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

Great. Welcome, everyone, here in the afternoon session of day 2 of the 27th Annual Global Technology Conference. I'm Tim Chiodo, I lead Payments, Processors and Fintech analyst here at UBS. And we're very fortunate to have with us the team from Shift4. We have Jared Isaacman, the CEO; Taylor Lauber, President and Chief Strategy Officer; and also here at the conference is Tom McCrohan, who is Head of Investor Relations. So a special thanks to Jared, Taylor and Tom, who's been at this conference for many years, and we appreciate you making the trip to Arizona.

Of course.

Okay. Well, we will hopefully have some time at the end for Q&A. We'll have a microphone available. So if you'd like to ask a question, please be prepared. But we're going to start this out with hitting on one by one, each of the 4 idiosyncratic growth drivers that Shift4 has. We're going to walk through SkyTab, international, gateway conversion and new verticals. So with that, why don't we start with SkyTab, and let's talk about the distribution efforts there. Last year around this time, the talk was of the in-sourcing of about 350 salespeople. Maybe just bring us up to date on where we sit now in terms of both the in-sourced and the outsourced distribution of SkyTab.

Sure. So at the time of our IPO, we distribute almost entirely through third-party partners. And that was because we had a -- basically, we were processing payments in multiple different restaurant point-of-sale system software applications. Some we owned, some we built and some we partnered with. And basically, a year ago, we -- which was always part of the plan, you just couldn't do it essentially during a pandemic, we consolidated into a single cloud-based solution, which is called SkyTab. At which point, you were taking away the software and brand differentiation these various partners had. So you were going to inevitably lead to channel conflict. So it was a very opportune time to be able to in-source our best partners kind of leveraging the data we have, what are the best markets. We've been selling and successfully winning within the restaurant point-of-sale space for 20 years. We know that Fort Lauderdale, Miami probably going to be fine. And we know maybe parts of the Central Midwest, more sparsely populated areas might be a little bit more challenging, to which case, we insourced all the, like high conviction areas around the country, good data support. We've brought in over 400 employees in that process and pivoted largely to a direct model. We still have third-party distribution partners in those more sparsely populated areas just to round out coverage. But bottom line is that the product strategy is going incredibly well. In our last earnings report, we put a nice chart in that showed you just -- system count growth over the last year. And -- I mean pretty much all of our new -- I mean, all net new customers now are essentially on SkyTab. And -- largely it's a 2-horse race, us and another really good competitor, the only 2 with cloud-based solutions and the sophisticated distribution capable of servicing complex table service type restaurants. And I'd say we're both continue to be good beneficiaries from kind of legacy providers that don't have that offering.

Okay. So to that point, let's dig in a little bit there. So you've said in the past and maybe I think the truth is it runs a little bit at the gamut, but would you say that you generally target a larger restaurant or can target a larger restaurant relative to that competitor?

Yes. So I'd say, like a lot of things in sales, it's all about the sizzle features, right? The actual core product offering, for example, it's very mature for us and our competitor, right? The ability to ring up a cheeseburger or things like reputation management or analytics or online ordering, it's all table stakes. So the capability to power a restaurant is pretty universal between the 2 of us. I think that your sizzle features is what ultimately brings in customers. And if you want to target smaller or new restaurants, you have capital offerings and payroll offerings. That will resonate more with those type of customers. If you want to move up market, then you're leveraging your integrations within hospitality environments. You're providing business intelligence tools that are -- what larger customers would tend to gravitate towards. I would say that we -- generally, there's 2 players that are really targeting the complex table service market. And I'd say the bottom end of that would be more of your startups, your new restaurants, higher failure rate would be one, and we would gravitate towards the middle and the upper end.

Excellent. Let's move on to idiosyncratic driver #2, which is international. So with Finaro closing, you had given some numbers around the kind of run rate EBITDA for that business. But inherent in that, there was a little bit of portions of the business that you purposely exited, but at the same time, you were adding customers over to Finaro. So maybe you could just give us an update on the sizing and where we sit on the net of those 2 adds and subtract.

