Clearwater Analytics Holdings, Inc. (CWAN) Earnings Call Transcript & Summary

Let's go ahead and get started here. Thanks for joining us this afternoon as part of our fintech forum and symposium here at Morgan Stanley. And I want to thank Sandeep for joining us here. Today, we're going to talk Clearwater in just a moment, but I was just telling Sandeep that I have an important disclosure to read and sometimes I forget to read it. So with that, for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

You don't really read the disclosure. You just point to it.

Yes. Well, yes, I read to point to people where they can go get the actual disclosure. That's right.

So Sandeep, CEO, Clearwater, thank you for joining us today. This is exciting as we had a chance to catch up with the management team -- some of the management team a little bit earlier this quarter. But -- and we're going to dig into kind of current trends. But for those of you that are -- that may be listening, et cetera, can you provide a brief description of Clearwater? And in particular, the pain points you're trying -- specifically trying to solve for your asset manager customers, et cetera?

Yes. So quickly, I could do that for a few minutes is basically Clearwater does investment accounting and reporting for clients. So why do people care? People care because they're increasingly investing in many, many alternative assets. They're investing in mortgages and derivatives and real estate and things of that nature. They're also investing globally, right? So people are investing in Europe and investing in Asia and all of those markets. Now like times like today, lots of volatility. So what do you want? You want to see a comprehensive view of your portfolio. Try doing that if you got every accounting software for every asset class. Every country has its own accounting engine. It just becomes awfully hard to do. That's what Clearwater does. Clearwater, on a daily basis, if you're a client, at 9:00 in the morning, you'll come in, you'll see all of your assets in one spot, which you can double-click down to the Nth degree and see what's going on. You can then look at risk. You can look at portfolio decisions. You can look at regulatory compliance issues and all of that. That is the proposition we have. Who do we sell to? We sell to insurance companies. We sell to corporates and we sell to asset managers. And so just at a high level, that's what we do.

So let's go down just another layer, if you will, Sandeep, is that I would venture a guess that it doesn't matter what asset manager you are in the world. You probably already have an accounting program today, right? So how does Clearwater win? Or what's the value proposition for a typical insurance company? What's the pain point that they have beyond just as you said, there's lots of assets, et cetera? But I think there's the cloud and these other aspects that seem to be important at least to me.

So you just think about the business problem. So let's talk about technology for a second. So you said it exactly right. You're an asset manager and you've clients. So you -- the client wants to invest in mortgages. What do you do? You have an accounting system for mortgages. The client also wants to invest in private equity. So you have a different system of private equity. But the client wants exposure to emerging markets, CF systems in Japan and everywhere else where you have accounting engines there. But a client wants to see one comprehensive view of what's going on. That's where we come in. We don't do accounting better than the mortgage people or better than any of that. We do all of them together on a daily basis. So when you come in, you don't get 7 different reports from the asset manager. You get one portal. You see all of your assets in one spot. You see overall gain, overall risk, overall exposure. That's what Clearwater does, so it gives you information about your global portfolio on a, literally, ongoing basis.

And what's the benefit of scale as Clearwater grows and as the customer base grows? Because one of the things that struck me as I was learning more about the life insurance business or, better said, their portfolios of assets, a lot of times, they've got a lot of stuff that doesn't trade very often and it's not very liquid. How does Clearwater help address some of those issues?

Yes, yes. So I think what makes Clearwater totally different, so people talk about the cloud, and we are on the cloud, right, as you have to be, I think, and all of the benefit that accrues from there. So the question is, what is really different about Clearwater? And where do we get like your -- why are you more efficient or are you more efficient? And I think the secret lies and we have one single security master. That is the difference. So what does that really mean? What that really means is that if you have 100 securities you invest in, I process all those securities. But when J.R. comes along and there are 30 common securities, I don't process them a second time. I process the 100 still and the 40 he has which are unique. So as you add clients, you're processing less and less uniquely for the new client. And so your efficiency is completely different but it's not about efficiency. Let me talk about the more important thing, which is quality of data. Is the data accurate? So we process this every day. We use machines and then we use many, many people to try and make sure the data is accurate. But when you get a James, you may notice something. You must say, that feed or that data point does not look right. What are you going to do? You're going to call me. But when I fix it, that fix reports to all clients who use that security. That is the power of Clearwater is that you're not just getting quality of data because of what you find, is what anyone in the system finds. Same thing is true for how you amortize assets. You do it a certain way. And you may say, Clearwater doesn't do that. I can tell you, at that point, everyone who uses that asset, we can say 80% amortize it in this way, 20% amortize it in this way. James, why do you want to do it a third way? You could never do that if you did not have a single security master. I could have been on the cloud and you could have -- you have your own cloud version, J.R. has his own cloud version. Everybody has their own cloud version. It just doesn't bring you the efficiency or the quality, which a Clearwater can get.

