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

All right. Thanks, everybody, for joining us this morning here at the Morgan Stanley FinTech Conference. We'll be kicking off this presentation or this session with Clearwater Analytics, Jim Cox, CFO.

Thanks.

Before we get started, Jim, I do have to read this important disclosure. 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 rep. So maybe just as a -- Jim, as an introduction/preamble. For those of you that maybe aren't familiar with Clearwater, could you provide an overview of the business and value prop you bring to the asset management, insurance and corporate clients?

Sure. Yes. So Clearwater Analytics does accounting, reporting, compliance and risk and performance for asset managers, insurance companies and corporates. We actually do the accounting, right? So our value prop to these folks is at 9:00 a.m. every day, we provide clean, reliable data for them to then go and do their day interacting with their clients, interacting with the other stakeholders there. And I guess there's lots of firms to do that.

Right.

And so what's kind of unique about Clearwater is a couple of things. One, took a reasonably novel approach in kind of how they address this, which is as we go to the source data. So we're going to your custodians to your pricing sources. We're modeling the data ourselves and we think about things at the security level as opposed to the client or portfolio level. And so what happens when you do that is you pull the securities in. And then only once you get to your client level, do you think about the details of -- of kind of those individual portfolios. And when you're able to look at it at the security level and model that, you have this incredible single security master, this clean, reliable data that creates a great flywheel effect where we continue to -- for every next client, every next security you add, there are benefits that accrue to all of your existing clients.

Right, right.

That's the value prop to clients. I was a customer as a CFO at 3 prior companies before. Like the Hair Club for Men. I was also a customer. And so I understand really the benefit that it does. For corporate, we also do for insurance and those others. But maybe some metrics on the business, kind of a 20-plus percent top line grower, very consistent, durable, reliable metric. We're really proud of is our really high gross retention rates, [indiscernible], [ 98% ] gross retention rates and obviously, a profitable business. So it's -- that's a little bit of the prop to investors as opposed to the -- our clients, which we do focus on.

So I want to ask, maybe you can give a little bit of -- at least I always find it helpful to -- to go through how this account -- because every asset manager has to have accounting, right, like by definition? And so by definition, your market is 100% penetrated at any given...

Somewhat -- yes, a clear replacement market. Right.

That's right. Other than maybe if somebody is starting up. But what's different about Clearwater's approach? And what are -- to your point is, what are the pain points that you're helping address for your customers?

Why does someone? -- So in corporates, if you start investing -- as a CFO, this is -- I can speak to this. I have a day job. I got to figure out growth. I got to figure out profitability, I have to think about the business. And I also have this excess cash that I worry I'd like to make a little money with that. But I don't -- certainly don't want to lose my money. And I want to know when I'm going to get it back, so I can do things like dividends or buy back stock or buy another business or something like that. So I think about duration, and I think about that. That's what a corporate firm thinks about. And so that's that mechanism. For -- and 52% of our revenues are based on insurance companies. So we'll talk about insurance companies. An insurance company is generally doing the same thing. They don't want to lose the money that their policyholders have given to them. And they want to know when they're going to get it back so that they can pay claims and make some money on it in the meantime. So that's pretty consistent. But to your point, what has to change? So what happens is someone says, "Oh, I'd like to invest in a new asset class. I'm interested in mortgage-backed securities. I'm interested in derivatives. I would like to expand our portfolio into LP" or someone says, "You know what, I'd like to invest in Europe or Japan," or "I'd like to buy a business" or "I'd like to -- I'm a reinsurer and I'd like to acquire a set of assets and take on a set of risks." What do I do with that? In any of those cases for an insurance client, that's basically a reimplementation in their legacy platform? Or -- or more likely what they do is the investments are made and the accountants are doing it in Excel and figuring out a way to blue [indiscernible] back in. And so when that pain, that's the pain that -- I'm an accountant, so I could say accountants live in pain. And so you kind of live in that pain. And then at some point, you say, wait a second, this pain is too much. Let's switch. And so that's generally one of those drivers for an insurance client would drive that. Separate -- different kind of pain for asset managers. Asset managers, you're in the business of gathering assets. And when you lose mandates because your client reporting is insufficient. When you miss out on opportunities because of the information that you have and your relationships with your clients are in pain. Then you say, okay, I want to use Clearwater. So Morgan Stanley, thank you for being a great client. You're across many, many different business lines. But really what you're doing, why you -- how you use Clearwater and how many of our asset management clients use Clearwater is really to help interface with their client reporting and connecting with those clients and understanding that globally. So at other asset managers who perhaps don't use Clearwater, if they lose a mandate, we have a tendency that -- to hear from them. And that's generally an entree into the firm. And then it's our job to figure out how to win kind of other books. Sorry, one thing I didn't mention is generally, if you're an asset owner, like a corporate or a [ pension ] or an insurance company, we -- you take -- the whole of your platform comes on to Clearwater day 1. That isn't true at asset managers because you're kind of focused on different mandates and different things. So we have a back-to-base sales motion within our asset management clients that until this year probably didn't exist in our asset owner.