Yes, sure. So when we announced the Finaro transaction, we expected that -- had we owned it for the entirety of 2023, it would contribute about $15 billion in volume, about $30 million of EBITDA. The transaction took longer to close for regulatory reasons than we would have liked. But on the plus side, we were able to deliver a bunch of customers, and we're kind of in concert with that business around a lot of what the key strategic objectives were. Just to give you a sense for what that kind of extended review period afforded us, we would have expected the true synergy opportunity, which was to light up a restaurant in the U.K., for example, would have taken probably 3 years from the day we closed on that transaction. We lit up our first restaurants in the U.K. within a month of closing the transaction. So the synergy benefits have been immense from our standpoint, especially on the technical side. We can deliver a product that was pretty aspirational at the time of signing, we can deliver that today. That's really encouraging. The stats we've talked about publicly just to get a sense for what the blend of business looks like today as a run rate EBITDA in excess of $45 million a year. And we did try to break out some of what the kind of legacy business could contribute from a volume perspective. and what we think the synergized contribution can be in our most recent earning materials. I want to say that's not a guide. That's just a path that gets us to what has been a 3-year plan at this point that we're in year 2 of.

Yes. And maybe just to layer on because that's very transaction-specific of why did you buy an asset to open up a payments opportunity in Europe and what that transaction looked like pro forma for synergies. Maybe just give a rationale why do it in the first place. So for those anyone new in the story, Shift4 is doing business 24 years. And throughout those 24 years, we've derived virtually all of our volume and revenue from the United States. And we've grown both of those KPIs double digits every year without missing a beat through every downturn on that. And I say that because I think most would agree, the U.S. is the most competitive market for payments in the world. I think probably a lot of you would agree. There's a lot to get your arms around with all the different payments companies, public and private, right? So if we've been able to kind of prevail in that highly competitive market for so long and a lot of it is being very ahead on things like integrated payments, the convergence of software and payments, imagine what you can do when you take those products and services that have won in this highly competitive market, and you bring them into other markets that are less competitive. So Europe is a great example. Integrated payments, table stakes here in -- for restaurants and hotels in the United States, and we lead in that regard. In Europe, it's all stand-alone. So they might bring what looks like a wireless payments device over to the table. It doesn't do order a table. It doesn't integrate to the software. They have to reenter the check amount into it. Hotels, they'll pull up your reservation and then they'll key it into a local bank terminal right next to that. So like the opportunity set is really wide open. We wanted to follow a very important customer of ours all over the world, which is why we embarked on the transaction that Taylor just walked you through with the aim of taking those products and services that have worked very well for us here in the U.S. in a competitive environment and bring them into Europe, which is why we're chasing down restaurants, hotels and stadiums across Europe now that this transaction is complete.

Thank you, Jared, and Taylor. Let's move to idiosyncratic driver #3, which is the gateway and software conversion. So to set the stage, you recently updated us that there's about $180 billion of volume to go after. That split $150 billion from the gateways and about $30 billion or so from the software side. Those gateways, they were acquired pre-COVID, and you have been converting some of that business. We've talked about this many times in the past. But when we think about the mechanics of converting a gateway-only merchant over to full end-to-end, when you approach them, there's kind of 4 potential outcomes. And maybe you could just talk through those being: number one, there's some inertia and maybe they're just not ready; two, they convert; three, maybe they're repriced in terms of their gateway fees; and then the fourth is a small portion of them will depart the platform.

