Clearwater Analytics Holdings, Inc. (NYSE:CWAN) Q1 2024 Earnings Call Transcript

Clearwater Analytics Holdings, Inc. (NYSE:CWAN) Q1 2024 Earnings Call Transcript May 4, 2024

Clearwater Analytics Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Joon Park: Thank you, and welcome everyone to Clearwater Analytics’ First Quarter 2024 Financial Results Conference Call. Joining me on the call today are Sandeep Sahai, Chief Executive Officer, and Jim Cox, Chief Financial Officer. After their remarks, we will open the call to a question-and-answer session. I would like to remind all participants that during this conference call, any forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Expressions of future goals, intentions, and expectations, including in relation to the business outlook, future financial and product performance, and similar items, including, without limitation, expressions using the terminology may, will, can, expect, and believe and expressions which reflect something other than historical facts are intended to identify forward-looking statements.

Forward-looking statements involve a number of risks and uncertainties, including those discussed in the risk factors section of our filings with SEC. Actual results may differ materially from any forward-looking statement. Company undertakes no obligation to revise or update any forward-looking statements in order to reflect events that may arise after this conference call, except as required by law. For more information, please refer to the cautionary statement included in our earnings press release. Lastly, all metrics discussed on this call are presented on a non-GAAP or adjusted basis, unless otherwise noted. The reconciliation to GAAP results can be found in the earnings press release that we have posted to our Investor Relations website.

With that, I’ll turn the call over to our Chief Executive Officer, Sandeep Sahai.

Sandeep Sahai: Thank you, Joon, and thank you all for joining us. Building a durable business that grows consistently while improving gross margin, EBITDA, and cash flow has always been our stated endeavor. I’m pleased to report that Q1 2024 delivered on all those goals. Revenue grew 21% year-over-year to $102.7 million in the quarter, and our EBITDA grew 42.9% year-over-year to $32.2 million, or 31.3% of our revenue. Let’s discuss revenue growth, which was purely organic, in some more detail. It starts with NPS. We believe our NPS scores are industry-leading and we have taken to reporting it as 60 plus because the numbers are even higher. As a direct consequence, we had incredibly low churn and gross revenue retention grew from an already outstanding 98% to an incredible 99%.

Next, the revenue growth was widespread across geographies. North America grew 20% and Europe and Asia grew faster to deliver the aggregate 21% growth. ARR growth year-on-year re-accelerated to 19.3%. The multi-product journey continues to gather momentum, and new products introduced over the last two quarters delivered solid wins, contributing to an NRR of 110% for the quarter. The Clearwater JUMP platform had a very strong quarter and added six significant clients in the quarter. Finally, our win rates continues to be 80% when a proposal is written and stands testimony to the disruptive power of our platform. Our plan for sustained growth is founded on two strategic pillars; number one, continued acquisition of new logos across an increasing breadth of industries and geographies and number two, growing NRR to 115%.

Let’s take some actual wins in Q1 to substantiate the progress we are making. We welcomed a publicly traded healthcare company with multiple subsidiaries and $40 billion in AUM to the Clearwater community at this quarter. Their decision to transition to us came after growing frustration with their previous legacy technology provider. An on-site demo followed by an RFP process demonstrated our ability to comprehensively address multiple asset classes on a single instance multi-tenant platform. Several reference calls that attested to our ability to onboard efficiently and provide exceptional service sealed the deal. Our ever-growing solutions for alternatives continues to help us win deals and do more with current clients. We continue to see growth in these assets on our platform.

A newly introduced innovation, the Clearwater Intelligence Console or Quick LPx solution, our generative AI-based solution for LPs, is now delivering investment insights to our clients on-demand. Institutional investors can leverage Quick LPx to easily extract actionable insights from accounting data and performance metrics, even translating general partner documentation into 96 different languages. Let’s discuss a recent win driven by our capabilities in alternatives. One of our clients had been growing very rapidly, where the complexity and size of the operations outpaced their ability to manage investment operations effectively. An acquisition added a significant number of LPs to the portfolio and they relied on a legacy platform for its processing.

