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

I think we're ready to go. Jim Cox, Clearwater Analytics. Thank you so much for joining us this afternoon.

Thanks, everyone. Thanks for your interest.

Yes, thanks for being here at the Goldman Sachs Communacopia & Technology Conference.

I wanted to start off with some of your unique domain experience in the accounting software vertical because of your original role at Advent. And so I think a lot of folks in the room, we've seen the success story play out where you have a cloud-native technology come in and gain share, hand-over-fist of a legacy technology. I think there are some unique attributes that position Clearwater well with an accounting software, specifically when you talk about how you've got essentially one single source of truth for all of the securities that are at your customers. So maybe just a little bit about why the value proposition of cloud in the accounting space is so powerful.

So thanks, Gabriela. So obviously, the benefits that any software to cloud kind of transition occurs also within the accounting space, everything when you think about the IT and solving for that. But there's something unique about Clearwater beyond that in the way we're solving this accounting problem versus everything else out there, cloud or on-prem. And that really comes down to the way we solve the problem. So many other folks come in and treat clients as a set of portfolio, and we don't do that. We go to the source. So we have 2,700 different data sources that are feeding into our platform every single day and those are price information, those are custody information, those are trade order information, there's credit information, ratings information, all of that information is coming in, and we're aggregating that data. In addition to that, many of our -- many of the securities on the platform are fixed income and structured products. So there are cash flows associated with those. So it's not just, hey, debit, security A, B, C credit, cash. You're thinking about the cash flows and all of that. So we model that as well. So we look at all of that at the security level, okay? And so once you go through and you refine all of that, you come to a situation where a security is well understood. That security could be held by every single portfolio and every single client on the platform or it could be held by one. But either way, that is the single -- when we talk about a single security master. What we're doing is we're refining and getting correct that security before we think about who owns it or where -- how it rolls up or any of that information. So not only are we in the cloud, but this ability to pull everything into a single -- a true, single-instance platform where all of these securities are thought of really. So you might say, well, what are the benefits of that, right? Why would you -- I'm sure that when it was originally architected this way, people really didn't think it through this rigorously. But today, we really understand the benefits, which means like when a new client comes on to our platform, we already likely have 80% or 90% of the securities that they hold already on our platform. So if you're an accounting platform that's on-prem or an accounting platform that doesn't have a single instance of the security master, every single time you have to reconcile that security for every portfolio that you're in, you have to get that data right multiple, multiple times. So that's what's really the value prop is that instead of reconciling it for each and every account, instead of figuring out the data feeds and the break that occur every day in all of these across each of those portfolios, we do it once. And so that's really the power of the security master. And that is fundamentally different. So my time at Advent, wonderful, wonderful company, wonderful products that many people use, but each individual person had to install it themselves, had to upgrade it themselves, had to make sure that the connectivity was right. When the connectivity broke, they had to figure out how to answer that, had to figure out their own reporting and do that. That was -- you multiply that over thousands and thousands of customers. That's a ton of kind of duplicative time and process. And compare that to when you sign on with Clearwater, we take all of that. We take all of that work away, all of the aggregation, the reconciliation. And what you get our value prop to you is at the beginning of every day, you have clean, reliable data that you can start your day with accurate information to then use to run your business. And every month end, we close your books each month end and take care of that. And so really, what you're getting when you come with Clearwater is kind of that whole solution. So it's SaaS, it's the single security master, and then it's -- and then really all of the work that everyone is doing every day. That frees folks up to do kind of higher value work and have a single source of data that they're using throughout their organization to try and clean that up. It's really -- that's why Sandeep says, we revolutionized the investment accounting industry.

It leads a little bit into the longer-term vision for the company, which is if you think about Clearwater to date, you've essentially had one core accounting product with the embedded compliance and that is playing. I know that the company is thinking about what a more multiproduct could look like, what modularization could look like, what an analytics offering could look like. So tell us a little bit more about what other adjacencies you could see Clearwater monetizing, not just over the near term, but more over the long term.

