Fathom Holdings Inc. Q1 FY2023 Earnings Call

Good day, and welcome to the Fathom Holdings First Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the call over to Alex Kovtun with the Gateway Group. Please go ahead, sir.

Thank you, operator, and welcome everyone to the Fathom Holdings 2023 first quarter conference call. I'm Alex Kovtun with Gateway Group, Fathom's Investor Relations firm. Before I turn things over to the Fathom management team, I want to remind listeners that today's call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous conditions, many of which are beyond the company's control, including those set forth in the Risk Factors section of the company's Form 10-K for the year ended December 31, 2022, as well as our latest Form 10-Q and other company filings made with the SEC, copies of which are available on the SEC's website at www.sec.gov. As a result of these forward-looking statements, actual results may differ materially. Fathom undertakes no obligation to update any forward-looking statements after today's call, except as required by law. Please also note that during this call, we will be discussing adjusted EBITDA, which is a non-GAAP financial measure as defined by SEC Regulation G. A reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measure is included in today's press release, which is now posted on Fathom's website. With that, I'll turn the call over to Fathom's Founder, Chairman, and CEO Josh Harley. Josh?

Thanks, Alex. Good afternoon, and welcome to our first quarter 2023 earnings call. We're pleased to report a strong first quarter compared to the overall market, and what we feel is a great start to the year. I want to start by thanking our agents and employees across each of our businesses for their hard work and dedication as we navigate the real estate market. Their commitment to supporting our growth, vision, and serving others in the communities we operate is a testament to the Fathom culture, and I'm proud of them. The market has been tough for a lot of agents, but you wouldn't know it talking to some of them. Many agents I've talked to see this market as an opportunity to take greater market share by reinvesting their savings they get from being a Fathom agent into their marketing, while many other competitors are pulling back on their spend. I love to hear that because that's exactly why I started Fathom in the first place. Our agents have worked hard to continue to grow and thrive even with all the market uncertainties, and we're proud of our recent awards and recognitions within the industry. We were recently ranked second by RealTrends 500 as the industry's top mover for 2023 and ranked as the fourth largest public independent brokerage, another notable category up from sixth place last year. We're also proud to be ranked as the 10th largest brokerage in transactions in the recent T3 Sixty MEGA 1000. These achievements are a testament to Fathom's commitment to providing top-notch service and support to our agents and our clients and our ability to adapt and thrive in the rapidly evolving residential real estate industry. Before turning the call over to Marco Fregenal, our President and CFO, for a detailed review of our financial results, I'd like to touch on a few key highlights during the quarter and what gives us confidence in our business regardless of what happens in the housing market or interest rates this year. While the first quarter is typically the slowest quarter for transactions and was a challenging quarter for residential real estate overall, we're encouraged by some recent signs of stabilization across our markets, along with the moderation in interest rates during the quarter which has improved housing affordability. It's interesting to see that even in this market, 60% of listings are still selling within 30 days and 28% are still seeing multiple offers. While we don't know where interest rates will go this year or whether we're close to the bottom in the housing market, we believe that Fathom has a long and positive runway ahead. With the latest rate increase, the Federal Reserve signaled that they may be done raising rates, and inflation appears it's moving in the right direction. Our results this quarter continue to demonstrate the power of our truly disruptive business model and how we're able to succeed irrespective of the market environment. During the first quarter, Fathom completed approximately 8,532 real estate transactions. While this is down 15.4% from the prior year’s first quarter, the decrease compares favorably to our peers in the entire U.S. residential real estate market. In fact, according to the National Association of Realtors, the U.S. residential real estate market saw overall transactions in the quarter decline by 25% compared to Q1 of last year. So, I’m sure you can see why I'll count that as a win for Fathom. As our transaction volume reflects, we continue to take market share from legacy brokerage firms despite the volatile environment and saw year-over-year transaction growth in several of our markets, including Miami, Las Vegas, the Bay Area, and even Boston. We also increased our agent network by 18% to over 10,628 agents at the end of the quarter, significantly beating the domestic growth of all of our public peers who reported so far. I'm proud that we're able to continue providing compelling value propositions through innovation and an industry-leading commission model that's resonating well in this environment. We also made significant strides towards achieving our goal of adjusted EBITDA breakeven in Q2 and cash flow profitability in Q3 of this year. During the first quarter, we began to see the benefits from the cost reduction measures we've implemented and expect to see the full benefit of these actions in Q2. We're also continuing to identify opportunities to further rightsize our cost structure to the current environment and better position Fathom for improved operating leverage as the residential real estate market returns. Importantly, we believe these cost reductions were made without sacrificing our ability to grow. In fact, we have allocated some of those savings to further strengthen our recruitment efforts. These cost reduction initiatives, combined with the increase in agent transaction fees that became effective in January of this year, have positioned our business for profitable growth ahead. Fathom Realty continues to be among the fastest-growing residential real estate brokerages in the U.S., and we're proud of our growth as we expand our reach nationwide. Today, Fathom Realty operates in 37 states and the District of Columbia. Fathom brings a unique model to the residential real estate market as we offer agents all the tools, the technology, training, and resources that our larger traditional peers do, but at an industry-leading flat-fee commission split. More than ever, that remains the key point of differentiation during this period of high inflation and interest rates when agents across the industry struggle to generate leads and close sales. With our focus on servant leadership, our agents often say that they join Fathom for the higher income potential, but they stay for the culture. Our unique low-cost and disruptive model has allowed Fathom to attract high-quality agents and enjoy agent retention rates approximately twice the national average. Even though we charge our agents a small fraction of what other brokerages charge their agents, we believe our realty business can be profitable with a smaller number of transactions. The technology that powers our realty operations remains a key part of differentiation as well, as we can generate long-term savings and ultimately charge our agents far less than others by owning it outright. We also licensed our proprietary technology to over 750 brokerages through a recurring revenue subscription model that drives incremental high-margin revenue while enhancing awareness and differentiation of our brand within the industry. I'd like to provide an update on our agent trends and the steps we're taking to grow the Fathom network. Our cost to acquire one agent during Q1 remained low at approximately $900, making our breakeven on each agent less than the $1,150 that we'll earn back on their first sale. We also maintained strong retention rates, which are approximately twice the national average, remaining exceptionally strong given the backdrop of agents leaving the industry. More importantly, 71% of agents who left Fathom sold zero or only one home per year. Based on historic trends, we anticipate only limited additional attrition in the coming year will continue to be primarily from low-producing agents. We recently launched an enhanced agent referral program called 'free for life' and a revised agent commission structure. Both initiatives have been well received, and our agent referral program continues to have a positive impact on our recruiting efforts. In fact, this March brought us our strongest growth through agent referrals in our company's history. We remain confident that Fathom is well positioned to achieve EBITDA breakeven next quarter. As we mentioned on our last call, we believe 2023 will be a pivotal year for Fathom as we turn the corner on profitability and really start to show the operating leverage in our business. Plus, our ancillary businesses have the potential to dramatically increase our revenue and profitability per transaction over time, and we're continuing to see progress across those businesses, giving us increased confidence in our growth strategy. During the first quarter, we also saw improved tax rates within our title and mortgage businesses, as we continue to go deeper into the markets where we operate, and we recently expanded our title operations in Utah. To close, we remain optimistic about the year ahead and believe that we're well positioned to continue growing our business in 2023. With that, I'd like to pass it over to Marco for our financial update.