To get a comprehensive picture of the portfolio, they would have had to build a brand new data warehouse. A detailed demonstration of our platform showcased how Clearwater could streamline their processes for all asset classes into one single instance multi-tenant platform. They decided to adopt Clearwater LPx and Clearwater LPx Clarity, in addition to the Clearwater core platform that they had already been using. We have discussed Prism many times before. This product has become a real winner for us across geographies and market sectors. We signed Erste Asset Management, part of Erste Group Bank AG, one of the leading asset managers in Central and Eastern Europe, managing EUR 70 billion in assets for a broad client base, including pension plans.

They join a fast-growing community of European buy-side clients. This win demonstrates Clearwater Prism’s uniqueness and its ability to deliver a comprehensive view of their clients’ portfolio, attracting asset flows that are so vital for asset managers in this challenging market. Talking about international markets, we signed new contracts in APAC, Germany, France, and the U.K., all in the same quarter. We feel really good that the new leadership we announced last quarter is already adding value. We have identified new pockets of applicability for our platform, and are excited about the buildup of our pipeline. I’d like to talk about Clearwater for Stable Value funds. In Q1, we proudly announced that T. Rowe Price selected that platform to support the firm’s growing Stable Value fund business.

The core platform already addressed a vast majority of the need, but a purpose-built addition for that market, allowed us to address the complex needs of Stable Value funds, streamlining trade ticket processes for investment contract issuers and other third parties. Stable Value fund providers will benefit from a unified SaaS solution that offers daily reconciled investment data to both front and back office teams. Following up on that win, we now have another significant client on this platform. We also introduced Clearwater for pooled funds this quarter. It equips state treasuries and the pooled participants with a user-friendly web-based portal that integrates seamlessly with Clearwater’s accounting and reporting platform. Again, a vast majority of the need was already addressed, but we have added a purpose-built solution to address the specific needs already regarded as a best-in-class investment accounting platform for state Treasurer’s Offices, our new participant portal simplifies navigation of local government investment pools, providing participant portal logins and statement preparation all within one platform.

One of Clearwater’s JUMP platform wins is a company based in France and Luxembourg that manages assets including equity, fixed income, and private debt. Prior to partnering with us, they lacked full functional coverage for front, middle, and back office operations and depended on extensive manual processes. Clearwater JUMP closes these gaps by enhancing data accuracy, reducing manual processes through automation, and providing regulatory compliance. Another client specializing in fund and wealth management, primarily in equity and fixed income, embraced Clearwater JUMP as its end-to-end asset management platform and the seamless coverage it provides across their front, middle, and back office investment operations. This new client will use Clearwater to connect seamlessly with all its counterparties, leveraging critical market data and optimizing trading processes.

Our newest corporate cash client, one of the world’s largest pharmaceutical companies, enlisted our expertise to oversee the rapidly expanding separately managed account program. As their investment operations have grown to include multiple asset managers, custodians, and money market fund portal partnerships, they now depend on the Clearwater platform for streamlined operations and a consolidated view of the portfolio. We trust that these examples illustrate the very meaningful progress we are making on both the acquisition of new logos across an ever-increasing number of industries and geographies, and secondly, in our continued journey towards becoming a multi-product company that can deliver a sustained NRR of 115% and beyond. Switching gears, let me discuss progress on the addition of capabilities that will allow us to address more of the technology spend across the investment management lifecycle and not just investment accounting.

We started with the acquisition of JUMP and the Clearwater JUMP platform is doing well and resonating with our clients in precisely the way we thought it would. We won six clients this quarter and are now able to offer solutions for the front, middle, and back office. This quarter, we were thrilled to announce that we completed the acquisition of the risk performance and analytics platforms of Wilshire Advisors. Wilshire Axiom, Wilshire Atlas, Wilshire Abacus, and Wilshire iQComposite will now be integrated with Clearwater solution in the risk and performance space to create a powerful and compelling product for our clients. We are integrating these new capabilities into our risk and performance analytics platform, enhancing our capabilities many-fold.

