Shift4 Payments, Inc. (FOUR) Earnings Call Transcript & Summary

Welcome to Evercore ISI's 7th Annual Payments and FinTech Innovators Forum. I'm David Togut, I lead the Payments, Processors and IT Services Research Team here at Evercore ISI. Delighted to welcome Shift4 management. Joining us from Shift4 are Jared Isaacman, Founder and Chief Executive Officer; Taylor Lauber, President; and Nancy Disman, Chief Financial Officer. Welcome. Thanks so much for being part of our conference.

Thank you.

Thanks for having us.

You're rapidly transforming Shift4. If we look at your 4 key growth drivers, high-growth core, gateway conversions, new verticals and M&A. Let's start with the high-growth core focusing on next-gen SkyTab POS restaurant payment system and the in-sourcing of 50% of your distribution, which really go together. How do the 10,000 new SkyTab POS systems deployed to date compare with your expectations when you launched the product?

Thanks, David. Yes. Certainly, a lot to talk about within our high-growth core, which again, a reminder for everyone is kind of the restaurants, hotels, specialty retail, multi-software environment that Shift4 is a pretty unique right to win within that space. Presently, we touch about 1/3 of all restaurants in this country across a variety of different restaurant POS software applications that are integrated into Shift4. We began, many, many years ago, an initiative to build a cloud-based POS solution as the natural migration path for our existing customers, but also to ensure that all of our salespeople in the field, our direct team and our partners, have a real right to win with a modern product that comes at a disruptive price point, solves a lot of problems. So leading into the launch of SkyTab, which is again, the name of that product, towards the end of last year, we took all the data we had on which markets are the -- we've had enjoyed the most success in with our restaurant business, so we can kind of predict the future a little bit. Who our best partners were, in-source them, arm them with a really awesome cloud-based product and set them loose. We now have over 10,000 systems operational. And to get to, I guess, the heart of your question, David, we like -- we're happy with the results, it's more than we thought. So we did underestimate how much initial demand there would be from our formal go live in like mid-September. So we actually had equipment backlogs for like 20 days, maybe 30 days, maybe even longer. I mean, we had surge efforts like working 24/7 in our deployment operation and now intend to get devices out, which is great. I mean, it certainly speaks to demand. We are continuing -- we have pretty high feedback loops with our teams in the field to constantly optimize our process because we want a 5-day turnaround. So from the time a salesperson sells a restaurant POS system, we want the system operational in 5 days. There's a lot to do there. I mean, you have like the touchscreen workstations, you got the handheld mobile devices, you got to program the menu, you got to import the employees, like -- so to get it done in 5 days, would be pretty extraordinary, and I think we're getting a lot closer to it. But we anticipate a lot of success with SkyTab in the year ahead. I mean, we touch 1/3 of the restaurants in this country. They'll be great sources of referral partners. We have a lot of low-hanging fruit list of customers that we can easily have a kind of this natural foot in the door to sell our product. And customers want to migrate to more modern solutions, especially when you think about all the integrations so like Grubhub, DoorDash, there's mobile, there's loyalty. You just got to make life easier, and cloud does that. And I think us and Toast are going to have a lot of success. There's just a lot of older systems, a lot of non-integrated stuff that customers are actually going to migrate away from, and SkyTab will be one of the beneficiaries.

Got it. Do you have any targets for a number of systems deployed for SkyTab POS over the next 12 months?

I mean, we have -- just based on how our finance team, Nancy's team, does the budget buildup, yes, there's a number there. It's a lot. I just -- I don't think we'll speak to it very often. I mean, we just don't ever want to get into like a comparison with a pure-play company that solely focuses on restaurants. Like we have massive share in restaurants, and we also have massive share in hotels and specialty retailers and stadiums. Like we do a lot of other things, like who's winning quarter-to-quarter on the number of location counts and restaurants is less important to us. And I'd also say like we're also very upmarket from those that we would be compared against, like our -- the 6 or 7 live locations that just went live with SkyTab, like they'll do a $0.25 billion in payment volume this year. We're putting SkyTab in stadiums and our hotel, restaurants and such. They're very upmarket, which is different than like if you're trying to win the stick count game, then you're doing a lot of digital marketing and advertising, and you're throwing capital offering programs out there and you're trying to win that new restaurant, which could have a higher failure rate, lower -- and less long-term performance over time. So like I think at the end of the year, like Toast will almost assuredly beat us on site count and we will not be that far behind, and we will have done all the other things and all the other verticals that make us special.

