Fidelity National Information Services, Inc. (FIS) Earnings Call Transcript & Summary

Hello, everybody. So thanks for joining us. We hope that you're all staying safe. This is Jason Kupferberg. I'm the payments processors and IT services analyst here at Bank of America. We're very excited to have FIS Management with us here today. Specifically, we have CFO, Woody Woodall, and we also have Nate Rozof, Executive VP of Corporate Finance and Investor Relations. So thanks for joining us, guys. We hope you're doing well.

I wanted to maybe just kick off, if we think about kind of recent performance of the business, you guys have been pretty good about providing updates since the onset of COVID. I know you've given us some segment level performance data for the month of April as part of your earnings call. Curious now that we've turned the corner into June, can we get an update on how the segments performed for the month of May?

Yes. First, thanks, Jason, for having us today. I really appreciate taking the time. If you look at it, we certainly saw improvements in the back half of April. We've continued to see improvements through the month of May. Being June 2, really second work day of the quarter or the month, we don't have specifics around May from a closeout perspective, but I can tell you, we certainly saw volumes continue to trend positively throughout May. I would tell you, both Visa and Mastercard have delivered or put out some incremental information regarding their volumes. I would tell you, our merchant volumes are lining up very similar to the improvements. Both Visa and Mastercard have shown throughout the end of April through mid-May for Mastercard, and, I guess, Visas came out yesterday, and we were really quite on top of those trends. So very similar in terms of trends. I think we'll continue to see improvement in those trends through June as restrictions and recovery continues. But that's just a little color right there. It's a little early for us to get into the specifics of the segments mid-month right now.

Okay. Yes. No, I can understand that, but certainly encouraging. It sounds like there's -- the pace of acceleration just seems to be picking up, I mean, based on Visa data, which did take us, like you said, through the end of May. So that seemed to be kind of the biggest takeaway, and it sounds like you guys would echo that based on what you're seeing in your business on the merchant side.

I think that's right. I think the trend lines are encouraging. We are certainly seeing, in certain markets, restaurants begin to open back up even at partial capacities. You're seeing people wanting to get back out. You're seeing retailers open up with enhanced protocols around being able to shop or being able to go in the retailer, but people are spending some money. So certainly are encouraged by the trends and hope they continue, frankly.

Yes. So what about the banking side? What have you seen there recently? I mean, I guess I'm thinking mostly about the nonrecurring part of banking. Obviously, there's some transaction-based revenue in there. There's some project-based revenue in there. Just any color, even if it's just qualitative on what has been transpiring there?

Yes. To kind of reground you on banking, we've always talked about it being about 83% recurring in terms of the revenue base. The remaining 17% being professional services, primarily, and a little bit, a sliver of license sales. Within that 83%, about 13% is transaction-centric. Traditionally, we've considered that recurring because we've never seen anything like COVID before. We tried to break it down and add some incremental color. Those would really be transaction-centric revenues within banking around credit card issuing, debit card issuing and our debit card network, primarily. Those are going to be subject to consumer spending as well and consumer-centric habits. So it certainly had some impact in the first quarter and will certainly have some impact in the second quarter as we tried to outline back on the call about a month ago. But certainly, you're seeing improving trends there as well as consumer spending, both on the merchant and on the issuer side are going to have similar characteristics, maybe not the same volume levels, but certainly similar characteristics.

That's helpful. That's helpful. So maybe just to dive in a little bit more on merchant. And I was curious, if we think about the 75% of your e-com business in merchant, which is not related to travel. You talked about that on the Q1 call performing very well. Can you discuss a little bit about some of the specific e-com categories that are showing strength? And I would also be curious just to get some perspective on the difference in unit economics that you may be earning from e-com versus card present?

Yes, certainly. The digital channel within e-com is staying very strong. This is, again, since the travel component that we talked about. We saw even growth within the first quarter and April time frame of about 80% and certainly a bright spot. That would be really supporting digital streaming, for example, and digital gaming, which were really, really high over the past several weeks, as we've talked about. Outside of digital, and outside of travel and entertainment, e-com was up about 30% in our broader normal retail channels, in our traditional channels. We also had, as we talked about, North American grocery and drug up about 20%. So there's certainly some high spots and some bright spots. It continues to be offset by some of the broader retail and the traditional retail and some of the travel and entertainment flowing through there. With regard to some of the economics, the e-com transactions are quite profitable. Certainly, the cross-border transactions that have been negatively impacted by volumes are probably some of the most profitable transactions. So that tries to give you a little bit of color what's going on there. But e-com, overall, I think, will continue to be a strong performer. I think it will continue to be a differentiator for us long term. And certainly, it's something that our retailers, our traditional retailers are asking more and more about as they try to figure out how to operate in a post-COVID or within COVID environment, which may be the new norm.

