Fathom Holdings Inc. (NASDAQ:FTHM) Q3 2022 Earnings Conference Call November 7, 2022 5:00 PM ET
Josh Harley - Founder, Chief Executive Officer
Marco Fregenal - President, Chief Financial Officer
Roger Pondel - PondelWilkinson, Investor Relations
Conference Call Participants
Tom White - D. A. Davidson
Darren Aftahi - Roth Capital Partners
John Campbell - Stephens Inc.
George Melas - MKH Management
Good day, and welcome to the Fathom Holdings, Third Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note, this event is being recorded.
I would now like to turn the conference over to Roger Pondel, Investor Relations for Fathom Holdings. Please go ahead.
Thank you, Chad, and welcome everyone to Fathom Holdings 2022 third quarter conference call. I'm Roger Pondel with PondelWilkinson, Fathom 's Investor Relations firm. It is my pleasure today to introduce the company's Founder and Chief Executive Officer, Josh Harley; and Fathom's President and Chief Financial Officer, Marco Fregenal.
Before I turn the call over to Josh, I want to remind our 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 Fathom 's latest Form 10-K, subsequent Form 10-Qs 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 those forward-looking statements, actual results could differ materially.
In addition, results discussed for the third quarter and for any portion of the fourth quarter of 2022 are not necessarily indicative of results for the full fourth quarter or any other future period. Fathom undertakes no obligation to update any forward-looking statements after today's call, except as required by law.
Lastly, please also note that during today’s call we will be discussing adjusted EBITDA, which is a non-GAAP financial measure as defined by SEC Regulation G. Important disclosures about this measure and a reconciliation of it to the most recently comparable GAAP measure is included in today's press release, which is now posted on Fathom's website.
And with that, it is my pleasure to turn the call over to Josh Harley. Josh?
Thank you, Roger and of course, thank you to everyone who's on today's call. Our entire team really appreciates your support. I want to start by thanking our agents and employees across each of our businesses for their ongoing hard work and dedication, not just toward our vision, but also helping us grow, particularly during the current challenging time for our industry.
I also would say thank you to our Fathom family for their unwavering commitment to creating a culture built on service and more specifically serving and placing others first. If you want to know what makes Fathom so strong in the communities we serve, it's this very principle of server [ph] leadership.
Before turning the call over to Marco for a detailed review of our financial results, I’d like to touch on several subjects. First, the key attributes of our model that are enabling growth in today's business environment. Second, our recent growth. Third, several new and exciting updates that could have a significantly positive impact on our business over the coming years. Fourth, some challenges that we faced in the third quarter and likely to face for the rest of the year, including the present market conditions. And lastly, why we believe that Fathom can actually benefit from the broader market headwinds over the long term.
We've had the opportunity to speak with a lot of investors over the last few months who are new to Fathom and how we operate. In fact, we just concluded 14 excellent one-on-one meetings at the LD Micro Conference in Los Angeles. It's really gratifying when an investor has that A-Ha moment as they realize how different we are from other publicly traded real-estate companies.
While we certainly acknowledge that Fathom is not immune to the challenges being felt around our industry, we continue to believe that we've built a better mouse trap with more resilience and every day our thesis is being proven true. First, Fathom Realty is among the fastest growing residential real-estate brokerages in the United States. In fact, in just 12 years we've grown to become the 10th largest brokerage in the country out of more than 86,000 brokerages and the sixth largest independent brokerage.
What's truly unique about our real-estate brokerage is that we offer agents the opportunity to keep significantly more of their hard earned commission dollars through a disruptive and differentiated flat fee commission model. In fact, Fathom is the only publicly traded residential real-estate brokerage platform with this model.
More specifically, throughout 2022, we only charge our agents a small flat fee of $500 for each transaction with many of our agents closing enough transaction and we only charge them $99 per additional sale during the year. While these commission split amounts seem low compared to traditional brokerages, the leverage of our operating model allows us to generate higher margins, while some of our peers haven’t been able to do so, even when charging their agents much higher fees.
To address in practical terms, the average agent who joins Fathom from a traditional model brokerage takes home around $12,000 to $15,000 more in commission annually. This makes us highly attractive to agents and allows us to enjoy agent retention rates approximately twice the national average.
We don't just attract more agents, we keep them. If you want to know whether agents are happy, there's no greater indicator. We're the only company that I know of who publicly shares our attrition rate. Over the last 12 months our attrition rate has averaged only 1.5% per month, down from the 1.7% we announced last quarter. More importantly, only 6% of agents in that 1.5% figure closed 11 more homes per year. However, over 72% of the agents in that 1.5% figure close zero or one one sale per year. In other words, we see extremely low attrition rate among our highest producing agents.
We believe the overall value we provide agents who joined Fathom is unmatched by our peers. I know I'm a little biased, it's true, but our agent growth and our low agent attrition speaks volumes in backing up my belief. Keep in mind, we do not charge a monthly fee to our agents compared with the traditional brokerages who charge anywhere from $100 to $150 per month. This helps us attract and keep agents who are price sensitive during down months, especially in this market.
