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

Thanks, everybody, for joining us late in the afternoon. Again, I'll say, for those of you whom I've not had a chance to meet or you just showed up, I'm Dan Perlin, I head the fintech practice here at RBC. And I'm delighted to have my good friend, Nate Rozof, joining us today with FIS. So thanks so much for being here.

Thank you, Dan.

And I forget your title now. You're EVP, Corporate Finance, IR. I mean what the heck?

Yes. A couple of things.

Any more you want to add to this thing, right?

I'll let you know.

Good. Good. It sounds like it's on its way. So thanks again for being here. You've always been a friend of the conference, and you've always been very supportive of me. So I appreciate your time.

Again, appreciate you inviting us. Appreciate you having us. It's been a good friendship. I look forward to continuing it.

Cool. Cool. I agree with that. So let's just start bigger picture, and we'll funnel our way in. When we think about the demand environment and what you're seeing as you look across your organization, it's quite global. You touch a lot of things. Maybe if you could just address in the context of where we are today, what you're seeing across the operation, and then we'll go deeper from there.

Yes, absolutely. So what we're seeing in terms of the macro environment and how it's affecting our end customers is really status quo, right? So from the banking perspective the banks have begun or the financial situations have begun an upgrade cycle over the past few years. That continues, the macro challenges notwithstanding. And so as we see rates potentially rise, that's actually a tailwind for banks and bank spending. So that's not helpful. On the merchant side, we're continuing to see pent-up demand from consumers flow through with strength in categories like travel and airlines, which just seems to continue to defy gravity, pulling cross-border spending higher. And capital markets is just continuing to chug along. So I think we're all watching the macro environment with a degree of caution. We haven't seen demand challenged from the macro at this point in time. We haven't seen the consumer roll over. We think the banks are, will need to continue to upgrade. So from a top line perspective, I think we feel pretty good. We'll be cautious, but we feel comfortable sitting here today.

Good. Any discernible differences in terms of geographies, domestic versus international as an example. And then in international, anything worth pointing out?

Not materially yet. We saw a bit of weakness in -- within SMEs in the U.K. But it's been a month or 6 weeks. So it could be a blip. It's hard to tell if it's a trend. We haven't seen the Jubilee data through yet. So net-net, no, I think everything has remained fairly consistent, with the exception of the thing that's really stood out to the positive over the past month, 6 weeks, has been travel continuing to get stronger.

Yes. I feel it. I see it, and I desire it. So I'm empathetic to that, for sure. So let's talk about some of these investments in modernizing the platform and future-proofing FIS in a lot of ways. So you've done a lot in the past 5 to 7 years. It may or may not beg repeating, but one of the things it's done is it's driven up the CapEx as a percentage of revenues. And so what I wanted to know was, one, on some of those bigger bets that you were making early on and where we land today, which ones have been the most successful? Which ones are really paying the dividends today? Which ones are going to be drivers of future growth over the next couple of years, too? I'll start with that.

Yes, It's a great question. Really 5 years ago, and I'll keep it short, the goal and the intent of the journey we embarked on was really rearchitecting or replatforming FIS from a legacy batch mainframe type of architecture and technology stack to a cloud native set of, not only infrastructure but also applications, really driven by multiple things, not only efficiency, resiliency, the things that our clients demand, but also client eagerness to be able to roll out new products and capabilities quickly to be able to meet their customers where they are. And sitting here today, we've now largely deployed many of the most significant platforms that we invested in. PaymentsOne has been a success for our issuing business. Obviously, it saw pandemic benefit, but it's been growing double digits recently. That stands out for us. Digital One has been very strong for us with large financial institutions. That's an omnichannel solution. So what that means is you plug it on top of the core to run the mobile app and the online banking for the bank. Code Connect is kind of the integration layer that ties it all together. That's proven helpful and as banks want to pivot technologies that's worked. And modern banking platform is really just kind of coming to market. So across the banking space, we've got issuing core, and I didn't talk about wealth but wealth and retirement technology. Really, we feel like we're at the front of the product curve as the upgrade cycle is beginning to really kick in.

Yes. No, I mean when we look at the competitive environment, it does seem like you guys are in a good position. I did want to ask you that. But before I jump to that, where are we in the CapEx cycle of all of this, right? Because it had been pretty steep and quite frankly, got pretty high.

