line was as follows

[Ryan Martin:]

Thank you, Mark. I will provide some closing comments on Slide 9. Our Q2 revenue growth of 17% demonstrates the continued demand for our comprehensive manufacturing services and positive secular tailwinds and our adjusted EBITDA increased 16.1% to $8.7 million, representing a margin of 20.6%. Sequentially, our adjusted EBITDA was up over 40% in the quarter. Fathom has built a leading technology agnostic platform that delivers a differentiated customer experience while creating a more resilient supply chain for enterprise customers. We continue to see large corporate enterprise customers lean on Fathom to help solve their most difficult technical challenges and accelerate their R&D, continue to think of Fathom as an index for the additive manufacturing sector as we have decades of experience and extensive capabilities in additive manufacturing technologies, along with traditional manufacturing capabilities to provide a comprehensive solution for our customers. Although our anticipated growth rate for the full year has moderated, we remain a profitable cash-generating business, and we are highly confident in our long-term opportunities within the large, fragmented $25 billion digital manufacturing market. We have significantly strengthened our commercial team in Q2, and I'm energized by the team we now have in place to drive profitable growth while we continue to accelerate our digital transformation and integrate new breakthrough technologies to serve our world-class customers. Furthermore, we unveiled an optimization plan with an anticipated $5.5 million annualized savings to support our future results, taking proactive measures to empower a more lean, nimble and unified Fathom now that we are a listed company. While the macro environment has become more uncertain since going public in December, we believe our proven profitable business model, highlighted by an extensive customer base, including some of the most innovative companies in the world across diverse end markets and a track record of growth in previous downturns, positions our company extremely well. As we continue to navigate near-term macro headwinds, our focus remains on executing our go-to-market strategy, further scaling our business in support of our long-term growth potential for the benefit of our company and our shareholders. This concludes our prepared remarks, and we'll now open the call up for questions. Thank you.

[Operator:]

Our first question comes from Jim Ricchiuti of Needham & Co. Jim, your line is now open.

[Jim Ricchiuti:]

A couple of questions, but I'd like to start first with the overall change in the full year outlook because you're identifying, I think, two contributing factors, one being the challenge, I guess, in building up the sales platform. But you're also, I think, highlighting some macro concerns. So I wonder if you could perhaps frame that a little better first.

[Ryan Martin:]

Yes. Well, I hope all well. Good morning, Jim. Thanks for being on early Monday morning. As we talked about, we've got a great company. We've got a great growing company profitable. And so we feel really good about where we're at. But if you think about when we put this stuff together at the beginning, the last 6 months, worst S&P performance, obviously, the first 6 months of the year in the last 50 years, clearly, higher inflation, unprecedented moves by the Fed and the increasing the Fed rate. And so we still feel really good about the growth of this business, where we're at, the fact that we're a profitable growing business. But yes, the macro uncertainty as it relates to that, we've seen some slowing of orders, cycles, like how long it takes to actually commit. We're not losing the orders. And so we've seen some slowing of that. And then as Mark mentioned, we've seen some of the inventories that some of our larger enterprise customers were building up. They've taken their safety stock down on that. We think that's a temporary thing that we saw, and we're just trying to be conservative as we look for the full year, Jim.

[Jim Ricchiuti:]

Got it. And I'm wondering if you could, Ryan, just maybe give us a little bit more color on what you're seeing in some of the verticals. I think you talked about strength in EV. We're hearing conditions still pretty strong in semi cap. Where are you seeing some changes in demand in either direction?

[Ryan Martin:]

Yes. I would say in the Medical. So I was down in Texas last week visiting some of our key customers there in the semiconductor, medical and aerospace space places. In the month of July, we saw incredible demand year-over-year in our medical, especially the orthopedics side of our business. We saw the orders almost doubled versus the prior year, a lot of elective surgeries are certainly coming back very strong. So that's an area that we're continuing to see extremely strong demand. EV is an area that we play really well in both from a development all the way through bridge to production. So those two areas, we're seeing strong demand. We're seeing aerospace continue to come back, especially on some of the work we do in the interior side of aerospace. So those areas, I think we're seeing strong demand. General industrial seems to be doing well as well as Fathom.

[Jim Ricchiuti:]

Okay. And just a question for Mark, and then I'll jump back in the queue. Obviously, some pressure on gross margin in the quarter versus, I guess, expectations. And I'm wondering, Mark, if you could talk to perhaps in a just talking about just some of the cost pressures. Is there anything that we should be mindful of just with respect to gross margin on a go-forward basis? Or is it perhaps also mix related?

