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

Good morning, everyone, and thank you for being here. I see a nice crowded room. So that's always a good thing. I'm Ashwin Shirvaikar, I'm Citi's payments fintech analyst. And really delighted to introduce the next company up, which is FIS. From FIS we have Erik Hoag, who is the CFO; and Georgios Mihalos, who heads up Investor Relations. Thank you, guys, for being here. Thank you for doing this.

Thank you very much for having us.

Absolutely. Maybe, Erik, I could kind of start with a question with regards to the recent management transition. You and Stephanie, CFO, CEO roles, respectively, should we expect changes as it relates to FIS' go-forward strategies, operating philosophy, guidance philosophy, things like that?

Sure. And again, thank you for having us this morning. It's a pleasure to be here. So the key priorities for the company are really unchanged. We want to drive profitable growth. We want to be good stewards of capital and making sure that we're rigorous and disciplined [ associated ] with where we're putting our dollars, and we want to drive shareholder return. So with regards to the CEO, CFO transition, Stephanie and I have a great opportunity to take fresh eyes to all of our operating segments in all of our businesses to ensure that we're giving them the fuel to grow through capital allocation and resourcing. As far as guidance philosophy goes, Ashwin, my commitment will be clarity and transparency in terms of our guide as well as providing the building blocks associated with what builds up that guide with a clear bifurcation around the things that are associated with operating performance and things that are associated with the macro.

Okay. Okay. That's good to have. And assuming that you're still on track to maybe do an Investor Day or investor event early 2023, what's a reasonable expectation investors should have?

Honestly, we're working through that. So with our third quarter guide, we're taking a hard look at our midterm guidance. So more news on that to come. But clearly, we want to get the midterm guide back in your hands sooner -- sooner [ or later ].

Yes. Okay. Okay. And sorry to sort of jump into questions like this right off the bat, but you did announce an enterprise transformation program, $500 million. On the face of it, if someone says $500 million ,sounds like a big number, but you're a big company and it's only about what low-single, mid-single digits percentage of what your total cost base is. So should we think of that as sort of a first step? More to come? Or how should we think of that?

Yes. So really good question. I would think about -- so number one, we are laser-focused on the enterprise transformation program. And the broader enterprise transformation program, I would think about it through the lens of we're trying to reduce the cost -- we're trying to influence the cost structure of the organization. We're trying to influence the capital intensity of the business. I would think about it as a starting point. And we are laser-focused on driving the number well in excess of the $500 million that you're talking about that we referenced. Broadly speaking, I think that there are a couple of key precepts associated with what we're trying to do here. We're trying to get ourselves on a solid trajectory for consistent margin expansion going forward, trying to reduce capital allocation -- sorry, the capital intensity within the business, both of which should drive shareholder return.

Okay. Okay. And just as we sort of think of margins and margin trajectory, is it reasonable to assume margins go down before they go back up? At least it would seem so from what you said about 4Q, but how should people think of -- again, not looking for guidance -- but how should people think of next year in terms of the setup? And what I'm really more interested in is while you're new in your seat, you're not new to FIS. What are your levers? How are you thinking of the business in terms of margin improvement? For example, an easy thing is growth and scale, helps. Growth might hurt initially, but it actually helps. Things like that. What are the levers? How are you thinking of margins?

Sure. So maybe your first point, Ashwin, associated with 2023. We're not going to -- I don't want to get into operational expectations associated with 2023, obviously. But on the third quarter call, we talked about a couple of notable things. Number one, we've got a choppy consumer, and we've got some slowing banking sales.

Yes.

Both of which create a little bit of headwind as we head towards the start of the year. The enterprise transformation program on itself, on its face, should help drive profitable growth, should help drive -- put us on a trajectory for sustainable margin expansion over time. And as I said, we are laser-focused on the cost side. And I'm going to talk about maybe the cost side through a couple of different lenses. I mentioned CapEx, clearly, OpEx. We're taking a hard look at -- the non-GAAP add-backs too, all part of our spending that will ultimately drive free cash flow, which is clearly a priority.

And just Ashwin, maybe one thing to consider is, obviously, we would expect margins to improve throughout the course of the year, right, the first half of the year, there are some growovers that we'll have to get through.

Yes, a good point there. Good point. Thanks for pointing that out. The thing that you guys did with capital allocation, we do a lot of questions because there was a big push. Here's what we're going to do, capital allocation, a big share repurchase including -- with the assumption of debt, and you pulled back from that. Can you kind of go through some of the thought process around that? What is the current expectation of how you think about that probably is, I would say, one of my leading questions from investors. So if you could kind of expand on that.