Yes. It's -- I mean -- so we talked about the single security master and the benefit of that. And so just for context, we have $6 trillion in assets flowing through our platform every day. Every buy, every sell, every kind of movement and position, we can understand that. So you start to think about that as a scale and what you could do with it. How you can think about it more broadly across clients and thinking about that on an anonymized basis that data opportunity. That's one piece. As you said, Gabriela, what is so interesting about this is a single product works for corporations, works for insurance companies, works for asset managers, works for pensions, works for state and local governments. It's the same product. It's all flowing through the same thing. That's an incredibly broad set of product capabilities that enable you to do the same thing for all of those different clients and have them get positive outcomes that are very different. Now that's the benefit, right? The detriment is, is we are a single-product company, right? The benefit of having such a flexible product makes you think about this. So then you step through and you say, okay, what are the things that not every client wants but some clients want and what can we do to deliver more value to them? And so if you think about it on the tail end, right, you have clean reconciled data. Everyone before they make a trade, they want to evaluate the risk. They want to understand their position. They want to understand how that works. So there's a whole different set of math that goes through from a risk perspective, but you have to start with the clean, positioned data certainly. When you think about performance, there's all these different benchmarks you can think about of how do you want to evaluate your performance. Across every investor in this room, I assume that all of you are tied to different benchmarks than each other. But you still need to start with a clean consolidated performance information that you've generated for yourself and understanding those cash flows. So those are things that we can do along that front. And then if you say also, we give you clean reconciled data at the beginning of your day, we would expect as we look into the future and kind of as we think about this, well, but we're just giving you that information. Our clients want to be able to do things with it. So how do you think about the workflow? How do you think about trading? How do you think about managing collateral? How do you think about all of those pieces? So when you look across the entire workflow of a day in a life in an asset management organization, it all comes back to that same kernel of truth that everyone needs to start with. But then what you do with it has a lot of different directions, where we can go. And that would be, as you look out into the future. From a product perspective -- we can talk about markets, we can talk about geographic as well. But from a product perspective, that's where we see our company.

Let's stay on the product side because I think we've seen a really interesting landscape emerge of software that sells into financial institutions over the last 5 years. And to date, there have been some pretty distinct [ filing ]. And then you have best-in-suite approaches, like some of your legacy competitors who are thinking to be able to do multiple pieces of software that sit around the accounting. And so the question for you is, how do you think those swim lanes evolve over time? How do you think about where it makes sense for you to compete versus maybe where it doesn't like an order execution or software for private wealth management clients, things like that?

Yes, yes. So I think that's exactly right. And so as we think about our product strategy, we do. We understand the capabilities that everyone needs and requires. And so we think about buying, building and partnering. And that's one of the -- when we think about why did we go public, our clients are relying on us to provide them with accounting information. So having the visibility that a public company provides to our clients, helps. That helps. Our branding is helped by it as well. But the third piece is really that we have some capital and some resources to think about those inorganic things that allow us to buy. So I think that we're open to partnering. We partner with lots of order management systems when thinking about that. And so when we think about what do we want to build, it ties back to what are our core competencies versus what do we want to buy and partner. We think about those things that are adjacent, but it is not our core competency.

What are, I assume, the parameters you would put around potential M&A as it relates to size of deal or impact to your operating model, size of the TAM, et cetera?

Sure. So we are 100% organic to the state, right? And lots of us at the company have done deals in the past and so we're familiar with that. But I think that given as a new public company and as a company that hasn't done inorganic deals in the past, we think about things that fit within buckets like that and think about it. And there's probably a certain size quotient around that. I'm not sure we're afraid of size, but I think we want to show -- we're all about credibility with investors, so we want to show kind of success kind of along the lines of that. And so I think that we would build with that momentum.

I want to marry the product conversation with the end market conversation because we started talking about pension funds earlier, and you manage you said pension fund clients. When you think about the functionality that you have today, do you need to make additional progress to be able to have a bigger practice in pension funds and private equity and alternative asset managers? What is the next lever that you can pull on the end market vertical place?