Thank you, Josh. I'll start with a detailed review of our first quarter 2023 results and finish with the discussion on guidance. First quarter revenue declined 14% year-over-year to $77.5 million compared with $90.1 million for last year's first quarter. GAAP net loss for the first quarter was $5.7 million or a loss of $0.36 per share compared with a loss of $6 million or a loss of $0.38 per share for the 2022 first quarter. Adjusted EBITDA loss, a non-GAAP measure, was $1.4 million in the first quarter versus adjusted EBITDA loss of $2.1 million for the first quarter of 2022. The $700,000 improvement in adjusted EBITDA this quarter was largely driven by a reduction in expenses and additional agent fees that went into effect in January. Notably, this improvement was achieved despite the 14% decrease in revenue this quarter compared to Q1 of 2022. G&A expense was $9.6 million in the first quarter or 12.4% of revenue, compared with $10.9 million or 12% of revenue for the same period a year ago. Again, to be noted that G&A did not meaningfully increase as a percentage of revenue despite the 14% decrease in revenue. In total, our operations and support, technology and development, and G&A expenses decreased by almost $2 million from $14.5 million in Q1 of 2022 to $12.5 million in Q1 of 2023. This reduction reflects the benefits of our expense reduction initiatives that commenced last quarter. Expense related to marketing activities was $716,000 for the first quarter compared with $1.2 million for last year's first quarter. The decrease in marketing expenses is related to leveraging internal resources and optimizing advertising expenditures. Now, I'll spend some time reviewing our business segment results in more detail. We closed 8,532 real estate transactions in the quarter, a 15.4% decrease from last year's first quarter, but well below the 25% reduction in the overall market experienced. We ended Q1 with 10,628 agents, which represents an 18% growth over Q1 of 2022. Adjusted EBITDA in the real estate division was approximately $1.3 million, an increase of $400,000 compared to adjusted EBITDA of $900,000 in Q1 of 2022. This increase was achieved despite the 15% decrease in transactions this quarter compared to the same quarter last year and reflects an increase in fees and favorable impact of cost-cutting measures. Our mortgage business generated revenues of $1.5 million in the first quarter compared to $2.9 million in the prior-year period. Mortgage adjusted EBITDA for Q1 was a negative $600,000. Our team continues to identify opportunities to reduce expenses to rightsize our mortgage business going forward, as well as increase revenues by adding additional loan officers. DIA, our insurance business, generated revenues of $1.6 million for the quarter compared to revenues of $1.4 million for the same period a year ago. This represents an increase of 7.5%. Adjusted EBITDA increased 265% from $100,000 in Q1 2022 to $391,000 in Q1 of 2023. This reflects the great work our DIA team has done in Q1 to adjust expenses while still growing revenue. Verus Title had revenues of $596,000 for the quarter compared to $1.1 million in revenue for Q1 of 2022. Adjusted EBITDA was negative $330,000 compared to a $50,000 positive adjusted EBITDA in Q1 of 2022. The decrease in revenue and adjusted EBITDA is primarily due to the significant decrease in purchase and refi business due to higher interest rates. However, in March and April, we have seen a significant increase in the number of file starts from Fathom agents in the North Carolina and Dallas markets, which should represent an increase in the attach rate in Q2. Now, let's move on to our technology segment. Revenues increased 17% to $756,000 compared to $645,000 for last year's first quarter. Adjusted EBITDA loss for the quarter decreased by 46% from $395,000 in the first quarter of last year to $212,000 in the current quarter. Our LiveBy team continues to increase its footprint across the country to reach over 235 MLSs and 400,000 agents at the end of the quarter. We continue to focus on our balance sheet, given the dynamic real estate market conditions, and ended the quarter with a cash position of $6.7 million. We recently completed a convertible note private placement to provide additional operating liquidity and flexibility as we execute our goal of getting to breakeven. We believe our cash position and additional private placement provides us with the adequate runway to grow the business and execute our strategy through profitability. We did not purchase any shares in the first quarter under the stock repurchase plan, and approximately $40 million remains under the authorization. Now, before turning the call back to Josh, let me briefly touch on guidance. Given the continued uncertainty in the macro environment, we are only providing guidance for the second quarter ending on June 30, 2023. For the second quarter, we expect revenues in the range of $88 million to $90 million and adjusted EBITDA in the range of breakeven to $100,000 to $200,000 positive. As a reminder, guidance is forward-looking, which, as we noted at the beginning of the call, is subject to risks and uncertainties. I want to thank the entire team at Fathom for their hard work, passion, and commitment to excellence. The last six months have been some of the most difficult months in Fathom's history, but through the hard work of our team, we have been able to demonstrate that we can outperform the market even in challenging economic times. With that, I'll turn the call back to Josh for closing remarks.

