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

Yes. Great. All right. Moving on to other verticals. So in addition to restaurants and lodging, you're going in several other areas, probably gaming, stadiums, entertainment arenas, eCommerce, nonprofits, kind of top of the list. There's others and international, I want to talk about separately. The overarching question I always have on that is, what gives you -- what do you feel like gives you the right to win in these distinct verticals? Because I think what we've seen in general in this market, it's much easier to win, obviously, if you're Toast, if you're -- I'm the restaurant specialist, I invest everything in designing those systems. So when we see you really trying to go very broad, it's ambitious, it's impressive that you're trying that, but what gives you confidence that you can actually do that across many verticals?

I don't know, 65%, 66% year-over-year volume growth. The fact that it's working. We've been growing volume really fast in revenue for 24 years. So we do know a thing or two, like I think some of this is like not PowerPoint, it's pretty reflected in the numbers. Look, that said, some of the -- like it's most like absolutely badass payment companies in the world serve like untold number of verticals. I mean, take Stripe and Adyen. Stripe and Adyen like they don't build a Netflix product, a Microsoft product, an UberEats product. They're an amazing payments platform that attracts integrations from software companies to meet their requirements, right? We built a payment platform that meets the needs of certain software companies and certain verticals requirements. Now it happens to be unlike the least s*** verticals, the ones like -- and maybe I actually think that there are awesome and s*** verticals. But like what people like is the visibility of seeing like, oh, that's a Square terminal. I know what that looks like. Look at that, that's a Toast terminal. That's a Clover terminal, right? Like you'd have to go into like the mainframe room at Caesars Palace to see the Shift4 magic, right? So like we specifically cater to the most like demanding and complex payment environments in the world, where no one piece of software can make it happen. If you can download a piece of software on an iPad and run the business, that Square's world. And then when they graduate at Square's world, they're going to Clover, right? We have almost every ski resort in the country, and it's not just the hotel portion, it's the ski rental shop is integrated to Shift4. It's the salon and spa, it's the 3 restaurants and the gift shop and all of that. Like that's where we thrive. And actually, when you zoom out and look at the verticals that we're playing in right now, they all share those characteristics. Think we were surprised about stadiums. We had one stadium at the time of the IPO, which was Raiders stadium, and they were using the same Oracle software that was in every one of our hotels. So we were like sure, we can do this. But then when you looked under the hood, you like it's just like a hotel, they just don't have the hotel rooms, like they've got restaurants in them. I mean, some of the ones have night clubs in them. They've got the VIP suites, they've got a merchandise store. We're like -- and it's generally all different software. So like we can do this. Actually, nonprofits was another surprise. But then when you realize, like this isn't a world where people are just sending a $20 check to their charity anymore, like you can have people streaming Fortnite and making donations like you're doing YouTube. They're using lots of different software. In the end, you're trying to get it all popular into a common donor management database. But all of the verticals we are trying to conquer, all share those same characteristics of lots of different software that integrates into a payment platform that's designed for that purpose. Just no different again from Adyen or Stripe or any other like really amazing payments company that's trying to attract software integration.

Yes. Are you competing with Adyen for some of those mandates or who do you see most often?

I mean, we generally try and pick verticals that the best-in-class players out there can't easily play in. Again -- for example, in hotels, specifically, I mean you need to have 500 software integrations in 20 years of Virgin history in order to ever be able to respond to an RFP from Pebble Beach or Caesars Palace or something. So we intentionally try and stay out of lanes like -- like we like when our competitor is like U.S. Bank. That's a good point. That's our biggest competitor in hotels. So I think like gaming, for example, is another good one. We were so advanced -- 40% or so of the casinos in this country, like the physical casinos are our customers, should totally go for gaming. I would hope if we could leverage the data the tokens we have in an in-venue casino that that gives us a right to win the mobile gaming solution. So we try and like have like a pretty significant advantage if we're going to dive into a vertical because anyone like that's purely going head to head with Adyen and Stripe, like if you don't have some extra magic or sizzle that differentiate, you should lose.

Yes, makes sense. All right. Let's talk about international quickly. So big strategic growth vector for you guys potentially. I guess talk about -- it's a huge opportunity, a huge market. What's your strategy of approaching it? How do you get a toehold there and where we are right now in that journey?