Sure. Sure. So I think we're -- so just to back up, just so that everyone knows kind of what we think about our core markets. So for us to have a core market, we have to have great product market fit. We have to have sales teams that are prosecuting against those kind of targets. We have to have clients that are referenceable and highly referenceable, and we have to have a win rate that's about 80%. That's historically what we've won in these markets. So those markets we think about those as core. And so we think about our core markets as being -- this product started with corporation and so -- corporates, and then moved to insurance company because they basically invest in many of the similar instruments and then moved to asset management. And so those are our core markets in what we would say is North America and Europe. So anything outside of that, we would say, okay, noncore. So where are we investing in non -- what we would call noncore, state and local governments, state pension funds, private pension funds, sovereign wealth funds. These are big, large pools of assets where we understand what they're investing in and think there could be a likely fit with that. Let's see, another place where it's a smaller market, but we've had a reasonable amount of success in it so far is real estate investment trust. So we've won a couple of clients there. Their lives are successful, and we think that there's an opportunity in that area as well. We also then pivot. We don't have a sovereign wealth fund client, but you also think 90% of our revenues are in North America. So as we start looking more internationally, we start thinking about that and how that fits and how those folks come together. So those would be kind of that's -- as we look out to next year and the year after, that's there. As you look beyond that, you just have to look at the largest pools of assets that are out there and will kind of continue.

Yes. Yes, that makes sense. Okay. I want to stay on the end market topic and ask a little bit of a demand question, which is one of the outages we use in vertical software is the health of the customer sometimes helps inform the health of the pipeline and the health of demand for that particular piece of vertical software. And so as we think about how the macro environment is playing out this year, I think many of us are familiar with asset manager performance year to date and how compares to prior years. So the question for you is talk to us a little bit about what you're hearing from customers in terms of demand and help bifurcate for us, are you seeing any change in demand between asset managers versus insurance, which I think has been a little more resilient versus maybe general enterprise, general corporates, where you also have a very strong business?

Sure, sure. So the thing to think about with accounting software and kind of portfolio management software is in times of volatility, you really want to know what your positions are and what it looks like. And so between both insurance companies and asset managers, they want to know every day what's happening when there's volatility and we provide that. That's our core value prop, right? Beginning of the day, clean, reliable, here's your information. So interestingly, in these times of more volatility, you actually do have people raising their hand and say, "I should know this, and I don't," right? Because if you don't use Clearwater, then what you do is you have a certain set of your securities in one system and another in another system and another in another system. And so when you ask the question, well, what is my exposure? Or how should I think about that? Or what should I do? It actually takes a human being to then go and pull this information from those systems and pull it together. So having that clean, reliable view actually helps people to understand the value prop of the switch. So that, I agree that -- and so people will ask, oh, our asset managers say, "No, I don't want to do this." We haven't seen that. So our pipelines remain the same in asset management and continue along those paths. In fact, the first quarter of this year, which was reasonably exciting, was one of our best asset management quarters in our history. So you can see how people think about this. The other thing I'll say is people don't wake up and say, "I want to try another accounting system for a month or 2," right? So these are decisions that are made thoughtfully. You need to have the best solution. And so we do have that. You need to have a lead. And when you have a lead, a disproportionate amount of -- the gains will drive to you over time because as people understand, okay, this is the right solution. This is -- we have this fundamentally different way of doing it. And I think everyone agrees like, boy, if you had a blank sheet of paper and you were going to design an accounting system, you would do it this way, like this just makes a lot more sense. Other people have done it differently in the past because they were beholden to whatever solutions. So when you have that as a tailwind, it helps with that. So I would say asset management continues for those reasons. Obviously, also when things are good, that's -- you're right, there's a good end market. But this is a little bit of a different market. I think for insurance companies, again, generally, these are decisions that are made over multiple quarters and sometimes multiple years, right? And so these things continue to flow and it's about executing on kind of those things that are available. In corporate, I will say that in 2021, right, with all of the IPO activities. So if you think about it, if you're kind of a small corporate and you don't have a lot of excess cash and then you go public and you have a bunch of excess cash, you typically then start investing that excess cash whether you're public or if you've gotten a big VC round or something like that. Those are generally rich kind of opportunities for us to sign new clients. Those are also probably our smaller clients, right? But those are out there. And what was interesting was in Q1 and somewhat in Q2, although there were no real IPOs during that period, people were finally raising up their head and saying, "Okay, I have a couple of hundred million on my balance sheet. I have $500 million on my balance sheet. Okay, maybe I should start investing that and get to that." I would say that, that tail, right, it's shrunk over time. And that, that tail is probably coming to the end until you get back to that. So I would say we don't have the IPO greenfield corporate sales. But it's interesting. The team is pretty resourceful. And -- so they're like, okay, we'll go back to the 23% kind of legacy ones that we haven't sold and still have those problems. And so they're kind of back in that space.

