Clearwater Analytics Holdings, Inc. Q1 FY2022 Earnings Call

Good afternoon. Thank you for attending today's Clearwater Analytics First Quarter Earnings Conference Call. My name is Tania and I will be your moderator for today's call. I would now like to pass the conference over to our host, JR Ritchie, vice president of finance and investor relations. Please go ahead.

Thank you, and welcome, everyone, to Clearwater Analytics first quarter 2022 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 up to a question-and-answer session. I'd 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. Expression of future goals, including business outlook, expectations for future financial 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 non-GAAP, unless otherwise noted. A reconciliation 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.

Thank you, Dan, and welcome, everyone. We had another strong quarter as we continue to deliver value to our clients, onboard new clients, and generate strong bookings to fuel further growth. More specifically, we have had consistent and durable revenue growth, high rates of revenue retention, and strong profitability. We're very happy to announce that revenue in the quarter grew 24% year over year to $70.8 million, a quarterly record. Our annualized recurring revenue, ARR, increased 23.5% year over year, reaching more than $287 million. We're also happy to announce that our Q1 adjusted EBITDA grew to $18.9 million, an increase over last year, even after incorporating additional public company costs while continuing to make investments in strategic initiatives. And testimony to our focus on client success, we are happy to report a gross revenue retention of 98% for the 13th consecutive quarter. Our success in Q1 continues to prove that the Clearwater platform not only dramatically improves the efficiency of investment operations teams but also has become an enabler of growth for organizations around the globe. Our clients in their search for expansion use our platform to scale globally, invest aggressively in widely varying asset types, and confidently acquire new businesses while integrating the operations rapidly. The Clearwater platform provides investment operations teams the infrastructure to expand on-demand, eliminating the need for large upfront investments, which is even more important during uncertain economic times. In Q1, we collaborated with a firm called Hobson & Company to study the value that Clearwater brings to clients. Hobson found that, in addition to a significant decrease in operating costs compared to legacy technology, Clearwater offers much greater efficiency and enables recognizable increases in assets under management (AUM). Our platform continues to be disruptive and is very effective at radically simplifying our clients' investment operations. We operate in a very favorable competitive environment, especially as more clients, like Catholic Life Insurance and HighMark, move from legacy incumbent providers to Clearwater. We are especially proud of these wins because, as you've heard me say many times before, with each new client, we improve our ability to manage and service the next, continually adding to the network effect. There were several exciting wins in Q1. A very large asset manager signed a significant deal with us to replace their legacy on-premise solution for accounting and client reporting for approximately $100 billion in assets. We also won T. Rowe Price as a marketing client. Rowe will provide a dramatically improved user experience for T. Rowe Price's growing roster of insurance clients who will now more easily manage their books of record while staying ahead of regulatory requirements. Nuveen Asset Management signed an agreement to use Clearwater as a reporting solution. As Nuveen grows its businesses globally, Clearwater's