In addition, attracting more agents to our low cost commission model, our proprietary technology platform and wholly owned mortgage title and insurance businesses should allow Fathom to generate significantly more revenue and profit per transaction over time. On top of that, we currently license our proprietary technology to outside agents and brokerages through a recurring revenue subscription offering, further increasing the long term revenue potential for Fathom Holdings and the stickiness of our brand.
When you combine our asset light virtual platform with the savings we generate long term from fully owning our technology, you get an important key distinction for Fathom namely, and as I mentioned earlier, we're able to charge our agents far less than our public peers while building a model to generate margins similar to or even better than our peers over time. Even those who charge agent 7x to 10x more than we do.
As some of our earliest investors were quick to realize, it's not just that Fathom wins because of our unique commission model, but because of the walls that we've built around the business. We believe it would be extremely challenging, if not impossible, for many of our competitors, especially our public peers, to shift to Fathom’s model given their high cost and franchise structures.
Despite today's market conditions in the residential real-estate sector, for the third quarter our year-over-year revenue grew by more than 10%. Importantly for the sixth quarter in a row, our real-estate brokerage operation was adjusted EBITDA profitable, think about that. We charge a small fraction of what other brokerages charge their agents, and yet we believe that over the long term we can achieve profitability far faster than they have. Even with today's economic uncertainty, we believe that Fathom has a long positive runway ahead of us.
In Q3, our agent count grew by 33%, which we believe is particularly noteworthy since we had a tough comparison to last year's quarter during which we made a sizable broker's acquisition. In addition, our transactions grew by 5%, again coming off 10% -- 42% rather transaction growth in the previous Q3, while simultaneously managing through current market conditions.
As we see other real-estate companies share their quarterly results, I believe that our revenue, agent and transaction growth will prove to be even more impressive. As I stated earlier, adjusted EBITDA for our real-estate business was positive this quarter. However, total adjusted EBITDA was negatively impacted, primarily by our mortgage operation and the unprecedented speed of interest rate hikes. Still, we are seeing improvements in this business as we right size our expenses to current and future market conditions. Now Marco will speak in more detail about that in a few minutes.
Our cost to acquire one agent during Q3 remained low at approximately $1020, making our breakeven on each agent less than the $1,150 that we’ll earn on their first sale. I also want to point out that the average lifetime value of an agent is currently over $21,000 on just the real-estate side of the business. The ratio of that lifetime value to our cost of acquisition is around 21x and that does not take into account the revenue we're generating from our mortgage, title, insurance and technology companies.
Now, when I started this call I referenced several changes that we believe could have a significantly positive impact on our business over the coming years. I’d love to share those changes with you now. The first change is to our commission model. Effective January 1, 2023, we'll be raising transaction fees by approximately $50 across the board. That means that our current $500 transaction fee will increase to $550 and our $99 transaction fee will increase to $150.
Raising prices is always difficult, but given inflation and the ongoing fed rate increases, we felt we had no choice, and we're confident that our agents will fully understand. Even with these small changes, agents will still be generating significantly more income than they could by hanging their license with the traditional brokerage charging large splits. An important point to remember is that our commission fee is not based on the price of a home. So we have very little compression risk as housing prices come down.
We will also be increasing the annual cap on the number of sales in which we charged the full fee for individual agents from 12 to 15 sales and we're increasing the cap for team members from four sales to five sales. You recall that once an agent hits their cap, their fee per transaction decreases from the $550 to the $150. The last time we raised fees, we did not lose a single agent that I or my team is aware of as a result of the raised fees. This is in large part because even at $550, our agents are still saving an average of over $3000 per sale versus the industry average commission split from the traditional brokerages.
We have also decided to eliminate stock grants for closed transactions. Dilution per transaction has increased too much for our comfort level as our shares have become so deeply undervalued. For this reason, we felt it was important to end those grants. This too will become effective January 1, 2023.
Okay, on to some exciting change that we're making to our business. Effective immediately, we're rolling out a new agent referral program called Free4Life that I believe is superior to any other agent referral program out there. The program has three levels, the first level is similar to our previous program. When a Fathom agent refers another agent who joins our company, the referring agent will receive $250 in stock grants for each agent they refer. These grants have a two year vesting period.
The second level is called Cap4Life. Once an agent refers four agents who join Fathom, and each of those agents close a minimum of two sales per year, that referring agent will be capped for life, meaning the referring agent will only have to pay the $150 per sale from then on. They’ll never have to pay the $550 transactions fee in the future. This is in addition to the $250 of stock grant the agents receive.
The third level is called Free4Life. Once an agent refers a total of eight agents who joined Fathom, and each closed a minimum of two sales per year, the referring agent will be free for life, meaning they'll never have to pay another annual fee or residential real-estate transaction fee. Again, this is an addition to the $250 of stock grants the agent receives.
We believe this program will be incredibly exciting for agents. In fact, we actually rolled out the Cap4Life level in beta on September 1, and as a result we had the best for a month ever with over 40% increase in agent referrals for September. Now, I understand without doing the math, you may be thinking that we're giving way to farm, but even in the worst case scenario we're ahead. To help you better understand the benefits to Fathom, I’d like to explore the math for Cap4Life in a typical scenario.