So it's a few things. This has been something we've been working on for quite some time. If you think about the merchants we serve, we've got like a handful of the key ingredients for success around the world. We have the software integrations that are being used all over the world and take the -- we love to illustrate the Hilton in Madrid is using the same software as the Hilton in Times Square, it's integrated to Shift4. We can serve the merchant in that capacity, and we have the relationship with the merchant. What we don't have is the local payment methods that are prevalent that that merchant demands inside of their geography. And so it's been a multiyear effort of us exploring how are we going to tackle this. What is ultimately a big complex problem of supporting all the local payment methods that are relevant for our merchants. We've been fortunate through innovation and relationships to win a handful of big global e-commerce merchants that have committed to giving us business in any country we can serve them. And that's emboldened us to kind of accelerate this international expansion strategy. So we announced that we are acquiring a European payments platform, which is unlocking an entire continent for us with the plan always being we're going to double back now and make all the card-present magic that's made us successful in the U.S. work there. And what's really, really compelling about that is there really isn't the concept of software integrated payments throughout the world anywhere near how it exists in the U.K. still -- I'm sorry, how it exists in the U.S. You still go to many countries. And even if they have a piece of software, they've got a local bank terminal that's not at all integrated to it. So to Jared's point, we've had kind of 20-plus years of success integrating software and payments here in the U.S. in a highly competitive market, and we can bring those capabilities overseas. Very happy to report we already have. It's through partnership because we don't own this acquisition yet, but we already have SkyTab transactions working in restaurants in Europe by way of example, and that can be just a huge market for us. So it's, in many ways, taking the playbook that's made us successful in the U.S. and just identifying markets where they're not necessarily at the same level of maturity and saying, how can we get there?

I think -- I mean, look, it's a giant like TAM expansion opportunity. I think like a lot of companies when they talk about TAM expansion, like especially the unprofitable ones, is like this is why you can have comfort that eventually, I'm going to have this all sorted out because it's huge, right? Like we've been competing in the U.S., which is like a super competitive market for 24 years right now, and we've grown revenue every single year in that. We are profitable, and we have customers that have locations all over the world. And we've been afraid for the longest period of time to make that leap because international integrated payments is super hard, super hard, right? I mean, Visa MasterCard was a nonprofit organization for the longest time. Every bank was treated equally, specifically so a major U.S. bank couldn't go into another market and bulldoze it, right? So it's been designed to be hard. And then they came up with all their local like debit methods, their own encryption standards are different in different countries like there's not just the general EU standard for this. So it was made really intentionally to be hard. Now those that have success, and you're talking really only to, again, is like Adyen and Stripe that have like a really good global commerce solution. They did it with card not present, e-commerce because it is a nightmare to do it in card present. So like we were like, we want to do this. We have the customers. We have the integrations. We know if we make it -- if we're profitable, we're growing really fast in the U.S. I think we should be able to -- like there's restaurants and hotels all over the world, we should be able to take our products into those markets and find success, but how do you really derisk it to be willing to embark on what is a challenging journey that no one has done from a card-present perspective? And it was one like really premium customer and a great relationship that said, "I will give you this yellow brick road all over the world, you follow us, we'll tell you what we like, what we dislike, what we've already learned because we're already there and you're not. You'll make your product better, make us happy. And then once we're there, and we've got to figure it out, you bring all your restaurant, hotel and stadium integrations, everything that made us successful in the U.S. into those markets because they have restaurants, hotels and stadiums." So that's like the whole game plan, and we're really far along with the Finaro. Like from the time we announced that deal, 13, 14 months ago, it's a better company today than it was at the time we signed the deal. And we've plenty of time to work through our integration approach to such extent that like we've been dating long enough that we should be able to get married and then go on and look for our next bride, which is what we're doing now in other continents.

Got it. All right. We're going to be looking forward to that being resolved finally. Moving on to a couple of other topics that I wanted to hit before we run out of time. One is coming back to the distribution strategy and what you mentioned, Jared, right? So you -- that was a relatively big strategic move last year. You acquired 50% of your third-party distributors, in-sourcing them. So just taking a step back, historically, you really liked, I think, and relied on the third-party distributor model. It seems to be pretty core to the company as they gave you flexibility to grow, et cetera. That's how I'm thinking about it. Why the decision to make this move now or whatever, like last year, what prompted it?