Right, right. So as we've seen more states continue their reopening phases in recent weeks, and I know your home state was one of the first ones. Have you guys seen any significant reversal in the e-com behaviors that took hold while the lockdowns were more prevalent?

Yes. I wouldn't say we've seen a reversal in e-com. But we have seen some of the traditional channels come back, if you will. Seeing more people spending on restaurants, more consumers are allowed to eat out, even at restaurants at 25%, 50%, 75% capacity as we phase in a more normal set of reopenings. We also are seeing spending at retailers coming back, walk-ins to stores, walk-ins to various communities and driving spending in those traditional retailers. So I wouldn't say we've seen a backstop or a backstep in e-com, but we've just seen overall volumes continue to move forward. Grocery continues to be high. People are still doing a lot of pickup orders as well and curbside pickup. So that's helping supplement some of the restaurants and the traditional restaurants and still giving them some volume in the current environment. And then as we've noted, travel and entertainment continues to be negatively impacted as expected.

Right, right, right. Has that gotten any better at all? I know it's obviously faring far worse than the overall segment. But is it -- has it bounced off the trough levels, at least, on the travel side?

Yes. I think you've seen just a little bit of travel coming back. I believe we've seen the trough. I would say, it's still pretty low. We have not seen a significant rebound by any fathom of imagination. It's still relatively low, but we are certainly seeing some level of travel again, some transactions on the travel side flowing again. So again, it's very low.

Understood. Yes. Yes. Yes, I don't think anyone's holding out great hopes for a significant rebound in that vertical anytime soon. If we just stay in the merchant segment for a minute, I know that the legacy Vantiv business had a decent amount of exposure to department stores. Obviously, a sector that's been pretty hard hit. Can you give us a sense of what percent of merchant does come from those department stores? And is bankruptcy risk in that sector something that you're worried about? I know there have been some filings out there. And so the fate of some of these merchants, I guess, is a bit up in the air, but would love your perspective on that topic.

Yes. I think the health of our merchants is going to be critical longer term. I think the efforts that the U.S. government and other governments have put in place to try to supplement consumers at the end of the day between paycheck protection and other things that are also trying to help the merchants themselves continue to operate or continue to bridge operations and the environment is going to be important. I think consumer spending is continuing to move online. We expect the pandemic to accelerate this trend. I think we're positioned pretty well as the global leader in e-com, and omnichannel provide these capabilities, particularly to department stores and retailers where we do fund or provide full omnichannel capabilities. On the bankruptcy risk itself regard to the larger department stores, for example, the risk is pretty minimal because, typically, department store purchases, the goods or services are picked up at the time the transaction is made, so there's really minimal chargeback risk that we've seen for potential unfulfillment of the merchant obligation. Because usually, the customer takes the handbag, the pair of shoes, the shirt or whatever they're buying at the time. Our traditional merchant business does include department stores. Our traditional merchant business generates about 50% of our total merchant segment revenue. We really don't talk about department store specific for -- frankly, for competitive reasons. We continue to monitor bankruptcy risk, as I talked about or started with the answer to this question. But we haven't seen a significant change or significant move in sort of our overall customer base help in terms of bankruptcy. We continue to look at certain verticals heavier than others. Obviously, the travel verticals, we're looking and monitoring probably more heavily than others. As we look at refund activity in the airlines, for example, has been pretty heavy. And some of the stress and pressures on the airlines have been pretty heavy. So we certainly continue to monitor the health of those merchants on a go-forward basis.

Yes. And then just on that topic of chargeback risk. Do you feel like we're past the riskiest period? Or is this something that could still flare up and potentially be an issue over the next quarter or 2?

Yes. I believe the worst is behind us in all candor. We've seen a lot of backstopping and standing up of the higher risk areas in terms of trying to make sure they are continuing to be viable. I think a lot of the sovereign entities are backstopping, particularly some of the airlines, to make sure they're doing well. We have processed a lot of refunds, as you can imagine, over the last 8 weeks or so. We are seeing some new processing or new bookings, as we talked about on airlines, albeit a pretty small increase. So to the extent those new bookings come online, you're reducing your sort of credit risk or chargeback risk every day. So I do believe kind of the worst of it is behind us, but we'll have to continue to see how the economy rebounds and whether or not we see some spike of cases or we have to see some potential lockdown again in the fall or in the winter as flu season comes back around. We'll just have to see. So my gut, Jason, is the worst is over. The information and trends we see internally says the worst is over, but we'll just have to continue to monitor.