Thank you, Marco. We remain focused on execution and are well positioned to achieve breakeven profitability in Q2 with our model and can thrive throughout various real estate cycles. With that, operator, let's open up the call for questions.

We will now begin the question-and-answer session. Our first question will come from John Campbell with Stephens Inc. You may now go ahead.

Hey, this is AJ Hayes stepping in for John Campbell. Congrats on the quarter, and I appreciate you guys taking our questions. First thing, on your guidance for EBITDA inflection, just kind of wanted to see if there are any additional steps needed to get there. How dependent is your outlook on the market in your brokerage business? How dependent is it on a recovery in mortgage, in better attach rates and maybe mortgage gain on sale? I'm just trying to get a sense of what underlying assumptions may be built into this outlook here.

Thank you for your question. As we are today on May 10, we have a good feel for the quarter. So that's the first and foremost. We are definitely seeing an improvement in file starts in Q2 compared to Q1. There are two components of that. First is certainly seasonality, and second, I think Josh mentioned earlier that many of the Fathom agents are using the savings they get from Fathom and they invest in marketing. So, we are anticipating an increase in revenue and transactions. In terms of cost structure, I believe about 85% to 90% of our $3 million has already been built into the Q1 number. So there's a little bit more in Q2. Overall, we feel pretty good about the guidance we're giving. We're not assuming a significant increase in the market. If the market continues to increase even in a greater way than we are anticipating, I think that our numbers could be better. But we feel fairly confident about the guidance we're giving, given the market conditions today.