It did. So I think CapEx was probably 9% of revenue last year. We think it peaked in the first quarter and actually, I think, poked above 10%. We're expecting CapEx to be coming down as a percentage of revenue from here, think we're forecasting 8-ish percent, 8% to 9% for full year '22. And it will continue to step down from there. The target is to get CapEx back down to the, call it, 6% of revenue range. We're expecting CapEx to -- in absolute dollars to remain fairly consistent or potentially growing a bit, but percent of revenue will come down. We really feel like with the solutions we just talked about, they're largely in market. We're continuing to deliver incremental components, but the core solutions themselves are largely complete.

Okay. So now on the competitive side, you've spent all this money, right? You're on the other side of the mountain in terms of spending. And quite frankly, the demand environment seems to be much more favorable for the products that you bring in the market now. And there was some concern early on that there were some competitors that were a little more digitally native in that context. So maybe outline as you think about wherever you think you have the most competitive advantage that exists today based on some of those investments that you've made.

Yes, it's a great question. Our #1 competitor is in-house, the bank's own IT department. Historically, banks have built those applications themselves to run them in-house because they wanted to customize them. That's no longer feasible. Having these new solutions that are cloud native that they can implement easier, digest easier, pick the components they want, pay as they grow is critical to competing with strong inertia of a significant internal CIO, CTO development staff, I think relative to the smaller competitors where you were really trying to get to, the total side of the question.

Could you sense that?

Maybe. There are some great companies in market, right? And what we've seen is they've developed strong solutions that meet a particular niche of the market, whether that's a specific channel like the mobile kind of online market where we've seen good competitors or it's a piece of lending workflow. But in terms of the ability to add new breadth core, whether that's retail core wealth and retirement issuing really the ability for someone to deliver that type of a complex solution, we really haven't seen much success from those smaller players yet.

Yes. That's good to hear. That's good to hear. I mean there's -- all good businesses have to reinvent themselves over time and the ones who are really successful do that. And that's -- it seems like what you guys decided you were going to do, as I said, like 7 years ago. So you had the foresight to do that was pretty positive. Let's talk about the guidance a little bit, just to get that out of the way. The organic revenue growth, I think you were calling for 7% to 9%. And so what I want to be able to leave here with, with investors is what are some of the things that are giving you the confidence as you gave that guidance. Also in the context of maybe where we sit today, where there's been a lot more consternation in the market and quite frankly, around rates and inflation, that we should feel pretty good about the top line growth numbers.

Yes. I think in terms of the top line, we've got more tailwinds than headwinds sitting here today. As we look at a segment by segment level, we're expecting 10%-plus growth in Merchant, 9% to 10% growth in the second quarter, really driven by continued pandemic recovery, and that seems to be continuing to play out. As I mentioned, we haven't seen the consumer rollover. Travel and airlines continues to improve. Within our Banking segment, we're expecting upper single-digit growth for the full year, mid-single digits in the second quarter, which is really the most difficult comp quarter of the year, driven by continued progress of this upgrade cycle. So we've got some onetime items to lap, primarily related to the pandemic. PPP, as a for example, we had some large term fees in the second quarter of last year. That will affect compares in 2Q and, to a lesser extent, in 3Q. We'll work through those. And so we expect kind of banking revenue growth to be accelerating in the back half of the year to support that outlook. Last but not least, Capital Markets continues to benefit from the transition to SaaS-recurring revenue-based pricing. And the products they've brought to market, again, as an end-to-end solution versus niche point products, in this environment, that's resonating well with the clients. So end-market demand feels strong. The products that we have in the market feels strong. The competitive environment feels favorable. And the consternation around inflation is actually ironically more of a tailwind to revenue for us than a headwind in that in our Banking and Capital Markets businesses, we do have inflation escalators relative to a number of those products, where, as we anniversary the contracts with those clients, the inflation escalator will increase the pricing on those products by 2% to 6%. So that's helpful. In Merchant, about 45% of our revenue is based on volumes. As consumers spend more with inflation, we're getting paid on that volume, and that's helpful. I think the primary risk or headwind to revenue at this point in time won't affect organic revenue growth, your 7% to 9%, but FX is certainly becoming an increasing pressure to the nominal or dollars of revenue on a go forward.

Yes. I mean we've seen the dollar strengthen. We were trying to measure it from every company's -- when do they report? Where does it stand? And there was a period there where it was actually looking like it could potentially be positive like the tailwind to you guys. That has quickly changed, quickly gone. So you're not alone in that regard. But how do we translate that set of commentary to how we're thinking about kind of EBITDA trajectory?

