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

Good afternoon. I'm Kevin McVeigh, formerly of CS, and I'm thrilled to be here as part of the UBS effort in the tech conference. Next up, we have Jim Cox, who's the CFO of Clearwater Analytics, a company we've been -- we took public back in 2021. It's truly been a really, really nice opportunity to come back and revisit Clearwater pretty consistently over the course of the years. But at this event every year, and you can see the way they really execute and just continue to grow the model. I try to keep these as iterative as possible. I'm going to start off with a little Q&A. If anyone wants to ask a question, we can do with a mic or through the iPad. Obviously, this is ballroom at and then alternatively, you can also e-mail me [email protected], and we'll get to it.

We started this right after Clearwater went public in 2021. And I think it's been helpful. And I'd like to start this way for a couple of reasons. Number one, I think it really helps frame the success you folks have had in the public markets, but also to provide a little bit of a lens where you differentiate relative to some of your competitors. So I don't think Jim never gets tired to answer this question, but I'll start with tell us about Clearwater today versus the time of IPO. And what's kind of been interesting is it hasn't been the most accommodating markets and you folks have really executed. And I think it really underscores what you and Sandeep have done and the team collectively, but just also the strength of the platform. So maybe we'll start there a little bit.

Thanks. So first of all, Kevin, thank you very much. Thanks to UBS for supporting us and for your continued support all along this. We really appreciate it. And since the webcast, so I don't know if people can see us or not, but this is a legit green backdrop. And the other thing I have to compliment UBS on is as big a fan as big a buy as I am on Clearwater, the cookie and ice cream in the mid-afternoon snack is at every -- I've been to, maybe not thousands but hundreds of conferences. That is -- that's right at the very top. So I'm very, very long on the cookie and ice cream. So at the very -- if there's one thing you take away from that it's go get the cookies and ice cream. So well played. Well played. And yes, thanks for your support. I mean I remember the first time we were here, it was this time in 2021. We've just gone public in September. And we were still in -- this was the first -- and we did it outside because of COVID and we're still doing it outside. This is -- the other thing I'll say about this conference is you can get a tan while you're talking to investors which is a tan, ice cream and investors that's...

Does it get any better.

That's a good day, but take us back to kind of where we were in 2021 or even when I joined in 2019. In 2019, when I joined Sandeep, it was -- so the company is still proudly headquartered in Boise, Idaho, but 90% of the employees were Boise. Today, we still have more employees in Boise in 2023 than we had in 2019, but we have hundreds in Edinboro, hundreds in New York -- or about 100 between New York, Seattle, the Bay Area, Washington, D.C., hundreds in India. So it's really become a much more global organization since that point in time. When we went public, a lot of stayed the same. So it's been nice that consistency is good. So we're in a replacement market where we sell portfolio accounting, reporting, analytics, compliance, performance and risk to -- we started in corporates long ago. That's when I was a client. Before I was a CFO, I was a client of Clearwater, a user of the system, a light user of the system, but a user of the system, and then move to insure and selling to corporates, insurance companies and then asset managers. And much of that is the same. We've added on. We have a number of REITs that we're proud to welcome to the threshold, to the party, a number of state and local governments in North America. So it was -- so kind of that has stayed the same, and we continue to kind of consistently displace and win. And why is that the case? That's because the problems from 2019 to 2021 to 2023 have only gotten harder, right? So when you do accounting, you need to be comprehensive, you need to be trusted, you need to be accurate. And when people continue to invest more globally and continuing to invest in different instruments and increasingly complex instruments, the needs continue to become greater and greater and greater. And basically, what ends happening -- what ends up happening is there's a little tipping and it just makes sense to move over to Clearwater. So that's -- we've all -- what stayed the same. We've always been quite profitable. And we've always consistently grown kind of 20% to 25% in these new markets. What is new? Not necessarily new but has evolved is a couple of things. One, we are more and more internationally focused as we expand when we went public. Less than 10% of our revenues were outside of the United States and now it's in the double digits, but we've -- if you look at the global wealth, especially from like UBS that understands it as well as anyone, half the world's wealth is outside of North America. So in the long, long term, you would think that we would be as large outside of North America as we are in it and nicely profitable and generating cash flow and continuing to invest. So that's -- I would say other things that have evolved is -- what's the same is our clients have generally always loved us and they still do. We have -- we benefit from really high gross retention rates, and really high Net Promoter Score. So our clients are really promoters. What has -- that stayed consistent over that period of time I've been here. But what's different is we're really leaning in to try and think about what more can we do with our clients for our clients to make them better. And so you'll hear us continue to focus on net revenue retention and growing with our clients as they see the need. Sorry, that's a very long-winded answer.

