Fathom Digital Manufacturing Corporation (NYSE:FATH) Q3 2022 Earnings Conference Call November 14, 2022 8:30 AM ET
Company Participants
Michael Cimini – Director of IR
Ryan Martin – CEO
Mark Frost – CFO
Conference Call Participants
Greg Palm – Craig-Hallum Capital Group
Jim Ricchiuti – Needham & Co.
Wamsi Mohan – Bank of America
Paul Chung – JPMorgan
Jacob Stephan – Lake Street Capital Markets
Operator
Hello. My name is Emily, and I will be your 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’d now like to turn the call over to Michael Cimini, Fathom’s Director of Investor Relations to begin. Please go ahead.
Michael Cimini
Thank you, Emily, and good morning, everyone. Welcome to Fathom’s third 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 www.fathommfg.com, where you will also find links to our SEC filings along with other important information about our company.
Turning the 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 to become aware of the risk 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, the Chief Financial Officer.
I will now hand it over to Ryan.
Ryan Martin
Thanks, Michael, and welcome everyone to Fathom’s third quarter 2022 conference call. I’d like to begin my remarks on Slide 3, where we will provide our Q3 highlights. Our performance for the quarter was in line with management’s expectations, as we continue to increase our orders and sales momentum, while extending our track record of profitability in our core operations and cash generation, a key differentiator of Fathom.
In Q3, we posted revenue of $40.2 million, while adjusted EBITDA totaled $7.1 million. We continue to benefit from positive fundamentals in our business as product driven companies localized and reshore their manufacturing to ensure a more resilient supply chain. Additionally, we work closely with enterprise level customers who seek a comprehensive digital manufacturing partner to help them iterate faster and reduce time to market.
As we discussed on our previous call, we made important strides during the second quarter building out a high performance, platform based strategic sales team to help drive long term growth. I’m excited how our new commercial team members have steadily ramped up their activities. During the quarter, both our orders growth and revenue growth improved each month and encouraging sign as we aim to close out the year and enter 2023 with increasing momentum.
In fact, Fathom achieved record order performance in the month of September for additive technologies. While Mark will discuss our financials in more detail, our orders totaled $40.3 million in Q3. During the quarter, we secured new additive orders from two notable customers in the fast growing EV market totaling $1.2 million. We also achieved new wins in other key end markets, including aerospace and defense, semiconductor, and robotics by taking advantage of our robust technology agnostic platform, which allows us to adapt our 25 plus manufacturing process to our customers’ specific needs.
As you’ve heard me talk about before, one of the key strengths of the Fathom platform is our entrenched relationships with large strategic customers, which provides Fathom with an attractive reoccurring revenue stream given our retention rate of 90%-plus. By partnering with some of the world’s most innovative Fortune 500 companies, working with them across multiple sites and developing extensive contacts within each company, we have seen continued growth among our strategic accounts over the past year.
On an LTM basis, we have grown the number of customers spending more than $1 million with Fathom annually from 26 customers in 2020 to 35 customers today, an increase of approximately 35%. More importantly, we have generated a revenue CAGR of approximately 20% within our $1 million plus revenue customers since 2020. We believe these positive trends demonstrate how our land and expand model among strategic enterprise level accounts is working.
As our commercial activities continue to take hold, we plan to open our new Silicon Valley technology center in early Q1 ‘23. This advanced hub will ensure continuous proximity to our strategic customers and provide a unique opportunity to demonstrate first-hand, our cutting edge technologies and provide an outlet for Fathom to better partner with leading OEMs to showcase new technologies. This facility will be where we introduce our customers to some of the latest advancements in additive and advanced manufacturing, including the EVOLVE system.
Throughout 2022, we have made important progress expanding our industry leading platform by adding new technologies, which have considerably strengthened both our capabilities and growth prospects. Most recently, we took delivery in the quarter of three new multi-jet fusion machines from HP, providing breakthrough productivity for additive manufacturing ideally suited for low to mid-volume production environments. We also made investments in our post processing equipment to enhance the quality and efficiency of the plastic additive parts we produce.
