Clearwater Analytics Holdings, Inc. (NYSE:CWAN) Q3 2023 Earnings Call Transcript

Clearwater Analytics Holdings, Inc. (NYSE:CWAN) Q3 2023 Earnings Call Transcript November 2, 2023

Operator: Thank you for joining, ladies and gentlemen, and thank you all for standing by. And welcome to the Clearwater Analytics Third Quarter 2023 Financial Results Conference Call. My name is Brita, and I will be your event specialist running today’s call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Thank you. And I would now like to welcome Joon Park, Head of Investor Relations. To begin today’s conference call.

Joon Park: Thank you. And welcome everyone to Clearwater Analytics’ third quarter 2023 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 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 the SEC. Actual results may differ materially from any forward-looking statements. The 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 statements included in our earnings press release. Lastly, all metrics discussed on this call are presented on a non-GAAP or adjusted basis and include the results of JUMP Technology. Since the acquisition on November 30, 2022, unless otherwise noted. A reconciliation to GAAP results can be found in the earnings press release that we have posted to our Investor Relations website.

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

Sandeep Sahai: Thanks, Joon, and thank you all for joining us. The very strong numbers in Q3 were the result of disciplined execution from our operations and onboarding team, strong and sustained product innovation from our engineering and product teams, and finally, our ability to focus on client success, with a genuine desire to partner for the long-term. Normally, I will provide a business summary in this opening section of the call. But given the financial outperformance in Q3, I have asked our Chief Officer Jim Cox to discuss the financials first.

Jim Cox: Thanks, Sandeep, and thank you all for joining us. Sandeep is right, we had another strong quarter. On the heels of Q2 solid results at our impactful first Investor Day in September. I am happy to report strong results for Q3, where we beat guidance on top and bottomline once again. Revenue continued to reaccelerate, but the real highlight is our greater than 30% EBITDA margin for Q3. At our Investor Day, we announced our intent to expand EBITDA margins by 200 basis points in 2024 to approximately 29%. After our strong Q3 results, our current 2023 guidance implies full year EBITDA margins increasing to approximately 28%. Today, we intend to expand EBITDA margin by 200 basis points in 2024. So we expect our 2024 EBITDA margin will be approximately 30%.

In effect, we believe these higher profitability levels will persist in the business going forward. Turning to revenue in the quarter. In Q3 2023 we delivered $94.7 million in revenue, which translates to 23.7% year-over-year revenue growth, driven by marquee client wins displacing our legacy competitors, continued expansion at our existing clients and continued to increase inefficiency of onboarding new clients by our operations team. In addition, clients continue to remain with us with a strong and consistent 98% gross retention. We have achieved 98% gross retention for 18 out of the last 19 prior quarters. Our net revenue retention rate continued to remain healthy at 108% as of September 30, 2023, which is higher than the prior year’s one or three.

We continue to aspire to expand NRR to 115% or beyond, through upsell of new products and modules, that we are now offering our clients like, Clearwater LPx, MLx, Prism and our JUMP solution, and we expect our improve CTM and a difficult product to help us meet our goals. As we saw during our recent Clearwater Connect our clients are excited about our new offerings that we continue to develop to meet their dynamic needs in an ever-changing investment world. Now let’s turn to profitability result. We are pleased to report that both our EBITDA margin and gross margin showed strong improvement in Q3, we reported $28.6 million in adjusted EBITDA and 30.2% EBITDA margin in the third quarter, which was 550 basis points higher than the third quarter of last year.

Just like last quarter the outperformance in our revenue put straight through to EBITDA and we are starting to see real efficiency gains with the operations team, using our Gen AI technology. Yet another highlight of the quarter was our free cash flow at $30.9 million. Free cash flow exceeded EBITDA in the quarter as there were limited changes in working capital and increased interest income contributed to our cash flows. Put this altogether and we ended the quarter with $302.8 million in cash, cash equivalents and investments, our highest ever balance. This level of cash on the balance sheet and the free cash flow generation of this business provides us with significant strategic optionality in a number of areas. Overall, the third quarter was exceptionally strong, continuing our positive momentum.

We could not deliver these results, without the great work about over 1,700 employees, who are tirelessly focused on delivering for our clients. And certainly, we could not achieve these results without partnering with our terrific clients. With that, I will turn it over to Sandeep to share the exceptional client detail that generated the stellar results.

Sandeep Sahai: Thank you, Jim. I wanted to cover the three topics I laid out at the beginning of remarks, namely, disciplined execution, client success and product innovation. Disciplined execution and a focus on client success are very important to our business. At the highest level, we are excited to be executing ahead of the models we presented on Investor Day and these results were delivered before the R&D cost starts to normalize. The entire Clearwater team continues to be relentless and the urgency and precision with which are executed. The commercial model adjustment of last year, the highest ever NPS in the company’s history this past quarter and the sharp improvement in the time taken to onboard clients are examples of our ability to execute.