We can now offer our clients significantly enhanced capabilities that would have taken us years to develop in-house. Risk and performance models need to establish credibility by extensive use and it often takes years or even decades to achieve that. Simply put, this acquisition allows us to capture additional TAM immediately and scale the business. Our clients will benefit from a comprehensive suite of modular tools for portfolio construction, quantitative performance attribution, risk analysis, stress testing, and portfolio analytics, all using the same underlying data from the core Clearwater platform. Our vision is to create the preeminent investment management platform for firms around the world. And by partnering with Wilshire and bringing their robust time-tested models into our platform, we are one step closer to that vision.

With the JUMP and Wilshire acquisitions, we are building people, technology, and market leadership to establish Clearwater as the definitive enterprise platform for the entire investment management process. Shifting to unit economics, we are very pleased to report that we have achieved this revenue growth while simultaneously increasing our gross margin to a new record high for the company at 78%. Our generative AI programs have started to positively impact our ability to deflect customer inquiries and enable our client servicing teams to deliver faster and more comprehensive responses. We feel very confident about our march towards our stated long-term goal of achieving 80% gross margin, perhaps meaningfully faster. Thank you for your continued support.

And we look forward to sharing more about our product offerings and the latest innovations at Clearwater Connect in London on June 19. A great event where we expect hundreds of institutional investors will gather to learn about new technologies and solutions that can help grow their business. With that, let me turn it over to Jim to review our financial results in more detail.

Jim Cox: Thanks, Sandeep, and thank you all for joining us. I’m delighted to report that 2024 is off to a great start with exceptional results in Q1 across various key metrics. In the first quarter, we decisively beat guidance for revenue by $2.2 million and adjusted EBITDA by $3.4 million. Our organic revenue growth reaccelerated to 21.4% over Q1 of 2023. Revenue in the quarter was helped by incredibly low churn, resulting in a best ever reported gross retention rate of 99%. In addition to limited churn, we also expanded our relationships with our existing clients through cross-sell of products, increasing our share of our clients’ investment books on Clearwater and growth in our clients’ AUM. When you put that together, it results in net revenue retention of 110% and solid revenue growth.

The impressive improvement in both net revenue retention rate and gross retention rate is reflective of our market leading competitive position. Our single instance multi-tenant product was stronger than ever in the first quarter versus legacy tech incumbents. The strong revenue results flowed through to both gross margin and adjusted EBITDA. We achieved adjusted gross margin of 78% and an adjusted EBITDA margin of 31.3%, which is a stunning increase of 470 basis points from the first quarter of 2023. The unit economics of this single instance multi-tenant platform are simply phenomenal. When you compare the EBITDA growth over the last year to the growth in revenue, the marginal EBITDA expansion is 53% over a year. And during that time, we increased research and development spend by 13%.

So we are investing more in developing new products and generated more than $0.50 of EBITDA for every incremental dollar of revenue. With profitability characteristics like that, investors can have high confidence in our long-term EBITDA targets of 40%. It was also satisfying to see tangible progress on our path to NRR 115%, with our net revenue retention rate increasing to 110% as of March 31, 2024. I want to remind investors that we expect our NRR 115% path to progress directionally upwards in future quarters, but not necessarily in a linear fashion. The first quarter continued to show good signs of progress in upselling. And we believe that the positive momentum in upselling should continue to increase beginning in the second half of this year, as we roll out new products and modules developed by the more than 60% of R&D capacity, we are focusing on these growth initiatives.