Understood. Related to that, can you quantify the impact on new bookings since you insource 50% of your distribution from your software partners? In other words, what impact do you expect building out a direct sales force to have on the pace of new contract signings this year?

It's gone up. I mean, the majority of our production now is direct. So all of our new verticals were direct, stadiums, non-profits, travel, leisure, sexy tech, gaming. Those were all pursued direct anyway, and now, the majority of our restaurant production is direct. So even though we have like kind of a 50-50 balance of direct and indirect within restaurants, the 50% that are indirect are our authorized partners. They're in sparsely populated areas. They're not kind of major markets where the data would have supported us acquiring them. So like 50-50 mix, but the majority of the production is coming from the direct side, and production is up. That's why we underestimated some of the initial inventory demand in the fourth quarter, which we still work through and got all those sites live and everything. Why is it incredibly beneficial? I mean, our margins and free cash flow have been expanding in a pretty material way even without in-sourcing our distribution partners. It definitely contributes to it, but it's a dramatic improvement to the unit economic model because not only do you no longer have to be -- what can add up to be a very costly expense of sharing in the payments revenue with third-party distribution from a historical perspective. You don't have it going forward either, and you're adding a lot of customers. So it actually -- it means it directly enhances the unit economic model and the payback on pursuing these customers. So yes. I mean, it has immense benefit to the organization on top of all the other margin enhancement initiatives are underway.

Very clear. Gateway conversions drive about 50% of your end-to-end payment volume growth and you're still early in this multiyear initiative. As part of your gateway sunset plan, you've recently renewed agreements with several enterprise customers at pricing that's actually equivalent to your end-to-end payment offering. How have you managed to do this, and what percentage of your gateway volume do you expect to renew at end-to-end payment volume pricing?