Yes. I mean, at some point or another, you had to let go of like the legacy brands that we acquired in 2017. So we squeezed all the payment volume out of it. Now you're maintaining a lot of Windows-based POS systems. I mean -- by far, I mean, if you look at, call it, 2,400 employees, more than half of our workforce is supporting restaurants. Like that is your most labor-intense high overhead -- you have one employee supporting a multibillion-dollar hospitality customer, and you need like 1,000 employees to capture the equivalent in restaurant volume, right? So you got to unlock efficiencies, you have to delete the parts, sunset like your Windows-based POS products and align everyone around a common product. That's hard to do, right? Like our 4 or so POS brands, plus we played really nice with MICROS and Agilisys. We're able to differentiate based on their product brand and their software. And now you're saying all that has to go away, right? So that's like a forced migration to a new product. So knowing that that was like inevitable that you had to do that from a sake of brand building and operational efficiencies and concentrating resources on single product development and everything else like, how do you do it, right? And now at the same time, you also have the advantage of a new cloud-based solution where you no longer necessarily require the same amount of resources in the field to support the customer. You still want local service and support, that is an important way we try and differentiate from the other player out there. But it's not as labor intense in the field as it was previously because it's cloud based. We can log in, see what they see, make a change, they see the change we made, so on and so forth. So that's what kind of gave us the rationale of you have to do this. you have some advantages now with cloud-based product to say, like, let's pick off our best partners, let's bring them in-house. These are the best relationships we've had for like 15 years. They've built the business for the last 10, 15 years. You know which markets are going to be successful based on just historical customer base and production trends, say, we're going to bring them in-house. It's obviously change -- dramatically changed the margin free cash flow profile business. But again, it's huge unit economic enhancement here, quicker paybacks, lower customer acquisition cost. And then in markets where you're unsure, the more sparsely populated areas where you don't want to trade a variable cost for a fixed cost, you keep those partnerships rolling. And that's exactly what we did towards the end of last year. And by the way, like this -- I put that in my shareholder letter at the beginning of 2022, which is the road is uncertain right now. Like we don't know if the $100 stakes are going to last, like the good times of '21 are -- look like they're coming to an end. Our promise is to prioritize our resources towards the absolute needle movers. And that's exactly what we did. Like we focused on a couple of key things, gateway sunset, launching a new restaurant POS product, in-sourcing distribution, and the results of it were extraordinary, and it's obviously, it's played out way better than we've expected. I mean you've got thousands of new customers coming every quarter from SkyTab.

Got it. Great. Okay. And now the topic I wanted to talk about quickly, at least is the unit economics, the direction of the yields, et cetera, I think that's an important topic for you guys. So starting with the yields, investors look at the yields closely. So first, when we compare your yields to the other players in the industry, they are very high. I think you've already mentioned it, Jared. And I think that -- correct me if I'm wrong, that sounds like just a function of almost how you monetize your products versus the other. So that's probably important point. But then now they're coming down, and it comes in I think last quarter was kind of a big year-over-year drop, 4 bps sequential drop. Can you talk a little bit about what's driving that? And what can we expect going forward on the yields?

Yes. Can I -- you guys should both weigh on this, but I want to set the stage because it's like, I think rightfully, like a lot of investors are like, I don't even understand payments anymore, and I hate it all or something at times, right, because it's confusing, like who's winning, who's losing, who can I trust, who can I not? Like to be really clear, like there are no real price wars anymore. Like that was like a different generation when scale mattered, and there was a lot of consolidation going on right now, like actually like the good platforms, like we get really good take rates. Like if you're adding a lot of value from -- like from a commerce experience perspective, you've good take rates. I mean look, in the last probably quarter, Stripe, Toast, Shopify, they all went up in price. If you want to use our online ordering modules, you want to use like -- they all went up. Everybody just takes more. Square added like subscription fees to like every one of their third-party services like you're adding good value, you're getting decent take rates right now. So when you see take rates come down, like this is purely a factor of mix where you're going from 17 years of our history, serving just the Irish pub on the corner that does between, I don't know, $800,000 and $1 million a year in payments, you get like 90 basis points. right? But when you sign up like the Washington Commanders or the Baltimore Ravens, they're not paying that, right? You sign up like a multibillion year hotel operator, they're not paying like 70, 90 basis points. It's like, oh, it's got to be like crazy market forces at play here like highly competitive. Believe me, like there is no way a major NFL stadium or a multibillion-dollar hospitality operator is switching for 3 basis points. I mean the Four Seasons went from like $600 a night to $1,200 a night, guys. They don't care about 3 basis points. What do they care about? Mobile check-in, because they can't get people for the front desk, right? Like that's -- it's all about adding value through a broader commerce experience and very, very little to do with an approval or declining more. So like what is the KPI that matters? If you are growing volume, you are adding value and you're winning. If you are not sharing what your volume KPI is anymore as a payments company, you are shrinking and you don't want to talk about it, right? So like moving that needle first makes sense. And if you're moving upmarket from $800,000 a year customers to like $4 billion a year customers, yes, you should expect take rates to come down. But I still think like we are like relative to anyone that we're compared against like we're meaningfully higher because 85% of our restaurants don't pay any SaaS fees at all. We choose to entirely monetize fee payments. And with hotels like where we're often like criticized. Look at these guys, customer acquisition costs, they give away devices. But you get 10 basis points more on like 2 million a year, it pays back in 9 months. It's actually smart. So anyway, please layer in.