Yes. And I want to talk about that because as we've talked to Clearwater customers and that kind of thing, what struck me was that for a lot of times for their assets and as they're trying to value their portfolios, historically and the way they've historically done things, is it might take them 1, 2, 3, 4 weeks to even figure out asset values of what they own and have owned for a very long period of time. And whereas like you come in, as you said, is you've got like a single master. And so if there's been a transaction in an asset, it populates automatically for them and creates a big difference. And so with that, I think the value proposition is pretty clear. And as evidence of that, you talk about 80% win rates for deals that reach the proposal stage. What would you characterize in those deals as the 1 or 2 drivers that allow you to compare so favorably? Is it just this single-instance cloud or is it the daily reconciliation? Or is it some other aspect?

I'm going to hire you. Yes, it's all of those, right? I think those are exactly right. But if you think about the business value, so let's -- I think technology is really interesting, but what do we solve and why do we win? In asset managers, almost always, it is the reporting we do for their clients. So it's not about the asset manager. It is the reporting that clients get. And if you want to win a deal or a mandate from your clients, you want to show really high-quality reporting. So I would say 70% of all the value we provide asset managers, number one, is client reporting. You come to insurance though, it's completely different. In insurance, it is the 2 thing which drives it is, one is regulatory reporting because they have assets around the world. So James, just to give you a sense of this, an insurer could have invested in 60 different asset classes. A single insurer may have 40 different currencies they work in, 20 different accounting bases. And you can understand, oh my goodness, how complicated that can get. We do that every day for them 2 seconds. You can say, show me my book on IFRS, I will show it to you. And you said, "No, no, I want to see U.S. GAAP. 2 seconds, sub-2 second response changes it. You say I want a tax view, sub-2 second response. So the point is that when you look at a single-instance system, you get regulatory reporting and you get to close your books within 1 or 2 days of quarter close. And that's because we are doing a soft close every day. We're closing our books effectively every day. How often does Morgan Stanley close the book. It takes quite a while to close the book at the end of the quarter. But the point is we do that for our clients on a daily basis. And so that's what drives it. But technologically, what drives exactly what you said, a single security master is sort of hard to beat. And then we take away all your pain. We do the data ingestion. We do the aggregation. We are doing the accounting. You come in as a business user. Every morning, you have your whole data laid out for you, and that's the proposition.

Got it. Yes. So I mean, look, I think that's, to me, is fairly clear. It seems to be clear to your customers, as we said, particularly as you get them to the proposal stage, the conversion rates are very high. So let's talk about the demand and the demand environment then. What do you see right now? Like there's been a tremendous amount of pressure on assets. Equities are down a lot, bonds are down a lot, et cetera. So how are your customers responding to that environment right now? Are you continuing to have engagement to add new customers? Are they taking a wait-and-see approach? I mean, it seems like it feels like at least some of the pressure maybe have been more acute on managers in Europe, but I don't know, like, yes, what are you seeing?

So in the spirit of transparency here, look, I think in 2020, in quarter 2 of 2020, we were a little bit psyched. We thought the market was just going to freeze and we're going to -- we just weren't sure of what's going to happen. And the reality is now in retrospect, no, no, no, because people could not come to office, they could not access the software on-prem, actually, our business really took off and did really well. I think right now, if you look at this situation, what is going on? Massive volatility. That's what happened, volatile like hell. Okay, what do you want to do? You're Chief Investment Officer for an insurance company. You want to see a book and don't want to see it 3 weeks later and 5 weeks later. So I'm not quite sure that it hurts us. I would imagine it would help companies which can speed like us and the other companies who do this, which can get you a data all the time, every day. I think it should help, right? I do think as the markets become more and more alternative asset-driven, I think it should help us. Everything that adds complexity should help us. And frankly, that's what delivers a moat around us is the more complex. If you were just doing equities, there's no point doing equities, there is nothing we had. So complexity helps us, volatility helps us and frankly, moving to the cloud helps us. And we can radically, not little but radically simplify your infrastructure.