So a Fathom agent who closes six sales per year refers four agents who each close six sales per year. In this scenario, we're ahead by more than $13,000 in incremental revenue as we now have six agents paying a $600 annual fee, along with their $550 transaction fees. Plus we now have five agents who have a potential to refer another agent rather than just one.
Now let's run the same math for Free4Life. Using a Fathom agent who closes six sales per year and referring a total of eight agents who each close six sales per year. In this scenario, we're ahead by more than $27,000 in additional revenue per year, and again we now have nine agents who have the potential to refer other agents rather than only one.
While we do not believe that we'll have thousands of agents to keep the Free4Life level, imagine how many more agents who may not have otherwise referred anyone will try to ultimately refer one, two or even three agents. I hope you can see why we're so excited to roll out this new agent referral program.
So to recap the changes; we're raising transaction fees across the board by $50. We're raising the cap from 12 sales to 15 sales. We're eliminating stock grants for transactions. And lastly, we're rolling out a new agent referral program with three levels, $250 in stock grants for each agent referred, Cap4Life and Free4Life.
At this point, I want to transition from the company and focus on the current market conditions. When I started this call I referenced the difficult market, and I’d like to add a few thoughts to clarify what I meant. We're living through unprecedented times right now. Inflation is at 40 year high, inventory is still in short supply and we have not seen interest rates rise this quickly in well over 50 years, which is concerning for potential buyers and putting a halt on the refinance business altogether.
These outside influences are having a negative impact on all real-estate companies, and as I said earlier, we are not immune. Moreover, none of us have an accurate crystal ball for still what's to come, although we are assuming that we will continue to see some pressure through the end of this year. As such, we're taking extra precautions to protect ourselves and even leverage the market to our benefit. We believe these macroeconomic conditions will prove to be much more impactful on our competitors than on us, but we are mindful of the challenge that we made.
Over time, we believe that we can turn the otherwise adverse market conditions into a tailwind for us. Our conviction to this theses has not changed and has in fact strengthened. Our focus remains on reaching adjusted EBITDA breakeven in the first half of next year.
Although our fourth quarter projections, which Marco will discuss momentarily are lower than originally hoped and planned, with market conditions in mind, we are working with each of our business heads to reduce companywide expenses by a total of $1.5 million per quarter by Q1 of next year. This is twice the amount we discussed on last quarter's call.
We are determined to right size the company's expenses and we have set a target to achieve cash flow breakeven as early as Q3 of next. It's important to note that even though we are finding ways to cut cost, we will not sacrifice our ability to continue growing.
While the current residential real-estate market is challenging, I do believe Fathom can benefit from it. That's because we could see more agents joining our brokerage when those agents begin to see their income negatively affected at their current brokerage. Our model resonates with the agents who hear about us for the first time and actually take the time to learn more.
Remember, there's only two ways for real-estate agent to net more income, increase their revenue by closing more sales, which is hard to do in a down market or decrease their expenses. We believe we can help agents do both. For the majority of real-estate agents, their largest expense is not their marketing, it's the splits they pay their brokerages. With Fathom, agents have access to all the technology, training, resources and support they used to getting at one of the legacy brands, yet they save an average of $15,000 or more per year in commission splits paid to the brokerage.
In essence, an agent could close 20% fewer homes, which could be likely given the current market and still earn more income with Fathom than they did the year before with the traditional brokerage. We believe it's a key reason why our agent count continues to rise and why so many agents and even full brokerages are interested in joining the Fathom family.
Now a word about acquisitions, then I’ll turn the call over Marco. As you know, our mortgage title and insurance operations are all added through strategic acquisitions and we're continuing to work diligently to integrate each business fully to ensure strong attach rates. While this process has been slower than we'd like due to our focus on achieving breakeven for the full company, we are highly committed to getting there as soon as possible, while making sure expenses throughout the company are in line with the current environment and our long term goals.
Since taking Fathom public, we've also made several strategic real-estate brokerage acquisitions, each of which was immediately accretive to our business. We're receiving a fair number of inquiries on a regular basis from smaller brokerages who are interested in joining us. While we're eager to move forward on many of these opportunities, we remain highly selective and thorough in our diligence process prior to proceeding with any acquisition. We have been careful to educate potential acquisition candidates and help them re-evaluate their expectations as virtually all company valuations have decreased.
Given there is typically a big disconnect between what owners believe to be their company's credit value and what we believe to be actual market value, we did not make any brokerage acquisitions in Q2 or Q3 of this year and we do not believe it will close any acquisitions in Q4. For now as market conditions continue to play out, we are choosing to keep more cash and reserves and minimize any extra dilution.
However, we do expect to continue evaluating and completing strategic acquisitions over the coming years. We believe valuations could become even more attractive if current macro headwinds persist to accelerate. To be clear, we have many opportunities ahead of us, even without making additional acquisitions. In fact, we anticipate opening several new geographic markets in the next 30 to 60 days and will keep you apprised when we do.