Regarding EVOLVE, we expect to take delivery of this new additive technology by early 2023 at our Silicon Valley Technology Center. We’re excited by this opportunity for this advancement in additive manufacturing. This technology is a one of a kind additive process, which dramatically reduces lead times for parts compared to traditional injection molding processes. We have already started receiving our first orders for this technology and interest continues to be extremely high.
All of these new additive technologies followed the expansion earlier this year of our large format SLS 3D printing capabilities for the creation of prototypes and end use parts in durable engineering grade thermoplastics. I’m pleased with the continued execution of our capital investment strategy and the significant benefits this will provide our on-demand platform in 2023 and beyond.
At the same time, we remain focused on consolidating our national footprint and increasing the operating efficiencies in line with our previously disclosed optimization plan. Our facility in Oakland is scheduled to officially close in January, following the transfer of our entire CNC operations and additive technologies to our company headquarters in Hartland, Wisconsin.
With this transition, we expect to optimize our existing capacity and increase utilization in Hartland. This transition will also help pave the way for our Hartland facility to serve as the premier new product innovation facility throughout North America with the unique set of capabilities unrivaled in our industry.
In addition to our new MJF, DMLS and SLS technologies that I just mentioned, a Hartland facility recently took delivery of two DMG Mori 5-axis machines. This dynamic, high performing technology integrates speed and precision and will help expand our dedicated quick turn CNC capabilities which is a high margin and our fastest growing segment within Fathom.
Our state-of-the-art MPI facility in Hartland will enhance our national manufacturing footprint while serving as a valuable complement across our other sites to provide a one stop outsourced solution for low volume, high mix production that supports customization and delivers a superior customer experience while generating greater economies of scale across the entire data manufacturing platform.
Consistent with our strategy to create world class manufacturing centers in key strategic markets, we remain on track to open a greenfield site in the Austin, Texas area in the first half of next year. As part of this initiative to expand our Texas footprint, we intend to consolidate our two existing nearby facilities, which will eliminate redundancies, reduce costs and further increase our scalability. And we look forward to providing and update on our progress during our next quarterly call.
In further in our efforts to accelerate customer engagement, we had a strong turnout at the International Manufacturing Technology Show or IMTS. This week long event, which was held in September for the first time since 2018, represents the biggest manufacturing event in North America with over 85,000 attendees and 2,000 exhibitors. This is our first in-person event since 2019 and it was exciting to see so many new and familiar faces. We met with existing customers exploring opportunities to expand our relationships, while securing a significant number of new high quality leads across a wide range of the industries.
We believe our flexible, hybridized approach applying the best manufacturing process to deliver the most effective solution that achieved the desired outcome resonated significantly with the attendees. We remain focused on ramping our sales and marketing activities as we continue to invest in new technologies and expand our breadth of leading offerings. By executing our go-to-market strategy, we expect to build deep and entrenched relationships with additional Fortune 500 tier companies and achieve greater market penetration for our additive and traditional manufacturing technologies.
With that, I will now turn the call over to Mark.
Mark Frost
Thank you, Ryan, and good morning, everyone. I’ll begin my remarks of our quarter three results on Slide 4. Our revenue for the third quarter totaled $40.2 million which was slightly above the midpoint of our previously stated guidance of $39 million to $41 million. In quarter three ‘21, revenue totaled $41.5 million. Our performance in the quarter was driven by growth in precision sheet metal and CNC machining, we continue to build positive momentum on the commercial front and posted a sequential increase in our monthly sales throughout the third quarter.
For quarter three, our revenue by product line was as follows. Additive manufacturing totaled $3.2 million or 7.8% of total revenue. As mentioned earlier, we are investing in new additive technologies and believe our new Silicon Valley Technology Center will further strengthen our growth prospects in this segment. We also expect the record order growth that we experienced in additive for the month of September to have a positive impact on revenue in the fourth quarter. Injection molding was $6 million or 14.9% of total revenue.