So I think that makes sense that, but that's how clients and customers should be responding in that kind of environment. But I guess the question is, are they? Or are they hesitant? Like because even back in 2020, when everybody started working from home, there was like a period of like, "All right, let me figure out what we need to do here and take a breath."

I think you told me right. Look, in Q2 of 2020, everything stopped. Everything was pushed out because people just weren't sure. I don't think that's -- and also the R word hanging around everyone. The recession is coming, is it tomorrow? Who knows, right? And so in Q1, we said, we didn't see anything at all. We grew 24%. We had 27.5% EBITDA. We didn't see anything. Q2, we continued to watch. To be honest, we are really watching. Is the pipeline conversion slowing? Is the is not going in the top of the funnel not going up? We don't see it yet. We don't see it yet. But we are ridiculously watchful is what I would say.

So talking about the first quarter. And like you said, the overall revenue growth, et cetera, looked quite good. We did see about a 4% sequential deceleration in net revenue retention. And I think you cited annualization factors related to a large client being acquired as well as some fixed income pricing. How much was attributable to lower fixed income pricing? And do you anticipate that will be a drag on retention and this NRR figure for a while to come? Or did we get rid of -- get past that in the first quarter?

So our thinking is that our gross revenue retention is world-class, right? So we have a gross revenue retention of 98%, and I think 12, 13 quarters has been the same number. So we cheat a little because we don't give you the decimal point, but between 97.6% and 98.4% is that. Our net revenue retention is not world-class, right? I think there can be much, much better numbers out there and we don't have a program around that. So let's talk about Q1, let's talk about 4 points. So one is, instead of it being a mild tailwind, there was a 2% decline in ARR-associated like-to-like, right? So when you look at clients and the ARR, they had same portfolios and all of that, there was a 2% decline there, right? I think it builds, it factors in what the Fed has said they would do. But if the Fed did more, it's possible, then that -- I don't think that by the time. You can see the point there, right? So I think the Fed went to 5% or 7%. Who the h*** knows, right? I think all of it is on the table somewhere.

It seems to be.

So I think from where we expect the market to be, I think it's all priced there. But I don't think we'll really hey, it can't be worse it could be, right? But [indiscernible] that when we look at our client base, who is our clients? Corporate CFOs. Think of how they invest their own money. They don't want it to go down. They don't want it to go up also a lot, but they don't invest to make 10% like you and me do, right? And the point there is that's how they hedge the books. But the reversals are true when the markets are really good, we don't see any 4%, 5% tailwind. It's always pretty constrained in this plus 2.5%, plus 3% to minus 2% is that we have seen it move for the last 10 years. Now it could be -- it could move a little bit more perhaps but we don't quite expect. Think about the insurance companies, they're not trying to generate 10%. They're just trying to generate 5%. But they definitely don't want to lose 2% and 3%. So it's not so much as Clearwater is a genius, that's not it. It is how our clients behave is a lot more important. Obviously, we have minimums and we have lots of other things to sort of make sure it is less volatile. But I would say that client behavior is more important here.

So on that point is like I think that's one of the most common questions that we get around Clearwater is with your fee structures typically being based around assets under management of the customers, if we're in this kind of weak market period, like how much headwind does that create for you? And is that roughly that 2%? Are we like -- and so is that kind of the right range we should be anticipating right now? Because I think it's -- in a lot of ways, it's easy to say that, but until your customers really get tested to see how well they are able to preserve assets, as you're saying, that it's hard to say for sure. But is that what you're feeling like right now then?

Yes. I think in 2017, '18, we have built all these fancy models, a lot of good stuff. In 2020, it was put to the test. So peak to trough, equities fell, what, about 37%. And peak to trough, that value like-to-like fell 1.8%. But remember, it's not just equities. This time, what's happened is equities and interest rates have gone, right? So it's a little bit more pronounced than you would have expected, but it is a full 2% for us and that's quite a bit. And like I said, I think it's a customer behavior but also the way the contracts are written, James, it's different, right? On the initial fee, there's a fixed fee for large. And then when you say AUM is on top of that, right? So the variability isn't -- there's no direct variability, so to speak. I would say, loosely, AUM influence is the right way to think about it and that's how we think about the business here.