I'd like to pick up on this idea of multiyear decisions that get made to your customers on accounting platforms. We've spoken in the past about 70-plus replacement cycle on the installed base, for example. How do you manage your sales team and your engagement of a customer based on when you think the sales cycle or a legacy-installed product that's coming up for renewal? And what can you do, steps within Clearwater's control, to potentially catalyze and speed up the potential replacement cycle?

Yes, yes. So we have short contract terms. We don't hold clients into that. But typically accounting firm -- software firms have signed up for 3- and 5-year deal. And so for what I'll call the largest clients that we're familiar with, we understand those cycles. And so folks will work on that. So typically, you'd say, hey, if your contract is up in a year, you should probably make the decision this year so that we can be onboarded in parallel and ready to go, and we can shut it off at that time. So there is a little bit around -- and certainly everyone has a process, where they evaluate -- just through a diligence process, they would evaluate those opportunities. And I think people feel like, okay, yes, this is better. I mean the truth is, how we sell is we explain how the pain you're in now will end up going away and how that's worth switching, right? There are high switching costs. And so inevitably, the questions that we ask are, okay, what new investment strategies have you made since you last made this decision? What -- have you entered any new countries, right? Are there any new geographies? And these types of things is what happens is the legacy system just isn't malleable enough, flexible enough. Do you have strategy -- the other thing we would ask is your strategy for growth. So the truth is, if you're an insurance company who has aspirations of growing, you should really be on Clearwater. And that drives a lot of the acceleration. People say, "Okay, we're going to enter -- we're going to do a big reinsurance contract and bring a bunch of assets on." We take care of that. There's no effort at the client. We just do that and a lot of insurance companies have been really successful growing around that. So those are things that even if you don't have a contract up for renewal, you would be thinking about that.

Especially as you've gained maybe a little more credibility and momentum with the IPO in the public markets, have you noticed any competitive response when your salespeople go into those types of accounts to give the compelling ROI pitch on Clearwater?

Yes. I think, the biggest -- the -- of course, everyone will try and execute their strategy to the best of their ability to keep their customers and grow and win customers. I don't think that competitive landscape has changed meaningfully. I think where we have been pleasantly surprised potentially about the benefits of the IPO is internationally. So one of the things we said was we really need a better brand presence in Europe. And I think we've continued to see the momentum in Europe. We're really strong there. And of course, there are competitive responses that everyone kind of executes for. But I think that, that's been net more positive than we even hope.

It's a good opportunity for me to ask on international because we've seen software companies do really well in North America, and they look to expand to the season, they realize that it requires a lot more work-wise stuff in approach than maybe they initially expected a budgeted for. And so how are you thinking about the LTV to CAC in some of these newer markets? Is it accepted barricade? This will be a drag on our broad LTV to CAC numbers until we get to scale. How have the results been relative to your expectations when it comes to unit economics internationally specifically?

Yes. So I think we would accept that in a more nascent market, your typical CAC to LTV would look differently, right? And I think that that's how we've modeled it. And I think when you look at the investments that we made in growing sales and marketing is still like 13%, but it was about 9% before. So that's a meaningful kind of uptick kind of within the organization. That is in all international that we've also kind of thought about a more thoughtfully a marketing program and things about that. But international is a big piece of that. Obviously, we measure all of that, and we'll know how to make the decisions around that. But it's just such a ripe opportunity. So if you look at the size of the market in North America, where we're 30% to 40% penetrated in insurance, and then you look at the size of the market in Europe, it's actually bigger. It's actually bigger. Now you're right. Like are there nuances, are there different countries? Is there all of that? We have -- within our R&D investment, that's one of our big drivers for R&D investment is kind of this international features and functions that are needed for that. But you just see how compelling that opportunity is. It just makes sense. At the highest level, Sandeep talks about, well, 60% of the wealth of the world is in North America, 30% is in Europe, 10% is in Asia Pac. Our revenue should look like that. They're like 90 plus, 10 in Europe. And we have 3 people in Singapore and people are calling us asking we seem to get kind of a bluebird once every few quarters. So I think that's very exciting to hear about that opportunity.