One final point I like to make is this. The prevailing wisdom is that real-estate brokerages can't grow or gain market share right now due to some of the unprecedented macro changes in the industry. As I said earlier, while Fathom is certainly not exempt from these challenges, we believe that our market and our model positions us well, and our execution to-date continues to drive solid growth. Last but not the least, I believe you know that Marco and I and many others in our organization are significant Fathom shareholders and cares as deeply as you do about our stock price.
I know its a little consolation to you that other publicly traded real-estate brokerages platforms are also experiencing dramatic decreases in their public market valuations. My own family owns around 38% of Fathom and I feel exactly what you feel. That said, our entire team is working diligently and I am confident that we will deliver sustainable long term value. So thank you so much to all of you who share that vision, and who continue to support us.
With that, I will turn the call over to Marco. Marco, it is all yours.
Thank you, Josh. I’ll start with a detailed review of our third quarter results. Revenues for the most recent quarter grew more than 10% year-over-year to $111.3 million from $100.9 million for last year's third quarter. The increase reflect a growth in real-estate transactions, high average revenue for real-estate transaction and revenue contributions from acquired businesses.
GAAP net loss for the quarter was $6 million or a loss of $0.38 per share, compared with a loss of $3.4 million or a loss of $0.24 per share for the 2021 third quarter. The year-over-year change in GAAP net loss resulted principally from higher non-cash stock compensation expense and an increase in non-cash amortization of intangible assets and depreciation, plus increased investments in technology, as well higher marketing G&A expenses related to building our ancillary businesses.
Our adjusted EBITDA loss and non-GAAP measure was $2.3 million versus an adjusted EBITDA of $1.8 million for the third quarter of 2021.
While we over-delivered on top line, our bottom line came in below guidance that we gave last quarter. As the real-estate transaction, mix was not as expected, and we had higher recruiting and marketing expenses.
In the 2022 third quarter, G&A was $11.5 million or approximately 10.4% of total revenues, compared with $9.6 million or approximately $9.5 million or total revenues for the 2021 third quarter. However, on a sequential basis, the G&A decreased from $12.4 million for the second quarter of 2022. The year-over-year increase in G&A was primarily attributed to recently competed acquisitions and increase in non-cash stock compensation expense.
Our gross profit grew by $2.1 million to $11.8 million, up from $9.7 million for the third quarter of 2021. Gross profit increased to 10.6% of revenue in the third quarter of this year compared with 9.6% for the third quarter of 2021. Expenses related to market activities were at $1.5 million for the 2022 third quarter versus $591,000 for last year's third quarter. The change is mostly driven by an increase in marketing activities related to new market openings and promoting their services offered by our acquired company.
Now I’ll discuss our business units results. Our real-estate business continues to perform well despite market conditions. As Josh indicated, we grew our agent network by 33% ending the quarter with nearly 10,000 agents. We believe we'll continue to see our agent count grow as the value of our commission structure and referral program becomes more widely known throughout the industry.
To reiterate, we closed 12,077 real-estate transactions for the quarter, a 5% increase from last year's third quarter, the results were expected given the state of today's market. Adjusted EBITDA for a real-estate division was 576,000, making our sixth consecutive quarter of adjusted EBITDA profitability.
Our mortgage business generated revenues of $2.8 million for the 2022 third quarter, up slightly from second quarter results. While interest rates have significantly impact on mortgage industry, we narrow our loss on a sequential basis to approximately 406,000 from a loss of 860,000 in the second quarter of this year. We'll continue to make adjustments to right size our mortgage business.
Moving to our technology segment, revenue in 2022 third quarter was $702,000, which is higher than the $644,000 for the second quarter of 2022. Adjusted EBITDA loss in our – adjusted EBITDA loss in our technology segment was $372,000, compared with the loss of $325,000 for the second quarter 2022.
Our insurance and title businesses have combined revenues of $2.8 million, which is in line with $2.8 million for the second quarter this year. Adjusted EBITDA for these businesses increased to $346,000 versus a $130,000 for the second quarter of 2022. We ended the quarter with a solid cash position of $14.5 million, providing us with the means to grow our business and execute our strategies. We did not purchase any shares in the third quarter under the stock repurchase plan. Approximately $4 million remain under that plan.
Now, I'll finish up with our guidance for the fourth quarter and full year. The guidance assumes that the residential real estate market will continue to soften, and that interest rates may remain at current levels or increase. If market conditions improve, we believe Fathom may generate results that are better than currently anticipated.
For the fourth quarter of 2022, Fathom expects total revenue in the range of $85 million to $95 million, and adjusted EBITDA loss in the range of $2.4 million to a loss of $2.2 million. That leads us to a full year revenue guidance in the range of $415 million to $425 million, and adjusted EBITDA lost in the range of $8.8 million to $8.6 million.
To emphasize what Josh said earlier, our goal is to reach adjusted EBITDA breakeven in the first half of 2023 and breakeven cash flow by 2023 third quarter. We believe the combination of reducing expenses by $1.5 million per quarter and the increasing fees to contribute to reach in both of our goals.