I think you said it well, but I think the key is just to like go back from all that and just say, this is a blended spread. It is not a compressing spread, right? And so we've tried this a couple of different ways over the last couple of quarters. I'm hoping we've hit the mark at this point, but our high-growth core and our historical business spreads are consistent. They are unchanged. They are as solid as they ever were. When we came out this quarter, and I think even when I look at kind of exiting Q4, we're about 71 basis points, we messaged that we started Q1 right in line with Q4, but we knew, right, that we had a large hospitality client that was coming in that was going to bring those trends down. That's just math, right? It's a blended spread. And I think that's why we tried to give out the trajectory for this year of kind of saying full year should average about 65 basis points. The choppiness, and this is just new to Shift4 as we're going up market, and we're bringing in behemoths is that it could be choppy, right, quarter-to-quarter. We've joked that maybe we should have waited 1 more month to bring in that hospitality client and had a quarter of spreads that looked just like Q4. And of course, not having that large enterprise hospitality client in for a whole quarter, it will blend it down slightly as we go into Q2. And that's why we thought putting that measure out was so important. I think though it would be remiss not to just mention what I think has already somewhat been stated. There is an offset of the service model in exchange for a lower take rate. You also are investing lower SG&A, right? And that's why we're able to expand margins over time even with the blended spread coming down. So I think EBITDA margin and free cash flow conversion is really the test point at the end of the day of the model, and I think those kind have spoken for themselves.

Yes. I would like just if spreads weren't coming down and we were dropping the same logos that we have been in our quarterly earnings report, that should be a huge red flag. Like how is that possible? Like are they like -- man, that product must be really good, they're going to be a 1% partner in an NFL stadium that's worth $5 billion or something, right? Like that should -- I would think like instead of reacting the other way, it's like the product is winning and it's just making sense given the size of the customer. If take rates weren't coming down as we're mix shifting up, that would be a red flag.

Right. Great. Okay. Well, perfect segue into a conversation about EBITDA and free cash flow because I did want to hit that in before we run out of time. First, a very simple question that's I get asked often, and I don't know if I have a perfect answer to it. What's the secret sauce? Why are you able to be consistently profitable, I'll just start with that simple question, versus the peers who are seemingly competing and doing basically the same thing, are in the red -- pretty deeply in the red, frankly. What is the secret sauce?

The secret sauce is we were a basement start-up in New Jersey. That's why. Like there was no Series A, B, C, D in Shift4, like it was $10,000 seed check from a grandfather and you've got to pay your own bills from here for it. I mean, honestly, it's like -- that's the truth. We were EBITDA positive -- we started the company in late 1999. We were EBITDA positive in 2004. First outside capital that we took was in 2014, our first acquisition. We financed all of our growth like making payroll meant taking in more revenue than expense for the bulk of our history. So like that's more our DNA. It's just a more disciplined approach. Like you look at like when you're hiring people that what you're paying them is like your cash that's going out the door. We're -- our actual normalized stock-based compensation is like sub-1% because at the time of the IPO, we had 2 shareholders in the company. There wasn't a stock-based plan now big in equity alignment, but it didn't exist prior to the time of our IPO. I think we were raised as a completely different organization that cash won't always be waiting around the corner and had to have an eye on profitability. It means like you're challenged to find a better way, right? Like exactly like the Focus POS acquisition this past quarter, like you got $45 million of cash, you probably didn't know we had. You could throw it towards digital marketing and Google AdWords and brand building. And you might attract a lot of restaurants that go out of business in the first year because their pizza sucks. Or you put it towards a company that has 10,000 customers highly sticky on their product that do $15 billion a year in payments and you probably synergize that thing down to less than 1x. Great use of capital. I mean that's what you're -- when you're using your own cash the entire time, you find a better way to get there. And that's not like knocking the other way. The other way works. If you time it right in a 0 interest rate environment, you can create some pretty extraordinary businesses. And I think Square and Toast have great products, but they're much more of like, I think, like a West Coast success story from Silicon Valley and kind of how we do.