[Mark Frost:]

Yes. I mean we took a slight mix challenge though. If you look overall, you'll see we improved gross margin versus prior year and quarter two. It is more a question of what I was talking about that we're not going to obtain in the short term as strong an absorption benefit because, obviously, our revenue growth is going to be lower than we were expecting for the second half. We do continue, though, we talked about the optimization plan, which is more going to be a 2023 benefit, which we will fully see in 2023. So it's more a moderation that we won't get the absorption benefit as strong a benefit, Jim, as we were expecting in the second half because of the lower volume. That's the basic message.

[Jim Ricchiuti:]

Got it, thanks very much.

[Mark Frost:]

No worries, Jim.

[Operator:]

Our next question comes from Noelle Dilts of Stifel. Noelle, your line is now open.

[Noelle Dilts:]

I was hoping that you could maybe comment on order trends that you're seeing. So if there was any sort of notable trends as you went through the second quarter and even into the third quarter that could just kind of help us understand how that's informing your guidance...

[Ryan Martin:]

Yes, so as we mentioned, the orders for the second quarter were nearly $40 million. As we've seen some pickup in the orders in the third quarter, which is a good sign as we mentioned on the call, there's a lot of times from a macro environment that we can't control. But what we're focused on is controlling what we can, which is strengthening our commercial sales team, which we've made tremendous progress in the second quarter, and we feel will build momentum into the second half of this year. We can control the cost structure of our business, which we talked about through the optimization of the plan. And then we can control the customer experience. And so we've invested in the commercial team into more technical resources that as we have evolved in this organization to be able to not sell just single manufacturing solutions to be able to sell across those different solutions. As it relates to specific orders, we're seeing continued pickup, like I talked about in the medical space, especially where we're doing orthopedic implants where elective procedures are certainly coming back very strong, seeing strong demand there from end customers, defense, aerospace and some of the EV space or the other areas that we're seeing strong demand from an orders perspective as well.

[Noelle Dilts:]

Okay. Great. And then any comments that you could provide sort of on the competitive environment? When you look back to the first quarter, anything that kind of improved as we got into the second quarter and third quarter, how should we think about that?

[Ryan Martin:]

Yes. I think where we've seen competitiveness continues to be the additive phase, but I think that's why we're really focused on working to differentiate in that space. And the key thing for our platform that we're technology agnostic. And so we're trying to find whatever the best solution is for the customer. And so as you've seen through the strong double-digit growth in both our sheet metal and CNC machining side of our business, we've been able to differentiate more there. I think with some of our 1345 designations in the medical orthopedic space. We have a differentiated offering there. And so what we try to focus on is where we can differentiate with that and drive -- get away from the commoditization -- even in the additive side of things, that's where we're making investments, as Mark talked about, in larger formats. We're making investments in more efficient post processing to be able to provide better parts faster to our customers in the plastic additive, and that's why we've also talked in the past around the investment that we're making in the EVOLVE technology, which we think will be a really differentiated technology that won't be as commoditized and price driven in some of the other areas of additive manufacturing.

[Noelle Dilts:]

Okay. And then one last question for me. I know you talked about kind of making improvements or progress on expanding your sales force, but any additional commentary on sort of where you stand today relative to where you want it to be? And then how do you just think about those sales folks becoming productive? How long does it usually take them to kind of ramp up and start making an impact?

[Ryan Martin:]

Yes. So we feel really good about the sales force that we have in place right now. We're basically at full strength. We're always, as I mentioned earlier, we're always going to look at ways to continue to improve our sales force. So we're always looking at opportunities to bring on and add new talented sales folks because of the importance of them being in front of the customer, especially the larger strategic enterprise customers for us, but we're back at full strength there. And part of it is really just the evolution of this company as we went from a sales force that was good at selling maybe a single technology as we focus more on the platform. We had to evolve the talent that we had doing that. We made those changes in the second quarter, and we feel really good. Typically, we see a ramp of 3 to 6 months, I think we're going to have that condensed for us because we hire people typically from the industry. And so we've had people from the industry that can really hit the ground running, which is why we feel so good about the team that we've built and brought in and really the go-forward opportunity that presents for FAD.

[Noelle Dilts:]

Thank you.

[Operator:]

Our next question comes from Greg Palm of Craig-Hallum Capital Group.

[Unidentified Analyst:]

This is Danny Egerton for Greg today. I guess I will just start on, I guess, kind of enterprise customers. I appreciate the kind of order examples there. What's the progress been like on maybe the land-and-expand strategy with them and getting percentage of repeat orders and gaining overall wallet share with them?