It’s easy for us to see that 90% of the onboarding now happens within five months. But that is a truly extraordinary achievement. The reality is that systems like these can take several years to implement and the fact that we get customers on our platform invites within five months in a direct consequence of our single instance multi-tenant platform, our single security master and the relentless focus of our onboarding team. Which leads to the product innovation. The needs of the industry we serve continue to change and we continue to change in the future. But it’s our ability to adjust, execute and innovate, that allows us to deliver these results. The needs of the asset management industry continue to evolve and then now place relentless cost and growth pressures.

Recognizing this change, we started to invest in Prism and our current solution makes us a partner for growth instead of a partner we could just replace that accounting platform. In many deals in recent quarters, we are now helping our asset management clients deliver a better solution to their clients thereby helping them increase AUM flows. We have become a part for growth. Likewise, the asset order industry also evolved the investing strategy and increase the allocation to alternative assets. And while you already process alternative assets very well, two years back we started to invest the goal of becoming best-in-class when it comes to reporting on constituent elements within MLP, expanding data linkage, compliance and reporting requirements.

We now have Clearwater LPx, LPx Clarity and MLx. These products play a significant role in our ability to continue to win and differentiate our solutions. We are very proud of our ability to win 80% of the time we write a proposal. But we maintain that win rate by continuously listening to our clients and prospects. We believe that we have a truly disruptive platform, but we will continue to innovate to sure that we broaden our competitive moat. How do we do this? We evaluate product ideas and categorize them into one of three areas. First, back to base, products that can help our current clients get better value or help us to solve additional pain point. Second adjacencies, products that can help us provide full investment lifecycle solution for investment management instead of just investment accounting.

Third, disruptors, leveraging the power of the single instance platform, these are products that help us leverage the power of the single security master and have the potential to disrupt the industry. We then waive the investments against bookings potential both over the next 12 months and in the long-term. We take a portfolio approach that include single and double while also reserving some investments potential home growth. One key tenet of our innovation process. That is common to all ideas he’s partnering with actual clients at least step of the way. We solicited client input directly through our Customer Advisory Board and through our Annual User Concepts, Clearwater Connect. Speaking of Connect, in September, we hosted over 500 clients and prospects from across the globe to discuss our innovation roadmap, take their feedback and conduct joint design sessions.

We held over 160 client meetings. We actively sought inputs to our roadmap and received feedback from them on our upcoming initiatives. Most importantly, we collaborated with design partners to ensure that our products are immediately beneficial to them. Let me try and bring these trends to life with actual seven-figure client wins this quarter. I will start with the leading insurance company that we won in Q3. This was a significant win, because they had outsourced their entire investment accounting function to a competitor. But when they saw an on-site demo of the Clearwater platform, they realized that it was possible to get a comprehensive daily view of the global portfolio, including public and private assets, which in turn would enable their decision-makers to make better and more informed decisions.

That demo led to an accelerated review of the accounting book of record solution and this insurer selected Clearwater in record time. Another large win was with a leading life insurance and annuity company that administered nearly $100 billion in assets under management. They selected a competitor over two years back and they have yet to go live. Meanwhile, they bought another pool of assets. But given the challenges the parent company was facing, this subsidiary chose Clearwater. Clearwater was able to swiftly implement the subsidiary assets as they went live on our platform in relatively fourth order. Looking at that experience, we are joyous to report that the parent company came to the conclusion that the prize system they selected was unable to scale and operate under pressure and opted to consolidate all their assets onto Clearwater’s platform.

Today, Clearwater is their sole investment accounting solution and we once again proved the power of our platform in Q3. We also signed an asset manager who had previously decided to migrate to the cloud version of a competitor’s offering. As we attempted to move from an on-prem to the cloud version with this vendor, the complaint covered the gamut, from inaccurate data and segregated PSO asset classes to reporting limitations and the overall inexperience of the provider. They found themselves consistently late on monthly close, unable to provide users with a view into the daily holdings across all assets or while their fees crept up, Clearwater took a different approach. We started by collaborating. We conducted a number of in-person sessions outlining every asset class, illustrated the efficiencies Clearwater would be able to deliver and met users across the spectrum, leading to complete functional alignment and trust.