We remain focused on adding more resources to improve our overseas supply chain, including the development of a new software support system to drive future growth in our injection molding business. CNC machining climbed 9.7% to $15.5 million or 36.8% of total revenue, reflecting our ongoing ability to capitalize on cross-selling opportunities and previous acquisitions completed in the first half of 2021.
We also became operational on our Quick Turn CNC sell, which contributed to revenue. Precision sheet metal increased 3.3% to $13.7 million or 34.1% total revenue as overall customer demand in this business remains healthy. And finally, ancillary technologies, our smallest product line, rose 4.5% to $1.8 million representing 4.5% of total revenue.
For the first nine months of the year, our revenue increased 13.8%, primarily due to acquisition related activity and growth within Fathom’s strategic accounts as we maintain our focus on expanding our share of wallet with existing strategic customers and adding new corporate accounts.
On Slide 5, we provide our adjusted EBITDA performance for the third quarter. In quarter three, our adjusted EBITDA totaled $7.1 million representing a margin of 17.5%. In the prior year period, we reported adjusted EBITDA of $8.6 million for margin of 20.8%.
Our performance reflects reduced volumes primarily due to the upgrade and build out of our commercial team mentioned last quarter and the related impact from lower absorption. We remain focused on taking steps to ensure a more cost efficient cost structure as evidenced by our optimization plan and fully leveraging our broad on demand platform as revenue expands.
Gross margin in the quarter was 37.5% up year-over-year by 160 basis points. This was driven in part by strategic pricing adjustments and ongoing cost improvements, partially offset by lower volume leverage. On a sequential basis, our gross margin improved 50 basis points.
Now we realized limited savings in the quarter from the execution of our optimization plan, which remains in the early stages. Upon completion in mid-‘23 of our various initiatives, we expect to generate annualized cost savings totaling approximately $5.5 million. We also held additional Kaizen events at our facilities in Hartland, in Tempe, Arizona to foster a culture of continuous improvement following our initial workshop at our Miami location earlier this year. By identifying incremental opportunities to remove waste and enhance productivity, we intend to achieve our objective in becoming a truly lean organization.
SG&A increased year-over-year by 12% to $11.9 million, primarily due to the incurrence of public company expenses following our listing on the New York Stock Exchange. Now excluding stock compensation, our public company costs in quarter three declined as anticipated on a sequential basis by approximately 13% to $2.1 million.
We expect these expenses to trend further downward in the current fourth quarter by an additional 20% as we seek to normalize our public company infrastructure. We also remain on track regarding our new shared service center for finance and accounting with transaction activities to be completed by year end and accounting by quarter one ’23 to help streamline company-wide processes while further scaling the business. We plan to pursue additional centers in other administrative functions over the coming quarters.
On Slide 6, we highlight our liquidity and cash flow. We ended the third quarter with available liquidity of $31 million, this includes $8 million in cash and cash equivalents, and $23 million of undrawn commitments under our $50 million revolving credit facility. As of September 30, our total gross debt excluding cash was $149.7 million and net debt totaled $141.7 million with no debt maturities before December 2026.
We generated $2.3 million in operating cash and our CapEx totaled $4.3 million, which is higher mainly due to timing as we do expect a notable decline in CapEx spending in the current fourth quarter. Our CapEx spending for the year is slightly ahead of our plan, but our year-to-date CapEx also reflects payments from previous commitments that were made at the end of 2021.
Now as Ryan mentioned earlier, we continue to execute our capital deployment strategy with key investments in additive and CNC machining to further enhance our unmatched capabilities increase throughput and we expect to begin generating positive returns on these investments beginning in 2023. We also continue to integrate multiple ERP technologies into a single scalable cloud based solution to boost our productivity, in line with our efforts to improve the overall digital threat of our business and expect to complete the ERP process by the end of next year.
