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

Good morning, everybody. I'm Kevin McVeigh, part of the UBS Research platform here. We're thrilled. This is actually our first fireside chat, and I couldn't think of a better way to start it than with Jim Cox, who's the CFO of Clearwater. Jim and I go way back from the time of the IPO, which was back in 2001 -- 2021, rather.

And what I'd like to do -- I know it sounds basic, but Jim, we always start with the same question kind of a little bit about Clearwater, particularly then and now because what you've been able to do has truly been transformational and the markets clearly recognize that, but maybe a little bit about Clearwater even from time of IPO and bring that to kind of where we are today.

Thanks, Kevin. Thanks for hosting us. Thanks for putting us in this morning. Thanks for everybody for your interest in Clearwater. NVIDIA is a pretty -- I've heard of them, too, they're next door.

I said I felt bad for NVIDIA. They're up against Clearwater too.

Anyone who came in to see us, we really appreciate it and appreciate your interest in Clearwater. So when we went public -- so I've been at Clearwater, almost 6 years now. But as we went public in 2021, a successful company even before we went public, started, there were 3 founders in Boise, Idaho, beautiful place, very livable city in the summer, a little colder in the winter, but -- and founded it there. And really, their idea was to provide transparency to investment accounting to -- and they started with corporates, moved into insurance, so asset owners, corporates and insurance and then into asset managers. When we went public, it was -- and what was notable about that they really did create -- the founders created a real special sauce which was they thought about something truly structurally differently, which was instead of almost all other kind of investment accounting solutions, think about a portfolio as the container that things are in, they thought about things at the security level. And so by thinking about things at the security level, what you're able to do is reconcile, organize all the cash flows associated with that security and get that absolutely right. And therefore, if many, many people on your platform own that same security, you've gotten the security right for one, the benefits accrue to all. And so there's a true flywheel effect with that in the quality, in the scale, and the ability to do that. And so that was kind of where we started. When we went public, nice business, growing consistent -- profitable, growing consistently 20% over time and continue to be more profitable and continue to grow 20% over time. But what we were then was a single product company mostly in the United States, but on this great platform across these 3 kind of client bases. You fast forward to now, we're still growing in North America, but also have grown more internationally since we're up to 18% of our revenues are international. And half the world's wealth is outside of North America. So we're very much focused on growing logos internationally. So that's kind of another driver. But the second thing that we did was move from a single product company, this core kind of Clearwater, which is accounting, performance, compliance and risk to doing more for our clients. We have great gross retention rates. We had that back then, and we continue to have those now. But we -- but our clients were asking us back then, what more can you do for us? And now we're able to say to them, okay, we can do more, be it an additional risk, more depth in certain asset classes and the ability to trade in those, order management, portfolio management activities and those sorts of activities. If you think of trying to build the whole suite for our client base. And that's really driven by the relationships that we have with these clients where they're asking us to do more. So kind of great business, great gross retention. When we went public today, all of those attributes are still there. What is different today is multiproduct, international and I suppose one element of moving from the single product to multiproduct was we've always had incredible gross revenue retention, 98%, 99% gross retention. But when we went public, our net revenue retention was kind of in the high single digits, 108%, 107%, 1-something-like-that. Now a couple of years ago, we talked about aspirationally moving that to 115%. And just last quarter, we had NRR of 114%. That's really driven very much by doing more with our clients and that comes the whole bedrock of the theory behind moving to NRR 115% is the -- that's the quantification of the multiproduct strategy as we're able to sell more back into clients. That went on and on and on.

No, no, it's helpful. I think two of the other things that even impressed us at the time, I feel we talked about this. I just want to frame it a little bit more because it's really important is, you don't have any minimum contracts?

No.

It's not like you've got to sign up for 3 years, your retention rates are industry high. And I think that underscores the power of the platform. And you talked about this a little bit, but -- and again, I'm showing a little bit of accounting bias because that's how I started. But the IP you create is just, I think, really, really transformational. So maybe talk about the ingestion because I think I'm not going to frame it. You will frame more eloquently than me, but the ingestion, I think the success rate is what, 92% or something like that. And again, because one -- and the reason I'm asking this is one of the central questions we get a lot is, competitive threats and displacement. And it's I think when the market really -- and you articulated it really eloquently understands the nuances of the models and how important it is, it really helps [indiscernible].