Right. All right. So, can you help us think about the durable rate of growth for you and the TAM generally? And you mentioned that Clearwater consistently has been a little over 20% growth. And -- and the TAM has sized at around $11 billion. But I'm curious how you think about your existing penetration, what that ultimately could scale to? And that's really kind of the important thing here. Your revenue base right now is around $300 million. That means you're about 3% penetrated. But if you compound for 20% for the next decade, and the market grows mid-single, you're still going to...

You're still a huge...

Still a lot of runway. So just help us think through what are the drivers there? And why is -- and I guess maybe the question we get a lot is like why...

Why not faster?

Yes. Why not faster? Why is that number so consistently in that low 20s range?

That's the same question I ask everybody in my company, why not faster? We're really focused on that. And so let's talk through it. So okay, step one, let's talk about our TAM and where we are and where we've come from. So we talk about an $11 billion TAM, that includes some adjacent markets, that includes Asia Pac and some new products that are relatively nascent. So we, internally, when we think about our go-to-market teams and what we're driving at, we really think about our core TAM which is $5.9 billion. Of that, about $4 billion is in asset management, $1.6 billion is in insurance and [ $300 million ] is in corporate. And so now -- but let's click that down. Why do we call that our core TAM? We have teams that have our go-to-market kind of -- in each of those verticals, we have go-to markets driving against those. We also have 80% win rates referenceable clients across all of that. That's for us to say this is our kind of core TAM. That's what we have to believe and that's our experience.

Right.

So -- but then let's kind of separate into kind of the next level down of that TAM when we disaggregate it. And we understand this because people have to file their assets for regulatory filings. So we take that kind of -- assume that into that level. About half of that [ 5.9 ] of TAM is international, and it's only 14% of our...

Right, right.

So kind of as you think about how do we accelerate that or how do we -- we think about it a little bit differently as opposed to the penetration of the TAM because I think we would -- we both want to expand our TAM. We want to grow kind of our core TAM as well as just the penetration levels. But we do wake up and think, how do we become a $1 billion company? Like what is this business look like? And I think at a $1 billion company, if we're 14% of last year's revenues was international and half the TAM is international. As you move from this year, it's roughly -- we're guiding [ $360 million ]. As you move to $1 billion, there is a significant increase in that international element. In fact, in insurance, which is our largest kind of percent of our ARR, it's 52% of our ARR. There's more TAM outside of the United States than there is in the United States.

That's right.

So obviously, the international element is a key to adding more to that kind of growth rate and continuing to penetrate that TAM. But I think that investors -- you can look at that growth rate and the consistency of the growth rate. We have really high gross retention rates. And so we really want every client that we bring on board to be successful, especially when you're entering new markets, it's important to make those clients successful or doing new things with clients to make them successful, referenceable and drive that. So I think we're deliberate about that process and we've grown at that rate pretty consistently. We would love to grow faster and we focus on thinking about that every day. But what investors probably underestimate is just the power of this compound. Even with these legacy platforms, their retention rates are 90-plus percent. So that really means, okay, that's [ $6 trillion ] of TAM, [ 5.9 ] of TAM, really [ 600 ] is up for grabs every year. And then you split that between kind of International and North America, you're talking about [ 300 ] in each place, okay. So our job is really to capture as much of that [ 300 ] in North America and as much of that other [ 300 ] internationally and figure out where that is, frankly, internationally, to grow. And so I think we've got a real opportunity to continue to compound kind of indefinitely.

Got it. Got it. So talking about the markets and you highlighted the international market. It's about half the TAM. It's only about 14% of your revenue. Where are you excited specifically internationally about the best opportunities for Clearwater to win business? And -- and what regions should we be paying attention to?