Now as a final note on this slide, subsequent to the end of the third quarter, we amended our existing credit agreement, providing for covenant relief for both leverage and interest coverage. Specifically, the maximum net leverage ratio increased to 4.5 times through June 30, 2023 with a step down to 4.25 times through December 31, 2023. These modifications increase our financial flexibility for a continued investment into the growth of Fathom.
Now turning to Slide 7, we provide our updated forecast for 2022. With just under 50 days left in the year, we revised our range for annual revenue, which is now expected to be between $163 million and $165 million for an increase of approximately 8% at the midpoint on a reported basis. This implies revenue for the current fourth quarter of approximately $40 million to $42 million as our focus remains on outperforming the overall digital manufacturing market.
The range for adjusted EBITDA has also been revised as we now expect to generate between $30 million and $32 million in 2022 for an implied margin of 18.4% to 19.4%. For quarter four, we expect adjusted EBITDA of $8 million to $10 million representing a higher margin of 20% to 23.8%. We are continuing our focus on ramping our sales and marketing activities and increasing operating efficiencies.
We will continue to monitor the impact of global economic conditions and we’ll provide our next outlook on our quarter four earnings call in late February or early March. At that time, we intend to begin issuing guidance on a quarterly basis only. This time frame is aligned with our backlog, which typically extends 60, 90 days is more indicative of our future results.
Now finally, as a reminder, our current outlook excludes the impact of any future acquisitions. M&A remains an important part of our overall growth strategy and we remain opportunistic in our approach to pursuing accretive tuck-in acquisitions and maintaining our role as an active consolidator in our large and highly fragmented industry.
I’ll now turn the call back over to Ryan. Ryan?
Ryan Martin
Thank you, Mark. I will provide some closing comments on Slide 8. We are pleased with our performance for the third quarter, which was consistent with our expectations as we continue to deliver profitable results and generate positive cash flow. We also gained solid traction from our commercial actions with expanding our monthly orders and sales throughout the quarter, and continued strong growth within our most important segment of our large strategic accounts.
We’re encouraged by our increasing productivity, which bodes well for further improvement in Q4 and into 2023. In addition to building a strategic platform based commercial team, we successfully bolstered our growth prospects by taking delivery of new technologies, particularly in additive and CNC as we continue to invest in the business. With numerous steps we have taken to date in 2022, Fathom is in a much stronger position to drive long term, profitable growth than when we went public just under a year ago.
And with the ongoing execution of our optimization plan, we expect to enhance our ability to fully leverage our scalable platform for the benefit of the company and our shareholders. Although, the macro environment remains uncertain, we are focused on what we can control and we believe in our differentiated business model, highlighted by extensive and entrenched blue chip customer base across diverse end markets, comprehensive manufacturing services and a track record of profitable growth during previous downturns such as what we encountered in March of 2020, when our key customers leaned on us even more. This all positions our company well to navigate any near term macro headwinds.
I’m proud of the progress our team has achieved in transitioning to a New York Stock Exchange listed company, and I’m confident the best is yet to come as we advance our mission to accelerate manufacturing innovation for the most product driven companies in the world, while creating a more agile and responsive supply chain.
This concludes our prepared remarks and now we’ll open the call up for questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question today comes from Greg Palm with Craig-Hallum Capital Group. Please go ahead, Greg.
Greg Palm
Yes. Good morning, everyone. Thanks for taking my questions here. I guess I just wanted to start with the outlook and maybe more specifically what you’re seeing in October this year as it really seem to follow kind of normal seasonality trends based on the guidance you’re setting for the fourth quarter. So just a little bit more on maybe what you’re seeing intra quarter would be helpful to start?