I was going to say, does everyone [indiscernible] background because you again, getting into the meat of it, but understand like why gateways even exist, why this opportunity even presented itself, like the card brands and the original legacy acquired essentially the backbone to the payment industry, like the technology is really binary and quite dumb, actually. It's an approval or a decline. And that's it. Maybe every now and then it said like voice authorization. So as there were new use cases for payments coming up that required capabilities beyond just an approval or a decline, the card brands and the payment processors took a very lazy approach and said, "talk to this company, they'll fix it for you." And what happened is like best example is like an authorized net. It was like, well, people are buying on this Internet thing, and now we need to make sure that where we're shipping the television set is the same address that's on the card. So like there's ABS, and then we got a white list like IP addresses that come from like international markets that shouldn't be ordering this. And these gateways basically became a technology layer that lived in front of the card brands and the legacy payment providers. And all the software that businesses needed to make that commerce experience happen, integrated into that technology layer instead of the processors or the card brands. And again, became a very lazy way out of, oh, hotels, you need to do authorizations online, but then you got to check in, but you can go to the lobby bar and charge back to your room, lots of different transaction amounts moving around. But when you check out, it's only a single card type. Well, we know there's a gateway that took care of that. Just go talk to them. And basically, they would do all of this work, integrating the software, tokenized transactions, provide the encryption, all the analytics associated with it for the smallest portion of the payment economics pie, right? Like if 50 basis points is the magic, they're getting $0.02 or $0.03. And they had to exist in an agnostic environment, where they didn't partner with any payments companies or they didn't favor any payments companies. They let them all play equally. We recognize that. So there's like a $0.25 trillion in volume sitting on these gateways, right, that were not being rewarded for the service they are providing, acquired them, gave up the Switzerland agnostic model and pivot them towards our own processing service, which in the spirit of just general vertical integration, which makes sense, owning more links in the value chain is more value to the customer. They ultimately save money. And in the process, it's a huge gross profit uplift for us. And for the better part of the last 6 years or so of our 24 years of existence, half of our production has come from moving those customers to our end-to-end platform through a variety of kind of carrot-and-stick methods, which is where I think you were ultimately team tailor up for.

Yes. So if you talk about the response from a customer who's integrated to the gateway, they've got a lot of software. They know inherently that we have a very different value proposition from their historic go-to-market. They don't have to work with 6 different vendors. They don't need the gateway to send transactions to a merchant acquirer, which creates multiple sort of points of failure for the transaction, a lot more complexity and just a lot more mouths to feed inside of it. So the natural proposition is, if I shift to end-to-end, which is our full stack offering, there's no physical friction inside my merchant location. Nothing changes from a technology standpoint, but all the transactions are in 1 spot, and that's really valuable for me, and I save money. So why doesn't everyone do it? And inertia is a huge point to it. And I think, Tim, you coined this in your like opening research on Shift4 a month after we went public. You said if there's an enemy to this strategy, it's inertia. And I think that's the reality of it. Like we'd love to think that hoteliers and restaurateurs and retailers are waking up every morning, thinking about how to optimize their payment processing transaction costs. They're not. They're waking up thinking about how to provide an amazing experience for their guests. So what tells us that the strategy is working. Number one, Jared mentioned this, about half of the growth of our business comes from these conversions. Number two, and probably more impactful, basically, every new resort that's been built in the country over the last 3 years has chosen Shift4 for all of those value proposition characteristics from the start. Whether that's the Fountain Blue in Las Vegas being built. They could have chosen any 1 of the competitors that we have. They chose Shift4. They know the value proposition. So the hardest challenge we have is in the summer of '23. I don't think we anticipated. This would be the busiest time for hotels in probably a decade. It's a hard conversation to compel them to have. With that being said, it drives a healthy portion of our production. We've got multiple teams that focus on this. And we're not unhappy with the pace, and I think that's most important. We have implemented strategies like modestly increasing the price to compel more of the conversations to happen. But I think as you lay out the likely outcomes, you've got a healthy portion that just kind of ignore the phone call and leave things status quo for a while. You've got a really healthy portion that migrate to end-to-end. And you've got this more modest portion that are willing to accept the price lift because they've got kind of nothing going on. Very few leave. The technological barriers to leaving are significant and you don't save money, you don't save complexity. So the reasons for leaving are quite, quite idiosyncratic related to a decision a merchant might have made 5 years ago, but very few ever take that path.

What all this means is that Shift4 just in terms of winning net new customers in the addressable market, which across restaurants, hotel stadiums is pretty enormous. It's probably 1 of the fastest-growing payment companies out there, and then we're further advantaged because we sit on a $180 billion plus, plus of volume that's highly dependent on our technology. That's a natural cross-sell. And it's basically like an embedded ARPU expansion story in the business. And for every $1 we make from a gateway customer, when they move to end-to-end, it becomes $4 or $5, and they're paying less in the process because they kill off 3 other mouths they're feeding. It's 1 of our unique advantages.

Thank you. There's a couple of follow-ups there, but we'll save if we have time at the end. Let's go to idiosyncratic driver #4, which is new verticals, which you just alluded to in terms of stadiums. I think a good place to start is just to talk about how many stadiums you had at the time of the IPO, which I believe was 1 versus how many that you have now? And then also just updating the audience on how you view the size of that TAM for stadiums and entertainment.