[Ryan Martin:]

Yes. So we continue to see strong growth within that side of our business, strong double-digit growth across the strategic customers, which represents about 100 or so customers across our enterprise there. And so that strategy is working really well. We're continuing to see opportunities. I was up in Minnesota 2 weeks ago, meeting with a key customer there that historically, we've done about between $2.5 million to $3 million. They're looking to consolidate down the amount of suppliers that they're working with. And we think there's a really good opportunity for this customer that will double the amount that they spend with us on an annual basis. And so we're having those conversations across those roughly 100 or so strategic accounts. And consistently, what we're hearing is they want to go from -- they may have 10 suppliers right now that they work with, with whether it's CMC or sheet metal Fathomrication, and they're looking consistently what we hear is they want to consolidate that down to 2 or 3 suppliers. And we're at the top of their list because of the amount of things that we can do for them, the expertise we have and the investments that we're continuing to make to be able to serve them. And so we're going to have a lot more to talk about in the future quarters as it relates to that. But the strategy is working. I think we're the clear leader in our market when it comes to large enterprise customers, and we're going to continue to double down on that strategy, Danny.

[Unidentified Analyst:]

Got it. Makes sense. I guess just one more, maybe dig in a little bit more into Evolve. I mean, how is that coming along? -- you said you're continuing to make investment in there in that technology? What's the demand like for that technology? And maybe any update on the move into Hartland?

[Ryan Martin:]

Yes. So incredible interest in that technology. I mean I think it really goes to the foundation that the fact that you can create real thermal plastic parts, you can do it at a cost price point that makes sense and not hundreds, but you can do it in the thousands. And so incredible interest for that. I don't know how familiar you are with you evolves leadership, they went through a recent leadership transition. Industry veteran, Joe Allison is now the CEO of Evolve and we've had multiple conversations with him. We're really excited about the really his vision for the company. And I think because he comes from service provider background, he understands what it takes to bring that technology into a company like Fathom and ultimately commercialize it effectively. And so we feel really good about this. Obviously, with any new technology that's really a breakthrough technology like EVault, and we're being the first person to commercialize that in North America. There can be some delays or hiccups along the way. So it's taken a little longer than we initially anticipated, but we anticipate hopefully having that technology in Hartland before the end of the year, hopefully, by the end of third quarter, early fourth quarter, if all things go as planned right now. And we feel really good about that technology on a long-term basis based on the feedback that we've had from our customers.

[Unidentified Analyst:]

Yes. Good stuff. I'll leave it there. Thanks.

[Jim Ricchiuti:]

Thanks, Dan.

[Operator:]

Thank you. Our next question comes from Wamsi Mohan of Bank of America.

[Wamsi Mohan:]

In your 3Q guidance, you're guiding slightly down quarter-on-quarter in revenues. And I was wondering how much of that would you attribute to the sales reorg issue versus the weaker demand? I know your orders were slightly below expectations in 2Q, but you also said that the order trends were improving here in the third quarter. So curious if this is just sort of what you'd call an execution issue versus a broader macro. You also called out broader macro trends, a lot of headwinds, but it sounds like you might not have seen a lot of that in your own orders. So if you could give us some color on that, that would be helpful. And I have a follow-up.

[Ryan Martin:]

Yes, Wamsi. So I would say I would not categorize it as a reorganization or restructure with the sales team. It's really a strengthening of the sales team as we evolved from the legacy company to where we want to go on a broader enterprise platform sales basis. And so we feel really good about the team, as I mentioned before, that we have in place to be able to grow the orders on a go-forward basis. I think the key with our business is, obviously, from a macro environment, there's a lot of uncertainty that's going on with the environment right now, especially when you think of the large enterprise customers that we focus on. If you think back to the second quarter, which the orders that you're going to get in the second quarter are typically where you're going to see the revenues in the third quarter, those types -- the companies that are in the S&P 500 had the worst performance from a stock perspective in the last 50 years. So those companies had a little hesitation to what was going on in the market. So like I said, we weren't losing orders. Just the sales cycles were taking longer than we historically would have. We're seeing that start to come back. We feel really good about the commercial team that we have in place. And the great thing about our business is that it can turn really fast, right? So we have about a 90-day visibility into the business. And as we then to build momentum, it can turn really fast in a positive way for us. And so we've got a great business, continuing to grow strong, profitable with industry-leading EBITDA margins.

[Wamsi Mohan:]

Okay. If I could follow up on that EBITDA margin point, right? Or for your lower adjusted EBITDA for the year, how much of that is just lack of revenue leverage versus maybe incremental costs that you're seeing from inflationary headwinds? And are you taking any specific pricing actions as you're going through the back half of the year?