Yes. So I would think about -- so as we head towards 2023, think about capital allocation, number one, we want to invest for growth in our businesses, right? Whether it's building products that can help us with cross-sales or things that can help unlock an adjacency for us. We want to continue to invest for growth. Number two, we want to maintain a healthy balance sheet. The remaining investment grade is very important to us. Number three, we want to pay a dividend. So we've increased our dividend roughly 20% in the last 2 years. And we're going to do that again in 2023. And then number four, we want to return -- our predominant, our default use of excess free cash flow, Ashwin, is share repurchase. So in terms of your -- maybe where you were going with that question associated with what we provided some guidance at the Wolfe conference back last spring. A lot has changed since that time. Inflation has spiked. The dollar has strengthened. We've got broader macro headwinds. EBITDA has come down. But coming back to our capital allocation principles, our preferred use, our default use of excess free cash flow will go to share repurchase. During the third quarter call, we also created a little bit of optionality and flexibility associated with 2 maturing bonds that we have in the first half of 2023. And we'll certainly look to deal with those based on where the credit markets are when that $2 billion comes due.

Okay. Okay. So you have so very targeted use of cash flow and that you're going to do. Understood. And then post that, so what I'm trying to also clarify is, is there a post debt cleanup thought process with regard to share repurchase. So is this, I'm temporarily tapping the brakes? Or is this, no, the way we were going was not where we should have gone.

No, I wouldn't say it like that, Ashwin. I would say the 4 general categories of -- that I think about with capital -- invest for growth, maintain of healthy balance sheet, pay an increasing dividend, the default use excess free cash flow for share repurchase. I would say, in 2023, 2 subtle nuances. Number one, we've got $2 billion of debt, and we want to make sure that we've got some optionality associated with how we may have to -- might deal with that debt. And the second thing is just based on the broader macro, we won't be levering up to -- for share repurchase either. So for the avoidance of doubt, in 2022, we continue to maintain 2.9 turns, and we use that incremental debt for share repurchase. As we head into maybe a more uncertain macro environment, we're not going to take on incremental debt for share repurchase. Beyond those 2 pieces, our capital allocation philosophy remains intact.

Okay. Okay. And that you've kind of sort of demonstrated that with the comments around dividend as well as the comments around incremental, but tuck-in M&A, to be clear, not transformational M&A, would that be fair?

Maybe I'll touch on the M&A piece for just a second. The enterprise -- I'm focused, we are focused on internal right now, Ashwin. I don't think about transformational M&A. And I would say where we sit as we head into 2023, we're more focused on internal capital allocation, the cost footprint of the organization, capital intensity across the organization, making sure that we're putting the appropriate amount of dollars into the right products and the right projects within those products. So M&A, not really in my purview right now.

Okay. Okay. Understood. Switching to macro, and you guys have obviously pointed out the weakness that you're seeing in merchant and some with regards to enterprise purchases on the bank side. Just to put a finer point on it, when you talk merchant obviously, you have a very idiosyncratic exposure to the U.K. Are you primarily speaking about that? Or are you also talking about actually seeing weakness here in the U.S. and in other markets as it relates to the consumer?

Yes. So as it relates to the consumer, I would say that the U.S. consumer continues to hang in. Clearly, to your point, yes, we're exposed in Europe, in particular, the U.K. We are seeing some subtle movements within spending patterns within the U.S. full service dining, QSR, high-end retail, more generic retail. But I would generally say spending in the U.S. is hanging in there. More broadly around the macro, you mentioned banking briefly. We've got a couple of things going on within banking, large deal sales elongation. We talked about that after the second quarter call, leaned more into that in the third quarter call where large deals -- we're not seeing a pipeline challenge. We're not seeing a qualified pipeline, but we are seeing an elongation in actually getting deals closed. And then more broadly, within banking, we're seeing fewer bank consolidation. Less bank consolidation drives fewer termination fees, which over the longer term is a great thing for FIS as we retain the recurring revenue associated with that. But clearly, in '22, it's not just a headwind to revenue, but it's got very high contribution margins, and that impacts the '22 number as well.