It was winded, but I think you're being modest, though, too. And I mean that sincerely in terms of I think one of the things we [indiscernible] was your ability to change the pricing model without really impacting the revenue at all. So maybe talk about that a little bit. And I think while simultaneously doing that, identifying, I think, within the existing market, I think one of the things that really -- it's lost on the market sometimes, and I think I'm a little biased because I'm a CPA by background, is just the complexity of the accounting software that you have. I mean there's a reason and maybe talk to this a little bit, too, within the framework of the pricing, there's a reasoning you serve insurance companies, corporates, asset managers, domestically because it's a very complex accounting and you folks made a very smart strategic decision to start in the back end, and you flexed out that product through, again, another very strategic acquisition in JUMP. So maybe talk to that a little bit because there's a reason you've been able to grow 20% where a lot of the relative comps and more an even macro haven. And again, I think it's the stability of the clients, the modules, but talk to that a little bit because I think it's really important within the context of a very efficient tech stack.

So yes, so maybe backing up to kind of when we went public, we had generally an AUM-based pricing model and kind of had fallen into that from the perspective that, in general, assets go up, and so that generally helps. And then it's aligned with how our clients think about their business and their assets. Both our asset owner clients as well as the asset management clients, they think about the assets that they have. And so created great alignment, and that was kind of in 2021 when we went public, we talked about that. And we said, hey, 80% of our assets are high-quality fixed income. And so we don't have that much volatility in the revenue stream. Well, then 2022 came along, and we were a public company where people were tracking us quarter by quarter by quarter. And the Fed funds rate went from basically 0 to 5 in a record amount of time, which put -- let's just be clear, it did put significant pressure on our revenue. And we came to the realization that there was a better way to do that. There were a lot of things that -- there's always a list of things that you can do better. And so we -- Sandeep and I will always talk about never waste a crisis. So this was an opportunity for us to rethink our commercial model into a better way. And so what we did was we pivoted from this AUM-based pricing model to what is called a base plus pricing model. So it was interesting. What we used to do when we would get a new client, even in the AUM pricing world is we would say, okay, tell me about your assets. Tell me about kind of where they're domiciled, how complicated they are. Tell me about what you need to report on and all those things so that we can kind of understand that. And then we would kind of figure out what we thought it would cost, and we thought, hey, we probably need at least 80% gross margins, and we would think about the specific market we were in and we would come up with what we thought was an annual price that made sense. And then we would take that annual price and we would do division. We would divide it by the AUM that they had and say, here's your basis point. And so we did this amazing thing with the sales team we said stop doing division. Just that number, $100,000, $0.5 million, $1 million, whatever that annual fee is, that's the base fee. But we have the plus, right? And so because a lot of people are leaning into Clearwater because they want to do something new. They want to grow their business. They want to move into a new geography. They're investing in new asset classes or different asset classes in doing something different. And so that book is going to evolve. And so you can then say to those new clients, okay, here's your base fee for your book today. As your book grows and evolves, there's a basis point fee that goes along with that. Then the third thing we said was, hey, let's not create a problem in 5 years from now where your assets have doubled and your base fee is basically the same price and now we don't have the -- we haven't derisked the downside. So we have kind of an annual price increase on that base fee that kind of builds up. And so that's kind of the commercial construct of that, that went through. And -- but the most strategic element of it was up until that point in time, we had sold this thing called Clearwater, one product to everyone. And then we would spend $0.25 of every dollar of revenue we got on R&D, and we would put that in the product and give it away. These are things we can do better. So the final piece that we did was we said, hey, what you bought is we're going to define what you bought and what we build in the future that is different. We will charge you separately for that if you want to buy that. All very rational things. It's amazing that it took us that long to come up with that. But that's kind of the pricing scheme that we went through. It has worked incredibly well for all new clients. And the other thing we did because we had a little bit of a hole in the bucket in 2022 was we went back to our existing clients and said, we'd like to change that. And that's where the proof is in the pudding of high NPS scores, high gross retention rates, high customer satisfaction. When you go back to your customer and you say, hey, we need your help and they say, weren't it with you, we can understand that. That was a really great outcome for investors, for the strategy of the company. And for our clients, because what it allows us to do is really lean in and invest for growth in areas that we can then offer these products to our clients going forward. So that was kind of the pricing model change. Again, I went on, you had a second -- doing more for our clients and the JUMP acquisition. So that's the other -- and so now that we have the commercial construct in place where we can do more for our clients. We have organic elements that we're doing for them, like Prism or LPx, which -- these are additional products. Fundamentally, LPx is just -- we already had LP investments on the platform. But when you invest in an LP, you want to know different things than accounting about it and you want to be able to look through it and understand it. That's what LPx provides you. And guess what? Clients understand there's incremental value for this. I'll pay more for this. That's one example of that product. We also at -- on December 1 of last year, did our first acquisition. We had been 100% organic growth until that point, did a small acquisition of a company called JUMP, which is about 100 people based in Paris. And what they provide us is kind of they did more of a suite for the asset manager. Middle office, trade order management as well as some accounting and reporting, and they had some specific nuances for the French-speaking marketplace that was useful. So we did that. And I think that, that acquisition has gone relatively well. So we're excited to both invest with kind of -- within our R&D for organic additional product expansion as well as look to doing more things for our clients through an inorganic approach as well.