[Mark Frost:]

Yes, Wamsi. I would say more of the challenge is the lower revenue volume because a lot of our business is prototype quick turn, we're constantly requoting based on the latest material costs. So you can have some timing issue on production kind of orders. But in prototyping, we have very limited exposure. So more of our challenge is because we're not getting, as I indicated to Jim earlier, strong revenue growth. in the short term. Now as we discussed, we think that's a temporary situation, and it's going to start turning around. I think we are looking Lonza at other operating actions. We talked about the optimization plan. We are actually, as we indicated in that plan, looking to at centralizing further activities, which will bring both benefit on the G&A and operational side. So there are a number of actions in place to improve our margins. So we're still expecting to have margin improvement over prior year despite the fact that we've moderated our revenue growth targets.

[Wamsi Mohan:]

Good luck.

[Mark Frost:]

Thank you.

[Operator:]

Thank you, Wamsi. And our final question of today comes from Troy Jensen at Lake Street Capital Markets.

[Troy Jensen:]

Maybe a couple of quick questions here for Ryan. So Ryan, I guess it's my belief that the industry growth for machine shops and service bureaus is probably in that 8% to 10% range given supply constraints and reissuing efforts and whatnot. But -- and you guys are right smack dab in the middle of that based on your organic growth. But can you just talk about cross-selling? I guess I thought that was a key strategy for you guys with all the acquisitions you guys have done prior to the SPACs.

[Ryan Martin:]

Absolutely, Troy. Yes. So that continues to be a key strategy. As we've talked about from a lot of the growth that, as Mark went through his comments, a lot of the growth that we've seen in CNC and sheet metal has been looking at legacy areas. We had an example down in Texas where we worked with a semiconductor company down in that region where primarily in the past, we'd only done CNC machining forum. And as we brought them into the platform, we were able to grow very significantly with sheet metal for them as well as they have a significant need there. And so that's an area, as we've continued to strengthen our sales team. That's an area that we're very focused on, as I talked about earlier, the company up in Minnesota. -- another perfect example. Historically, we'd only done CNC machining for them. Right now, we're looking at multiple injection molding, both prototype as well as production opportunities for that company. So that is going to continue to evolve and grow as we continue to bring in the right sales team to be able to identify not only those opportunities, but to be able to connect the dots to across the organization within the different areas to be able to do that. Another example was working with a seating aerospace company down in the Texas region. Historically, we've only done prototype form, mostly just FDM, SLS. Now we're looking at production injection molding as well as CNC machines. So we're making that transition in a lot of these large enterprise companies from just being a prototype development partner through to mid-volume production partner for them as well. So that doesn't happen overnight. But as you think about the long-term value creation of this business and really being an extension of the manufacturing and R&D teams for these enterprise customers, I feel stronger now than ever that we're going to continue to be the leader in being able to grab significant market share in that market with the large enterprise customers.

[Troy Jensen:]

Perfect. All right. And then, how about just on acquisitions. I know you guys touched on it and doing some little tuck-ins. I guess I'm curious to know if you feel like you're in a position to do it now, just kind of based on the balance sheet, you've got like $11 million in cash and net debt position. And the currency, your stock currency is really not where you thought it was going to be, right, when you kind of started this back process. So how likely are you guys to do acquisitions? Do you think you guys just going to focus on the core business now and kind of grow it and some quick thoughts on that, right?

[Ryan Martin:]

Yes. So as Mark talked about, so we have looked at quite a few acquisitions out there. We continue to think there's obviously a valuable opportunity from a consolidation play within this market. We still have the flexibility to be able to do as we talk about maybe 1, maybe 2 smaller tuck-in acquisitions. As we go forward, one of the positive things about our business is that we continue to generate cash. So we're going to continue to generate cash and delever as well as put more cash onto the balance sheet. So I think it will create opportunities for us. But we're going to be selective. We're going to -- we're only going to look at opportunities where we believe that they can be accretive to the platform. We've seen opportunities. We've looked at a lot of deals where it just didn't make sense from a valuation standpoint to really add to the company. And so we feel really good about the platform that we have today that we can continue to grow with what we have today, and we'll be opportunistic as M&A presents itself.

[Troy Jensen:]

All right. Perfect. And just a quick one for Mark. Mark, do you want to give us just like a number that you think the SG&A will be here in the September and/or December quarters?

[Mark Frost:]

What I would say is we would expect it to maybe reduce 3% to 5% kind of level from the previous quarter? So the modest decline is what I would say, Troy.

[Operator:]

Thank you, Troy. At this time, we currently have no further questions. Therefore, this concludes today's call. Thank you for joining. You may now disconnect your lines.