industry expertise and reporting capabilities will be a critical component supporting the business growth and expansion. Looking beyond our core markets, we signed our first French insurance client and our first European foundation. Both chose our SaaS platform to standardize the investment accounting operations across several countries. These clients prove that the platform successfully addresses the needs of adjacent markets. Our clients continue to adjust their portfolios as they look at the changing economic environment. And given market conditions, we increasingly see our clients add alternative assets to the investment portfolio. But as you likely know, alternatives introduce complexity into accounting, compliance, and risk management. And increasingly, we see clients turning to our platform to handle that complexity. The Clearwater platform, because it is a single-instance, multi-tenant, cloud-based solution, allows us to meet the needs of clients and support their dynamic investment goals. We are not the only ones uncovering the need for improved automation for investment operations teams. In Deloitte's 2022 insurance industry outlook report, they found that 69% of firms plan to spend more on investment data processing, and 67% plan to spend more on analytics. This data further supports our premise that as insurance companies grow, expand, and merge, they need trusted partners to support their operations. This is why organizations like Harvard Mutual Insurance, Cornerstone National Insurance, and Citizens Property Insurance Company are bolstered by going live on the Clearwater platform in Q1. A key area of focus for us is new product offerings. We continue to gain traction for our new product, Clearwater Prism, a modular data and reporting platform. Let me describe some actual use cases. Clearwater Prism's open architecture allows for seamless aggregation of data across all assets. A large multinational insurer is utilizing Clearwater Prism and Clearwater's accounting solution to consolidate data across public and private assets and real estate. Prism enables this client to get a comprehensive view of the portfolio, even though we will not be accounting for the real estate assets. Clearwater Prism will enable investment data aggregation application without the need to build or maintain costly infrastructure for consolidated reporting and analytics. A pension plan has chosen Clearwater Prism as the foundation of a data and reporting platform to combine total plan data from multiple sources. Prism provides a solution, even though investment accounting for a majority of their assets will initially not be performed by Clearwater. Finally, a leading wealth manager has selected Clearwater Prism to provide data and reporting across multiple portfolio management solutions where Clearwater Prism serves solely as the aggregation and client reporting platform while doing none of the investment accounting. Overall, we are very excited about the progress we are making. We expect Clearwater Prism to extend Clearwater's cloud-based platform to new customer segments and help us grow wallet share with existing customers. We are proud to share that our chief client officer, Subi Sethi, won the Women in Technology & Data Awards by WatersTechnology. She was recognized as the vendor professional of the year because she has onboarded large global clients to the Clearwater platform and improved the operations of some of the world's largest investment teams. We know this is a well-deserved recognition of the impact she has had on our clients' success. Before returning with a few closing thoughts, I would now like to hand the call over to our chief financial officer, Jim Cox, to provide more details on our first quarter financial performance, as well as updated guidance for our second quarter and full year 2022.