Ryan Martin
Yes. Good morning to you, Greg. Thanks for joining this morning. Ryan here. Yeah. I would say, as we talked about in our prepared remarks, we saw through the addition of our — the commercial resources that we talked about in the second quarter. We’re seeing them ramp. We saw orders growth every month in the third quarter and we continue to see that progression on the same path that we saw in the month of September and October so far.
So we’re cautiously optimistic as we see the growth throughout the year. I think the value of our platform is really the diversification around the different technologies, the end markets, the entrenched customer base that we have. It’s a very large market obviously out there. And so we’re continuing to focus on trying to capture the demand that exists out there. And I think we’re cautiously optimistic as we look into the remaining part of this year.
Greg Palm
And what about if you could maybe differentiate between the activity you’re seeing on some of the shorter lead time kind of Quick Turn prototyping stuff or some of the longer term strategic projects or programs?
Ryan Martin
Yeah. As it relates to that, so we’ve seen — I think as we talked about before in the second quarter specifically and even a little bit into the beginning of the third quarter, we saw a lot more pressure on the more commoditized really quick turn additive. We started to see where we’ve got differentiated value in some of the offerings that we have especially on additive and being able to leverage the multiple different technologies that we have.
And so that’s really where we saw the value and why we saw record orders in the month of September from an additive side of things. It wasn’t just the commoditized quick print and ship. It was kind of leveraging post processing related to the additive side of things. And so we’re continuing to see strong demand there. I think some of the larger projects that we’re seeing, — we’re still seeing really good demand in those.
We’re seeing a lot of especially as I talked about earlier in the call on the EV space, we’re leveraging maybe three or four different manufacturing processes where we may be helping a customer go from that initial prototype 3D printing to urethane casting through bridge production injection molding and the opportunity of the reason they’re looking for us is that we’re able to reduce their entire time to market. In a lot of cases, somewhere between 25% to 30% by — being able to handle all those different phases of the development all the way through to mid-production.
Greg Palm
Okay. That’s good. And then, Mark, just a little bit of help on the facility consolidation in the cost savings program. Is that mostly going to be on the COGS line? And then just in terms of modeling that?
Mark Frost
Yeah. Good question.
Greg Palm
Yes, go ahead. I’ll let you start.
Mark Frost
Yes. No, Greg. Good question. We expect it to be split pretty much evenly between COGS and SG&A. As we — and most of it should start incurring one-one. We’ll get a little bit of it in fourth quarter, but most of it will start cutting in. We’re in good shape to shut down the Oakland facility. As I said on my prepared remarks, Finance accounting is almost complete and we will finish some of the other leadership transitions at the sites, which was more actually on the SG&A side, Greg. So that’s why it’s about equally 50-50 split between COGS and SG&A savings for ’23.
Greg Palm
And in full run rate savings started in the second half of ’23?
Mark Frost
I’d say, if I handicap, I’d say 75%, 80% of it will start first quarter and 100% by the end of quarter two next year.
Greg Palm
Perfect. Okay. All right. I’ll leave it there. Best of luck. Thanks.
Ryan Martin
Thank you, Greg.
Operator
Our next question comes from Jim Ricchiuti with Needham & Co. Please go ahead.
Jim Ricchiuti
Hi. Good morning. So a couple of questions. Maybe first on the additive side and recognize it’s a smaller part of your business. But I wanted to see, if I could reconcile the sequential revenue decline. And then the increased order intake that you’re talking — that you highlighted, any of you could walk us through that?
Ryan Martin
Yes, absolutely. So the additive is probably the biggest area that we saw — the turnover in the sales team to get the right team in place to be able to grow this platform, which we’re fully staffed and we’re really excited about the team that we have in place. You saw the impact in the revenues because that would — the revenues per additive in the third quarter would be the orders that you would have gotten May, June, July time period.
We usually see about — and depending on the size of the project, about a 30 day lag there. So we saw really strong record orders for the history of the company in the month of September. And so we’re seeing the sales resources that we brought in ramping really quickly. And so you’ll see the benefit of that in the revenues in the fourth quarter. We saw that momentum from an additive orders perspective continue to keep going in the month of October.