One other thing before we get off topic because I think important too is the construct -- your contracts are such that a client could opt out any month. I mean there's no minimum...

They can, right?

So if you think about that relative to more traditional software contracts, it could be 3 to 5 years and then you enjoy the retention rates you do really underscore.

I've been a CFO at a lot of software companies. The first thing I did in 2019, I went to Sandeep. I said, I got an idea, a 3-year contract. He goes, try and figure out what problem you're trying to solve, Jim. And we have 98% gross retention and the month-to-month contracts, the founders understood a few things right. This is another one of these things because it's created a culture within the company that is so client-focused because you can't sign a 3-year contract and ignore a customer for 18 months and then kind of warm them back up in time for the renewal. You have to prove your value every day. That's why we have contracts like that. Clients like that. And I think the gross retention rates prove that you can do that on a month-to-month basis.

Great. Are there any questions in the audience? Or I'll just check my e-mail real quick. Otherwise, I want to pivot over to the Investor Day because I think there's a couple of things to really focus on.

Sure. So for the webcast, the question was, talk about competition. So we're generally in a replacement market. Someone has something typically. And so let's talk about it market by market. There's nuances, North America versus international as well as [indiscernible]. So within -- so I'm going to contradict myself, within corporates, that's the one place where there is some greenfield. So a start-up that's funded with $100 million, and they start investing in that, that would be one place but there are also various legacy treasury systems where someone's using treasury system and doing some accounting within it, and we will displace those. Within the Insurance segment, there's a variety of legacy competitors that we're replacing. And those would be kind of either large software companies that you've heard of that are a variety of different brands or software pieces that have been kind of subsumed into maybe trust banks or something like that and so that's in that -- and then on the asset management side, we're also competing against a variety of those legacy competitors that are kind of large public companies with lots of brands. As you pivot internationally, there's -- what's interesting is accounting -- investment accounting is -- I had an old boss, she used to say, it's the land of 1,000 niches. And so there's lots and lots of these when you get into France or Germany or Hong Kong or the U.K., there are special purpose kind of entities. And what we -- our value prop is really any asset class, any geography. And if you want to have a consolidated view, that's what we're selling. So when we come in, we're generally displacing that legacy competitor, we're displacing all the spreadsheets that sat around where that legacy competitor fell short, and we're generally displacing at least from an accounting perspective, a data warehouse, where people have put stuff together. And then those people can go off and do other things.