I mean, all the all of the -- I mean, all of the gateway-only volume that we touch today should make its way to our end-to-end solution or they should pay the equivalent. Like, that's the position. And really, like people are like, why, why can't they go somewhere else? I mean it's the same question as like why can't a Square customer use Global or a Square customer use Fiserv. Why can't a Shopify customer use Global? Why can't a Stripe customer use Worldpay or Heartland, or something like -- those choices shouldn't be available because all the value that's being delivered for that commerce experience is coming from the tech platform, and that's what we have here. Now what we have to do is fix many, many years of history of the gateway previously being processed or agnostic and playing nice with everyone, but that's not the world of integrated payments anymore. So like, the position we've taken and was initially -- I mean, because keep in mind, this strategy has been working incredibly effectively for over 5 years now. We had to start with Carats only because there's a pandemic. It's not the time to kind of have a nudged migration path for restaurants and hotels that have a lot of other problems going on with COVID-19 everywhere. So it was a Carat-first approach, but now we're balancing Carats with like a tiny stick. And what we're just trying to do is take what would otherwise be like a 10-year migration because you've got -- you're talking about like $150 billion-type plus of volume. It's a lot of commerce. And you're trying to condense that down to like 3 years or so, which is a path they were going towards anyway. And our position is like, there are some gateway connections that are just so old and uneconomic that we're going to have to shut them down, and we think the majority of those customers will just come to end-to-end because bear in mind, life is better. You only have to deal with one company, not 5 companies. Your overall effective cost of service is less. Like it is true, one hand to shake, one throat to choke, and in the process for us, it's a big gross profit lift. So there are some connections that are just uneconomical we're going to shut them down, you're going to have to move over. We'll get plenty of notice, we'd be really nice about it. We've only done one, by the way, so far, so it lets you know how early innings it is. And then there's other connections where there's a lot of volume and traffic and maybe they're JPMorgan, First Data, Fiserv, and what our position is like you can move over and get all the benefits or pay us the equivalency because like we're delivering all the value. Global, Heartland, they're doing nothing for you over here. It's our integration of software, it's our encryption, it's tokenization, it's our business intelligence product. So you can pay us the equivalency and then we'll give you all the benefits you want, and that's fine. And maybe you'll tell Global like you want a better deal, and that's what I think many of them are doing, or you'll migrate over to our end-to-end platform. And that's just -- again, this is all stuff that's been working really, really well over time. We're just trying to condense it a little bit into like a 3-year period because I want to free up hundreds of employees to focus on building our products for the future across the world as part of our global expansion initiative and not maintaining our competitors' connections and security certificates and stuff, which is just a very dated model. So, yes. With all of that said, it shouldn't be that surprising that enterprise customers are arriving at a point and saying, you're right, this is where all the value is. And we should be renewing on more appropriate terms for the service we're providing. I mean, like I'm going to give you an example. I've had direct conversations with some of them saying like, you do -- I don't know, $3 billion or $4 billion a year in payment volume, just hypothetically. And we make like $0.01 a transaction off of you. I am not lying awake at night thinking about your account. Like you could literally leave, and it has no bearing on our financials at all. Like, is that the kind of relationship you want to have with the company that's powering all your commerce? Like, I should be worried constantly about you leaving, but I'm not because these terms were constructed at a different time by other companies that own these assets and it's just completely uneconomic, like it doesn't make sense. So -- and that resonates with them. They're like, you know what, you're right. Like, you should actually be having more in line with the spreads. And then they're going back to the other acquirers and telling them they want to pay less because they're not doing much, and it's working out quite well.

Very clear. In the fourth quarter, your blended high-growth core spreads in restaurants and hotels dipped 2 basis points to 72.7 as you ramp payment volume from your large customers, even as spreads from your existing customers increased sequentially. What's your outlook for high-growth core spreads and restaurants and hotels this year?

Yes, I'll jump in there. Right now, I think the scripted comments that we shared were that both high-growth core and nonhigh-growth core spreads improved in Q4, David, and we have that same trajectory heading into next year for high-growth core. We definitely are expecting the blended spread to dip down as we get a greater share of these large enterprise contracts coming in and ramping and we've got great line of sight, especially domestically, to what those wins are. So we definitely see an overall dip. At the same time, I think as we look to kind of ahead and beyond, I think as international starts blending in, you'll see that normalize again and probably be a little bit more like what we saw in Q4. And so we'll have some dips and puts and takes as domestic large enterprises kind of ramp more quickly and international kind of blends later in the year, but I hope that kind of gives you some perspective there.

Just to layer on, I'd say -- like as Nancy mentioned, like all our high-growth core stuff is very stable, like restaurants, hotels, specialty. There's no competitive pressures really there at all. But 20 -- being in business now 24 years, where 22 years of it, we were dealing with the same type of customer. Now we have multibillion-dollar multinational customers. For sure, they come in at lower spreads. They're not like ridiculously low. They're comparable to what Adyen or so would get. And based on different international markets, like when you start supporting them in other geographic areas, those spreads naturally come up. But I think what's really important, too, is like the margin profile associated with those spreads is considerably better. Like you can get a 90 basis point restaurant, but you have a lot of personnel to field phone calls every time they want to change the price of buffalo wings or whatnot. You take a customer like hypothetically BetMGM for us, where, of course, they're very large customers, the spreads are going to be well less than what you'd have with a restaurant or whatnot. But as they light up more and more states with us and just turn more and more volume on, we're not hiring additional people for them. We're not fielding many more phone calls. So you have like -- that's kind of a little bit of the Adyen effect that's happening on the other half of our business where you've got really great customers that are growing really fast, which is contributing to your own growth. And you don't have a very large customer acquisition cost or OpEx required to support them, which translates into really nice margins, good flow through to free cash flow.