Just as an example, I talked about the 3 HP multi-jet fusion machines that we added in the third quarter. Those machines since we’ve added them have been running pretty much twenty 24/7 non-stop. And so we’re continuing to see strong demand there on our DMLS side of things. We’re continuing to see strong demand there, especially for some aerospace and defense customers with running pretty much 24/7 there as well. So we’re seeing the ramp up from the orders which will translate into the revenues into fourth quarter and into Q1 of next year, Jim.
Jim Ricchiuti
Got it. Hey, Ryan. Just a broader question on the orders in the quarter. Nice to hear that sequentially it was growing each month. Has that been in line with your expectations? And I wonder if you could talk about the market verticals where you might be seeing changes in demand either way and any implications that might have for margins just given the mix of business you’re seeing?
Ryan Martin
Yeah. I think as we look across the margins in our different manufacturing process, they’re all relatively similar from a margin perspective, which is why we really think about technology agnostic approach to the customer and trying to understand what’s the best technology, what’s the best material, what’s the best process to solve the manufacturing challenge they have.
If you think about the areas from end markets that we’re seeing that are really strong for us right now, the medical space, we’re continuing to see strong growth there. We do a lot of work in the robotics space. We’ve got some really strong customers there. And I think what’s interesting especially in that space is the amount of multiple technologies that they’re leveraging. They’re leveraging typically four to five different technologies.
So it’s additive, both plastic and metal, injection molding, CNC machining. We’re seeing good growth in our Precision Instrumentation business as well. Just an example of that, Jim, we have a large customer in the Minneapolis area. Typically, we’ve done $2.5 million to $3 million of CNC machining of high precision kind of mid-volume production components for them. And they have an internal mandate to generate about 30% of their new revenues from new products.
And now they’ve started leveraging us for 3D printing as well as injection molding. And so those are all ancillary new processes that we’re able to add. And it’s all under the guise (ph) why they’re leveraging us is speed. It’s our ability to provide a faster solution to allow them to ramp their new products, which is a key initiative for their company. And so that value proposition is resonating across multiple different industries.
And I think it lends itself to just the breadth of these large entrenched relationships that I talked about that we have — the customers that are spending over $1 million on an annualized basis with us and how we’re growing with those customers. And so that’s kind of where we see it from broad in a couple of different examples of different industries and markets that we’re seeing in spite of maybe the macro environment that a lot of people talk about, we think there’s still a lot of opportunities to gain market share and continue to grow.
Jim Ricchiuti
Got it. Maybe a very quick one for Mark. Mark, you talked about sequential decline in public company costs in Q4. Just wondering, just SG&A in general in Q4, any thoughts on how we might think about that expense levels?
Mark Frost
Yes. What I would say is, it will be probably down roughly 5% from quarter three as we continue to normalize and to improve our — get more efficient, I would say, on managing the public company costs. So that’s what I would expect Jim in the fourth quarter.
Jim Ricchiuti
Got it. Thank you.
Mark Frost
Yeah.
Operator
Our next question comes from Wamsi Mohan with Bank of America. Please go ahead.
Wamsi Mohan
Hi. Yes. Thank you. Good morning. I was wondering, if you go back to historically and look at your end market performances by technology. You’re seeing some real bifurcation and performance across the different categories by product line. And so just curious, is there a lead or lag associated with how these work based on what customers are doing at any given point in time either positively or negatively could this be signaling any sort of inflection? And I will follow-up.
Ryan Martin
Yes. Good morning to you Wamsi. So you’re talking about the different manufacturing technologies and kind of the lag in the revenues on those. I would say, if you look at the performance through the first-nine months and in Q3, you can see the growth that we’re having within the CNC machining and precision sheet metal, which is a little more of our mid to low volume production side of our business.