Yes. So maybe just turning to banking, to that segment for a minute, which I thought a lot of the commentary you had coming out of the Q1 earnings call, was certainly quite upbeat. And I wanted to see if you can give us an idea of how we should start to think about the organic growth potential of that business as we head into next year. Because presumably, you're going to have recovery in the nonrecurring portion of the business, and you touched on that a little bit already. And then clearly, you've had these next-gen platform wins in both Q4 '19 and Q1 '20 that should be a tailwind as well. So I would appreciate any thoughts on the growth there as we think about next year.

Yes. As you've heard us talk on the last 2 calls and really probably the last 6 or 7 quarters' worth of calls, we're pretty excited about banking and what's going on there. We really started investing heavily a few years ago. We saw an opportunity to really break through, if you will, in terms of creating a new modernized platform built digitally or cloud-native from the ground up. And we have experienced strong acceleration of revenue growth in a pre-COVID environment in the banking business with continued line of sight to continued acceleration there. New sales have grown double digits year-over-year for the past 9 quarters. Our backlog is up 6% year-over-year, Q1 '20, on an organic basis. We're pretty pleased with it, and we think we can continue to see acceleration there. I think you saw that group grow from 2 to 3 to 5, and we're looking at closer to 6 this year pre-COVID, and feel very good about continue to see that accelerate. Demand, so far over the last 8 to 10 weeks, has been solid in banking. We've continued to see decisions being made. We've continued to see adoption of the digital channels where you're seeing more and more customers utilizing those digital channels versus going to the branch. So that's been a pretty hot area from a sales and pipeline perspective. The financial institutions continue to embrace next-generation and cloud-based tech. I think it helps them with continuity, helps them with disaster recovery and it gives them more flexibility compared to the legacy on-prem systems. And I think that's really been an area that has been enhanced in a COVID world as they look at their own infrastructure and where they want to be on a go-forward basis and where they want to be for the next 3 to 5 years. So I think you continue to see accelerating growth there into 2021, not providing specific guidance, because at some level, it's going to depend on what COVID does on the consumer spend standpoint. As we talked about, a portion of it still has some transaction-related revenue, but we do believe it's going to continue to accelerate. We've had several large wins that we've talked about. Those continue to be on track for delivery. Very excited about being able to deliver those remotely. And banking is doing pretty well right now. Our banks are certainly healthier than they were at our last major economic pullback, which was the '08, '09 time frame, and the banks are just positioned differently here in a health crisis versus a financial crisis.

Well, let me pick up on that, because I think you raised a couple of important points, and I wanted to delve in on some of those next-gen wins because you had 6 big ones here over the past 2 quarters. So I mean, are we seeing almost the domino effect of sorts where other similarly-sized banks potentially accelerate these investments and these decisions, but they don't fall behind their competitors?

Yes. I don't know if 2 quarters create a domino effect, but I can tell you, I'm very pleased with the execution of 6 large wins on MVP or related to MVP in the last 2 quarters. The pipeline is robust. Right now, around MVP, I think you're going to continue to see wins be announced over the next several quarters on this front. So I'd love to get a few more quarters to call it a domino effect. But I can certainly tell you that getting through that first signing, the pipeline has accelerated in terms of its move from pipeline to closed contract. So I'm very positive on it right now. I'm pretty excited about it. You saw me lean in really heavy on the first quarter call regarding it because I'm pretty excited about it. I'm generally pretty conservative on this front. So I don't know if I'd call it a domino effect yet, but I can tell you, 6 inked wins on this new platform or related to the new platform, is certainly very encouraging in the first couple -- last quarter of last year and the first quarter of this year.

Yes. Well, the commentary certainly sounds very upbeat. So maybe can you talk a little bit more about kind of sales cycles and how those are going in this COVID world? And maybe as part of that, just discuss the competitive process that you went through for the 6 new next-gen wins over the past couple of quarters, how many of them were takeaways versus going from in-source to outsource, et cetera? And then maybe just touch on who the primary competitors are right now that you're seeing in the large FI market, not sure if that's changed at all given the macro backdrop?