At the time of our IPO, which was June 5, 2020, we -- the majority of our customers were restaurants and growing very quickly, which is not the most desirable vertical when during a pandemic from a regulatory perspective. You weren't allowed to go out and eat. So we kind of committed if you pull off an IPO during a once in a century pandemic, you should diversify, so we went into other pandemic-sensitive verticals like hotels, travel, stadiums that were equally shut down during the pandemic. But it turns out they're all really good now. And at the time of the IPO, we did have a single stadium. To give you a sense of where we're at presently today, some 750 stadiums and entertainment venues -- what's an entertainment venue? The big theme parks in the country use Shift4 software to power their commerce experience. Of that 750, a little over 150 in Venue are using us for payments, so software plus payments. The other 600-and-some-odd will all come over the next 2 years as we migrate them from appetite to VenueNext. Of that 750, at the beginning of this year, we had 1, maybe 2, that were giving us ticketing volume. Ticketing volume is huge. If you think about when you go to a stadium, whatever the face value of the ticket is, you probably spend like a third of that at best, in just food and stuff at the stadium, right? If it's like $200 ticket price, spend $50. So like every time we get ticketing, it's like a 4x lift in volume per customer and it's actually a substantially higher take rates than what a concession stand would be. So we started this year with like 1 or 2. We're going to end this year at 10. And then kind of in the ecosystem around the stadium, you've got parking and retail, and we probably have -- of those 750, maybe 20 or so that are using us for retail and parking. We say that it's not in any way to imply that like we're not having success in this vertical, we're killing it in this vertical. It's more or less to set expectations of what you should expect to see over the next couple of years is all 750 of those wind up moving over to payments. And then we think a very large portion will wind up in heavily moving ticketing retail and parking.

Okay. Great. I think we covered those 4 quite well. Let's move on to take rates. So the take rate has been pretty stable in that 65 range, and I think that's been well received by investors. And that's despite some mix shift that we would have expected for it to come down more. So you're bringing on larger merchants, whether it's through new verticals or through gateway conversion. and there's also the mix shift over to Europe that's sort of pending, which has some markets that are higher, some that are lower, where we net out is we're modeling take rate coming down slightly over the next few years, each year, a few basis points. Is that the right way for investors to think about it?

The first thing I want to start because I really get the sensitivity to take rate and how easy you can make some of the modeling on this. Just to level set for everybody, right? If a competitor of ours, like our biggest value prop for us in moving into stadiums why we win like crazy here is we enable to order a burger and a beer in your seats and it gets delivered over. And that gives us leverage to get concession stands, the suites, the ticketing and everything else. Reality is like a multi-hundred million dollar a year stadium, isn't going to pay 100 basis points. If they were there's a problem, it should be a red flag. But what I can tell you is, let's just say, hypothetically, they pay us 30 basis points. There is no way any competitor can come in and say, "Look, I'll do it for 5. I'll do it for 2 basis points, but you got to give up this whole order, order the burger and beer in seats. They just would never do it. So I say across all fintech right now, like actually being able to grow payment volume is very difficult, right? You have to be providing a superior commerce-enabling experience, not an approval or a decline, but a broader commerce-enabling experience even to have the right to win. And then once you do have the right to win, the pricing corresponds to the size of the customer. So of our 24 years in business, like 17, 18 years of it, all we did was the Irish pub on the corner, like 90, 100 basis point customer. Last 5, 6 years being in business, we've got some of the largest hotels, resorts, half the Las Vegas Strip, massive stadiums, they don't come on at 90 -- 100 basis points. They come in less. And what happens is it starts to average down. It's a mix shift towards somewhere around 65. Now what I would say is, like I do believe we reached a point where we're exiting this year, call it, $110 billion in volume, you're dealing with such large numbers now, that when like a $3 billion a year enterprise hospitality customer comes on at appropriate pricing for them, it has less of an impact as it did a year ago when you still had a lot of smaller 100 basis point customers that comes on and it brings down the averages. So I think Nancy said, we're probably -- using 65 is a good launching off point for this year is -- makes a lot of sense, and that they were still a majority of our customers are the small restaurants and hotels that come in north of 65, but we also are doing a really good job winning some monsters too, and hopefully averages out and stays in that ZIP Code, but it should progressively come down over time. I mean, it just makes sense.