Thanks, Sandeep, and thank all of you for joining us today. We are very pleased with our continued strong financial performance in the first quarter. Once again, our quarterly results exceeded our guidance for revenue and adjusted EBITDA, indicating the demand for our disruptive solution remains strong from both new and existing clients. Moving now to our first quarter financial results. Please note that our results will be discussed on a non-GAAP or adjusted basis unless otherwise noted. Revenue in the first quarter was $70.8 million, up 24% year over year and largely in line with our expectations. The continued strong top-line growth was driven by a solid increase in total clients and continued strength in client onboarding. As of March 31, 2022, annualized recurring revenue, or ARR, reached $287.1 million, a $54.7 million increase over March 31, 2021. This represents an increase year over year, again due primarily to continued strong client demand and revenue retention. Speaking of revenue retention, gross revenue retention was a consistent 98%, marking yet again the 13th consecutive quarter that we have reported a gross revenue retention rate of 98%. Net revenue retention was a healthy 107% despite significant market volatility in the quarter, and existing clients continue to add new assets to the Clearwater platform. While healthy, especially for our asset management clients, this quarter's net revenue retention rate was lower than Q4 for two reasons. First, growth from acquisitions within our global insurance client was broadly lower in the first quarter with one specific large client's early 2021 acquisition now being fully annualized into the retention rate. In addition, we've seen an unfavorable impact on our clients' fixed income security prices due to the recent change in expectations for future interest rates. We have incorporated the impact of those changes into our forward-looking revenue guidance. Gross profit in the quarter was $52.5 million, and gross margin came in at 74.2%. Gross margin continues to be strong, even as we continue to invest ahead of new client demand in Continental Europe and Asia, as well as new client verticals, including pensions and foundations. In fact, we're really pleased with the progress we're making internationally, and we're further encouraged by seeing our international revenue growth to 13% of revenues this quarter, compared to 9% in the first quarter of last year. With this success in this key growth driver, we expect to continue to invest to further establish our presence in these adjacent markets. As a result, we expect gross margin to remain at similar levels in the second quarter. Research and development expenses in the quarter were $16.8 million or 23.7% of revenue and slightly below our expectations as the labor market for top engineering talent remains tight. As we noted last quarter, we remain committed to investing in R&D and are advancing our efforts to accelerate hiring and third-party resourcing in this area. Sales and marketing expense in the quarter was $8.6 million or 12.2% of revenue, up 110 basis points year over year. We expect increased investment in this area over the coming quarters as we roll out all of our planned marketing programs, including hosting our upcoming in-person user conference in September. Therefore, we anticipate an increase in sales and marketing expense as a percentage of revenue starting in the second quarter. General and administrative expenses in the quarter were $8.3 million or 11.7% of revenue, up 280 basis points year over year as we continue to annualize the impact of incremental public company costs resulting from our IPO last fall. Looking ahead, we expect that general and administrative expenses will remain at a similar level in the second quarter before falling slightly as a percentage of revenue in the second half of the year. Adjusted EBITDA in the quarter came in above our expectations at $18.9 million or 26.7% of revenue, due largely to the favorable revenue performance in the quarter. I'll touch on our overall adjusted EBITDA expectations for the second quarter later in my remarks. But first, let's turn to the balance sheet and cash flow. We ended the quarter with $263.7 million in cash and cash equivalents and $52.4 million in total debt. Free cash flow in the first quarter was $4.7 million and included $2.2 million of capital expenditures, which were primarily made up of capitalized software development costs. Focusing now on guidance for the second quarter of 2022. We expect revenue to be in the range of $73 million to $73.5 million this quarter, representing 20% year-over-year growth. We expect the second quarter adjusted EBITDA to be in the range of $19 million to $20 million with adjusted EBITDA margin expected to be roughly flat to the first quarter of 2022 as we continue to make targeted investments specifically in addressing new markets while also increasing the pace of client onboarding and absorbing incremental public company costs. Now let's talk about full-year guidance for 2022. Based on our performance in Q1, we are raising our full-year revenue guidance, which is now expected to be in the range of $303 million to $305 million, representing 21% year-over-year growth at the midpoint. We continue to expect our adjusted EBITDA to be in the range of $80 million to $82 million. The guidance we provided previously for all other measures remains unchanged. So let me summarize. We're very pleased with the performance of the business in the first quarter. We once again exceeded our expectations for revenue and adjusted EBITDA as the demand for our disruptive solution remains strong both with new clients and with existing clients. We continue to see ample opportunity to expand the application of our platform across different regions and market verticals and are therefore choosing to continue to invest even in the face of a less certain macroeconomic environment. As always, we remain committed to driving consistent, durable, and profitable growth. With that, I'll turn it over to Sandeep to provide some closing thoughts.