Yes. Four of the 6 were really in-house-developed or in-house deployment to outsourced, fully outsourced. The other 2 were more competitive takeaways in the marketplace. I would tell you that the most significant competitor in this space, as we've talked about a number of times, is really in-house development or the IT team that is doing IT deployments, in-house deployments. The banks continue to choose FIS because of the deep insights we have in this space. The architecture itself has been really a differentiator in how customers have come to embrace it being cloud-native and with open API-type architecture. Clients have continued to make investments right now and maybe have even potentially accelerated some investments right now. As they've looked at the inflexibility of their infrastructure and what modern banking platform can do for them on a go-forward basis. With regard to sales cycles themselves, it's funny, because I think some of the access to the C-suite level and some of the heavier decision-makers out of the process may even be more open and robust in COVID or in a remote working environment than they were before, where people are not traveling right now. You can find 30-minute hour windows, et cetera, that are easier to find without the commute and the logistics flowing around the edges for some of the executive team that's traveling. I can tell you, for example, myself, personally, I'm not traveling very much anymore, traveling 0, basically, over the last 10 weeks. I've been able to connect a lot more live via Zoom or via Teams, et cetera, and actually connect with people. So sales side, although different, still remains pretty robust.

Okay. Okay. How long is the average sales cycle for one of the next-gen opportunities, typically?

Yes. You got a tale of 2 cities here, right? We've had 1 of those wins that was probably 1 year to 18 months in the making, Jason, which would tell you, the larger bigger deals that are encompassing more components, traditionally, have taken longer sales cycles. We had another 1 that connected with us. They had actually signed with, or were about to sign with another almost a start-up type provider that ultimately couldn't reach the capabilities that we had. We ended up not even RFP-ing on that. They came back after looking at the discussion of that competitor and came back and said we need to regroup. There's nothing there. It's only slideware. Let's really dig into your architecture, really dig into the software and the application layer and see what's there. They did that over the course of about 60 days. And then within a quarter, we signed a transaction. So we've got a bit of a tale of 2 cities here, but I would say, generally, these are longer sales cycles, but we have seen some shorter ones in certain instances as well.

That's [ great product ]. So I don't want to forget about the Capital Markets segment. It's obviously quite material at 20% of your total revenue, had a very strong first quarter. I think you had indicated that growth in the month of April was more like flattish. So that was a bit off of where we were in Q1. Maybe you can just walk through some of the growth drivers in that business, any recent trends, near-term pipeline?

Yes, sure. I think it's -- the longer-term growth algorithm is going to continue to be driven by increasing the percentage of recurring revenue that we have while managing license sales appropriately as we transition from a licensing model to a SaaS model. I can tell you since we bought it in 2015, there's significant structural improvement in that business, where in the 2008, '09 horizon, that business was down 10% or 15% year-over-year. And this year, we were up in the first quarter and even flattish in a very shocked environment in April. It still has some impact on nonrecurring and professional services. That's what really drove some of the trends in April. I think we have seen some level of improvement there in May as people figure out how to work remotely and to consume services, professional services, et cetera, on a remote basis. So we probably have a little bit of an improvement from where we were in the first quarter call, only slightly though, as we continue to see some impact on the nonrecurring basis. But business, a lot healthier than it was several years ago. We've certainly seen a continuing trend of moving from a licensed model to a SaaS model. We think that trend continues and really positions us well as we go into 2021 and beyond to continue to accelerate organic growth there.

That's helpful. That's helpful. So now if we sort of roll together the thought process around all 3 segments collectively and we reflect kind of pre-COVID, FIS was targeting overall corporate-wide organic revenue growth in the 7% to 9% range, kind of moving through that as we looked out to 2021 and 2022 proceeding through that range. So given the continuing appetite that the banks seem to have for the investments in the next-gen solutions, is that kind of 7% to 9% range still attainable? Assuming, obviously, that there is some general economic recovery, and we don't take some big step back due to a resurgence of COVID.

Yes. Let's just -- let's put COVID to the side for a moment, if we can, because that's been the biggest uncertainty and the biggest thing to try to delve through. If you do put it aside, we announced on March of last year that we thought we could get into the 7% to 9% type growth in '20 to '21 -- 2021 and beyond. And I would tell you, we think we still can. Revenue synergies continue to be robust even in a COVID environment. We've seen some nice wins there. We continue to see the teams executing on our revenue synergy plans as well as our cost plans, but our revenue synergy plans on the Worldpay side. One of the things that was misunderstood or a lack of conviction around was our ability to grow banking faster when we started talking about the transaction in the 7% to 9% this time last year and our ability to improve capital markets growth rate as well. So yes, in a non-COVID world, we feel very good about being able to grow in the 7% to 9% range over the next several years with revenue synergies, with strong execution in the e-com world as well as the broader merchant world, and then a continuing acceleration in both capital markets and the banking business. So yes, we still feel very good about it. The business is healthy right now, setting COVID aside.