Yes. So apologies. So I talked about how they built a better mousetrap and talked about how we think about things at the security level rather than the portfolio level. So what does that mean at the next level down. So first of all, built in the cloud first, always originated in the cloud. And so that's a powerful piece. And so you might say, hey, your competitors can move to the cloud or think about that. True. And if I were them, I would want to do that too. That would be good for clients. But even if we do that, this is what's really fundamentally different is we have -- probably this morning, we probably processed 800,000 unique securities. And these aren't just equities. These are fixed income structured products, derivatives, LPs that have unique cash flows associated with them. And so really, what we do is we ingest information from custodians, from trading systems, from other third parties. If you think about mortgages, it's bank processors, private debt. These are other locations where we're gathering all of this data. We're pulling it in. We're actually modeling the cash flows of these sophisticated securities ourselves. And we're doing a tri-party match that says, okay, the custodian says it's this, your system says it's this, our own calculations say it's this. And when those 3 match, it just flows through. And so even if a competitor were to move to the cloud, they still haven't -- because we've architected the system to think about securities first and portfolio second, even if as a Portfolio Accounting System, even if they move to the cloud, they would still have this portfolio viewpoint. And so when you have something like that, what you can't do is, you don't get any benefits of, okay, when you kind of understand the uniqueness of security and if there's an error in the security, without Clearwater, if you have to find all your own problems. With Clearwater, we ingest the information, our machines look at it and correct stuff. If it kicks out because it's a break from our -- we have 200 people who go through and make sure that it's correct. It flows all the way through the system to all of our clients. Let's say that we have a dozen clients that are looking at it, that information, and one of them says, I don't think that price is right. They can call us, we can pick -- we adjudicate that and the price is right. When we correct that for that client, it ripples to all clients who own that same security. So the way to think about it is the quality of our data is at least as good as our very best client. And so that's kind of -- that's the benefit that accrues to our clients is the accuracy of that. What benefits to shareholders is, once we have those securities and we have the model and we bring someone else on, 80% of the book that they bring on is probably already on the platform. And so there's less to model going forward. Now as we move into new jurisdictions, those percentages are lower, but that's how you kind of build kind of the true flywheel effect of that. And that's why we're providing full kind of accounting through the SaaS platform at 80% gross margins when we're also doing all of the data management, the reconciliation and all of that work for our clients. That's why I think our gross retention is so high is when they -- when a client moves to Clearwater, they're literally turning over the keys to us and saying, "Please, handle this for us." And now they have choices to make, right? And you get to make your choices, but all of the work about reconciling, cleansing, doing all of that comes to us. And we're able to do it at a scale like we can at the margins that we have because of this pretty innovative -- you got to thank the founders. It was a novel idea, and it worked.

For sure. And the other thing that's kind of interesting is remember, the end market consumer could be an LLP, right? So not only do they aggregate the data, they generate the financial reporting and then ultimately, the year-end audit, right? So if you switch auditors, the efficiencies that bring to bear are really, really transformational. And I think what's interesting is the market is endorsing it, right? So I want to talk about the M&A a little bit, not only what you've done, but also externally, right? So when you hear transactions like SimCorp being acquired by Deutsche Borse. When you had transactions like Adenza being acquired by NASDAQ, right, different types of platforms, but that's what Clearwater does, right? So there's that aspect of it that the market is really endorsing the uniqueness of the model. But also, Jim, you folks have been pretty nimble too, in terms of you started on the back end, which to me is probably the most complex. And then you've kind of fortified the product through kind of order management, execution management, through job and then Wilshire. So maybe talk -- jump a couple of years old now, but Wilshire more recently. Maybe talk to what drove the decision on those acquisitions and how they kind of feed into the model because this is important.