Yes. So we guided to 50 basis points, I think, of EBITDA margin expansion for the year. And really, that includes a few key assumptions that get you there. Number one is the revenue headwinds I mentioned for Banking, those create margin headwinds in the second and third quarter as well. So we are anticipating Banking margins to bottom in the second quarter and expand through the year. Really, we will have lapped those things by the fourth quarter. So fourth quarter Banking margins, we're expecting to be strong relative to the other 3 quarters. In Merchant and frankly, across the business, we typically see a seasonal ramp in margins through the year. The first quarter is the lowest margin, Merchant, as a for example, right? Following the holiday season, the fourth quarter is the strongest. So that creates opportunity for us as well. So from a margin perspective, I think the core assumptions we made that drove us to our margin guidance, feel good about those. I feel like those are all intact. I think the biggest risks we have to the margin for the year, probably more to the back half given the trends we're watching. FX as that continues to flow through, that does create some pressure on margin as we're now more heavily weighted to employment in the U.S. versus abroad. Inflation affects our business as well. That's both wage inflation, which we obviously called out when we provided the guidance. And we're seeing some of that inflation broaden out across the economy. So that is something that we'll have to monitor. So what I'd say to you guys today is right now, we're seeing risk increasing. Where we're really focused, and I think we'll probably spend some time here, you may want to follow up, is around driving free cash flow so that we can continue to buy back FIS. One of you today asked me, will we protect the margin at the expense of revenue? And I think based on where we are in our product cycle and the investments we made, the answer to that is no. We've made significant cost reductions related to integration, et cetera. Right now, FIS is about bringing new product to market, capitalize on the scale we have and a time when scale is going to matter a lot. So we're going to be focused on revenue growth above protecting the margin. And then driving cash to return that to shareholders and drive value to shareholders.

Yes. So what I'm hearing there is the top line trajectory feels like it's got more positives than negatives, even in the current backdrop, which is quite positive relative to a lot of other companies that we follow, but also in other industries. And on the margin side, the trajectory can hold, all else equal, unless a couple of these things get a little bit worse, which right now, they're trending in that direction.

Correct.

And you're really not going to protect that at the cost of revenue growth because you just spend all this money to drive revenue growth.

Exactly.

Okay. Then we go to the capital redeployment, which is your point about free cash flow. So although you may not be able to be protectionary around the margin, what about earnings?

Yes.

Right. You've put in a pretty big buyback sort of commentary both this year and next year. So maybe if you could bring us up to speed on that.

Yes. So we're focused on driving free cash flow conversion. Bringing the CapEx down as a percentage of revenue was one lever that we're using to do that. Through the remainder of this year and '23, we intend to deploy that free cash flow into share repurchase, which should help earnings. And so that is the intent. I think as we think about positioning FIS for post-recession, reducing or taking down close to 15% of the market cap creates the highest probability. One, it's the lowest and best use of capital today. But two, it creates the highest probability of us having a real powerful currency as we all start to sift through the wreckage 2 or 3 years from now.

Yes. So you're still committed to 3 billion, I think, was the number for this -- really the second half of this year.

Second half of this year, correct.

And then $6 billion in 2023. No change for those numbers.

Correct. No change.

Yes. So this idea of sifting through the carnage is an important one, and we've had a lot of conversations about this. We had a lot of private companies here today.

I'm sure, yes.

And the valuation reality hasn't totally set in yet. In fact, what we hear more of is that the Boards of a lot of those companies are -- they're not seeing enough proof points to just go ahead and do those big down rounds. What are you prepared to do? What are you seeing? What kind of conversations do you guys have internally about when these opportunities, if ever, present themselves?

We're focused on investing in the highest growth segments of our business, right? And positioning FIS to be able to deliver more value to our clients over the medium and long term. So you have to look at where is the market moving? Where is it going? E-commerce is an obvious answer in Merchant. What drives e-commerce, geographic expansion, the ability to drive incremental revenue from merchants through auth and fraud, which is AI, data analytics. On the Banking side, it's how do we unlock banking to drive embedded finance through our distribution channels? So where we can identify a technology or an asset that we can push through our channels or unlock our assets to drive through a new channel, that's where you're going to see us focused. And so a lot of those small companies that you're meeting with are probably more on the great asset side of the house where it might be more -- where it may make more sense a few years from now to buy than build. Today, we're building and buying back stock.

Okay. That's the message. I got it. Very clear. So let's go into each one of those segments just a little bit deeper. In Merchant, you've had this weird dynamic, right, where we've had periods of time when there was these rebounds in the economy. And everyone said, we didn't participate quite as much. And the reason for that, again, is because you have a lot of these big enterprise clients and it's fixed fees per transaction. You already alluded to the fact that there is inflationary benefits on average ticket as long as it doesn't push the consumer out of the world. But what you didn't say was that there's a lot of frequencies that are also increasing potentially, at least that's what we're seeing. I wanted to see if that's what you were seeing in the transactional data. And why would that be a big benefit for what I think is like, I don't know, 45% of your business.