Your pace of acquisitions has accelerated. You've added important new growth factors, especially with Finaro, which brings substantial e-com payments and international expansion. And on the earnings call, you indicated international expansion was your top capital allocation priority. What types of international acquisitions are you looking for?

I'll start, and then Jared can layer in. The world is really big, so I think our priority is really around creating connectivity in the markets that our big international merchants want to be able to access directly. It needs to be -- Jared comments on this as being integrated payments 3.0. You need to be able to light up geographies on behalf of your merchants in a really quick and seamless way, so the Finaro acquisition gives us a really nice right to process payments throughout Europe, but there's lots of other continents there. I think our priority is going to be looking at platforms that give us what Finaro gives us, but in a few more geographies. And then, of course, we'll be organic in building out connectivity in markets. Singular countries, for example, that become important. And then also partner where necessary, right, like merchants want to be able to easily do business all over the world. And where it makes sense, we'll build a partnership with a smaller market.

I guess the only thing I'd add is just there's just so many more choices than ever now, which is great. First, our expertise in international payments has grown to the extent that we can organically expand in certain areas and we can partner to cover certain gaps, as Taylor just spoke about. But you do need your own rails, the rails are very, very scarce. And it's imperative in this 3.0 evolution of integrated payments right now where you have to be able to take all those awesome product service integrations that make you special in one part of the world, like the U.S. for us, and enable commerce everywhere globally with it. And you need a certain number of rails to get to kind of critical mass for that. And 2 years ago, it would have been incredibly hard. 1 or 2 targets are maybe or so out there, and if we even talked about them, we be like, oh, that's who they're thinking about. Now there's like tons of choices. I mean, BC&P have pulled out of entire hemispheres, so you've got companies being starved for capital that way. SPACs are gone, capital markets are closed for IPOs, and then you have 3 big public companies that are parting out assets right now. I mean, FIS, ACI and Paysafe all have interesting assets in different parts of the world that may be under-delivered for them, but like we have tons of synergies we can bring to the table. Like we have volume that we're just waiting to turn on in certain markets. So it's actually like -- Taylor -- actually both Taylor and Nancy's team have benefited from our talent upgrade initiatives. Like they're both stacked with awesome talent, and we're going to need it right now because we're -- we have more choices to look through right now than we had since the entire time we've been a public company in support of international expansion.

Well, on that score, would you do something large and strategic? Some of those assets would be very large.

Yes. And to be clear, I'm not -- I'm specifically saying parting out assets. So we are not making a run for the entirety of any one of those businesses, like that -- we don't need that. What we need is -- we need rails in certain geographic markets that are important for our customers, and I do think it's imperative to own those rails. And I think other companies like whether they had ambitions in, I don't know, LatAm or APAC and just didn't work out for them, like it might very well work out for us based on what we already have in our pipeline. So yes, it's very -- it's specific. The point is there's a lot of assets right now, which is great, so...

Very clear. On the earnings call, you underscored your very disciplined approach to expense management this year. What is your view of the restaurant and hotel industries for 2023? We've definitely continued to hear pretty strong things about global travel, which obviously feeds through to your primary end markets, but you're definitely taking a pretty cautious/conservative approach.

Yes. I'll start here. And I would say we -- or at least myself by nature, are pretty pessimistic. I'm always very cautious. The pandemic recovery has led us to points where you think a merchant has recovered, but then you look back and find out that they actually did more volume in that recovery than they had at any point in the history. So we really want to be cautious around what same-store sales growth looks like coming out of this. Now, I would say we are particularly cautious on the restaurant vertical at the beginning of last year. I think that caution has been prudent, although we haven't seen a deterioration in volumes. You've certainly seen a slowing in growth, but you haven't seen same-store sales retract or anything like that. So we're watching it with, I think, just a keen eye, but there's no reason to believe that volumes will change materially inside of that sector. Travel is one we're looking at with, I think, the same lens you are, which is global travel is still recovering. There are still countries that are opening up. There is a reason to be really optimistic about it, but we also had a really good summer last year with regard to travel inside the U.S. So what this all manifests itself in terms of our guidance is that we're being cautious around same-store sales broadly speaking. We see as many reasons that they could moderate as that they can improve, and so we try to err on the side of expecting some moderation. But you, again, haven't seen it in the data, so it's a theory at the moment as opposed to anything else.