I'd love to talk about the pricing model.

Sure. It wouldn't be an investor meeting without talking about that.

As of 3 months ago, you had this pricing model where year in and year out, there is a very natural cadence towards assets under management growing at your key customers and in your installed base. And so the pricing model has been a tailwind to your growth over the history of Clearwater. And this is the 1 year where [indiscernible] events, et cetera, you've got fixed income under pressure, equity under pressure, et cetera, to a much greater extent than I think what a lot of us could have approved it. Why make the decision to change the pricing model in response to something that hopefully is nearer term versus stick with the pricing model that has been a tailwind to the company for so many decades almost?

Yes, so I think the way we've thought it through is we still have that opportunity for the tailwind. But just to be clear, when you think about Clearwater and our brand to investors, it's really we're durable, we're reliable. We have really good visibility into the business. And when you start to look at AUM, we had a lot of confidence in our AUM pricing model, in this tailwind because we've been in the business for 5 years, and we've seen kind of annually that this has been a tailwind. And then we look back at March of 2020, specifically, which was a really volatile time, and we realized this was not impactful to us. And so on that basis, we thought this is aligned with the durability. Well, Q1, we had a 2% headwind. In Q2, we had a 3% headwind. And remember, when we were privately held, we thought about things on an annual basis. And so we just understood that this was something around this durability model that we really had to rethink in the context of being a public company where quarterly numbers and these things are just much more focused on that. So although we made Q2, we were -- we understood that this is important to make a change. And I think what's been positive is, as we've had these conversations with clients, they seem to understand it. And I think it's been positive. We rolled it out. We've kind of done 2 prongs. One is for new clients, what are we doing? And then for our existing clients, how do we kind of go back to those folks. For new clients, so we talk about with investors having an 80% gross margin on our steady-state business. And that's how when we are in conversations with prospects, we are actually -- we have an algorithm where we go through. We understand their assets. We understand how many data feeds they are. We understand kind of the complexity of those assets, how that's going to work, and we actually come up with a cost to serve. And then we think about, okay, then we ought to price their book at such that we can get an 80% steady-state gross margin. Well, that's actually -- like that's an annual number, right? And so what we used to do is then take that annual number and figure out what their assets were and come up with a basis point. So we -- so what we've told the sales team is just stop, stop the annual number. Tell them, here's your annual number. Here's your number. And then all of your business grows, there's these basis points on top for your business growing. So we do like to scale our model of the AUM, but we also understand we have to have the stability and the durability of this kind of base model. And I think, so far, all of our conversations with our clients -- everything we've closed under this new model has been incredibly successful. We're also going back to kind of our 100 largest existing clients and talking to them about how to modify their contracts to create that same structure.

So it makes a lot of sense in terms of limiting downside to Clearwater while still preserving upside. So for the larger customers, the top 100 that you were just alluding to, if you turn the table a little bit in an event where they do well, they pay Clearwater more and an event where they're not doing well, they're paying Clearwater the same. So it's a little bit asymmetric of a return relative to their existing pricing model. So how do you -- yes, exactly.

So how do you incent -- so you're right, so you incent them to do that, right? So the other thing to remember is if they were paying us $100 at the beginning of the year, they're now -- because just -- and they were an average customer, they'd be paying us $95 today. So they -- and they're probably already budgeted for the $100. And lo and behold, as we've talked to a number of our clients, they're like the certainty of the budget process, and I understand that, that's great. Now how we've modeled it and thought about it is, look, we always used to get kind of a gentle 2% to 3% tailwind from AUM. And we used to get 2% to 3% from price increases. So we've kind of tried to model this to be neutral for our clients and say, "Hey, we'll just grow at 5% every year," which is kind of what a lot of vertical enterprise software companies will look to. And so we get to kind of that same model. How it works with individual clients is really bespoke. We have conversations -- folks on my team who have the conversations, who understand. And remember, a lot of clients have chosen Clearwater because they expect to grow. And so that's really what it's about. And by the way, that's what they already signed up for is that growth. And so when we had -- in the past, when we had clients who had grown significantly and they came to us and said, hey, we're a much -- because remember, at scale, like your basis points do go down, your cost to serve does kind of get less and so there's a rational approach to saying, "Oh, with scale, your basis points should be lower." And we would then say to those clients great. We'll put a kink in your basis point curve for your future growth. We'll have that same conversation with them. We'll just draw a line under where they are now and try that going forward. So yes, I think that I've been pleasantly surprised at how open and large the conversation, and we're progressing as we speak.