That's right, yes. So our -- and alluding to our enterprise clients, those are going to be large grocery store chains, drug store chains, gas stations. Where the consumer tends to move, they're spending in times of economic stress, right? They go from discretionary to nondiscretionary. And what we historically see in times of recession or customer -- or consumer stress is they hoard cash. They go to the gas station. They don't fill up for $150. They put in $50 because that's what they can afford today, and then they go back in 2 days. We charge those enterprise merchants on a per swipe basis or a per tran basis. So if we can get 3 swipes out of $150, we can make 3x as much revenue as if we get 1 swipe out of $150. In the pandemic, the world was upside down and consumers actually went to the store less often and spent more. I think interestingly, going into the pandemic, we all thought about the recessionary resilience of these businesses, but the pandemic that the option what a recession normally does. So going into the recession, FIS and those with enterprise clients should be resilient going in. We won't get quite the same benefit to the high growth coming out as quickly. But I think in a period of time like this, the scale of the model will show through in the way that a lot of folks were looking forward to do so going into the pandemic.

Right. While others may not?

Correct.

Right. And so that was kind of the point of distinction. Are you seeing any discernible differences in terms of affluent versus less affluent consumer spending? And we kind of talk about how they're maybe going to have more frequency. But what we're really trying to figure out is, is the low income consumer showing signs of really cracking? Or quite frankly, are we seeing the affluent consumer may be pivoting a little bit more than a lot of people would have expected?

We're not seeing -- in the data that I've seen, there isn't a distinction. So you may see an affluent customer pull back from a trip that they deem to be overly expensive given the inflation in travel? Or you could see a sub-prime consumer decide not to buy a transaction on buy now, pay later. But net-net, the consumer is very healthy post the stimulus, post the pandemic given the job market. So we haven't seen it affect the consumer materially at this point in time.

Okay. You proactively offered up travel maybe 3 times, maybe 4, I'm not sure. So why don't you do 2 things? One is remind us how big a piece of business that is and where it sits. And kind of how we as outsiders looking in, would be able to feel good about those proof points as you're describing.

Sure. So Travel sits within our Merchant business. And specifically within Merchant, it sits within e-commerce. The business is primarily driven by airline bookings, cruise line bookings, online travel agency bookings. And pre-pandemic, the Travel vertical by itself represented about 6% of the Merchant segment revenue base. During the pandemic, that dropped to as low as 2%. As that comes back, that creates kind of 4 points of tailwind, which is why I keep mentioning it. And we're seeing that start to flow back through. We're also excited to see if we can get it to be larger than 6% in the future, just given that one, e-commerce is growing as a percentage of mix; and two, we continue to win significant new-to-travel clients and won a lot of them through the pandemic that contributed nothing at the time, really from an incremental revenue and volume standpoint. So I think we're feeling pretty bullish on travel.

Yes. I could tell.

You want to talk about travel? I can talk about it all day long.

That's fine with me. That's good. That's good. It's about time. I mean it's been a topic of discussion for a long time. And for whatever reason, it just hasn't truly manifested itself into the numbers. But I did want to ask about Europe and particularly, the U.K. and kind of the card, more card-present book. I was just speaking with a colleague of mine earlier today, and she was saying that London was open for business more so than the United States. So what are you seeing in terms of your data? And how helpful would that be for you guys?

Yes. So our U.K. business, I think grew mid-teens in the first quarter.

Mid-teens?

Yes. So where it shut down in December, I think you guys may all remember, it was trending at mid-teens. Pre-Omicron went to 0. In December of last year, yes, it's open for business.

That's awesome. All right. So Banking Solutions, you've got this big backlog that's been growing. Help us understand how that translates throughout the year. Again, how are implementation cycles? Are you finding -- you have a lot of innovation that you spent on it so they obviously want the product. Are they in a position to be able to implement that? And again, just the time lines, so we're not getting over our skis when we hear you talk about great things that are going on in that segment.