Got it. You've highlighted 4 major growth initiatives, high-growth core, gateway conversions, new verticals and M&A. As you continue to introduce new products and globalize Shift4, how do you intend to build out your management team to support this expansion?

Yes. I mean, I think that -- Well, first of all, it's already in works. As I mentioned before, Nancy is an incredible CFO. We're lucky to have her, and she's brought a lot of great talent into the finance organization. Taylor's strategy team has continued to make investments in really, really quality talent. But that's the theme -- that's the theme of our spending going into this year is we are upgrading talent, we are not adding to it. We have 2,300-plus employees, and we're about to add several hundred more through Finaro. We did a lot of -- we did a lot of hiring to support our growth during a very inefficient time in the world when people are working from home without good, like, learning and development and training tools, and that certainly hurts productivity. And also, we didn't always attract the best talent. I mean, like, if you want to change the world in payments and fintech, you probably went to Stripe, PayPal, Facebook, I don't know, somebody else, so you weren't getting the best. And although we have a lot of great people, don't get me wrong. But this year, in support of all 4 those important growth priorities, we are going to upgrade talent. And by upgrading talent, we're going to get a lot more -- we're going to increase productivity a lot, but it's also, I think, going to really demonstrate the scalability of the organization. And what I kind of hope to show, over time, is this nice pie chart of just what the evolution of our head count is like. And that in totality, the headcount ideally did not grow much at all, but like the mix between, I don't know, 1,500 people supporting operational roles of legacy POS systems dated gateway connections can be repurposed into the things that really move the needle, which is international expansion, supporting new verticals and such. So huge focus for this year. I'd just say it's already like actually well underway, like we've been trying to do this in some -- since talent started becoming available. I'd say like in the third and fourth quarter of last year.

Got it. At the time of the IPO, you highlighted a major effort to in-source your merchant processing from TSYS, which have been doing that for you. You're building your own back-end capability, taking that process in-house. Is that process completed at this point in time, and to the extent it is, what additional capability does it give you in terms of winning business?

It's not complete. We run everyday transactions and settle transactions through our own back-end systems. It just -- in 2022, beginning of the year, I mean, you think back the letters I wrote to the team is like this is the time now that you focus on the real needle movers because I think we're like so much better equipped and experienced to navigate challenging times because we've been there before than those that have never seen it, and you want to make tough decisions. Last year at the beginning of the year is we're going to unlock a lot of value with SkyTab, pursuing our new verticals in our gateway sunset program, and we got to repurpose resources from somewhere because we're not going to spend in this climate. So we deprioritize that. There's no question, it's a margin lift. Like there will be lots of savings coming from it. Whether it's this year or in 2024, like it's always there. And it's growing, obviously, because our transaction count is going through the roof. But just like if we have to pick 3 or 4 things and the others can create like totally billions in market cap value, it's going to get the priority. So I'd also say that when we close on Finaro, you're now going to be introducing a lot of talent in the organization that has been managing their own front-end and back-end settlement systems for the last 10 years, and we hope to reassign some of the personnel to keep what is called our Everest project moving forward.

Great. As the founder and CEO and the largest shareholder of Shift4, you by far have the most skin in the game. What are the principles by which you lead Shift4 that are likely to be different from many other CEOs and payments who are really more professional managers?