Thank you, Jim. As you just heard from Jim, Q1 continued to provide further validation of the disruptive nature of our platform. We continue to win new clients across the globe, win new clients in adjacent markets, and finally, win new clients to solve diverse business problems. Besides winning new clients, we continue to make our clients successful. Last week, I had the pleasure of meeting more than 70 clients and prospects in London. Let me tell you, the energy was palpable. We look forward to riding that wave of energy as we execute on the goals for this year and beyond. With that, let me turn it over to the operator for questions.

Good afternoon. Thanks for taking my question. Jim, I'm hoping that you can bridge us with your expectations from a few months ago. Is it fair to say that the rates impact on net revenue retention was a little bit worse than what you were expecting? And if so, what is the offset that is trending better that's driving the full year guidance up by an additional $1 million?

Thanks, Gabriela. That's a great question. When considering a rising interest rate environment, did you want me to discuss our guidance or focus on the interest rate? My apologies for any confusion.

Yeah. The first piece is was the interest rate environment worse than what you expected? And if so, what's the offset? Is there something else in your business that's trending better than you expected two months ago that's allowing you to essentially raise the full year guidance by $1 million despite the worse interest rate environment?

Yeah, perfect. So thank you for clarifying that for me. I appreciate it, sorry, as we jumped on. So I think you're right. I think that you would say that the expectations around interest rates in the month of March and April have gone down relative to where they were in the beginning of the year when we spoke to you at the beginning of March. And so you're right. Generally, we talk about AUM as a gentle tailwind to us. And now as we're looking at, with those changes, we're not seeing that gentle tailwind. We're seeing a gentle headwind to that. But just for perspective, when we've seen the most kind of volatility in the markets, we've seen this ranged around 2% plus or minus. So I just want to manage everybody's expectations around that. Underlying that, to your point, we had great bookings in Q1, and we feel a really strong pipeline and good demand environment in Q2, which helps us offset that. So I would say that those are part of the pieces to think about with respect to that. Other things, just to remind everyone, contractually we have minimums in our contracts. We have tiers in our contracts. Our clients are also moving their assets between these asset classes, and that helps to ameliorate all of those pricing changes that we see.

Gabriela, this is Sandeep. If I can just add – if you look at our guidance at the beginning of the year, which really was 60 days ago when we came up with the guidance. When you see us increase it by $1 million, that's really just an acknowledgment of the fact that we overperformed in Q1. So we're just increasing the guidance by $1 million. We think it's a little bit early to do anything to the EBITDA. We still expect to come in where we laid out, which was between $80 million and $82 million. And so that's really more than that.

Understood, understood. And then the follow-up to that is how should we be thinking about net revenue retention going forward? The rate environment would do whatever the rate environment does. And so, Jim, you're pointing out having the minimum. What are the pieces that are within their control that can allow you to drive net revenue retention higher from here? And what's your expectation for the rest of the year?

This is Sandeep. If you think about NRR, the interest rate expectation for the rest of the year is priced in. We look at the value of the assets we have on our platform that is already priced in. Unless something changes materially in what the Fed does, and it looks like it's able to do a little bit better than we thought, you would not see further changes on that. We already see on our platform enough of our clients rebalance the asset mix. If you understand who our clients are, insurance companies, CFOs of corporations, and asset managers, they will always rebalance to try and take out volatility. So that should have a positive influence on how we think about it, but I do believe the current situation is priced in.

Thank you for the color.

Thanks, Gabriela. The next question is from the line of James Faucette with Morgan Stanley. Your line is open.

Great. Thank you very much. Really good, obviously to see kind of close to mid-20s or around mid-20s revenue growth. How should we think about what kind of scenario you would need for that level to be sustainable over the long term, especially since you're looking for something more in the low 20% ranges, is it things like that upward from Prism and expected Horizon two initiatives, etc.?

Hi. Thank you for the question, James. If you look at our performance over the last several years, we've consistently delivered in the 20s. If you look at Q1, we frankly had a really great booking quarter. Booking was great. The pipeline continues to show no impact of potential inflation or potential problems with Ukraine. We don't see that at all right now in the pipeline. Now having said that, we're being very watchful about Q2 through Q4 to see what happens. We also worry a lot about NRR. The gross revenue retention is still at 98%. But in our business, we believe we can deliver 20% plus on a sustained basis. The fundamental change is about whether the platform is disruptive. Absolutely. We win more new clients than most of the industry expects. Do we win against competition? Absolutely. We don't see any change in either the economic environment or the competitive environment. We still think we can continue to deliver what we laid out last year and at the beginning of this year, which is 20% revenue growth, good solid EBITDA. Profitable growth is key. We don't yet see any change, and we increased our outlook by $1 million because we overperformed by that much.

I think, James, it's a bit of the same story. How do we keep going? How do we keep accelerating? What do you have to believe? We continue to win in the key North American markets of insurance and asset management. We've had great momentum internationally over the last few quarters. So we continue to feel good about that, but we need to see that accelerate. We have all our adjacent markets where we are seeing good early progress, but they aren't yet meaningful growth drivers.