Yes, great question. So our backlog has been growing consistently 6%, 7%, 8% on a year-over-year basis for the past, it feels like, 12 quarters. We typically convert and expect over the next 12 months to convert about 30% of that backlog into revenue. Backlog is total value of revenue under contract, where there is a termination fee, meaning that we're locked in and we'll get the revenue. We use backlog as a leading indicator of revenue growth because, obviously, if the amount of revenue we have under contract is growing at 8% like it did in the first quarter, presumably that should convert to revenue over a period of time. It's a bit of a leading indicator in that, obviously, it's a total contract value concept and contracts, let's say, average 5 years in length. So that said, if we can grow the number of 5-year long contracts, 8% per annum, then that's beneficial for us. In terms of implementation cycles and/or converting it direct to revenue, it's difficult to make a 1:1 from backlog to revenue, just given that you've got new wins coming in the top of the funnel as it converged to revenue that comes out of the bottom of the funnel, and you have implementation timing, et cetera. So it can be challenging to make that math equation work perfectly. But in terms of our ability to flow it through and drive it to revenue, I think we've seen that in terms of accelerating revenue growth, particularly in Banking and Capital Markets. And we're seeing it in the strong growth rates that we're having for Modern Banking Platform, right? We've now converted that into a $100 million a year annual run rate business, growing at 50% plus. We're running red hot in terms of delivery. We're delivering about as much as we can. So we're not anticipating to go to the moon from here. But I'd say delivery and the amount of delivery capacity we have is probably one of our biggest challenges from a revenue perspective sitting here today.

What about banking-as-a-service, right? We hear that a lot more frequently. It seems like it's a pretty busy space in terms of competition. So what's the update there in terms of your pace of play? What you're seeing from competitors who are trying to get back into the space, smaller ones here again that we would talk about. Maybe any kind of framework around that would be helpful.

Yes. So we're highly focused on delivering banking as a service in order to enable our financial institution partners to be able to deploy capabilities to their customers and new products quickly and, therefore, grow their revenue and compete against, whether it's a neobank or a fintech or whoever that may be. We've had some announcements there. I think you'll continue to see those, where we can enable banks to quickly deploy deposit-taking capabilities, money-movement capabilities, card-issuing capabilities through a cloud-based set of APIs so that they can pay for what they use and kind of pay as they grow. We believe that we have the leading set of capabilities in our banking space across core deposits lending issuer, wealth, et cetera. And it's about unlocking those capabilities to be able to be consumed more easily by a broader set of clients through our fintechs -- or through our bank partners, fintechs, corporates, et cetera.

Okay. You're getting a little choked up there.

I am. I'm emotional about it.

I'm going to give you a second. We only have a minute here anyway. That was a really, really touching -- but it leaves us with capital markets. We're in capital markets. So like tell me what's happening in capital markets, right? This has obviously been a transition business. You talked about it a little bit before. But where will this land in terms of total recurring revenues? Like you've been making this pivot. I forget, I think you're in the 70s or something like that now.

Yes, I think we're at 72%...

72%, yes.

Recurring revenue, up from probably below 60% when FIS acquired SunGard. The intent is to get that up to 80% or 80% plus. And really, as we've gradually moved from license revenue, which you can recognize almost immediately at 100% margins and move to a SaaS-based revenue model just like in the other software companies, that's posed a headwind to growth. We decided not to do the big step-change shift, but to do it gradually. We've kind of now gotten to the point where it's becoming more of a tailwind than a headwind. I think our recurring revenue in Capital Markets grew 8% in the first quarter versus total revenue of 6%. So we feel good about that. So we're continuing to make progress, and we'll continue to move the needle in that direction.

Okay. Well, we've got 22 seconds left. I'll leave you with the last word. So is there anything you want to communicate to the group? Just here again, as we sit here today, the market has been incredibly volatile. I do think the narrative on your company has become a lot more positive with the conversations I've had with investors.

Agreed.

It sounds like that might be also happening with your conversations today. But any last kind of closing remarks?

Yes. I think that the market has always underappreciated the value of scale. And by scale, I don't mean margins. I mean the ability to provide an end-to-end solution, the ability to provide a global solution and the ability to provide a bundled set of solutions to different types of clients. As we go into periods of stress, that scale becomes increasingly important. I think the market is recognizing that at the moment. I think they'll continue to recognize that, particularly if things continue to become more challenging and the large cap scale providers that were largely left for dead during the pandemic are now priced in a way that's very attractive from a valuation perspective, with highly resilient business models, profitability and cash flow. So from a fundamentals perspective, we feel really good. And it's just about taking advantage of our strengths over the next 3, 5, 10 years.

Cool. Well, you've positioned yourself well to do it. So awesome.

Thank you.

Thanks so much for being here. Really appreciate it.

Appreciate you.

All right, man. Very good.