In addition, JUMP progressed nicely in Q1, with the key booking wins as Sandeep mentioned. JUMP has proven to be a good proof point as our first ever acquisition. And we continue to explore tuck-in acquisitions and JUMP and Wilshire platforms that can allow us to harness strategic functionalities adjacent to our core strength and bring those functionalities to market more quickly for our clients. As of March 31, 2024, ARR increased to $402.3 million, representing a reaccelerated year-over-year increase of 19.3% from the prior years, $337.4 million. This year-over-year growth is purely organic. Furthermore, ARR grew sequentially by $23.2 million, our highest ever sequential quarterly growth in ARR. Now let’s turn to profitability results. On the heels of blockbuster results in margin expansion throughout 2023, we made further tangible progress on our margin expansion path in the first quarter of 2024.

This displays the power of our profitable unit economics and shows the true leverage of our business and the clear pathway towards our long-term adjusted EBITDA margin goal of 40%. In Q1, we achieved gross profit of $80.2 million and 78% gross margin, an increase of 210 basis points over Q1 of 2023. This results demonstrates that we are progressing quite nicely towards our long-term gross margin goal of 80%. In addition, we reported $32.2 million in adjusted EBITDA and 31.3% adjusted EBITDA margin in the first quarter, which handily beat our EBITDA guidance expectation and improve over the prior year’s EBITDA margin by 470 basis points, in line with prior quarters, the outperformance in our revenue flowed straight through to EBITDA. Having already achieved our EBITDA margin full year guidance target of 31% in the first quarter, we expect to moderate the EBITDA margin expansion in the second quarter of 2024 to prudently reinvest some of that excess profitability back into our growth initiatives in R&D, including the integration of the acquisition of the Wilshire platform, which recently closed on April 22.

Additionally, we will continue to lean heavily into the investments in international go-to-market activities. They are producing results, and we see an addressable market that is right for the same disruption we’ve been able to achieve in North America. As we have indicated in the prior quarter’s earnings call, R&D spend as a percent of revenue will continue to moderate over time, since we have already completed our migration to the public cloud last year. In Q1, R&D dollar expense was up 13%, but as a percentage of revenue, it decreased to 24.9%, which was 190 basis points lower than Q1, 2023. In Q1, equity-based compensation was $28.5 million, a decrease of $4 million from Q1 of 2023. As we noted in our Investor Day presentation in September 2023, the high watermark of equity-based compensation as a percentage of revenue is behind us.

Going forward in future years, including 2024, this percentage should continue to trend down. Lower equity-based compensation expense, as well as lower income tax and tax receivable agreement expense in the first quarter contributed to GAAP net income being positive in the first quarter. Let’s turn to the balance sheet and cash flow. Operating cash flow was $10 million in Q1, a 26.5% increase year-over-year. Free cash flow was $8.6 million for Q1, which again was a year-over- year improvement of 38.3%. Due to the seasonality of free cash flow, the conversion rate of EBITDA to free cash flow is generally lower in Q1 than other quarters. However, as previously mentioned, when looking at this conversion rate on an annual basis, the steady state should be approximately 70%, taking into account quarterly seasonality in free cash flow.

We ended the quarter with $296.5 million in cash, cash equivalents and investments. This total cash amount reflects the payment of $28.8 million in taxes for the net settlement of equity awards, which is a financing cash flow, and was completed to reduce share count dilution from the issuance of equity awards. Total debt was $47.9 million, thereby resulting in net cash holdings of approximately $249 million. We closed the Wilshire Risk and Performance Product acquisition on April 22, and we paid $40 million from our bank. Even with this payment, we have plenty of dry powder should we choose to execute another tuck-in acquisition. Now let’s turn to guidance. For the full year 2024, we have meaningfully raised our revenue guidance to $438 million to $442 million, representing an improved year-over-year growth rate of approximately 19% to 20%.