Yes. So I mean, I think like I have -- the other leaders within the payments industry fall into a couple of categories. And I think, yes, you have some -- you have some professional managers in there. I think a lot of legacy acquirers and their -- they're shrinking. So they're cutting costs and raising rates, and it's not a strategy that's like super compatible with my way of thinking. I don't even really think about them at all because I think it's pretty obvious when you look at Stripe volume, Adyen volume, Square volume, Toast volume, Shift4 volume, like they're losing, so there's not a whole lot they can do to fix a leaky bucket. And then you have some of the more frustrating ones like the ones that capital has always been available to them, like the series, ABCD is just part of their vocabulary. I've never spoken it, like we self-funded our business, our first 15 years before we took on a PE partner, so we grew through our own cash flows through some really challenging times. So I do think -- it's not just me. I'm, like, fortunate to have an incredible management team. I think we've all seen tough times in the world, like we never thought the 15 years of 0 interest rate would continue. And at some point, like you're going to have to pay that bill in growth at all costs, and worry about margins and profitability later would come to catch up with you. And I think like we drew on that experience in 2020 and 2021 when people were out of their minds and doing a lot of crazy revenue multiple deals. We didn't do that. What did we do? We raised a s*** ton of cash, like converting 0% coupon cash on converts at a big premium over our equity price, and we said we were going to wait for the world to turn and we're going to put it to work, and make sure that we're a bigger and better, more resilient company going forward. And how do we do that? We diversified away from just restaurants, hotels and retail into a lot of new exciting verticals, and we improved margins and free cash flow along the way. Now, how do you get everyone on board with a business model that kind of beats the drum around boldly forward? You make everyone an owner. I mean, literally everyone in the company is a shareholder. We did that at the time of the IPO. I took -- I mean, I funded 50% of our forward shares program, which made -- with my own stock, not shareholders because I'm like offended by stock-based comp in most of those other reckless companies. I funded 50% there to make sure every employee, including those taking customer service and tech support calls, would at least have some good equity alignment. And then we educate them on what the hell it means, which is don't lose customers, like sign new customers. See, I think like 24 years of history not growing up in Silicon Valley, [indiscernible], we've learned an awful lot. There's a lot of wisdom inside the organization that I think we've -- has become part of the Shift4 way. And I think it served us -- I think it serves us really well in times when it was hard to see, which is 2021, and then hopefully became very apparent in years like 2022 and how we positioned ourselves for the years ahead.

Just in closing, you've had a number of new wins in one of your fastest-growing verticals, sports stadiums. And a lot of the business there is coming from concessions. How do you gauge the opportunity to win the ticketing business at a lot of these stadiums, and how should we size the TAM from ticketing within your stadium vertical?

Sure. I'll start with that. It's an entirely new TAM for us. And it's typically about 5 to 6x the total concessions volume within a particular arena or team, or something like that. The way to think about it is it's a software integration, just like the 500 others that we have, and any merchant using that platform is now accessible to us once we've completed the integration. So it opens up the TAM quite meaningfully. I think what's nice about our offering is that historically, teams have looked to separate vendors for all of these different pieces, and we can deliver them the entirety of the stadium and the ticketing, much in the same way we can facilitate all of the revenue centers at a large multinational resort. So it's a benefit to teams. They're starting to be able to understand their business through a single lens that they haven't before, and it's a TAM expander for us. That's quite meaningful, and it's well beyond the concessions volume itself.

Got it. And how does the RFP process work for ticketing versus concessions?

It typically doesn't. So the conversation with -- whether it's a sports team or a stadium operator, is talking about what they want to do, which is get the fan-first mobile experience inside of the stadium, make concessions, a much more efficient process, faster and better fan experience. And we're the ones approaching them saying, hey, let's talk about all the ways you collect revenue, not just the concession stands and the ways we can make that experience better for you. So it's a value proposition we're leading with. As I mentioned kind of briefly before, it's not something that teams and operators have been educated to even think about. They kind of just let the ticketing volume go through the default provider of their ticketing platform, and we're educating them on why it might make sense to consolidate all of that around a provider like ourselves.

Great. Thanks so much for that. Well, thanks so much for your time and insights. Greatly appreciate it, Jared, Taylor and Nancy, and have a great day up ahead.

Thanks to you as well.

Take care.