Over the long term we continue to believe that we can generate adjusted EBITDA exceeding $40 million per year and $100,000 to $110,000 annual transactions and that we should be able to reach these levels in the next several years. As a reminder, the guidance we are providing is forward looking, which as Roger noted at the start of this call is subject to certain risks and uncertainties.
Now, before I turn the call back to Josh, I would like to add my thanks to the entire Fathom family. Regardless of market conditions, our team gives it’s all each and every day. While the current market is difficult and challenging, we strongly believe that environment will improve over time and that with the industry's most agent centric model Fathom will prosper.
Now, I’ll turn the call back to Josh so we can take your questions.
Thank you, Marco. We believe Fathom has a clear, visible and long runway and solid growth prospects. No matter what the market holds, we believe our model is positioned to win over the long term.
So thank you again for your trust and being part of our Fathom family. With that operator, we're ready to open the call to questions.
Thank you. [Operator Instructions] And the first question will be from Tom White from D. A. Davidson. Please go ahead.
Great! Thank you. Good evening, everyone. Thanks for taking my questions. A couple on the outlook if I could. So the fourth quarter revenue guide at the midpoint implies you know decline year-over-year. I'm presuming you know that, you know you expect some of that core real estate segment to potentially decline year-over-year too. Could you sort of just parse out I guess maybe your expectations as it relates to kind of agent productivity and kind of transaction volume, which I guess I'd use as kind of a proxy for the macro versus you know your expectations around agent growth for the fourth quarter.
And then just on the cash flow breakeven by the third quarter of next year, maybe Marco just talk a little bit about what that factors in about, you know kind of topline trends. Like is there a broad range of outcomes related to the kind of the macro and the housing market that could kind of transpire and you guys could still get there. Thanks.
A - Marco Fregenal
Okay, thank you Tom for your question. So let's talk about Q4 first. The reason – so there are several factors that contribute to those numbers, right. One is, again, the topline revenue is related to the commission times the average price of housing. We are already beginning to see a compression on the prices of houses. As a matter of fact, Q3 this year, there was about a 5% or so compression in house price, so there are several factors that contribute to that.
What we're seeing overall in the market is roughly around a 25% decrease in transaction, right, and then you combine that with a, let's call it a 30% to 35% increase in agents for us, right? And so Q4 is not so much that we are projecting a decrease in transactions for Q4 this year compared to Q4 last year. As a matter of fact, if you look at Q3, our transaction grew by 5% right, and probably anticipate somewhat similar.
So we think that Q4 transactions will be somewhere in line with last year, but we think there will be some reduction in the average price of houses, and therefore the revenue, the top line revenue decreased. So it's more related to the average price of houses decreasing in Q4, which then decreases top line. It has no effect for us on our gross profit, because we charge a flat fee, right, and so that's kind of where we see the overall look for Q4.
Transaction is somewhat flat to last year, decreased top line because the average price will decrease, but it will not have an effect on gross profit. Did I answer your question for Q4 before I go into next year?
Yeah, that's helpful, thanks.
A - Marco Fregenal
Okay great. So when we look for next year, what we're looking for is if you look at the two key things that we are doing; reducing expenses by $1.5 million a quarter, and then the increase in fees.
The increase in fees, you know based on a variety of factors and a lot of things can contribute to that, but we believe we’ll generate an increase in revenue or really gross profit of anywhere from $4 million to $5 million dollars. And so when you put those two components, you know those two key variables together, we think that we can hit gross profit – sorry, cash flow breakeven by Q3 next year.
We are making the assumption that almost no transaction growth in order to reach that, so. And we do think that we're going to increase transactions next year as well, but we're making the assumption of no transaction growth, so assuming the worst if you will, but the combination of the increase – the combination will continue to increase our agent count by hopefully over 30% a year, and then the combination with combined, with the increase in fees and the reduction in expense, we feel that we can reach the goal of breakeven cash flow by Q3 of next year.
Okay, that's helpful. Maybe just I'll slip in one more and then I can hop in the queue. But just on the OpEx commentary, I think Josh you mentioned you guys are looking to maybe – I think you said maybe by the first quarter have – you know be like kind of $1.5 million less than kind of quarterly OpEx. Can you just talk a little bit about where that’s coming from. Is this just sort of like general efficiencies or are there some of the maybe newer initiatives or newer products where maybe you've – you know that maybe will have a little bit less kind of growth capital if you will as a result of those change.
So, several things. The reduction in $1.5 million will be fully implemented by the end of this year, which should really have the effect next quarter, right, and so we anticipate a $1.5 million reduction in expenses to be fully implemented in Q1, which will have an impact of reduced expenses of $1.5 million in Q1.
The reduction will come in a variety of factors. We certainly have right sized our mortgage business and continue to do that, and really, there are really two or three main components. One is just right sizing the size of the business, right. We were growing at a certain level and now we have to adjust the size of that. So we are adjusting expenses to that.