Got you. And then maybe shifting the focus to hitting positive cash flow in Q3 '23. You guys reiterated that target again, which is great to hear. But given the uptick in interest expense as a result of that new convertible note, can you walk us through the moving pieces there? Did you change your underlying assumptions needed to hit this target, such as the macro, the existing home sales, maybe mortgage gain on sale? This might be much of the same as what you answered in the last question, but I'm trying to get a sense if there was a degree of conservatism in that inflection. Any color there would be much appreciated.

Sure. Great question.

I mean...

I don't want to step on any toes, Marco. Go ahead.

Well, I think, look, we continue to apply the same model in terms of Q3. The components that lead us to continue the curve of adjusted EBITDA in Q2 to profitability in terms of our cash flow positive in Q3. One aspect of that is the seasonality of the industry. Second, when we look at the ancillary businesses, all our ancillary businesses continue to grow. Even in a tough market, they continue to gain market share. DIA, for example, has done a really great job and continues to increase its revenue and EBITDA. A 265% increase in EBITDA is a phenomenal result. So, we continue... it's a combination of our ancillary business continuing to gain market share and grow, the full execution of our $3 million quarterly cost reduction, and certainly the aspect of seasonality. We are not anticipating a significant increase in the market in terms of upside. Some have argued that the Fed may start lowering interest rates in Q3 and Q4. We are not putting that into our model. We're being somewhat conservative regarding the upside in terms of getting to cash flow breakeven in Q3. It's really a combination of all those factors.

I want to add some color if I may, though. I want to make sure you understand that we didn't do that because we were worried about not being able to reach the breakeven or reach cash flow profitability; it’s really just out of being wise. You don’t know what you don’t know. We don’t want to be foolish. We want to make sure that we had some additional buffer there for just in case something happens in this world, especially in this market. So, we're just trying to be prudent, trying to be thoughtful about the business. At the same time, we have to ask ourselves if we really want to do this because we feel very confident that we're going to be able to continue to achieve what we've said we'll be able to achieve. So far that hasn't changed. But again, bringing that extra capital was really just, I guess, a touch of wisdom in the business.

That makes sense. Thank you for the color there. One more question if I may, and then I’ll pass the mic along. But I wanted just to narrow in on the mortgage business here for a second. Josh, you had said attach rates improved in mortgage as well as title. But can you provide an exact number for mortgage and maybe title, or just a general estimate? And then, Marco, you may have briefly touched on this, but what was this improvement attributable to? Was there anything specific? And also, is gain on sale something that's starting to normalize? What’s your updated outlook in terms of gain on sale?

I think the first part of the question is directed at me. As for attach rate, we haven't shared the attach rate with exact numbers other than the fact that we're seeing improvements. I feel strongly that we probably need to keep it that way for right now. I know none of our peers share those specific numbers either. There's a reason for that. Things kind of ebb and flow, but we are seeing improvements. We still feel a lot better about attach rates. We're starting to see a lot more agents really buying and understanding the fact that these are part of our Fathom family. The more we support our ancillary services, the more we support that Fathom family, the more benefits everybody. While we’re not prepared to give the exact attach numbers, we are definitely seeing improvements.

Our improvement in the mortgage business is a combination of several factors. One, the leadership in our mortgage company continues to recruit more loan officers and continue to grow the revenue base. I think we look forward to demonstrating that when we announce our Q2 and subsequently Q3 numbers. So, it's a combination of adding more loan officers to the team. Second, we focused the attach rates; we took a more focused approach towards expanding our mortgage business in the North Carolina and Texas areas, which enables us to grow our market share in those states much deeper. So that has certainly helped the attach rate. We've also implemented a variety of pilot programs in Q1 in terms of marketing programs, and we'll be able to provide an update on those in Q2 once they're fully executed. Lastly, concerning gain on mortgage, the market has become a little more consistent and stable compared to Q3 and Q4 last year. It was a highly unstable market concerning gain on mortgage. There's plenty of data out there showing how mortgage companies' profitability decreased significantly in Q3 and Q4. Yes, we're definitely seeing a more stable market. Not a great market yet, certainly not compared to Q1 of last year and Q2, but it is definitely more stable. We're not seeing the ups and downs in loan profitability. I think that's a good start. We're hoping that by Q2 and Q3, things continue to stabilize further, which will make it easier to anticipate market performance. But we feel better today about our mortgage business than we did in Q4. We're very hopeful that as we continue to work hard, we'll see better results in Q2 and Q3.