Yes. Okay. Okay. And the thing is, since macro is also a leading question that keeps getting asked every time and fairly and very justifiably so, could you maybe sort of look sort of walk us through the portfolio that you currently have? As you look at segment by segment by segment, what are the pieces that, in your view, are more discretionary or less discretionary or even countercyclical sort of ? Like just help us balance out the pieces of how you think of in a normal downturn, how FIS might do?

Sure. So maybe even just pivoting back to the last economic downturn. So the banking business in 2008 was generally flat and the downturn in '08, much different dynamics, right, led by FIs. The banking business, it's big. It's durable. We've got long-term contracts with price escalators that are included in them. Durable, recurring revenue here in banking, roughly 80% to 85%. So durable business, last economic downturn, relatively flat. When I look at the merchant business and maybe the legacy Vantiv business specifically, going back and reflecting on their growth rate, they were a positive grower in '08. The capital markets business, I don't have a good data point for you, Ashwin. But I will say that over the last several years, the capital markets business is behaving much more like the banking business where it went from a license business to a point solution business to solution selling. They're seeing their concentration of recurring revenue continue to expand, somewhere between 70% and 75% here in the third quarter, up materially year-over-year. Contract durations are elongating, price escalators. So the composition of the capital markets business is starting to look and feel much more like the banking business. All that said, I think as you think about a recession, what '23 may look like, the depth and duration, an awful lot of caveats associated with what that might mean for us. But as I sit here, I certainly feel like we've got a business that will grow next year.

Right, right. And there are yield dynamics as well to think about, right, as you think of discretionary versus nondiscretionary.

We do. And so maybe diving in a little bit on the merchant business. So the merchant business has got 3 general subsegments. We've got an SMB book. We have got an enterprise book and we've got an e-commerce book. So our enterprise book, mostly nondiscretionary. So it's a great balance of a mix of portfolios within the merchant book. So as people leave dining and move to quick service restaurants, which sits in our enterprise book, as people leave dining and go more to grocery, that sits in our enterprise book. So the enterprise book is a really nice balanced portfolio. It's priced a little differently. So the enterprise book ,we price on transaction versus volume, which is like our e-comm and SMB book, but it's got -- it will perform very well in a down cycle.

Okay. Understood. Understood. And those tend to also be larger merchants?

They are larger merchants, larger nondiscretionary. So think grocery, think pharma, think large retail.

Okay. Okay. Understood. Understood. And one of the questions that has come up on a recurring basis over time, right, is because everyone -- and this didn't necessarily used to happen pre-pandemic. But since the pandemic, many investors want to compare your volumes, volume growth to Visa, Mastercard and the indexing becomes very important. So are there idiosyncratic factors that you'd like to point out why you may be different or in some cases, similar to -- where should we expect similarity? Where should we expect the differences? Because that does -- I think that is a message that probably does need to be told.

Sure. So you're right. We generally follow the same curve as Visa, Mastercard, the networks do. We're under-indexed versus them. And I would say that we're under-indexed really on the back of the concentration of our book with the broad enterprise portfolio that we've got, but also the concentration of geographies, right? So we're in the U.K., very mature geography. As I look at some of the networks, I think that they've got exposure in much -- in some geographies that are better moving much quicker than us as well. But generally speaking, under-indexed, but that spread has remained relatively consistent over time, Ashwin.

Okay. Okay. I get it. The impact of inflation. It's not something we had to consider prior to this year, but certainly a factor now. How much has it benefited your merchant business this year? And I'm going to use the word benefited because I think so far, it is a benefit, right?

Yes, I think you're thinking about it right. Yes. So inflation hits us a couple of different ways in the merchant business. So our -- as I mentioned, our SMB business and our e-commerce business, we generate revenue off volume. So as the price of goods go up, as the price of dining at an SMB goes up, we generate some -- we generate revenue on the back of that volume. And then as inflation continues to move and spending patterns change, SMB to grocer, we've got a -- we pick up revenue within the enterprise book, which is price per transaction. So sort of netting that out, inflation helps on the volume side with e-commerce and SMB. And then as spending pattern shifts, we pick up more transactions in enterprise, which is, again, pharma and grocery.

Right, right. Okay. Understood. In terms of just kind of talking about SMB, which you mentioned a few times, obviously, a focus of yours as you try to transform. In terms of just kind of breaking down that business though into sort of the component pieces, ISO, ISV and so on and so forth. Could you maybe start there and tell us what your SMB business within merchant is like today? And then the follow-up to that would be what would you like it to be?