Finally, they talked to a number of our clients and then even though they had several years remaining on their contract with the previous vendor, they signed with us this past quarter. Another client is a North American full-service life insurance company. They recently went through an acquisition, essentially doubling their AUM. At a recent meeting with the Chief Investment Officer, we learnt of their plans to diversify into adjacent geographies and markets and the challenges that would pose from an infrastructure point of view. We demonstrated the Clearwater platform and its ability to report comprehensively and seamlessly on assets around the world. Not only that, but we could also generate financial reports in local GAAPs and address local regulatory needs.

That convinced them to sign a seven-figure deal. Of course, we also signed a number of six-figure deals with medium-sized businesses. Let me start with an asset management firm with a variety of institutional customers. Before signing with Clearwater, this business had grown tired of continuous Band-Aid solutions. They turned to Clearwater for a comprehensive portfolio of front, middle and back office reporting, relying on the depth and breadth of Clearwater, Clearwater JUMP, LPx, and Prism. Using Clearwater JUMP, this client is implementing a new OMS and PMS, while Clearwater LPx Clarity provides the front office with the transparency needed to understand risk and exposure to limited partnership investments when making portfolio decisions.

Finally, they use Clearwater Prism, which allows users to build and edit reports and client statements and define custom approval workflows to meet their clients audit, attribution and ESG reporting needs. The next client is a prominent insurance company in Asia. Their aggressive growth rate puts significant strain on their operational team, systems and processes, particularly their investment operations team. They were introduced to Clearwater by one of our existing clients in the region, once again demonstrating that our happy customers are our best sales channel. This reference led to an accelerated review using a series of workshops. This hands on experience with our solution led to mutual success and reinforces the belief that Clearwater is the disruptive, best-in-class solution.

You have heard us talk about how we support REITs and during the third quarter we added a significant REIT to our client base. This client chose Clearwater to replace their previous solution. We also signed a publicly held wellness brand to resolve the inconsistencies with investment data and more. And finally, we signed several new clients leveraging our partnership with Morgan Money, a strategic partnership we announced with JPMorgan in May of this year. The joint solution makes it easier for financial professionals to have a global connected view of their investment portfolios and empowers them to make real-time investment decisions by working on the Clearwater and Morgan Money platforms in tandem. And while all of these client wins are very exciting, we are equally excited about the recent progress we have made on two fronts.

Number one, gen AI, the response to the demonstrations and vision we provided our clients and prospects at Clearwater Connect were very encouraging. The pilots we have done with our internal operations team continues to build confidence about the impact of this technology on the efficiency of operational steam and therefore to gross margin and to the productivity of our engineering team and therefore to the cost of innovation. Second, building products that leverage the power of a single security master through single instance multi-tenant platform. Again, the visionary demo that we showed a small group of clients under NDA was very encouraging and has led us to doubling down on that area of investment. As a summary continue to delight our customers.

We have an exciting roadmap with client design partners guiding our approach and we are capitalizing on the latest technologies to improve our internal operations and deliver unparalleled scale and growth opportunities for our clients. All of this is evident in our strong Q3 results. With that, I’d like to turn it back to Jim to cover our guidance.

Jim Cox: Thanks Sandeep. Now let’s turn to guidance. Focusing on guidance for the fourth quarter of 2023, we expect revenue to be $98.5 million and we expect adjusted EBITDA to be $28 million or approximately 28% EBITDA margin. For the full year 2023 we have increased our revenue guidance to $367.6 million, which is an increase of $2.6 million from the midpoint of our prior guidance range and represents approximately 21% year-over-year growth. We have also increased our full year EBITDA guidance by $4 million from the prior quarter to $104 million for the full year 2023. That guidance represents EBITDA margins of 28% for the full year, an expansion of over 150 basis points over the full year 2022. With that, I will turn it over to Sandeep to provide some closing thoughts.

Sandeep Sahai: Thanks Jim. We have long said that we want to build a truly exceptional company. I am so happy to report that we are executing ahead of the plan we laid out at our Investor Day. We united in purpose with our clients to become better together and are incredibly excited about what lies ahead. With that, I will turn it over to the Operator for a live question-and-answer session.

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Q&A Session

Operator: Thank you. [Operator Instructions] The first question we have comes from Rishi Jaluria of RBC. You may proceed, Rishi.

Rishi Jaluria: Oh! Wonderful. Thanks guys so much for taking my questions. I wanted to start by asking a little bit about gen AI. Sandeep, when I was at Clearwater Connect, I definitely got a chance to see Clearwater GPT demoed, seems really impressive. Maybe can you talk about early feedback coming out of the conference and how we should be thinking about the roadmap of future use cases over, let’s call it, the next year based on that customer feedback and maybe monetization alongside that. Then I have got a quick follow-up for Jim.