I think, Jim, to drill that point home, I think one of the settlers to a lot of these models is the IP buildup over time, right? Because I think -- correct me if I'm wrong, but 90% is flow through, but then there's that incremental 10% where you're creating what the accounting interpretation is, and then that goes into your system, right? And -- to your point earlier, and it's a terrible example, but the war in Ukraine, right really drove home, people needed to know what their exposures were and it really exposed a lot of the shortfalls of your competitors. And with the systems you have, it gives you that real-time capability, which...

Thank you, Kevin. Thank you. I buried the lead. This is the most important thing you can understand is we truly have a differentiated technology. We do it differently, and I always forget this. So most portfolio accounting systems think about a portfolio. Whether you're in the cloud or on the ground, you're thinking about a unique portfolio that's unique to you as a customer or you as a customer or even within customers, unique, you might have multiple, right, within a customer. We do it differently. And this was a second thing that the founders did brilliantly. I think they looked into it, but it's still brilliant which is we don't think about a portfolio. We think about the securities in your portfolio. We have a single-instance, multi-tenant platform that has a single security master. And that is a little nuance that we're accounting for the securities underlying that, but it's really important because what it means is if half the people in this room have the same security, we ingest it once, we reconcile it once and we clean it one. The benefits of that are obviously efficiency to us. But the benefits are also to our clients because the quality, let's say that the price is wrong on that security, we fix it once and it ripples through to every client that has that security. Find it once, fix it once, ripples to everyone. And so we actually have a view that's, to my knowledge, no one else has this architectural construct. No one. Legacy new entrant, anything like that. No one does it this way. And it's very powerful because we have 2,400 data feeds that are coming in that are driving those securities. And we've modeled those thousands and hundreds of thousands, if not millions, of securities have also been modeled. And so we get the securities right. And only after we have all the data clean, validated and run, do we actually care whether it's customer A or customer B or portfolio C and you run that up. This allows you to go up and down, it allows you to do any gap anywhere. You want to look at GAAP, you want to look at IFRS, you want to look at tax, boom, boom, boom. It's all the same core underlying data. It's just spun up. All accounting is a set of underlying rules as long as you get the data clean. That's honestly the true differentiator. And when people see that, they're like, oh, Sandeep likes to say, and I agree with him. If you knew to do it this way -- no one says, oh, you shouldn't do it this like everyone who hears this is like this is the right way to do it. It's just that the founders came up with that.

And then another subtle impact is how more efficient the year-end auto processes and consolidation, things like that?

Absolutely. Absolutely. So yes, so when we go out after we get a client, a year later, we'll ask them, okay, what problem did we solve for you? And across insurers, it's time to close because we're doing a daily soft close. So when they get to month end, 80% of our clients are closing on day 1 or day 2. And trust me, before they come to us, they're closing on day 16. And there's 22 days in the month. So if you haven't closed until day 16, do you really -- how do you act? How do you trade with any confidence around that if you don't know that?

Switch gears, I think, an inaugural Investor Day this year, which is really just really, really eloquent we thought at the time and continue. But a couple of things that really jumped out were the improvement you're seeing in the net revenue retention over time. So maybe talk to that a little bit, if you can build it up maybe from the gross to the net. And then ultimately, you said and I promised I was going to bring the shirt to my bag, 115 NRR, which is terrific where, again, depending upon the quarter and I'm not -- 106 to 109 is where it's been over the last year or so, but maybe help us understand that and then a little bit of a bridge to the 115. And we have to spend some time on it because it was important, but you've got really, really impressive margin expansion targets that don't have any AI fit in them. So a lot to unpack there. I know, but I think, again, it's a framework that really, really endorses and efficient.