The additive injection molding, the revenues in Q3 is really more of an impact related to as we talked about really getting the right sales team in place. That tends to be a little more project driven and the additive tends to be more NPI transactional. And so as you experienced, as we transitioned our sales team from kind of a legacy to more of a strategic platform based sales team. We certainly saw an impact in the orders momentum in the second quarter, which then impacted the growth in the third quarter, specifically within injection molding and our additive side of the business.
Like I talked about before, we’re really excited, we’re fully staffed from a commercial team. We brought in a lot of people with deep industry experience. Typically a sales rep in our industry takes about six months to ramp. And so a lot of those reps are still in months, three at this point, but we think we can ramp them faster because of the industry experience and we believe that will lead to. You’ll see some improvement into Q4 on that.
But I think that you’ll really see the impact of that into building momentum into 2023 from that perspective. And so we still feel — we’re still very, very bullish, which is why we talked about the investments we’ve made from a capital perspective to be able to support the orders ramp. especially with additive as I talked about in my prepared remarks, Wamsi.
Wamsi Mohan
Yes. No, thank you, Ryan. That’s helpful. And if I could follow-up for Mark, can you help us with seasonality as we think about the jump off point here in your implied fourth quarter guidance as we look into the March quarter, would you say given what you know right now that seasonality should be normal or better or worse, maybe just a thought sort of getting into specific guidance? Thank you.
Mark Frost
We don’t see as much customer related seasonality, but there is an impact from the commercial impact on our business that we do historically tend to see a little stronger fourth quarter and a little weaker first quarter because of that commercial impact on how your reps are pushing for the end of the year. So the customer seasonality is now significant. And Wamsi, we are expecting similar to prior years. That’s how it’s going to behave, which potentially, I’ll be honest, could be an upside in quarter four, but we’re not guiding in that matter. We’re trying to be cautious here as we move forward, but that’s normally what we see in the business Wamsi.
Wamsi Mohan
Okay. Thank you so much.
Mark Frost
Yeah.
Operator
[Operator Instructions] Our next question comes from the line of Paul Chung with JPMorgan. Paul, your line is open.
Paul Chung
Hi. Thanks for taking my question. So just on gross margins, you saw kind of like 165 basis point increase here in 3Q with kind of similar run rate of revenues from last year and also kind of up sequentially here, kind of expand on the drivers. You mentioned higher margin CNC and some pricing benefits. But how do we think about gross margins as you find some scale hopefully next year? And kind of pace of expansion we should expect as we kind of look into ‘23?
Ryan Martin
Yes. Paul, we’ve talked about on previous calls that we’ve been selectively, particularly on some of our low to mid production business, gone back and raised pricing on certain relationships and we haven’t really gotten pushed back. So we’re seeing some benefit of that in our margins. Secondly, we started from the beginning of the year looking at — for efficiencies standardizing how we operate all the sites. So we’re starting to finally get some benefits coming from that.
The improvement really in quarter three wasn’t from leverage we actually probably took a little bit of a hit. That’s why we’re at the lower end of our EBITDA as we didn’t get as much absorption. But as we move forward, and can get the revenue in that 40 to higher 40s level. We do expect a nice improvement and that’s one of the key ingredients that we think can move us back towards that 40%, low 40% level of gross margin and that’s why we’re pretty positive.
And obviously with the optimization plan benefit, which is half of the $5.5 million, that also will support pretty significantly our ability to improve the margins as we go into 2023. So does that give you a little better color, Paul?
Paul Chung
Yes. Thanks for that. And then can you kind of expand on the material goodwill impairment here? Any details would drove that?
Ryan Martin
Sure. So that wasn’t — it’s non-cash, doesn’t affect our liquidity or covenants or anything. It’s a technical test that you have to go through once a year. We triggered it one quarter early driven by a couple of factors. One, was the lower stock price. Two, was the macroeconomic issues. And those macroeconomic conditions also contributed to higher discount factors because of higher debt and cost of equity cost being applied to the valuation model and then us lowering some of our forecast for the year.