Yes. So here, we had -- we had a great set of clients, world-class clients that stay with us for a long time, and we wanted to pivot to this multiproduct strategy. So we're building, obviously, products as well there are other opportunities for us to look inorganically to find leads to kind of doing more for our clients. We did a bit of work and realized that for every dollar someone spends on accounting, they spend $4 on other vended solutions in the stack across the entire investment life cycle. So we said, "Wow, there's plenty of TAM to go get as we kind of grow with other clients." So a couple of years ago, we bought a company called JUMP. They provide order management, portfolio management, think of it as intraday kind of information that they're providing and some trade connectivity, particularly in Europe. Then just this year, we went to Wilshire. So Wilshire is -- the Wilshire 5000, people have heard of these. They have model indexes, they have math that was built by the Jet Propulsion Lab, Rocket Scientists in the '70s. And then -- so the software itself was reasonably long in the tooth, but the models had been through kind of long-term capital management have been through kind of 2001, and been through 2009. These were really well tested models. And when you get to risk, you want to have models that have kind of have the history and have accrued that. So what we did there was we took their math and we said, okay, we've got a -- we're good at building software. We'll take that math, we'll reengineer it into the software to provide risk reporting for our clients. It's all in service. So those are a couple of tuck-ins. A couple of things that we've done organically is LPx, MLx. These are -- we have an LP interest and you're an insurance company, you have 400 LP interest, it's not that difficult an accounting answer because they send you a number once a quarter. But what you really care about with an LP is what are my distributions going to be? What are my capital calls going to be? How do I want to think about my cash flows? And how do I look through into this LP interest to understand my exposure vis-a-vis this LP interest versus my fixed income and equity exposure that I have across my entire portfolio? We're all about being comprehensive for clients. And so that's where we fill that. We've thought about M&A and as kind of what more can we do for our clients. And we think about it this multiproduct strategy as both organic and inorganic opportunities for them. And so those are the sorts of things that we look at. And when we build, we really try to go out and find 3 or 4 client development partners who are willing to say, "I'm going to pay to help you really solve this problem that I have for me." And so when we think about inorganic, we're also looking at folks who have customer sets that are interesting to us, adjacent to us. It was fascinating. When we met with the Wilshire folks, they were -- going back to your comment about the platform of having clean reliable data, that's really powerful -- these Wilshire folks, they were talking about math that I didn't understand at all. But they said the math is easy. Don't worry, Jim. What's really hard is getting clean, reliable data. And I was like, "Oh, well, we have that." So that's kind of the benefit of kind of where we sit when we think about building out where we're going to go. Everyone wants to start with the same set of data to do whatever decision they make, make a trading decision, make a risk decision, communicate with your underlying investors.

Super helpful. Maybe we'll switch -- shift a little bit, talk about -- because what we thought was a really effective Investor Day. Talk about those growth targets a little bit kind of longer-term growth targets and maybe the margin too. And what I want to also leave into the kind of growth, Jim, is, again, relatively kind of soon after the IPO, you shifted the pricing model, right, from kind of AUM basis points to more traditional subscription. So maybe talk to that a little bit. And again, I keep going back to the point, kind of the uniqueness of the model, right, and the way it's architected, affords you the opportunity really do things in the public markets, with really no ripple effect at all. So maybe talk to those targets a little bit, the pricing, the margin and then the modularity because I think part of the discovery process, you realized you shifted the pricing was there's probably more opportunity.

It goes hand in glove with the multiproduct strategy. So September 2023, we laid out a few targets. Our brand always has been durable, reliable, consistent. 20% growth and profitability. And so we talked about -- we were a little more crisp in September 2023, where we said we continue to see 20% growth, ad infinitum. And we're really focused on durably doing that. We're not -- we don't grow 40% 1 year, 10% the next year. It's kind of 20%, 22%, something like that, since -- for the 5, 6 years I've been there. We've always been profitable because of the good unit economics that we have from that kind of core underlying architecture. We also probably spend about $0.25 of every dollar of revenue on R&D and about half that $0.12 to $0.13 on sales and marketing. And that's because clients generally get more clients. Clients like to hear that we're investing so much in the product and then refer us. In September 2023, we said, hey, we're going to continue to grow 20%, but we're also going to add 200 basis points of margin improvement every year. In 2023, we did better than that. In 2024, we're on pace to do better than that, and we will commit to doing 200 basis points margin improvement until we probably get to 40%, so that kind of is the target on that front. One of the things that we learned that was different today than when we went public, we talked about some of the things that were the same, but what -- the other thing that's different is, when we went public, we had an AUM-based pricing model, kind of aligned with our clients, and it was just, hey, what are your -- but how we sold it was we said, "Oh, tell us what your asset, the composition of your assets, tell us the scale, who are you connected to? How does that work?" We kind of have an algorithm where we say, okay, I think this is what the cost to serve is. And then we would say, okay, we want to get a long-term 80% plus gross margin. That's how we should price this business. Well, but then we would figure out what we price the business and then we take the assets and create a basis point number for them. And when we went public in 2021 and 2022, kind of there were a lot of Fed funds move, 500 basis points, that created a reasonable headwind for the business, which prior to the company had been private. And so you thought about things annually and things always even out. But on a quarter-to-quarter basis, that created more fluctuation. And so what we did was we pivoted to what we now call as a base plus model. There were really 4 pieces to it. One was you have a base fee. So basically, what we said to the salespeople is stop dividing. Just go through the same algorithm that we do to figure out the cost and you come up with a number. Just tell them that's the number, and that's the base fee. But then to the extent your assets grow, we will -- that's the plus. And so there's a basis point for the growth of your asset. So that's kind of base plus. The other things that came along with it, which were new to the business was the concept of an annual price increase. So the base fee goes up at least annually, the basis points go up to that. And then the most strategic piece of it was we were very clear with clients that what they bought at that time was clear with what they bought. In the past -- it sounds stupid today -- but in the past, we just kind of said, "Hey, you have Clearwater, everything we build in the future is yours for free." And so what we said was, hey, what you bought was there's 4 corners of this, of what you bought. And that enabled the multiproduct strategy. That was -- we did that in 6 months. I have a very good boss. He's a very demanding boss, and he said, I thought we'll do this, but it will take us 3 years to do it. He said we're going to do it in 6 months, go focus on it and it got done. What that told me was we'd always had great gross retention. We'd always had really high NPS. And I think that was the first financial expression of actual NPS. I'd always -- I'm an accountant. So it's like what is NPS worth? I don't really know what is NPS worth. It was going out to these large clients and saying, hey, this is important to us. We've been a partner for a long time. This is what we want to do. We want to change these contracts and folks said, okay, I understand that like this is what's fair. We were also trying to be very fair with everyone. And so they understood that. That was really the first point where I realized, wow, this NPS is really worth something and it's been -- again, it comes back to that durable, reliable growth. And this base plus just helps fortify that growth.