Okay. And I know when you and I spoke a few weeks ago, we did spend some time talking about margins. So I wanted to maybe revisit that topic as well. And specifically, how we should maybe think about potential absolute levels of margin in 2020 and 2021 compared to what we would have thought pre-COVID. I mean, for example, we were modeling just over 46% EBITDA margins for 2021 prior to COVID. And so what are sort of the puts and takes now as we think about cadence of margin expansion this year and next, and then where that potentially lands us in absolute terms?

Yes. We originally were looking at margins of about 300 basis points of improvement this year or about 44% of a 41% or 40.7%, to be accurate, in 2019. COVID obviously impacted us, is going to impact us on the margin front as those transaction volumes are coming off at pretty high margins, call it, 75% to 80%. We've taken short-term actions to try to help that in 2020. Some of those short-term actions will become more permanent. We were also getting longer-term cost actions from a synergy perspective that will obviously help permanently to drive 2021 and beyond. We tried to give some color in the first-quarter call that we do anticipate at least second quarter margins to be down. We also tried to give some color based on our expectations, and those have continued to get slightly better. As we've seen volumes improve, that we would anticipate overall margins to be up in fiscal 2020 compared to that 40.7% number that we exited last year at. So we also believe looking forward into 2021, it's certainly going to help us accelerate as we continue to try to pull synergies forward as quickly as we can and take some of these short term actions, turn them a little more permanent as well as watching volumes return.

Right, right. And so regarding that dynamic for the second quarter in terms of the adjusted EBITDA margins being down year-over-year, I know some of it is because of, obviously, the volume drop on the transaction side, like you mentioned, has high incremental margins. But you also have the timing issue related to the $90 million or so in tax filing related revenues. I wasn't sure, is that revenue also very high margin? And if so, how should that inform our view on maybe where margins [indiscernible] based on where the tax filing deadlines are?

Yes. It's a good question, and it's a little unique for us compared to maybe others in the market, where the change in the tax filing deadline from Q2 into Q3, from April 15 to July 15, is certainly going to have an impact on us. We talked about it, about $90 million of revenue impact. It certainly has a pretty high-margin overall impact that will further put pressures on Q2 margins. Obviously, it should swing back in Q3 as tax filings are made with high margins coming on in Q3 that should help Q3 margins. And then having really 0 effect on the full year of 2020 is our overall expectation. So yes, I think it's a good point to think about as people look at second quarter versus third quarter and trying to think about this year, but should have really 0 impact on the full year of 2020.

Right, right. Yes. That is the important conclusion there. I know that this past quarter, you updated the timing to achieve your target leverage ratio. You're now looking to do that before the end of next year. Once you get there, we would assume that M&A is 1 of your primary priorities. So maybe you can just talk about whether or not that's a fair assumption. Would that include the prospect for large-scale deals even?

Yes. I think after we achieve our leverage target, we would certainly shift more heavily to an M&A focus. We continue to look for high-growth assets and advantaged segments of the market, structurally advantaged segments of the market. We announced our venture program that continues to have us looking at smaller tuck-in activity and smaller fintech activity in the interim. That was announced at $150 million over the next 3 years. If the right deal came along, we would certainly take a look at it, given trying to -- a focus of trying to drive long-term shareholder value and run our evaluation process in the manner we always do. But certainly, M&A has always been a significant component of our strategic growth initiative, and we think it will continue to be a part of that on a go-forward basis. With regard to the large-scale deals, we not only look at current leverage profile, we also look at where we're at on the integration of Worldpay. We don't want to take on another large-scale deal until we feel very comfortable. We've gotten Worldpay right. We feel like all the pieces have been put in place properly and that we're getting the results of the last transaction before we move to the next transaction. I think that's really important for us. I think it's really what's given us some permission to continue to do larger scale M&A, is our ability to digest these transactions and drive the shareholder value out of them over a course of a year, 2 years or whatever it takes. But we're certainly going to continue to look at longer term, larger scale M&A as a component of our strategic growth profile.

All right. That makes sense. And unfortunately, we're out of time. Great discussion, as always, with you Woody. So I appreciate you joining. And I hope you guys stay healthy, and we'll talk soon.

Same here, Jason. Thanks for the time. I appreciate it.

All right. Take care. Bye-bye.

Bye.