So we have a situation where we have very sticky customers who like us and want to do more with us. We really should do better than where we are at NRR. It's pretty average, 106, 108, 109, where we're living. Now it was very, very average when it was 104 in 2022 before when we had the headwinds from the AUM and had not changed the model. But if you start with -- it's really -- the NRR concept is same-store sales. We started that, we lose about 2% generally due to acquisition or people run out of money and they no longer invest. So that goes to 98%. Then you have some price increases that are involved, right? Some natural AUM expansion that's involved. And then you have some back selling both of additional business lines at some of our asset managers or additional products like LPx. That gets us to where we are. We really believe that when you look at great SaaS businesses, and that's what we aspire to be, those NRR rates are 115, 120 or even higher. I think we do a great job commercializing upfront. And so I think 115 is a really -- it's a hairy goal, but it's one that we are really focused on because we like to get behind those. And so as we add more products and solutions for our clients, we can see bridging that from, call it, the 108 of last quarter up to 115 as we sell more back into that client base and do more for those clients. That's really important. The other piece that we talked about to close out was we've always been nicely profitable. Before we were public, we were at about 30%. EBITDA margins went down a little bit when we went public, there's this thing called public company costs. By the way, lovely hotel. So in September, we thought 2023, EBITDA margins would be 27%. We've stepped that up to 28%. But in September, we said we're going to increment 200 basis points of margin improvement in 2024 and another 200 in 2025. We stand by that even though this year, we're going to do 28. So we'll go 28, 30, 32. Why can we do that? Because within our R&D, which is about 26% of revenues in the last quarter, generally, R&D will continue to grow and go up in a real dollar terms. But as a percentage of revenue, it's going to go down to normalize to 20% because we've just completed 2 major programs. One was we built all these global gaps that we could compete internationally. It's a huge lift by the team. That's now largely complete. Those resources are freeing up to do other growth initiatives. So we don't have to hire additional people to do those additional growth initiatives. We can just redeploy them on that. And secondly, we're fully in the cloud on AWS and so that also creates efficiency and there was a reasonable amount of work to do that. So R&D is going to step down. We've always had nice leverage, right? We have this natural security master. So there's a natural scaling in the business. And so we've seen gross margins continue to march up, and we expect those to march up to 80% gross margins, about 0.5% per year kind of as we kind of scale. You might ask, why isn't it over 80% already. And I would say that, that's because we were building out international. You have a lot of efficiency in North America with all the securities. But when you go into a new region, that's obviously a natural headwind against it. And then obviously, we'll continue to scale in G&A as we kind of -- those public company costs are at least relatively fixed. So that's a nice model, and we convert to cash at a reasonable rate along those lines as well.

I'd also say the JUMP acquisition, in addition to extending kind of the capabilities created a nice European beachhead for you, right?

Really important. That's probably the thing that I underappreciated was just having 100 people in Paris from acquiring JUMP helps Clearwater sell. The other thing that I probably underappreciated was JUMP being part of Clearwater, they're getting larger and more sophisticated clients than they had as well, just on their old -- their same platform. Now what we have to do is we've got to put those together and really deliver on the promise that we see available.

Any other questions in the audience? No. I would like to close these out. Jim, you've been really transparent in the public markets. Anything you think that if you were to think about across Clearwater today, maybe the market doesn't have as much focus from a Clearwater perspective?

Yes, I think -- so I think if I were going to say, what are the 5 things that everybody needs to understand. Number one, we do it differently, right? This -- having the single security master really is a fundamental differentiator. Number two, we're in a replacement market. And when you have a fundamental differentiator in a replacement market, the ability to compound on that and grow. Why do we believe we will grow 20% plus into the future because we always have. But that compounding in a replacement market where you are the next-generation winner goes -- it takes longer than everyone expects because accounting software is really sticky. But it also goes on much longer than anyone expects. And so that is a great business to be a CFO in because you can see the visibility and you can then make investments that are intelligent to be able to maximize that opportunity in the future.

You see in the R&D, to your point, it's -- you've always been very, very on the front foot of innovation, and that continues.

Yes. And we're just getting started with AI. AI, given the single-instance, multi-tenant solution and the single security master, we think we have an opportunity, no one else had in our little place in the world with respect to that. But there's more to do there.

Thank you.

Thanks, everybody.