Sure, sure. So start maybe starting again at the segment. The merchant segment within FIS has got 3 subsegments, talking about them a bunch, e-commerce, enterprise, SMB. Within our SMB portfolio, we've got 3 channels. We've got the ISV channel, which is roughly half of the SMB book. And this is a channel that's a little bit under duress right now as the ISVs are struggling to compete. ISV is predominantly restaurant retail -- struggling to compete with other PayFacs. And we are deploying the strategy here as Worldpay for Platforms to help enable them to better compete. Roughly half of our SMB book. We've got an ISO book, which represents about 1/3, and the ISO book, honestly, we're managing for cash. And then the residual piece, roughly 20% of the book is associated with bank channel. So this was -- the bank channel piece was one of the initial revenue synergies that we had coming out of Worldpay, where we can leverage the relationships that we have with large financial institutions and create an acquiring channel for them. So over the broader term, Ashwin, we would expect the e-commerce business to continue to grow very well and it'll be a higher concentration of total revenue within the merchant subsegment. We would expect the enterprise business to continue to grow low mid-single digits. And then the SMB book. As I mentioned, ISO, we're managing for cash. Bank channel will grow. It will grow but at a much more muted rate, a much smaller portfolio. It's the ISV piece that we're working on, associated with our Worldpay for Platforms, which we did an acquisition in the fourth quarter of last year called Payrix. That's going to further enable that.

Right, right. Can you talk more about Payrix, what it brought to the table? What is your plan with Payrix? Obviously, on multiple calls you all have expressed a lot of enthusiasm and excitement about it. So talk also about the integration. So just kind of a little bit of overview on Payrix.

So Payrix is foundational to our Worldpay for Platforms program. We acquired them last fall, last December. They exited 2021 with a run rate revenue, say, let's call it $60 million annualized revenue. In 2022, they'll do a double. As I look at 2023, I'd expect them to double again. The integration is going well. The business is continuing to scale, so we continue to invest heavily in it. It provides capabilities for ISVs to auto onboard and auto underwrite and really foundational to the Worldpay for Platform strategy going forward.

Okay. Okay. Is there a need for you guys to maybe invest more in verticalization within that space from a software perspective?

Yes. No. I would say, Ashwin, the answer to that is no, from a verticalization standpoint. I think we're going to continue to employ what I like to refer to as more of a Switzerland model, right? This is an offering that should span across multiple categories and verticals of ISVs. It's not going to be vertical specific.

Okay. Understood. Understood. Got that. Now part of your merchant business that has been doing quite well is e-commerce, right? And the question I get there is on the sustainability of that. So how much has travel benefited that? Sort of 22% growth ,quite impressive in the most recent quarter; definitely impressive relative to how most e-commerce processors did. So talk about the sustainability of that.

Yes, I feel good about eCom. So it's -- eComm is the marquee asset that we've got within the merchant subsegment. It's a global business for us. We continue to expand into new geographies every year. We continue to add new APMs. We're working very hard to get embedded finance capabilities within the eCom platform as well. We believe that over the next several years that the eCom platform -- the eCom business, excuse me, will approach 50% of total segment revenue.

Okay. Yes. What is the competitive environment there like?

Well, we're an established player. Adyen, obviously, is an established player. We've come across some others, but we've -- I think we feel very good about our competitive position.

Okay. Got it. Got it. Just switching gears to banking, right? And you mentioned the pipeline. It's still healthy. The deal dynamics might be changing in terms of only the complex larger deals expanding. But just moving back to the pipeline, and the competitiveness of the core offering. Could you talk about sort of some of the conversations that you might have been in with the clients and prospects? How are they proceeding? Talk about the banking business?

Yes. So maybe starting with -- so maybe I'll work my way to the core piece, Ashwin. The pipeline for banking continues to be robust. The qualified pipeline for banking continues to be very large. We are seeing large deals elongate, sales cycle elongate. We're not seeing pipelines -- we're not seeing them fall out of the pipeline. We're just seeing the decision-making process continue to expand. So sales growth in the third quarter in banking was roughly 4%. So we continue to see growth in a difficult environment, but we are seeing the elongation occur. On the core side, we've got an application called Modern Banking Platform or MBP, which we continue to invest in. We're currently working on continuing to build out modules associated with lending and commercial banking. We've got a robust list of customers that we're currently installing. We've got a healthy pipeline associated with new customers on the back of that. But even more beyond the MBP application, Ashwin, we've had a very successful year in selling our integrated cores as well. So in our one-to-many model with more regional community banks. We've had a lot of success selling those. And the benefit on the regional community side isn't on selling integrated cores -- we sell them all the ancillaries as well. It really is an integrated suite of solutions that we can provide. It creates a lot of stickiness, and those customers are generally with us for a very long time.