Agree. All right. Let's move to EBITDA margins. Specifically, your very high incremental EBITDA margins. So the past 4 quarters, they benefited from the residual buyouts, which had a benefit to the cost of revenue line, and the incremental margins were, I want to say, in the 90% range. But what's the right number to think about on a go-forward basis? Is it in that roughly 50% range for incremental EBITDA margins?

So it's a great question. I think the right way to contextualize this is all the new verticals we've introduced despite the spread consternation that I think some have had, the incremental margin is phenomenal on them. Like, when we enable ticketing for a stadium that we're already supporting, that is 100% flow-through. The Ticketmaster integration or the SeatGeek integration or the Paciolan integration, once they're built, the maintenance on them is relatively low throughout the time frame. So the flow-through margins are really attractive. One thing I want to emphasize because I think at -- like many of our competitors were not profitable businesses. They are changing the way they do business in a climate where being profitable is a requisite for doing business from their investors. We are in the opposite position, which is that we've been profitable for the entirety of the company's history. And we view times like this is a time to invest in the business. So despite the margin expansion we've seen, we implemented 2 new headquarter facilities in the past year. We've got multimillion dollars sort of software revamp projects for internal systems, and we're upgrading talent across the board. So if any of these investments have a positive ROI, and I think they all will, you'll see further margin expansion. But it's important to realize that the flow-through in the payments business is always very, very high, and the new verticals that we're penetrating offer that to an order of magnitude.

Yes. I'd also say like where our foundation was built, which is on restaurant -- small restaurant software customers and gateway business, you're talking about some of the most labor-intense customers imaginable. I mean, they call you for -- you want to change the price of buffalo wings. That's a phone call. There's a new tax in this county. It's a phone call. Like small volume, high take rates, lots of overhead burden to support them. So literally, everything we're doing in our strategy, which is consolidated around the cloud-based solution, which is SkyTab take out the parts and to lead gateway connections and move them to end-to-end, all favor margin expansion. I would say like better than half of the organization in terms of headcount, we have 3,000 people is spent maintaining legacy solutions, all of which have active efforts to drive them to a modern solution. So we've declared last year, essentially at this conference, hey, we're going to maintain flat head count going into this year, but you should expect all our midterm outlook growth numbers to hold, essentially exactly what has happened. We're going into next year, doing the same thing. And it's based on constantly reallocating personnel from the past to work on your future-based solutions as they inevitably move over towards it, not to mention all the new verticals are all very high flow-through type customers that don't require a lot of overhead, a lot of incremental volume from [indiscernible].

Okay. Great. I want to squeeze in 1 last question and then hopefully, we have some time for the audience. So Jared, as a part of your Q3 investor letter, you wrote that the company was and I quote, "actively exploring strategic opportunities and alternatives that will reduce distractions and serve our company, employees and shareholders best." Can you elaborate on that some more?

Yes. I mean my commentary would be consistent with what I said before, which is it's in the Board's hands. But like -- yes, I don't think we're always very appreciated for the results that we deliver, and that can become an expense from management perspective, like we -- management holds 40% of the equity in this business. We think with that equity on every decision we make, and I think that's reflected in the results. And it's like -- I mean, look, I write my own letter. I put in there like is it -- do you feel like the crowd is cheering for you as you're running very fast Or are they hoping you trip and fall? I'd say over the last year is more people rooting for us to trip and fall. And if you have alternatives, it's worth considering.

Thank you, Jared. I think we can go to the audience. If anyone would like to raise their hand, we can come around and ask a question. Anyone out there? Okay. I've got a few more if we can squeeze them in here with the time that we have left. So let's go back, Taylor, you touched on this a little bit in terms of the levers for the gateway conversion. And you mentioned pricing, and you -- I think, correct me if I'm wrong, you sort of alluded to, you haven't really pressed that too hard. And when I look at our model and I look at the gateway fees on a quarterly basis, they've been flattish to, and then in Q3, they were down a little bit, which me makes me think that you haven't really pushed that lever much at all. We appreciate that some of the volumes have gone away. So how much of an opportunity is this? And would you consider pushing that lever some more?