Yes. So -- okay. So when you think about where have we invested to date? We have roughly 250, 300 people in the U.K. Those are teams that are servicing clients in Europe and in Bermuda in that area. We also have sales teams in London, in Paris, and in Frankfurt. And so we've been most successful, I would say, in Northern Europe. And obviously, the JUMP acquisition in Paris, that adds 100 employees in Paris which helps in a French-speaking market and driving to that. And so I think we're very much excited about that market. We're excited about the combination of JUMP and Clearwater together in the insurance market in Continental Europe. And so I think that's exciting. And then honestly, we have not invested a ton in Asia Pacific, and we wouldn't even say that APAC is in our core TAM in that $5.9 billion core TAM, but we've been drawn into it. We had a couple of salespeople there. And honestly, their clients have come to us, right? And so I think we're interested about the opportunity there. Obviously, we continue to be the market leader in North America, and I see that, that drives that. But as we look to the future, I think the alliance share of kind of incremental new logo growth is in Europe.

Got it. Got it. Got it. And so if that's where you see the most incremental opportunity at least right now is in Europe.

Relative to where we stand today. We're going to -- if you say, hey, we're growing 20% here. And when you're at a -- when you're at a $1 billion in revenue, you've got to grow $200 million every year. That's that incremental.

So -- I mean like you mentioned the JUMP acquisition that added 100 people or so in France. But do you have the enough infrastructure and headcount in place to service that market? Or what should we expect expenses and expense growth to look like to be able to take advantage of that?

Yes. I think when I got to Clearwater in 2019, 9% of our revenues were in sales and marketing. And that's now up to the whopping 13%, still very efficient in sales and marketing. But that incremental investment was all in about building out international. So I think we like where we sit in sales and marketing as a percentage of revenues now and think we can execute on the opportunity at that level for a couple of reasons. One, we've made a ton of investment internationally, and we just are not as efficient in the sales and marketing function internationally than we are in North America today. And so stepping then through that. So obviously, we expect European sales to get more efficient. That will be offset, again, by incremental investment being pushed in APAC. As far as a servicing, as far as making sure that clients are successful in those markets, we've also put that investment in. And I think we're feeling that on the servicing side, we feel good about the investment there. And then actually, in R&D, we've spent a reasonable amount building out the nuances of German GAAP or Italian GAAP for that sort of things. We actually see that kind of -- we're coming to the end of that investment cycle on R&D. And so I think we'll see some efficiencies on the R&D side as well as -- obviously, we'll redeploy some of that. But I think as you look at kind of where we've been investing, I think we [indiscernible] efficient.

Got it. Got it. So maybe let's turn to pricing and the like. Can you spend a couple of minutes, Jim, outlining the changes that the management team has implemented on pricing since Clearwater became public. And -- and what impact do you expect that will have on the resiliency of the model moving forward?

Yes. So it's key. So when you think about the brand of Clearwater to investors, durable, reliable, predictable growth, right? That's what we've done, profitable, cash flowing and all those things. When we went public, we had one piece of the model that we had liked very much over a long period of time, which was we had an AUM-based pricing model, helps to align with our clients. However, being a public company where you have to report every quarter and also seeing kind of Fed funds rates go from basically 0 to 500 bps in the world's fastest period of time, made for some exciting -- basically, this time last year, all anyone would talk to us about was what's happening with your AUM pricing.

Right, right.

And not underlying the durables. So we pivoted and we did 2 things. For all new clients, they're on a base plus model. And for existing clients, we went back and we actually reached out to our clients to re-contract on a base plus model. So what is the base plus model? It basically takes out the AUM volatility. It says, here's a base fee, here's an annual base fee for your business. This is what you're going to pay. And obviously, that aligns with the resiliency that you were talking about in the business and the brand in the business. So there's a base fee. But you know what, as businesses grow, there's an AUM component or the growth in our clients' businesses. And then the third piece of it is the base fee then increases each year. So -- but however, if your AUM grows 7% in a year, the base fee, obviously isn't -- it's -- what it's doing is it's then ramping up to ratchet underneath kind of that AUM fee. So what we're doing is we're kind of remarking the base fee as the client's business grows. And really what that does is it limits the downside. And as we talk to clients, it actually -- they like the certainty of the base fee.

Right. Okay.

They liked understanding and people could appreciate, Oh, I can understand how a base fee goes up over time. And frankly, for most of our clients that are growing, it's transparent to them.

Right, right, right.

Because the AUM has kind of expanded. And what we're doing is just matching that base fee. And the argument we made to the clients, which fit very well was, hey, we're making investments in your team.

Right, right, right.