Right. Right. So you made a couple of really good points there, Erik. Maybe just delve into the timing differences, right? Because you talk about pipeline and pipeline converts into a backlog and then you've got revenues. And there's time differences between each of those. Should we expect to sort of see -- you had pretty healthy bookings for a while and the pipeline was healthy until very recently. So should we not see some of that health that sort of kind of bleed into and help your growth rate? I know the elongation of the very largest deals hurts, but is there not also that countervailing factor?

Yes. So I think your question is the backlog that we saw in the first quarter and the backlog growth that we saw in 2021 and the elongation of an implementation cycle?

Yes.

We've got a mix. We've got a mix of quickly converting revenue, TCV, and we've got a mix of large MVP-like transactions where the implementation cycle is a little bit more protracted. So it's a little bit of both.

Okay. Okay. Got it. Got it. And just one last question on banking. The pull forward in periodic revenue, could you maybe delve into that a little bit more because that seems to be...

Specific to the third quarter?

Specific to the third quarter, what happened and what should investors expect in 4Q as it relates to periodic revenue.

Yes, sure. So in the third quarter, there was a large license transaction that we pulled from the third -- from the fourth to the third, excuse me. It represented 1 to 2 points of banking growth in the third quarter. We've guided the fourth quarter across the enterprise as low to mid-single digits. And maybe just 1 follow-on associated with the low to mid-single digits. And we tried to be very deliberate in the call because the order of magnitude associated with the adjustment in the fourth quarter. We tried to be very deliberate with ensuring that we had visibility to the guide.

Right. Right. Okay. Okay. Got it. Got it. The third segment, capital markets. I mean, in general, has been sort of steady as she goes for a while now. And you kind of as a company, successfully converted that into a higher recurring revenue stream or a bit more cloud and so on and so forth. What is the prospect that you're seeing currently in that segment?

Yes. I couldn't -- so excited about how the capital markets business has performed over the last couple of years. Maybe for everyone's edification, when we acquired SunGard at the end of in 2015, it really was a license shop. It was licensed professional services. And over the last -- in the preceding -- in the couple of months -- a couple of years, excuse me, after the deal closed, we really focused on converting from license to recurring. And then in the last couple of years, we've really focused on modernizing applications and moving from solution selling to solution suite selling.

Yes.

The recurring revenue number is now low 70s; banking is low to mid-80s. So the characteristics of capital markets versus banking, they're starting to come -- they start to look very, very similar. Selling to a lot of the same customers, selling in the same way, consolidated account management across the customers, the characteristics are really starting to come together, and it's performing very, very well. I think the prospects, Ashwin, are good.

Okay. Okay. And just to complete the discussion on capital markets. Are there things in that business that maybe investors should be vigilant about things like AUM, things like deal activity. I recall the old SunGard asset used to have some of those fluctuations as it relates to capital market fluctuations themselves. So if you can talk about that.

Yes, good question. So our exposure to AUM is minimal. Since the time we acquired the business, we've parsed out and sold small little pieces here and there. We've really tried to focus on the things that we believe to be strategic, exposure to AUM. We've also got a wealth management business in our banking business -- in our banking segment. We feel like we have very little exposure associated with AUM volatility.

Okay. Okay. And deal activity, things like that, that's not a factor really just to be -- okay. Got it. Got it. Okay. Maybe I can sort of end our discussion here, a lot of good insights with sort of round up organizational question that does come up. And that's -- at its most basic, do you need to be the conglomerate that you are with sort of a 3-headed monster, so to speak? Or can you simplify that structure?

Sure. So I think I see where you're going. What I'd generally say, Ashwin, is that the Board and management, we're always looking at ways where we can unlock shareholder value. As we head into 2023, we're going to focus on the things that we can control. So we're rolling out a program called AMPLIFY, which is really cross-selling our solutions across segments. We've got a lot of customers and a lot of solutions that have a lot of white space. We're going to focus on the enterprise transformation program. We're going to focus on putting the merchant business in a position for sustainable long-term growth and really all of which is underpinned by a desire for us to drive shareholder return.

Great. Well, thank you very much for your insights. This has been great.

Thank you for having us.

Thank you.