Great. Thank you so much, and good luck for the rest of the year.

Thank you.

Thank you.

Our next question will come from Darren Aftahi with Roth Capital Partners. You may now go ahead.

Hey, this is Dylan on for Darren. Thanks for taking the questions. I'll start firstly with marketing; could you talk about both the reduction in marketing spend, but also the confidence you may have with referrals to offset that lower spend and still grow agents?

Great question. So, the reduction in marketing is not so much focused on recruiting; it’s really more focused on optimizing a variety of our internal resources. We have optimized many of our internal marketing operations. We optimized our advertising campaigns, resulting in a decrease in marketing spend. However, we actually have increased our recruiting team. So, while it looks like the decrease is there, we have actually increased our recruiting team. The second part of your question was the referral rate. As Josh mentioned, in March, we had the highest internal referral rate ever in our history. We feel confident that's going to continue as agents recognize the benefits of our 'free for life' program. I’ve always said that it will take some time for agents to fully benefit, but certainly in Q1, in March, we saw significant increases there. We anticipate that to continue as the number of agents we recruit continues to grow.

Yes. Just touching on that, regarding the sequential net adds of agents, how many were from referrals versus what you could classify as more organic?

For March, it was 60%. For the whole quarter, Marco, do you have that number off the top of your head?

So, yes, we don't provide the net number, Dylan, regarding that. We can give you that on a gross number; the internal referrals were 60% on the gross number. And keep in mind that Q1 typically has the highest turnover; the number of agents leaving the industry was significant. Our churn rate in Q1 was 2.2%, which is notably higher than our average around 1.5%, 1.6%. To note, 60% of our agents came from internal referrals, which is the highest we've ever seen; however, in Q1, we, along with the entire industry, saw significantly higher churn as agents left the industry because they don't want to pay all their annual fees for Q1.

By the way, if you go back in time and listen to some of our earlier calls, especially Q1 of last year or even earlier, you'll see we spoke that about 35% of our growth was agents referring other agents. Now to see that number hit 60% is pretty exciting.

Yeah. No, I appreciate the color. That’s helpful. And then, just a follow-up for me. On the productivity side, the demand is down due to lower home sales in the market. Could you talk about the type of agents you're recruiting or your existing base? How is their productivity evolving over time in terms of the potential number of transactions they can handle?

For Q1, it was fairly consistent across the board at about 15%. We've seen that consistent. Some states might be a little higher or lower, but that decrease in the number of transactions and productivity was consistent across the board. When compared against other public companies, our decrease percentage was about half of what everyone else has seen. Overall, we see a decrease of around 25%. However, our agents' decrease was closer at 15%. Some areas, such as the West Coast, see higher percentages, while East Coast states have lower percentages, but across the board it remains around 15%.

Great. I'll pass it on. Thank you.

Thank you, Dylan.

Our next question will come from Tom White with D.A. Davidson. Please go ahead.

Hey, this is Wyatt Swanson on for Tom. Thanks for taking our question. I've just got a quick one here regarding the agent value proposition. Looking two to three years out, what do you think are the most likely areas that will see some meaningful evolution or improvement in terms of ways to add value to agents?

I think it really comes down to better training. When you think about how — number one, obviously, how do we add more agents? And then, once we add those agents, how do we help them improve their productivity per agent? One of the things we've said in the past is the average agent who joins Fathom increases their business by 49% over a four-year period. That happens naturally because they've got more money to reinvest back in the business. Many agents will pocket that money, pay bills, feed their families, or take vacations, but a lot of agents are running businesses and will reinvest that money back into their business. That just naturally happens. One area that I think we can see great improvement is increased training, increased coaching for individual agents to say, 'Okay, you have the savings. Now what?' Not everyone knows where to spend that money; can we help coach them and show them how and where? Can we help train them to be better at their job, at their craft? I think this is an area where we can dramatically improve inside our organization and enhance productivity per agent. Also, by offering even more solutions, resources, and training to our agents, we should be able to attract higher producing agents. So, those are three strong ways we can increase the number of transactions per agent.

Great. Thank you very much.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Josh Harley for any closing remarks.

Thank you. Of course, thank you for joining our call today and your interest in Fathom. For those of you who are Fathom shareholders, thank you for your trust. We will continue to work hard and look forward to sharing future updates with you. Have a wonderful week.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.