Second, there are a variety of programs, specifically in lead generations that we are delaying to second half of next year depending on the market conditions, and so there is a significant investment that we already started to make already in Q3 – Q2 and Q3, and we're going to eliminate that and we may bring that back in Q – in the second half of next year depending on that.
And then third, a variety of savings in terms of efficiency into the business. We have some third party providers that we can actually bring in-house and become much more efficient in terms of reducing our expenses. So the $1.5 million comes in a variety of different ways, right.
Now having said that, you know we believe we're still a growth business and so we actually have increased our recruiting team by 50%. And so the message is, yes, we're reducing expenses and rightsizing the business, but we are becoming very aggressive and continue to be aggressive in terms of recruiting.
Certainly the new programs that Josh enumerated are programs that we're very excited about, and also we increased our recruiting team by 50% now. I think we'll be reaching about 30 recruiters already, and so it's a combination of right sizing the business, but also a message of growth. We are going to continue to be very aggressive in growing our agent count, especially given the value that we believe we bring compared to some of the other companies out there, and the programs that Josh enumerated earlier in this call.
Oh, great! Thanks for the detail Marco, I appreciate it. I'll get back in the queue, thanks.
And the next question will come from Darren Aftahi from Roth Capital Partners. Please go ahead.
Hey guys! Thanks for taking my questions. First, could you guys talk about the cadence of maybe real estate growth month-by-month in the third quarter, meaning like where are you going to exit on a growth basis in September?
A - Josh Harley
Are you – hey Darren, good to hear from you. Are you talking about sort of what's happening in the market overall, what we see in terms of kind of what it was month-by-month.
No Marco, so more just how fast Fathom grew transactions in the month of September.
So again, if transaction growth in September is around 5%, because by the end of Q2 the market has already changed, right, and so what happens was if the overall for the quarter was 5%, that 5% was not in line month-by-month, right, and so we begin to see some decrease really by July and ultimately by September, right. And so if you think about the overall growth of 5%, I would say that July was a little higher and then by August, September it was a little lower right, but not by a lot. It really was fairly evenly distributed, and so it's not like we saw a decrease and all of a sudden September is only 1% or 2% growth. It was fairly distributed.
I mean, I think we saw certainly a decrease in August and September from July, but not significant. So we really think that that 5%, because of our agent growth, we feel good about that increase in transactions going forward. I guess the better way to describe this is that, we think that our agent growth is going to outpace the transaction decrease, perhaps that's the best way to describe it.
That’s fair. I’ll tell you what, for me the decision 90 days later to increase cost cuts by 100% is just precipitated by the fact that maybe the market was or is weaker than you guys kind have anticipated or just kind of give me some thought process behind that thinking, even 90 days from when you guys announced.
I think… [Cross Talk]
Go ahead Josh.
A couple of things. One, is that no one predicted anything. I mean, people kept trying to predict, but nobody nailed this one. I mean it's been painful, but the fact is you know we are still really strong. You know we are growing. Our agent growth is incredibly strong, and so as Marco indicated that you know while we may see transactions decrease, we're still going to see higher transactions overall, because we're growing so much in agent base. But it is hard for anyone, right. No one has a clear crystal ball right now.
This market is pretty crazy. I mean, I've got a lot of opinions of what's going to happen in the future. I do truly believe we're in for a soft landing on this one, just because you know what I'm seeing from a lot of the buyers who – they are not saying I'm out, they are saying not yet, right. They are waiting to see, are home prices going to come down. Are home prices going to come down? Are interest rates going to come down? If they don't, okay, I'm going to go ahead and move. If they do, then when. And so I see a lot more people sitting on fence right now, which tells me again, they are not out of the market, they are just on hold and that gives me a lot of hope.
But again, I don't think anyone could possibly forecast this and so because of that, you know Marco and I are going to have to ask ourselves, what's the absolute worst case scenario? We want to make sure they position the company in such a way that if all hell broke loose, we're still incredibly strong when this all settles out, right, when the dust settles and so that's what we're doing. You know we're not doing it because we actually have to, we're doing it because we want to be wise, we want to be – we want to make sure that everyone here as shareholders knows that we are looking out for the company and looking out for all of our shareholders.
Because the fact is if we don't, you know if the crap doesn't hit the proverbial fan and the market doesn't drop as much as some people think – you know some people are saying it’s not going to drop at all, some people are saying it's going to drop a lot, the worst case scenario is we're in a great position. If it doesn't drop that much, we're in a fantastic position, because we're making these cuts. And so we're just – we're trying to be smart, trying to be wise with our decision making process. But Marco, I’ll let you add some more color to that.
No, I think that's the answer. I think we won – we don't have a crystal ball. I mean, we as you know there and we look at all kinds of data every day, but I think it's about being prudent. It’s about, I think you always should prepare for the worst, and if that doesn't come, which we – we think that the cuts we're making, combined with the increase in fees prepares – you know sets this company in a position that it can do incredibly well next year, even without any transaction growth, right.