Got it. So you, as a management team, have put out objectives of trying to grow roughly 20% per year for at least as long as we're going to be around, right, and operating here. But what has to happen for you then not to meet that? Like what are the hurdles? What would have to happen? Like if markets like we're seeing right now are giving a 2% headwind, like what do you see impacting your business such that it could make that 20% growth hard to hit?

Yes. Look, firstly, just to make sure we said this right, if we look at the last 5 years, 20% would be seriously disappointing. We've had a CAGR of 25% and 24%. We're guiding to 20% and we think that can be sustained for a long period of time. But that is organic and I just want to clarify, that is organic. And we have only been organic until now in the last 5 years so we have an expectation of using organic methods also. So that's one. So what has to go wrong? Lots. Let me think. But look, I still think that it's very easy on Excel to draw the line and say it's 20%. Okay. I still think you've got to execute. And I don't think execution is easy. I do think I feel really good about -- I tell you, from my vantage point, I feel like our steady state customers generate 80% gross margin. So we feel that 75% should edge up. We feel R&D should edge down from 25% to 20% and G&A should give us 2 points. So I feel like there's a 12-point normalization available to us. We feel that our TAM is $4.7 billion of core market TAM. We think there is $5.4 billion of sort of adjacent market TAM. So we feel like there's a $10 billion TAM and shame on us if we can't execute to it. So I feel like there's execution. Could there be some hiccups? We have seen us go down to 21% in 2020. We went down to 21% growth. And could that happen again? Yes. I think -- but it's not -- it really would be poor execution. I think more than anything, more than the market, I think it would be poor execution. I do see us a little bit like those PeopleSoft. Salesforce had a very different business model. And PeopleSoft -- sorry, Workday. And we are dealing with legacy competitors and we should execute. Doesn't mean we will.

Got it. So we started the conversation talking about the general value proposition of Clearwater and spending a few minutes talking about that. But you do have some incremental products that you've begun to roll out. One of them is Prism. Maybe you can talk a little bit about the -- what Prism is. And for financial perspective, when do you expect it to have impact to the P&L, et cetera? And how much does that impact the P&L?

Yes, we're pretty serious about this NRR not being up to snuff. And one of the big reasons for that is we just sell the whole platform. So if you bought the platform 3 years back, we've invested so much in R&D and we produced so many new -- for free. So we've been trying to think about what's appropriate and fair to both sides. And so Prism was really in that light. We said we want to prove that we can go out and sell another product and charge differentially for it. And so that's how we should think about Prism. And Prism does 2 things -- I don't know, very quickly in Prism, what we do is, if you are a corporate client, you basically get your full book. And then we do the accounting and we do the accounting book a record, blah, blah, blah. What happens sometimes the clients will say, "I have a real estate book in Germany. I don't want to move that accounting at all." And we would have maybe walked away or something, right? What Prism does is it sort of takes Clearwater. It takes the accounting feed from that other engine and pulls it together in the end and still gives you a comprehensive view within asterisks, which says we didn't calculate this number but here's how your overall risk looks. So Prism's biggest value to us right now is in expanding the TAM. TAM, we would take a long time to get to, we can now get to, right? It also opens up a whole comprehensive reporting for asset managers, which is interesting. So I think that we have now shown that we can be successful with this. More than a dozen clients on it. And so we expect it to start to really help next year and the year after that. And so -- but the bigger value may also come with the NRR is that we have proven to the company, not to you all as much as the company has always done it like that and to prove to them, look, we should be able to charge differentially if you're building new functionality. And so that's what it is.

So Prism, if I think about it from a customer perspective, in some ways, it seems like it eases the level of initial commitment. And then once you're familiar, you develop confidence, you can continue to drive improvement in your reporting and accounting, et cetera, by then ultimately opting for the full Clearwater platform? Is that fair?

That's exactly right. Even think of something simple like you have your own performance metrics you want on the display, right? Now if we don't calculate, we don't know what to do with it. Now we will take the accounting numbers, put an asterisks on it and display it along with our numbers, right? And so the client still sees a fully comprehensive report, not needing anything from you as an asset manager. So yes, I think it's -- it allows people to get into it without having to cross the Rubicon.