This represents an increase at the lower end of $7 million and at the higher end of $5 million. This full year guidance has incorporated both the outperformance in revenue in the first quarter and the forecasted uplift of revenue from the Wilshire acquisition. When we announced the acquisition, we indicated the asset run rate was approximately $7 million. So you can assume 2/3 of that amount, or $4.5 million have been incorporated into our 2024 annual guidance. For the second quarter of 2024, we expect revenue to be in the range of $105 million to $106 million, representing a year-over-year growth rate of approximately 17% to 18%. Q2 2023 is a tough comparable, as a very large client went live in April of last year, resulting in 22% growth last year.

For the full year 2024, we have also raised our EBITDA guidance by $2 million to $137 million at the low end to $139 million at the high end, which provides an adjusted EBITDA margin of 31% and an uplift of approximately 260 basis points from 2023. We continue to have confidence in our margin improvement for the remainder of 2024, because of the significant efficiency improvements we are continuing to see throughout the business, including our Gen AI activities. In the second quarter of 2024, we expect adjusted EBITDA to be $31 million, or approximately 29% to 30% adjusted EBITDA margin. For the full year, we remain committed to our 31-plus percent EBITDA margin, and we can remain committed to greater than 200 basis points improvement in EBITDA margin over 2023.

In summary, we’re excited about our very clean first quarter in 2024 and look forward to utilizing this excellent start to build on our revenue growth, continue on our NRR 115% path and deliver on margin expansion for the rest of 2024. With that, I’ll turn it over to Sandeep to provide some closing thoughts.

Sandeep Sahai: Thank you, Jim. As we reflect on our Q1 results, I want to express my deep gratitude to our dedicated team at Clearwater. Their tireless efforts and commitment to innovation has allowed us to delight our customers and partner with them to build new products. Our achievements highlight not only our dedication to client success, but also our ability to grow and evolve. We are more excited than ever about the future and remain focused on a strategic path of customer-driven innovation, operational excellence and market expansion. As we push ahead into the second quarter and beyond, I’m confident in our company’s ability to maintain its momentum. Our strategic acquisitions, JUMP and Wilshire have laid the groundwork for continued growth and expansion into new markets, together with our industry-leading client retention rates and growing portfolio of innovative offerings.

We believe the company is uniquely positioned in the market. Our focus continues to be on creating meaningful value for our shareholders, clients and employees.

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Q&A Session

Operator: [Operator Instructions] Our first question today is from the line of Rishi Jaluria of RBC. Rishi, your line is open. Please go ahead.

Rishi Jaluria: Oh, wonderful. Thanks, Sandeep. Thanks, Jim, for taking my questions. Nice to see the ARR uptick again this quarter. Maybe 2. First, Sandeep, maybe if you could dig a little bit into Wilshire and the acquisition made there. Strategically, can you help us understand kind of what it brings to the table that you felt developing in-house, I guess, was superior to developing something in-house? And what’s the path to integrate the assets you’re buying there, especially given the learnings that you have after a relatively successful acquisition with JUMP. And then I’ve got a quick follow-up.

Sandeep Sahai: Yes. Thank you, Rishi. So about the Wilshire platform acquisition. So the first thing is strategically, we want to address more of the investment management technology versus just investment accounting. So if you go back to the Investor Day, we talked about changing our ability to address 4 bps of what our clients spend instead of 1 bp. One large pocket of that is risk and performance. And if you — when you think about risk and performance, it needs reconcile, accurate, and timely data. And we do that already. Now, we could have built it, but building risk and performance is expensive and cumbersome. But the most important point is, Rishi, that these models have to be out in the market for a period of time. People have to use it quite extensively, and then they mature.

And that could take you years. It could take you decades to get the right amount of respect, if you will, in the market. So given all of that, we had the opportunity to partner with Wilshire and go and buy this. We felt it was frankly a no-brainer. One of the items we were planning to build was risk and performance. So we can now take that, integrate it into the work we already do. So we already do risk and performance for our clients. This just takes it to a completely different level. So it felt super strategic, and we are really cannot be more delighted with being able to close this deal earlier this month, oh, pardon me, last month.