Now mind you, that's with no minimums, right? So if the client wasn't happy with the pricing, they could have canceled the next month.

Yes. Yes. It's month-to-month. Monthly, 30-day right to cancel.

As opposed to minimums. I just realized I've been asking most of the questions. I'm going to open it up to the audience. Does anyone in the audience have any questions?

Where is the coffee?

Where's the coffee? In the back.

[indiscernible]. And if you do lose what are typically the reasons why you do?

Yes. Yes. So we talk about an 80% win rate. And so let's talk about who are -- where we compete. So I'll go through each kind of segment. So corporate. Generally, we're competing with a base treasury management system if we're replacing it. Or in corporate it's -- it's actually one part of our business where we get a little greenfield. Companies go public, they suddenly have $500 million on their balance sheet. They figured they ought to invest it. They usually buy Clearwater. So that's kind of in that area. So that's somewhere there. In the insurance space, we're generally displacing PAM, which is owned by State Street Bank, of various solutions owned by FIS or there were legacy SunGard solutions or maybe some solutions within SS&C. So that would be in the insurance in North America. In Europe, it would be -- SimCorp has a large installed base within insurance. And so they just got bought by Deutsche Borse not just within the last year. And so we look to them and those are the incumbents. In asset managers, it varies more across asset managers. There are various SS&C solutions that are there, some FIS solutions. And then there's more variability in asset management, but there's a number of smaller players as well that sit in there. So that's kind of who we [indiscernible]. Generally, okay, that 20% that you don't win, what happens there, power of incumbency. It's where basically the folks choose to stay with the legacy provider. It's where we haven't done a good enough job explaining the benefits and the value of changing to the value of switching. You might say, what naturally comes with that is, well, why would anyone choose to switch their accounting provider other than, hey, we're the shiny new thing. But it really comes down to, in businesses where there is change for whatever reason, regulatory change, investment strategy changes, interest in new instruments, interest in new geographies, something at a business changes, and they have a need. And if you didn't have Clearwater, let me say, when you change your business in any way, if you have Clearwater, it's not your problem, it's our problem. We solve it. That's why reinsurers love us. They go out, they'll go buy risk. They'll go buy assets, they'll go swap out all the assets, put them into higher-yielding assets and do all that. All that work, that's on Clearwater to do. They just have the strategy of doing that. And so that's all our problem. If you didn't have Clearwater, you'd have to go through -- what generally happens is you enter a new asset class and you have a spreadsheet because the platform works okay for what it works for, but now that you want to do something new or you want to do reporting, you've got to pull something together manually. And so that's kind of -- what happens is we see some changes in a business and they say, okay, that makes sense. The other thing I think we need to do a better job of, particularly in North America within insurance, where I think we have a reasonable market share is we need to start this concept of FOMO. What do you get from being in Clearwater? I talked about this network effect of your quality is better, your information is better. That sort of thing is better, such that there is now a penalty for inaction versus there's generally no penalty for inaction. There's just the pain of staying where you are versus the pain of switching. So I think we can do a better job kind of continuing to drive along that front to try and drive those better.