Right, right, right. And you mentioned adjacent markets. I mean, it seems like maybe it's understandable why this would be. But like who are the adjacent markets that you think you can start to address more directly with Prism as a starting point that were harder for you before?

So just to be transparent about that, look, we think about core markets as insurance, corporates and asset managers here in the U.S. and in Europe. And we call them core for one very simple reason is if you win 80% of the time you write a proposal, that's a core market. And so the other markets are APAC, for example, Asia Pacific. Now we win deals there. Do we win deals in the wealth space? Do we win deals in REITs? Or do we win deals in state and local governments? We do but we don't win 80% of the time, right? So when you think about adjacent markets, those are the markets you're thinking about. Prism also, we don't win as much at all, right? And so that really is Horizon 2 opportunities for us, James. We think about those 5 as we are making a bunch of investments in them over the last 1.5 years. We'll continue to make investments in them. And really, our objective is to transfer them to the core markets. Like Europe 3 years back was not a core market for us because we weren't winning that much. We invested massively over the last 3 years. And after last year, it is now part of the core market is because it sort of checks that box.

So let's talk about customers, et cetera, then. So if you've got some incremental geographies and customer types that you're going to be going after. And we've seen notable deals from new types of customers and geographies, et cetera. Over the medium term, where do you envision the majority of your deal wins will be coming from on a vertical basis? Is it going to be like European asset managers, Asian life insurance companies, like where do you think the majority is?

No, no, let me be very clear on this. So in the next 2, 3 years, if we're talking about just the medium term, a vast majority of our growth is going to come from the core markets. We win there, it's execution. For example, when you talk about Europe, last year was 5% of our revenue. But 20% of all deals we won last year are now already in Europe. But that didn't come for free, James. What came -- we set up a big office in London. We set up a 7-, 8-person team in Paris. We set up a 7-, 8-person team in Frankfurt. And we have 150 or 170 people in Edinburgh. So when we go after market, we go after it properly or we're not going to do it, right? So in the core markets, the execution in the core markets is what's going to get us growth in the next 2, 3 years. But as you start to look ahead, you will not get -- and we're going to continue to be at this rate. But if you want acceleration, then you're going to have to execute on the adjacent markets. And so we get excited when we get an APAC win or a foundation win or a win with state and local government or Prism because these are not core to us. So those can help us accelerate and look out medium term, if you will. And then as you think out 6, 7 years, there's different markets you'll go to.

Got it. Got it. Got it. So you mentioned margins and kind of the rough margin profile and profitability profile of Clearwater. And you also talked about how you've, over the last X number of years, been able to grow faster than kind of this 20% number that we talked about. Is there a trade-off? Could you grow even faster at the expense of margins? Or do you think you're operating kind of in the right range of spend and growth -- top line growth?

Yes. I think that, look, this company was already well-run when I came here. But it was done by 3 founders, and founders build business in a different way. And so what we have done is continue to invest incrementally wherever there was opportunity to grow. But we need to make money. So I'm a little bit older, as you noticed, and so...

I don't judge any books.

So I'm not -- like a lot of CEOs would say, I'm going to take down EBITDA to 0 and get 5 more percentage points. I know I like to make money. I think it's important for the discipline of a business to continue to make money. And so we have -- if you go back 5 years, you'll see why we're growing, we've always made money. It's not like we did this trade. Now it doesn't mean we haven't taken sales up from [ 9 to 14], we have. But then our efficiency has gone up. Gross margin continues to tick up, take the money and invest it. So I think the answer is, yes, if we were more indiscriminate, could you get another few points? Yes. But for what? Our point has been delight clients. And if you do that, then you don't have to spend 30% on sales and marketing. So we could have gone to Europe a little faster, but it was much more important to me to get Edinburgh set up correctly so that the ability to operate and deliver to clients was running at full steam. It was really important to me to set up India and get that running properly before we sell a whole lot more. So it's a little bit more, I think, get the infrastructure right to delight clients and then push. It doesn't mean you shouldn't grow 25% or whatever number you can. Yes, you should. And I feel like today, we are more able to accelerate if we could because we have the global infrastructure, I think, to do this.