Rishi Jaluria: All right., wonderful. That’s really helpful, Sundeep. And then maybe one for, I guess, both Jim and Sandeep. Just thinking through the guide, especially for Q2, Jim, I understand your comments on having a tougher comp in Q2 of last year, but I mean, factually right, we saw ARR accelerate this quarter to a really healthy level. We saw NRR kick up. And when I look at the guide, you’re talking about an organic 2-year CAGR. That still implies meaningful deceleration from what you saw in Q1. Were there any one-time factors? Or maybe can you help us understand the puts and takes of the Q2 guide? Thank you.

Sandeep Sahai: Okay. So look, I’ll give you my perspective, and Jim, maybe you can add to that. So, firstly, we feel really confident about our annual guide. Now, in Q1, churn was meaningfully lower. You’ve never seen a churn this low, and it’s lower than the 2% historic number. So it’s not like we expect churn to go up, but we just don’t model this kind of churn. Third thing was that one of our larger clients were expected to go live in Q2, and they went live in February instead. So that’s good news, but it pulls some revenue from Q2 into Q1. Now, having said all of that, obviously, the NRR is a contributing factor, and that is driven mostly, Rishi, by new products. So I went through a whole litany of examples, but the point is, we just feel that new products are a little bit difficult to predict exactly when it’ll happen and how it’ll happen.

In the aggregate, we feel, yes, this revenue annual guide is really good, but quarter-by-quarter, we’re still a little bit — we feel concerned about projecting too high. Now, Q1 was great. We had said, I think, 100.5%, if I remember correctly, and we came in with a really good number. And so we do feel, we should be conservative on a quarterly level, while feeling really confident at an annual level. How about you, Jim, would you add?

Jim Cox: That’s great.

Rishi Jaluria: All right, wonderful, thank you.

Sandeep Sahai: Thanks Rishi.

Operator: Our next question today is from the line of Dylan Becker of William Blair. Dylan, your line is open. Please go ahead.

Faith Brunner: Hi, guys. It’s Faith on for Dylan. If I could start with maybe a more high-level question, but as we move back to base sales and engineering talent and the prioritization of the platform innovation, how should we think about the ramp cadence of these different initiatives? And how to benchmark the success and progress of them throughout both this year and beyond?

Sandeep Sahai: Yes. So Jim, why don’t you take that question? But I do want to just say something quickly, which is I don’t think there’s any let up in chasing new logos. We don’t see any difference in the market. We continue to see a demand for new logos to be quite high and robust. And the question is, should we also be building new products, which we can take to current clients and also use them to open new logos. Jim can provide a little bit more detail about the products we’re investing in and just the size of those and what it could be.

Jim Cox: Yes. Thanks Faith. So just at the high level, think about one of the key elements of driving to NRR 115% is really adding these incremental products back into our client base. And we have four products of the many that we’re developing that are in market now. And we feel like we’re getting good traction with them. You won’t be surprised by these, because you’ve heard these names before. LPx, Sandeep talked about the good traction we’re getting there. PRISM, Sandeep talked about the big win we had in PRISM in Europe. Risk, that’s very aligned to the Wilshire acquisition, but also we’re already delivering on that. And JUMP, which was an acquisition from 2022. Those are in the market and we see those doing very well. And as we see those continue to grow, we will continue to see ultimately NRR 115%, that metric tracking there.

But those aren’t the only R&D initiatives that we’re driving to. There’s a couple that are more focused on new logos, where we actually have a great solution. One of the best things about the Clearwater platform is that it is so flexible and has proven to be market-leading, not only in corporates and in insurance companies and in asset managers and now in governments. And we move forward from there. There’s two areas where as we add incremental functionality to the platform, it opens up those new TAM areas. And two of those examples that Sandeep spoke to. One is the pooled funds, right? The second is stable value funds. And those are in one instance, in a pooled fund very area, that facilitates state and local governments interacting better together and it opens up that government market.