And so if we prepare ourselves for that, and then we do get transaction growth, which we think it absolutely can happen, it puts us in a very strong position, right. And so let's prepare ourselves for a situation where we don't grow transactions and we still can get to a cash flow breakeven, and then if we – if what we anticipate happens, then we are in a much stronger position.
So you know we have to have the discipline to run the business in an efficient and effective way, and we have to be prudent about how you run this business, and so we're doing what we think is necessary to position ourselves to not only get through this difficult time, but at the same time put ourselves in a position that as we – as the market turns, which would probably be second half of next year, we are in a position that we can take advantage of this and even gain market share. And so, we just believe we're doing the prudent thing to prepare ourselves for unexpected market conditions next year.
One thing I want to add is that, one of the things I learned in the Marine Corps, if you want to, if you want to virtually guarantee mission success, your backup plans have to have backup plans, right. So we are always putting things in place to make sure that no matter what happens, we're good.
That's helpful. If I could squeeze one more in. So – and humor me and indulge me on this one. So on the third quarter assumption of cash flow breakeven, if you do see the sort of $4 million to $5 million kind of annual benefit from the fee increase, if transactions are not flat, but they are actually worse, like where does that put your cash flow break even target. Is there wiggle room with that third quarter or if units are down, just indulge me on that, thanks.
Sure, of course. Yeah, we actually can still get you breakeven even if the units are down, yeah. We actually have run all the models and even the combination – we actually think the fee increase can generate more than $4 million to $5 million, so let's be conservative, and I think that if you do the math of 1.5 plus that, even if the units come down because of the shift, and again we also have – we are adding more agents, we should have annual fees as well.
So we think that even transactions decrease, we still can get to the cash flow breakeven, but again, in order for that to happen, because we're adding agents at 30% to 35%. I mean transactions next year and already – Q3 and Q4 is already down compared to last year, right and so that would be a significant decrease for next year to even go down on the 10% to 20%, right, because already Q3 and Q4 is going down. But yes, we're prepared for that and think that we can actually continue to adjust to breakeven cash flow, even if the transactions go down by another 5% or 10%.
Helpful, thanks guys.
[Operator Instructions]. The next question is from John Campbell from Stephens Inc.,
Please go ahead.
Hey guys! Good afternoon.
Hey John! Hope your well?
Yeah, you as well. Thank you, Marco. I wanted to revisit your comment Marco. Around the account to build up to the first half EBITDA breakeven target that you guys called out, You know if I take into account the positive effect of a few changes, which you provided a range on that, and then also the cost reduction on a per quarter basis. It looks like – I mean last year. I think on the front half of last year you had negative $4 million of EBITDA. It just seems like to me, you know assuming no major kind of fallout from the pipeline that you can kind of get there from those two items. So I'm just kind of curious what you're assuming maybe for the non-brokerage contributions and maybe if you are assuming a decline in revenue in the first half, just curious about those two.
Yeah, I think that's – I think your thesis is accurate, right. When we put this together, we certainly look at a variety of different models, right. We looked at first half of this year and what that looks like you know and certainly first half of last year and what that would look like as well. And then we looked at ancillary businesses, we looked at the increase in the fees. We look at all the different, even a decrease in transaction.
But I think that your thesis is correct that if things continue the same, right, and we do the transactions next year that we did in this Q1 and Q2 of this year, combined with a decrease in expenses, combined with the increasing fees that we feel good about getting to adjusted EBITDA breakeven by Q2, and that's why we made the statement that we think that by Q2 we had adjusted EBITDA breakeven. And then Q3, you know we spend money in cap – in CapEx in terms of building our technology and then we'll look into that and hopefully we’ll reach our goal by Q3 in terms of cash flow neutral, right.
But I think your thesis is correct and that's how we arrived at that as well. But we also look at a variety different models, transactions decreasing, and so there is room in there for us to you know, because we don't know what’s going to happen, right. And so we feel good about our forecast to hit adjusted EBITDA breakeven by Q2.
Okay, that's pretty helpful. And then just broadly on the cash balance, what's a good kind of minimum level you think about to operate the business? And then kind of related to that, should we view the – you know that cash flow kind of positive inflection point as maybe you guys kind of triggering back to offense [ph] when capital returns as far as M&A and maybe the buyback as well.
Yeah, great question. And so when you look at the cash flow for Q4, keep in mind that we had about $1 million. If you look, our balance sheet are pre-paid, right and so there is $1 million in prepaid that we’ll expense that over time, right. So when you look at the cash flow sort of burn right, for the quarter right, it's really $5 million, but $1 million was already prepaid.
So we think that again, we get to cash flow breakeven by Q2. We think that in Q1 there'll be some burner of cash, by Q2 it would be breakeven. So our goal is to finish next year at minimum with the same cash that we finish in Q4 this year, right and that’s kind of our goal going forward.
When we think about cash, we certainly like to have $8 million, $9 million in the bank. That doesn't mean that that's what we need to continue to run the business. Actually it’s less than that, but it's just the ability to run the business in an effective way.
Yes, in terms of you know mergers and acquisitions and all that, we'll see how their market is in Q3, Q4. If by then we're generating cash and into our balance sheet, we’ll certainly be opportunistic.