Sandeep Sahai: Hey, Rishi. Thank you for the question here. Look, also thank you for coming over to Clearwater Connect. It was really good that you can talk to clients directly instead of always just listening to us. So look, about Chat GPT and gen AI in general here. So, firstly, we believe it is transformative and disruptive. I do think it can have significant and mostly positive impact on our business. As you know, we launched Clearwater GPT and then at Connect we showed a number of demos. And if you get to the next level, what we have done is, we have launched and funded five programs. Two of these programs are revenue generated. They are more about how do we increase revenue. One of them is insights, which we demonstrated, and the other one was how can customers talk to the data and really interact with the data themselves without sort of coming to us to understand what’s going on.

We think both of these are potentially revenue generating. Two of those programs are efficiency related. So the first one is about improving reconciliation and data. And the second one is how do you improve onboarding and client servicing. And frankly, the fifth one is know we talk about an NDA, because it’s something we aren’t ready to discuss quite yet. And the point, Rishi, is that this is nothing which is going to take us six months and a year. We are going to — we have already started to see some impact of that, frankly, on our financials and on our operating capability. So I would say that, do we expect it to continue to improve meaningfully in 2024? Yes, we do. We think it will have an impact. How much impact? I think that’s something we will have a better position to tell you when we provide guidance for next year.

Jim, would you add anything or..

Rishi Jaluria: All right. Thanks, Sandeep. Sorry. Go ahead.

Sandeep Sahai: Go ahead, Rishi, please.

Jim Cox: Yeah.

Rishi Jaluria: Okay. No. Thanks. Thanks. Maybe the quick follow-up for that — on that for Jim related and you are giving this preliminary outlook on EBITDA margins for next year. Really happy to see that and nice to see you continuing to expand margins as you are investing. Alongside that though, I’d have to imagine there is some impact on your P&L from the investments you are making in generative AI, the cost, as well as I am sure there’s going to be more focus on driving adoption in the near-term before really focusing on monetization in a big way. Maybe can you walk us through what are you thinking about the impact of generative AI on margins for next year and how much, I guess, room are you leaving yourself to invest and what is really a big market opportunity and not wanting to over deliver on margins? Thanks.

Jim Cox: Rishi, that’s a great question and the way you articulated it is exactly how Sandeep and all of us are thinking about it. So we have already started to see the benefits to a small degree of the gen AI tools that our teams are using it internally. And I think you can just see the expression of it partially in the gross margin expansion that you saw in Q3. That is not the entire reason for the gross margin expansion in Q3. It is only a very small subset of the client servicing team that is using those tools. But the results we are seeing from those are meaningful. And so I think that just gives us more confidence that 80% gross margin target that we think about in the longer term is extremely attainable. However, we want to balance that gross margin kind of targeting with kind of that incredible client service and focus on clients that we have.

And so, we don’t want to lean too quickly into that. We want to make sure that we are delivering for them. And so what I would say is, as we think about the 200-basis-point expansion next year, which we talked about at Investor Day and we are reiterating here, even at our higher EBITDA numbers for 2023, there is very limited impact of gen AI within those margin numbers. And I think that what we want to do is exactly what you said. We want to maintain the optionality. We see a very clear path to delivering 200 basis points of margin expansion next year, while allowing us flexibility to attack the opportunities that we see ahead of us.

Sandeep Sahai: Yeah. If I can just add to that…

Rishi Jaluria: Yeah.

Sandeep Sahai: …just be very, very clear. Yeah. Just to be very, very clear. We are not optimizing for profitability. I think when we presented at Investor Day, the gross margin should grow simply because of Europe and Asia normalizing. And also, if you remember, R&D should come down not because we want it to come down, but because that one-time conversion to the cloud and the investment for Europe have been completed. So really we don’t think that we are optimizing for profitability. It’s just a consequence of the business we have. And if I can just, since you asked this great question for that, just to be a little bit more declarative, I do think we are investing in gen AI. We have a significant dedicated team which does just that, but we are already getting returns on it.

Are we going to invest more? Yes. Are we going to be able to get results quicker? Yes. And that is the power of gen AI. It can deliver results in months and not in two years and three years. So, yes, we will invest more in gen AI and we are investing more in gen AI, but the efficiency we are getting is frankly there to see. So, yeah, that’s how we think about it.

Rishi Jaluria: Wonderful. Thank you so much, guys. I appreciate it.

Operator: We now have Ella Smith of JPMorgan. Your line is open.

Ella Smith: Hi. This is Alex Smith on for Alexe Gogolev from JPMorgan. Thank you for taking my question. So, for my first question, I noticed that NRR dipped ever so slightly sequentially from 109% to 108%. Was hoping you could speak to what happened there?