I'd like to better understand the puts and takes to the near-term impact on guidance. And so I know you look at the monthly data on assets under management. Scenario #1 would be new pricing model actually drives upside to guidance in the back half. Scenario #2, existing installed base, you have AUM continuing to be volatile. Help us understand probability of scenario 1, so upside to guidance from your pricing model? And then what is the data telling you month-to-date on -- well, not month to-date but the most recent data that you have on how assets under management are impacting your book relative to what you expected?

Yes. So I would say that the -- I'm very comfortable with what our guidance is for the year. I'm not going to -- and then I would say that AUM piece is one of many pieces that's pretty but relatively small. I think the most important thing to the long-term growth of our business, health of our business is continuing to sign new clients, driving the long-term value of the business and really continuing to expand on our need in those areas. And so I think it's been very difficult to predict the future. But we feel good where we are.

Well, great. Because I have one more future-prediction question for you, and then I am going to open it up for the audience, which is I believe the company has been very confident in saying north of 20% revenue growth is the longer-term goal and even the medium-term goal. You've had this unexpected setback in AUM pricing this year, which we've already discussed. Absent another step down in asset prices, is there any reason why you wouldn't be back at that 20% plus growth target for next year?

Yes. I think we're all incented -- like this is a really special business. We're here to make this a very big special business -- like we wake up thinking how can we be a $1 billion revenue company, and we do. We spend a lot of time thinking about that. And so I always say that -- so just to give you a crisp answer, there's no reason why we shouldn't grow north of 20% for a very long time. And so we're going to do everything we can to grow even faster than that, but that's what we really -- that's what we endeavor to do all the time.

Questions from the audience? Maybe I'll ask about the customer conference this week in Boise, which is a 2-part question. One is anything you can share with us that the team is excited about for this week. And then it allows me to ask a little bit of evolving go-to-market questions particularly around CMO and some of the things you're doing in marketing, which is how you see your marketing strategy scaling and evolving at the present point in time.

So I think we've been really happy with -- so I'll take the second question first and then --if that's okay. So the evolving marketing strategy -- so our marketing strategy, if you go back a few years was clients are going to say nice things about us to other clients, and that was really -- and then we would have people jump on the phone to call folks. So I think we've evolved the website, and I think we're getting a much more -- I mean, it has now become our best driver. People asking for demos through the website is a great driver of demand, like when you just look at how that converts, how quickly it converts. It's great. And so that's working well. I would say then it's kind of a barbell strategy. We have kind of the digital path where for our smaller clients, we try and push those through. And I think that's working reasonably well. And then what is our strategy, but we have more work to do is kind of at that highest end, particularly internationally. But at those largest customers, how do you think about asset base -- I'm sorry, account-based marketing, excuse me. And really kind of digging in and understanding kind of that whole ecosystem at that client. And that's work that we're excited to embark upon, but it's still work to be done. And then there's a whole thing of our own brand internationally. At the client conference, it will never be mistaken for a dream force, but it's really around -- you got to remember like we sell to accountants, and we are accountants, and I'm an accountant, so I can say this like it's a nice event where people really understand the product and the vision. And I guess my favorite thing about Clearwater is that our teams care intently about our customers. And so this is like the one time of the year where these people who -- I mean, they've been working in their houses, but they usually work on the eighth floor and the seventh floor and the sixth floor and speak on the phone to their clients every day. That's why we do it in voice. So that the clients who are in our system every day are then meeting the folks that they connect with, the people who help them with their reconciliation questions and help them answer how to run these reports and do these things. And so there's a great connectivity there. And we're really looking forward also to a lot of these kind of birds of the feather groups coming together and learning from each other. So it will be exciting, and it will be good to be back together since -- the first time since 2019. So we'll see. And hopefully, we have lots of really exciting things to announce as part of it, but I won't steal business thunder, if that's all right.

Absolutely. We will look forward to the rest of the week.

Great. Thanks so much.

Thank you so much for your time.

Thank you. Thanks, everyone, for your interest.