This is [indiscernible] working and people were pretty aligned to it. The last piece that we did which didn't have much of an economic impact. I'll say the other thing is -- as we made this transition, a lot of people asked, well, what did you think the -- what's the uptick? And we really -- honestly, we had a good model where we were having 3%, 4%, 5% kind of AUM expansion over time. So we really were able to view this as a neutral and I think that's why our clients also kind of accepted it as readily as they did. You could look back at history and say, look, you're kind of -- your costs have grown at this rate anyways, here's how it's going to work going forward and everybody kind of aligned to that. The last piece is we were not very precise. We were -- the benefit of Clearwater working across all markets and doing many things for different clients is that it's an incredibly flexible product. The detriment is, is that we were a single product company. And so if you were an insurance company and we got your whole book, and there wasn't a whole lot more we could sell you.

Right, right, right.

So the final piece of the base plus model was we just -- we're a little crisp about saying, "This is what you bought." This is what's in the product today, and this is what you bought. So that when we add functionality like German GAAP or additional regulatory reporting or additional kind of functionality around alternatives, which has been really successful, people understand, okay, I don't get that for free. And by the way, very fair. People accept that. They understand it. And so that's the last piece, which was the first step of us really making this evolution from a single product company to a multiproduct company. When we think about ourselves as a $1 billion revenue [indiscernible] I talked about, hey, we're going to get a lot more international than we are today. The other piece is we're going to have multiple products and that kind of composition of our growth between today, it's almost -- the vast majority is new client acquisition. Think as we move into a more mature business model, it will be -- it will tend to be both new client acquisition, and we'll continue to be focused on that. That's the lifeblood, but also selling back into our base.

Got it. No, I appreciate that. So you've clearly made progress on pricing. I would say that we've been pleasantly surprised how well you've been able to move.

You and me both.

Your historical clients to that. But how should we think about the cadence then of NRR over the next several quarters and years? How long do you think it takes us to get back to where we were, say, a couple of years ago of 110% or so?

Yes. And James, I think I've said this. Aspirationally, we think, if you think about yourself as a consistent 20-plus percent compounder and 10% in NRR is 110%, that's one thing. For NRR to be 115%, it really changes the business and it changes the trajectory and the opportunity. So that's -- we talk aspirationally as we -- we have the commercial construct in place now. We'll continue to evolve that. We have the go-to-market that we're starting to -- that is in place but continues -- will continue to evolve. And then the last piece is, okay, what are the products, both organic and inorganic that we're adding to the portfolio to try and drive that. You're right, 110% was kind of the high watermark of what we had historically done. We troughed at 104% when we were really into the AUM headwinds that we had seen and we're at 106% most recently. I think we'll steadily see that go back, and we want to march consistently. I think we see 115%, both through continuing kind of to sell within our asset management clients and broadening our footprint there, but also selling additional products and solutions across more clients. I think -- it's a multiyear program. And I think it's so strategic. It's worth us kind of ramping through that.

And so -- and look, you mentioned a couple of times selling incremental products or at least modularising a little bit like your offering. It's still early, but can you comment on the progress you've seen or made in terms of that module based pricing especially now that you're starting to have [ LPx ] and Prism, you mentioned the multi- [ GAAPs ] as stand-alone modules, how much impact or contribution are those having today versus where should they be?

So when we think about our organic -- multiproduct organic, it takes a long time to kind of create a product and throw it in and build -- historically it has. We should talk about to some of the innovations that are accelerating that. But we think about $100 million products. So we think of Prism as a $100 million product. We think of our alternatives, which LPx, mortgage. When you think about these, these are assets that we have on our platform, and we account for them. But with alternatives, you want to do more than just account for them. You want to be able to understand the underlying if you have a mortgage-backed security or a limited partnership interest. You want to understand cash, cash commitments, cash returns and cash flows. You want to think about with derivatives, collateral and thinking about kind of your counterparty relationships there. All of those aren't accounting. Those assets are on our platform. And if you talk to our clients, our users and you ask them, who do you send this information to or what do you do 15 minutes before you're on Clearwater or the 15 minutes after you're on Clearwater? They're doing these types of things. That tells us we have a right to win there. And those are important elements. So I think we're making good progress in alternatives and feeling good about that. Prism is a much more mature product. It's -- we started kind of developing it in 2020. And it feels like we've been talking about it to me for a long time. But we're now finally starting to see, I think its success would be net new business, 10%, 20% of that being Prism this year. So still small on the whole basis but when you start thinking about that and you start thinking about that compounding over time, you can see how you could -- you have either of those [ $100 million ] business. But it's still -- it takes too long. We're impatient. It's -- I wish it was all going faster. JUMP is also the inorganic piece of that. We didn't have any new client wins in Q1, but we've had 2 in Q2, and really, we're going to focus on making sure those clients are successful. That is -- what's really interesting about that is those were 2 back sells to existing Clearwater clients and either providing additional performance or portfolio management trading for those. And so as we think about broadening, I think we have a right to broaden our functional [indiscernible] for our asset management clients and that's the path. So we got to make those folks successful and referenceable, and then we'll really crank up the efforts.