Yes. Got it. Okay. And the path from here on EBITDA margin, and I'd love to hear your thoughts on free cash flow conversion. So the trajectory of improvement may be on both, what drives that? What should we expect over the next couple of years kind of medium term?

Yes. Look, we've kind of talked about this year's trajectory. You could get it from the guide that -- we do feel like there's still some expansion from here. We are very thoughtful. I like -- I was thinking the word that Jared said, which is disciplined. So we are investing when needed for growth, right? You can't not invest, right? We'll -- we talk about headcount flat, but that's offset by talent upgrade. So we'll make choices when it feels right to propel growth and stability for future growth. But look, we think there's room. And I know Jared hasn't used it in a while, but when you look at kind of where Adyen is versus where we are, we think there's room somewhere in between. We'll never get to be an Adyen because we have our legacy high-growth core, which has a higher intensive service model, but we think there's still room. And so I mean, I think with the discipline and the blend of the business that we're bringing in, we think you'll see some more from here going forward.

Yes, on the margin. And on the free cash flow conversion, just to point on that specifically, how quick to now are you kind of in the 50s on the adjusted measure, some gradual improvement this year. I know first quarter was much higher, but I know it also facilitates quarter-by-quarter. Over what time frame do you expect to get to your -- to the AD's level, which I think when you look across mature companies, that's where they are?

Yes, I'll be quick. We probably will never get to the Adyen because our model is equipment and our capitalized acquisition costs, like we like our model, right? So when you compare us to others, we do have a little bit more capital-intensive model as we trade off for other cost and unit economics. So again, I would give you generally the same answer. There's room, but don't look for us to be at an Adyen free cash flow in the near term.

Yes. This is like a critical -- we don't want to be immature, just to be clear, like if we're not investing meaningfully in customer growth with good profitability, like that is a huge caveat that I don't think the company is on the trajectory that it has been on for 24 years.

Got it. Great. Okay. Well, we covered a lot of topics in a relatively short time. Jared, maybe you can close off with your current elevated pitch. Why is now the right time to invest in Shift4?

Yes. I mean time of the IPO, when people first bought in kind of the Shift4 dream from a public perspective, we had like, I don't know. -- maybe like 80% of our business was from restaurants, like a substantial portion in a single vertical that at least during the pandemic was like for a while regulated closed. We actually were able to grow through that in double digits revenue and volume perspective. Like the business since that time, like we even said if we're able to pull an IPO off in this climate, right, like we have to emerge from this a more diversified and stronger organization, right? Since that time, moved into vertical of hotels, not like they exactly fared much better than restaurants did during the pandemic, but we have a lot more of them now today than we did before. Specialty retail and then moved into new verticals, right, eCommerce, gaming, travel and leisure and nonprofits. Now at the time we set expectations for investors like right when the euphoria was fading in late '21, we had nothing more than an anchor customer in every one of those verticals. Commitment from St. Jude, commitment from a very strategic eCommerce subscription player, a commitment from BetMGM, we had no integrations at that point, like we had to build it. We said we're going international, but we didn't have any means to authorize or settle transactions in Europe at that time, right? We got through and beat our first year midterm outlook. And basically, in the second half of the year got those integrations done and set ourselves up for year 2, which we're in now. This is the easy year, right? Like all those integrations are done, and you're getting the annualized effect from all those behemoths that we signed last year, and you've got like the international on a path where I said it's a better company today in the case of [indiscernible] then it was at the time we've signed. So the point is in terms of delivering on the expectations we told you at the time of the IPO, look at every one of the KPIs that are associated with it, look at every vertical, look at the penetration within it, and we've exceeded expectations. And I'm telling you it's easier now than it was at the time we set those expectations.

Got it. Okay. Well, thank you very much.

Really appreciate it.

Thank you.

Thank you.

Thanks, all.