I want to make sure if anybody has any questions, just raise your hand and we'll get you a mic. One -- let's start here. Yes, start here.

So 1 question I always wonder when I hear a company that has such phenomenal win rates, in your case, circa 80%, always raises the potential question, hey, are you charging enough? Can you perhaps push a little more pricing? Is there more of a balance that can be achieved there?

And I think the short quick answer is absolutely. I think I do want to say I sort of hinted that. Look, 3, 4 years back, it was a well-run company. It was making 20% EBITDA. And we have been able to accelerate that, get it up to 27%, 28%, right? But our pricing is quite simplistic. We look at your book, and we have -- whatever is 80% gross margin, we charge you that, right? And that's not the optimal way to do it, right? Now do we always achieve 80%? Actually, we always do. So when a client gets a steady state. When they're being onboarded, we obviously make less money, right? But once they get to steady state, we make this 80%. So that's our business model. Having said that, most sophisticated companies will do value-based pricing and not just cost plus, right? And so when we look at Prism pricing, for example, that's got nothing to do with what the cost is. There, we are saying, "Hey, forget about that. Let's go out and do this." Now having said all that, it's a little bit hard to push the organization when you make 80% gross margin and you're winning 80% of the time, how do you set a push there more? So I think there's that balance, but I absolutely believe that we have to go faster and faster to value-based pricing.

I think we got another question here in front.

Obviously, on the win rate topic as well. Can you just comment on what are the situations and RFP processes where for whatever reason, Clearwater doesn't actually win a mandate? Is it people have an existing solution that they think is sufficient and for whatever reason, they're choosing not to sort of migrate over? Can you just provide a little more color there?

Yes. Look, almost -- so it's a relatively easy answer. A very vast majority of the time, so when we lose, let's say 20% of the time we lose, right? And we lose, it's almost always because of incumbency. is the client has a set of systems, which are, let's say, 35 systems all over the world. We go in with the proposal and makes sense. They can't argue with it. It's not -- it's hard to argue. But they say, "I've got other priorities right now. I'm not going to change this." And that happens 1 out of 5 times, right? And I think we said it's a competitive win rate, which means sometimes the discussion doesn't move forward because the clients will say, "I see. I understand. I don't want to deal with this right now", right? So I think that is more of a barrier to us winning. And so the question around should you push more, should you put more feet on the ground? Yes, I think those are all legit. Now Clearwater did not have a marketing team very much at all. So last year, we set up a marketing team. Literally we hired the first CMO last year. And so it wasn't fully -- it's not a sophisticated SaaS company, which was running an old engine, it was not. 3.5 years back, we started [ 3, 4 years ]. And I think you're seeing the build-out of a best practice sort of driven business, but yes.

So just want to wrap up with you, Sandeep. So can you briefly remind us, you've kind of talked about your objectives in Horizon 1, 2 and 3, and we're kind of in Horizon 1. But what are your Horizon 2 initiatives and what's their level of traction right now? And if things start to move faster than you'd expected, what are the implications business-wise?

Yes. So the 4 things that we talked about Horizon 2. So we're excited about Prism. We think that this would take a little bit longer. It's actually really favorably [indiscernible]. Second one was state and local governments. So we probably have to do things to our platform. No, it's not how it works. It just works the way it is. So state and local government is sort of -- it's just that we are nowhere near the 80% win rate. It's just a different game selling to state and local governments. I shouldn't say that. I wouldn't last today, it just moves so slowly, right?

It's just a different decision and process.

Then the other 1 was APAC. So we set up a 1-person team in Singapore, right? And finally, it's -- we have announced, I think, I'm going to say when we announced FWD. Maybe we did. And so we feel we got success a little bit earlier than we thought. And so our sense is that we're getting traction a little bit earlier. A lot of our investments are in that space. In Horizon 1, if you're an insurer in North America, we already pretty much have all the pieces, right? And there's still an investment but that's more limited. I think the more investment is in Europe, more investment is in Asia. And so that's where a bulk of our energy is, can we accelerate Horizon 2 and really have that help growth -- sort of hasten growth, if you will?

Got it. Got it. Well, that's all the time we have, Sandeep. Thank you very much for joining us and talking about Clearwater.

Thank you so much. Appreciate it.

Thank you. You bet.