So -- and can I ask you, so you mentioned a little bit about some of the things that you're doing from a developmental standpoint, how do you improve the pace at which you can add additional capabilities and start to monetize it? I mean is that purely like a change in development approach or what other things can you do there?

So yes. So I think that -- I think what we've realized like everyone. Over the last kind of, call it, 4 to 6 months, is that your expectations around development productivity in this new world of -- are just much faster. And so I think that we view ourselves as a real winner in being able to develop because we do have that single security master, and that single data source. So we can understand how to solve that kind of at that -- in the level, and we just have a ton of data that we can read into to try and build that. So I just think, honestly, my kind of -- our headcount models, our way of thinking about headcount growth in the past based on clients or revenues or programs that we want to do. Honestly, we're thinking fundamentally differently about that because we're just seeing the productivity in our dev work going up. It has to do with the AI tools. It also has to do with the leadership and the focus and the product alignment. And frankly, we're in a really enviable position because our clients do want to co-innovate with us. And so when we talk about these things, we're able to find -- we understand it because we're in it every day, but we also want our clients to participate in that. I think that, that has fundamentally changed within our business over the last kind of as we think about that. So really excited about accelerating that.

Got it. Got it. So let's talk about profitability. You guys are already quite profitable and particularly relative to other vertical software companies we track, where they're typically running 75% gross margins and around 27% adjusted EBITDA margins. But you have higher aspirations than that.

We do.

You've talked about that you would like to get to long-term targets of 80% plus gross margins and 40% plus adjusted EBITDA margins. Help us think about what are the drivers in a reasonable or realistic time frame to achieve that?

Yes. So I think that -- so if you -- let's park aside the efficiency, opportunities that we can see in AI for a second. Talk about what our models were before. And then I'll finish with that. So we have made a ton of investment kind of globally to build out kind of support systems for our international client base and across that. We're seeing the benefits of that. And I think we continue to see efficiencies there. I think today -- at the beginning of this year, if you would have asked me, I would have said 100 to 200 basis point margin improvement year after year after year after year. The business is built for that. How do you get that? In Q1, we were 27% R&D as a percentage of revenues. I think we see that heading to [ 20 ]. I think we like where we're at on the sales and marketing as a percentage of revenue at [ 13 ]. And then we have additional efficiency in G&A and then a lot of efficiency in kind of continuing to expand at the gross margin level. Further, when you start thinking about with a single -- like remember, we're doing the accounting. So we're doing the data ingestion, the normalization, the reconciliation, the modeling of these securities. And we have -- we already have hundreds and hundreds of machine learning rules that are facilitating this process. Guess what? Trades break and humans fix that. And we have hundreds of humans that are fixing data breaks or data inconsistencies or frankly, these decisions. If you just back up for a second and you say, well, we know that it's generally one of these things usually. And we have the information, and we're able to pull that data, an efficiency tool where you -- then that reconciliation person instead of having to solve that is able to pick the best of their 3, right?

Right, right, right.

The efficiencies around this are meaningful. And so I think that we are really excited about that on that opportunity front. We're even more excited about what we can do for our clients with kind of the summarizing data and saying, "Hey, here's -- what insights would you like?" What would you wanted to understand, we're not going to share what other people do, but as we think about that derived data and benchmarks and thinking about those things, I think everyone will be interested in that data. And I think we have a unique opportunity, given the data set that we have and the new technology offerings that are available to be meaningfully more impactful for our clients.

Got it. And just in the last minute, Jim, as for you guys have had an acquisition strategy, recently acquired JUMP Technology, which you mentioned. How do you think about the prospect of incremental M&A? And what kind of assets and/or geographies are you looking at?

Yes. I think -- look, it takes a long time to grow internationally. So we're really interested in international opportunities. I think, if you just take JUMP as an example, we wanted European footprint, asset management functionality and something we could sell back into our base. Something along those lines -- because we have 30 seconds -- along those lines, that's exactly what we're looking for and we continue to look at that. What more can we do for our clients and how can we expand our global footprint.

That's great. Jim, thank you very much. I appreciate you for [ being here ].

Thanks everyone.