I think one of the challenges in acquisitions is really the price. I think as Josh indicated, a lot of the private companies, small private companies have not adjusted their price. And so if that happens in the second half of next year, you know we’ll certainly, we’ll look at that, but I think one of the things we're going to focus in the next six months or so is really organic growth.
Cap4Life and Free4Life are exciting programs, and like I said, we increased our recruiting team and so we look forward to continue organically. As Josh indicated, I think September was one of our best recruiting months we've had, our referrals went up by 40%.
So you know we feel good about where we are and we think again there will be cash flow neutral by Q3 and at that point we’ll start looking at how the market is and we’ll certainly start looking at opportunities to perhaps make some small acquisitions. But the market will tell us what the opportunities will be at that time.
Okay, very helpful. Thank you, guys.
Thank you. And the next question we have will be from George Melas with MKH Management. Please go ahead.
Thank you. Hi Josh! Hi Marco!
Hey George! How are you? I hope you are well.
All is well, yes, thank you. I have a question on the segment EBITDA, right. It seems that mortgage – or I look at it on a sequential. Mortgage in the last went down, the tech was roughly flat and the insurance in the title was up slightly. But the real-estate brokerage division, the EBITDA, segment EBITDA came down quite a bit. And my calculation suggests that the gross profit was relatively flat sequentially. So that tells me the OpEx went up. And I understand your adding a lot of recruitment sort of talent and resources there, but I'm just trying to see if there’s something else.
Yes George, great question. So it's a combination of several things. In Q3 we had increased our marketing. We had some marketing programs already scheduled and some events already scheduled from Q2 to Q3 and so that was an increase in expenses for marketing. We also increased our recruiting team. We believe that as we had planned for Cap4Life and Free4Life and some of the program we already launched in the beta for that program, so that's there.
Third, we had – in Q1 – in Q2 we had 13,300 transactions. In Q2 we had approximately 12,000. So that 1,300 transactions, you know once you hit breakeven EBITDA, that additional transaction, there's a significant amount of money that goes down to the bottom line, right. And so that was roughly, that was roughly $500,000, $600,000.
So the combination of those three factors is what caused the decrease in adjusted EBITDA. It’s the decrease in transactions and some one-time expenses in marketing in Q3, which would not have gone forward and then increase in recruiting.
Okay, so volume has an impact. Okay, yes, yes.
Yes, absolutely. Volume has an impact, especially once you’ve passed the adjusted EBITDA breakeven, right. Because if you remember what happened between Q1 and Q2, you know with the increasing gross profit between Q1 and Q2, we deliver 75% to the bottom line, right, and so it has a significant impact. And that's why as we continue to grow our business and gross profit, then it will have a significant impact to increase our bottom line as well. So that was pretty much the negative effect.
Okay, but on an absolute basis, the relative brokerage OpEx was up sequentially, right. So some of it I can see increased marketing, some of it is the recruiting team. But for the OpEx the volume does not really impact that. That's so – I feel like there's still something missing.
Yeah, that's correct. There was an increase in operational in terms of we hire a few people as we grow. Again we have a significant marketing event [inaudible], which is a significant marketing event for us in Q3, just in a marketing expense. So those expense were a one-time expense in Q3. We don't have that expense in Q4.
I think as you, we get into Q4, you're going to see that that will increase. Even transactions stay somewhat same. Now again, if there's a decrease in transaction, it’s going to have a negative effect, right. It's just the reality at a breakeven point, but those additional expenses in OpEx, they are for the most part one-time expense for the quarter.
Okay, great. And do you feel pretty confident about the season, the cap changes, increasing sort of gross profit by $4 million to $5 million per year of course, right.
Yes, I think your question – you're breaking up a little. I think your question is – can you repeat your question? I want to make sure I heard it correctly.
Is the increase in the gross profit generated by the change in the fee and the change in the cap, right?
Yes, so there are a couple of factors in that increase in fee, right. One factor is just basically a $50 increase in every transactor, right, and so you can see how many transactions we've done. You can multiply by 50 and you can see that impact there.
The second impact is based on changes, increasing from 1,200 to 1,500. We roughly have well between 1,200 and 1,500 agents that cap every year, cap in this year and so – and those agents when they cap, they typically do a lot more than 12. So we have between 1,200 and 1,500 agents, times three transactions, times the difference between $550 and $150, you arrive at a number right, that, we to do that.
And then they also increase in agents, increase in annual fees. When you put the three things together, we feel that the assumption of $4 million to $5 million is very reasonable.
Super! Great, I appreciate that clarity. Thank you very much Marco.
Thank you, George. Talk you soon. Thank you.
Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over Josh Harley for any closing remarks.
Thank you, operator. Of course, thanks to everyone who joined our call today, and of course for your continued support. We are extremely proud of all we've accomplished and we continue to work diligently toward achieving our collective objectives and adding greater value to our company for the benefit of all of our stakeholders.
Have a wonderful evening and of course, have a wonderful and happy season - holiday season! And thank you again.
And thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.