All of those factors contributed to the valuation and the one time, not one time, the goodwill impairment we had to take. So as I said, it’s non-cash. It gets added back, as you can see for both adjusted income and EBITDA. So it’s a technical accounting process unfortunately that all companies are subject to. And particularly with the stock market that’s what triggered it.
Paul Chung
And then lastly on cash flow, I know there’s a lot of moving pieces with restructuring and very dependent upon top line and scale. But how do we think about kind of more normalized cash flow conversion in ‘23 and longer term? Thank you.
Ryan Martin
Yeah. No, good question. And yeah, we are running lower this year on cash flow. Some of it is due to the lower revenue profile. The other is, we taken some one-off charges related to taxes related to vesting of shares that’s an almost $3 million cash usage we had. We had to pay an earn out, which was almost $3 million. So those were items that won’t repeat next year, Paul. So that’s $6 million of cash improvement.
We’ve also had slightly higher working capital, which we are working on. So our plan is to improve the cash flow performance. There’s a lot of effort right now and we would expect that conversion rate to go up much higher. I think we’re running in the 30%, 40% range right now and the ability to improve that by 30% to 50% is something we’re working on for 2023.
Paul Chung
Great. Thank you.
Ryan Martin
You’re welcome.
Operator
Our next question comes from Jacob Stephan with Lake Street Capital Markets. Please go ahead.
Jacob Stephan
Yeah. Hey, good morning. Thanks for taking the questions. Maybe just give us a sense of the platform sales rep build out. Maybe could you talk about potential headcount and kind of just give a general sense of progress on the efforts?
Ryan Martin
Yeah. As I mentioned — good morning to you, Jake. And as I mentioned in the prepared remarks, we’re — from a commercial perspective, at this point, we’re fully staffed. And so we’ve added back any of the turnover that we have. We’ve got roughly in our overall commercial organization between strategic sales, regional, inside sales, sales support, and our marketing team, there’s roughly about 60 resources that’s associated with that.
And then of that, about half of those are focused on the front end of the business between our strategic sales team, which covers roughly our top 100 accounts that generate about 70% or so of our revenues. And then the others are related to more of our regional corporate accounts and then our inside sales team is working on lead generation as well as leads that come through our digital marketplaces as well. So fully staffed at this point and really in a great position to continue to the orders momentum that we saw throughout the third quarter and into over as well.
Jacob Stephan
Okay. Got it. And could you just maybe outline again, what the typical ramp up kind of period is for those sales reps and how long have they been with you thus far?
Ryan Martin
Yes. So typically we see about a six — in our industry anywhere between a six to 12 month ramp up. Now the benefit is we were able to hire some experienced folks from the industry. And I think it’s a real testament to what we’re doing at Fathom, the value proposition that we’re selling and the capabilities that we have both through our internal 12 different manufacturing facilities and different centers of excellence around different manufacturing processes. So there’s been a strong desire from folks within the industry to want to join our team.
And so we’ve been able to add in my opinion some of the really best people in the industry have wanted to come to work here because they can take their relationships with their customers and they know they can sell them a solution that they weren’t able to do it at their previous employer. So think it’s a real testament to what we’re building, the value proposition that we have and the people we’ve been able to bring on.
So normally, as I said, it’s about a six to 12 month ramp about half of the team is new to their role within the last three months. So we’re still in that ramp period. But we think because of the experience and the types of people that we hired in Mcalibur (ph), we think we can get them ramped even faster and so that’s where we’re really excited. We should see really them fully ramping through the end of this year and into the first quarter of next year.
Jacob Stephan
Well, great. That covers my questions. Best of luck going forward here.
Ryan Martin
Thanks so much. Appreciate it.
Operator
Those are all the questions we have for today. So this concludes our call. Thank you, everyone, for joining us. You may now disconnect your lines. Have a lovely day, everyone.
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