Important point. I want to follow up on that, Jim, just 2 things, remind us, the mix today, kind of asset manager versus insurance and corporates. And I think the other thing, and I keep going back at such a terrible event, but Russia's invasion of the Ukraine, right? Like the time sensitivity of companies wanting to know what their relative exposure are, if you've got an Excel spreadsheet or kind of multiple kind of on-prem systems, you're getting that probably in 72 hours, you can deliver that in minutes, if not seconds. So the importance, particularly, the secular trend is your clients become more exotic with their asset allocation, they need the real-time data, which is what you provide.

That's exactly right. And it is -- you can -- for very liquid assets, you can understand the price of those. It's the illiquid it's the opaque instrument. And so what our value prop is, everything is on a single platform. You can see it all, you can understand it all and then you can react to it. And so that's one thing we were able to say, "Oh, well, who has ruple exposure, who has these types of securities, who has that?" And folks could understand that immediately, any of those situations. Folks talk about counterparty risk. In 2008, when everyone was worried about who their counterparties were, you can get that information instantly or near instantly. And versus if it's buried in a bunch of different places, you would not be able to truly understand that.

And then just again, remind us the mix of....

Sorry. The mix is -- so in ARR, it's just over 50%. I think it's 52% is insurance globally and then roughly 33% is asset management and about 16% is corporate and state and local governments and foundations and endowments. And that mix has stayed pretty consistent since we went public. All 3 of those have grown.

Another subtle point, I think, is important to maybe just talk about your clients' average asset mix, right? I think it's about 85% fixed income. Maybe talk to that a little bit.

That's right. That's right. So folks are very interested in, oh, well, because you have this base plus model, how does AUM changes or market changes impact your overall AUM. And I guess at the highest level, we think about 80% is fixed income and structured products and about 20% is equity. Obviously, that has nothing to do with us. It has to do with what our clients are invested in and how that mix works, but that's just been kind of historically the way. If you think of corporates and insurance companies, they have a tendency to move that blend more in that direction.

Only reason I make that point is, it was amazing what you delivered in an incredibly aggressive Fed tightening cycle. Now as the Fed eases, obviously, you're going to have a little bit of wind at your back from a revenue perspective, just in the AUM model and basis..

We definitely saw a part of that. One of the things we talked about at the Investor Day, in September '23, was really NRR 115% and really driving to that. And that was really about multiproduct. Last quarter, we were NRR 114%, that was great. We had about 3% tailwind from the market in that number. It's hard to know whether that's truly market or whether it's just asset flows because it's kind of -- it's all a blend of stuff but that was helpful. But we really -- when we talk about NRR 115%, we're really focused on durably, reliably driving to that number through the levers we ourselves can pull. But when the market is good, we appreciate it. When the market isn't good, we'll figure out a way to grow 20% anyway.

They were so convicted, they actually printed T-shirts at the Investor Day that they gave everybody.

[indiscernible] logo is a little higher than that a little higher than that. So the ARR was -- so there's revenue and then there's ARR. The ARR was 26%. And so 2% of that was the Wilshire inorganic. So kind of 114% and about 10%. that's not precise.

So I guess the question is, it sounds like there's a lot of local growth internationally. If you focus back on the U.S., just can you give us an idea of how -- like what your penetration is of potential logos? Are we -- and again, how much.....

So maybe let me give you our most penetrated market. Okay. So we say ARR is -- insurance ARR globally is 52%. So that's, call it, I don't know, [ 200, 220 ], something like that globally. And 20% of that is international. And so that gets you to -- but basically, in North America, based on the insurance assets and the take rate that we expect, we think North America insurance is between $500 million and $600 million of TAM. Internationally, it's actually this is interest. International insurance TAM is like double that number. So there's far more insurance assets in Europe than there are in North America. And so that would be our most penetrated market. So you're talking about, I don't know, 30%, 40%. And then when you get up to the kind of top 25, we're probably at 20%, 25% penetration in the largest asset.

I know we're up on time, but I think it's just an important point. If you follow the R&D, it's amazing where the growth is going to be. I mean it's pretty predictable.

Yes.

Awesome. Thank you all.

Thanks, everybody. Thanks.