I'm sorry to finish there. Really excited about Prism. I said in our comments, Prism seems to be opening markets we would not have otherwise had access to. And we continue to get wins on Prism. We're excited about the international growth, which is moving a little faster than we anticipated. We have already said Prism is moving a bit faster than we thought.

Got it. And Jim, I think you laid out really well kind of what was moving the net revenue retention rate. What's reasonable for us to think about in terms of how quickly we can get back to more of that 111% to 112% range between the price increases and upsell, etc.? What are the things that we should be tracking perhaps in the macro that could move that number as well? Is it just changing interest rates and the impact on assets, or just wanted to make sure we understand how to take that into account.

I think it's important to highlight the factors I didn't mention earlier, particularly our strategic asset management clients, which have historically been a significant source of net retention growth in that segment. This momentum is still ongoing. However, we noticed some differences in the insurance marketplace, where we have a bit less control since we typically receive the entire book of an insurance company. When a reinsurer acquires another book of business, we support that process. This is how Clearwater provides value, allowing them to think strategically about these acquisitions without being burdened by operational concerns. This aspect is somewhat beyond our control. To elevate our net revenue retention to a world-class level, comparable to our gross retention, we need to implement a multi-product strategy. We are just starting this process, but there is much more we can offer our clients, and we need to expand our offerings across various product verticals. Our clients require more from us, and we must deliver on those needs.

This is Sandeep here. I do think this is a program within the company. It's not something we're trying to do in half a quarter or one quarter. Our gross revenue retention is world-class. Our net revenue is not, and that happens through price increases, multi-product pricing, differentiated asset class pricing. We need to approach this sustainably, so looking out a year or two, if we can get it meaningfully higher than where we are, growth just becomes much easier. We can then chase larger numbers, but we have to develop this over multiple quarters.

All right. Wonderful. Thanks, Sandeep. Thanks, Jim. Appreciate you taking my questions and appreciate all the detail. I wanted to start by asking another question on net revenue retention, but just thinking specifically. As you are seeing more customers, new opportunities land on Prism and that opens up doors that you couldn't open before. It's really encouraging to see. As that becomes a bigger part of your land and you start to get success using the core platform as an expand once you have your foot in the door, what sort of impact should we expect that to have on net revenue retention, especially as it becomes a more significant part of the business and new logo lands? And I've got a follow-up.

Yeah. Thanks, Rishi. That's exactly the point. We used to go into a client base and just sell everything for one price. That was our approach, right? Here, what we're trying to do is get a foothold and then expand. Prism helps us achieve that. So our expectation is that going in with Prism should improve net revenue retention in the coming quarters and years. It's not just Prism, however. We need to think about how we become more multi-product, which involves disaggregating our sales strategy and building new products clients need. Both of those have to be sustained over the next several quarters.

Got you. Thanks, Sandeep. No, that was great. Really helpful. I just wanted to think about the current environment, right? You laid out why maybe the rising interest rates and about markets off may be a headwind we're seeing. But the flip side I think we have to ask is there's obviously been a huge pullback in some of these valuations around. How are you thinking about the potential to take advantage of this and, more importantly, to expand your platform and value proposition to customers via inorganic opportunities? Thanks.

I would like to make a point, and Jim, if you could comment on the M&A part. In uncertain times, as you've described the current situation with economic growth, inflation, and Ukraine, we believe this could work to our advantage. When economic uncertainty arises, companies tend to turn to the cloud to minimize large upfront investments. They often look for greater efficiency and cost savings. Our ability to manage risk becomes especially crucial for organizations in these times. Although we haven't seen a major increase in our pipeline, we still see strong opportunities. Jim, could you discuss the M&A aspect?

We actively pursue a multi-product strategy as an integral long-term commitment to meeting our clients' needs. While we have nothing to announce currently, we consider it part of our strategy. Employees and clients appreciate our solid and durable business model. They know they can rely on us, which is crucial for building long-term relationships. We're also eager to hire more talent.