So a few things. I think it's a constantly evolving process. We basically get, for simplistic purposes, a shot a year per customer to evaluate the pricing they're on. Our first year, we were, I think, more conservative than we necessarily had to be. It didn't necessarily create the phone calls that we would have liked. And in a -- to a certain extent, the same in the second year. And I think that -- if I'm being critiquing the strategy, I think it's generally worked a little bit less on conversions than we would have hoped, a little less phone calls, quite frankly. You get a steady number of conversions kind of just in the regular course way we think about and attack the gateway population. The things to keep in mind are, it's a hospitality-oriented group of customers. Hotel rates have gone through the roof over the past year. If our build goes up, it has gone nowhere -- up, nowhere near as high as probably the night to stay in this hotel over the course of the last 2 years. So you're in sometimes the merchants got a lot bigger things to deal with than just your pricing strategy. But we also want to be thoughtful and cautious and play for the long term. I think you've had 2 very notable missteps by competitors in our industry who introduced aggressive pricing, and 1 got a phone call from Congress. So we want to be mindful. We want to be thoughtful. We want to get the value we deserve. And the day we will find out our strategy isn't working is when we're not winning net new customers with the exact same value proposition. And to the point I made earlier, we're winning a ton. We're relatively content. We assess on a weekly basis, the tack that we're taking. And over time, we will get full value, and we're stepping in that direction. And whether they move to end-to-end or they stay on the gateway and pay a higher fee associated with that, we're reasonably content with either option.

Okay. One more time for the audience. If not, I have 1 more I'll squeeze in. Okay. Let's see if we can get to it. So you guys have given some color on this, even in a shareholder letter once. But could you just talk a little bit how you consider the total cost to the restaurant of SkyTab relative to some of your largest competitors?

Yes, I think that's -- this is just how we grew up in the -- as a company. Like, we're a basement startup in New Jersey. We never had like a Series A, B, C, D. It was all self-funded out of our own cash flows. You -- all our growth was driven. Every hire that we made was out of our -- essentially your own pocket. I think that shapes an organization a lot more differently, and we're a payments company, which means that's how -- we're going to monetize through spread on volume. But we also recognize very early on, going back to 2005, when created Harbortouch that you had to be able to differentiate from traditional payments companies by providing a broader commerce solution, a software application that will allow you to differentiate, win customers, you otherwise win and retain them longer. And we looked at that as pain points that you were solving for your customer to capture payments volume, right? So over time, you continue to have good feedback loops and you figure out how to evolve, whether it's your restaurant software, your hotel software in order to make a better application to win and retain more payment volume, right? I think it's very different to approach it as a software company that's like I have to depend on at some point, ARPU expansion. So I need like 8 different modules, right? And I better think of a 9th. And then I need a 10th as if customers are super excited about the 11th module that they get to pay for, right? So I think just that evolution has manifested itself in our pricing to customers. Like are you -- unit economics isn't something we had to learn in the last couple of years. It's been like foundational for us since the get-go. So we understand exactly where we can invest in a customer and what we need to charge. And if we'd rather charge that through SaaS or payments, we made a conscious decision long ago to do it through payments, which happened to work out really well in an inflationary time period, where you'd rather capture spread than a fixed dollar amount because the characteristics of the revenue, if anything, are superior probably in payments. So that's how it's evolved to such an extent where there's this massive disparity between us and our competitor in terms of what we're willing to charge from like a SaaS perspective and if we need to invent another module to get us across the finish line. And instead, it's like, you know what, the headline looks really good for us and we'll get a little bit more in take rate on payments and the customer will like that, right? And I don't say -- suggest and -- provide this in such a way that it describes like 1 has to win and the other has to fail. It's not the case. Talking about 2 players that really have the best solution to take a ton of share from, call it, legacy providers. So there's a lot of winning at the end of the day for both organizations, but we think a little bit lighter on SaaS, little bit more on payments. And I think that's just based on the organizations, 1 as a payments company, 1 as a software company and how they've evolved.

Well, Jared, Taylor, Tom, on behalf of our team here and everyone at UBS, we really appreciate you being here with us. You've been a big part of this conference for many years, and thank you for being here. It's been a pleasure hosting you. Thank you.

Thank you so much.