There's definitely more activity now than before. Last year, expectations among companies varied greatly. You'll notice an increase in activity currently. However, we maintain a high bar for acquisitions, as we don't want to disrupt our momentum. With $260 million in cash, we give serious consideration to capital allocation.

Good afternoon. Thanks for taking the question. I was wondering about Prism. Could you remind us where you expect to see the most success both by industry vertical and by geography, and what do you think that could reach in terms of revenue by the end of next year? Could you make a forecast there?

So in a word, Pete, no, I'm not going to make the forecast for that because everything is growing reasonably well. We want to think about that a little more. Discussing threats by industry vertical, we’ve found success across various markets depending on the use cases. We think Prism fits well in various asset management clients and within mega insurance clients who have a bit of their business that feels similar to asset management.

If I can provide real-life examples mentioned in my prepared remarks. For large insurance clients, they might want us to handle most of the accounting and reporting, but perhaps their real estate assets are in a different system and not transferred yet. Today, because of Prism, we can consolidate that data and provide a comprehensive overview. The same applies to asset management, where institutional clients have multiple systems for different asset classes and countries. We may only service a part of the accounting, but they rely on us to provide an all-encompassing view. Moreover, wealth management clients are also benefiting from Prism, which allows us to present a comprehensive view without performing any accounting directly.

That's helpful. And in terms of what we're hearing on wage inflation and higher attrition, you mentioned some delay in planned hiring. How are you incorporating that into your guidance and thinking about the marketplace? Do you see further acceleration, or have you reached a level of stability for the time being?

Sure, Pete. Yes, we have indeed observed inflation within our employee base. We are committed to being competitive and attracting top talent. We have some advantages because of our diverse employee base, including operations in Boise, Edinburgh, and India, which affords us some flexibility in managing costs. We recognize the inflationary pressures, and they've been significant. As for our guidance, we've taken those factors into account. We can still make the necessary investments; we just need to be prudent in our approach.

We did see some pressure on hiring new R&D staff, which was a bit more difficult than we anticipated. But overall, we performed well on the operational side, as reflected in the gross margin numbers. While we can effectively address hiring on that end, technology staffing in competitive markets like Seattle and California has been a challenge.

Hi, thank you for taking my question. I wanted to follow up on the macro commentary. In 2020, despite the market falling more than 30% from peak to trough, your AUM stayed relatively flat. Can you discuss how your visibility into demand today compares to prior market downturns, and in what ways might macro headwinds to your AUM growth be worse or better than it was early in the pandemic?

So I think what we said was historically, we saw at the highest level, negative 2% to positive 2% was kind of the range we historically see. In March of 2020, we hit that negative 2%. We haven't seen the same kind of reaction this time. Demand remains active, and the pipeline is full. We're out traveling again, meeting clients and driving business, so it doesn't feel the same as it did back then. I think what was great about the end of 2021 was we had enough quota-carrying headcount at the beginning of the year. While everyone usually aims to do this, it often only materializes in February or March. We've been successful in hiring in North America, but our brand is still relatively newer internationally, giving us room for growth there.

We mentioned last year that we expected it to take us a year to get Asia up and running. Then we announced SBB, and last quarter, we secured a deal with Sumitomo MSIG, which came in earlier than initially expected. The platform proves effective across sectors and strengthens our ability to service clients globally. We recognize that this approach has an impact on gross margin since we need to position teams in countries like Singapore, but we believe the investment is worthwhile.

Hi. This is Peter on for Brian Schwartz. I had a question on your competitive landscape, particularly regarding any changes since your IPO. Are you noticing any vendors evolving in specific areas or seeing new entrants? As you contemplate your multiproduct strategy and potential enhancements, are there areas you find more or less attractive due to competitiveness?

Thank you. The primary change is that we are now much more visible. Everyone is aware of us, and they're gearing up to compete against us. Competition has become slightly more aggressive since our IPO. However, we continue to outperform as we've always done. Our commitment to spend 24% of our revenue on R&D remains steadfast to maintain our pioneering status. This unique offering supports our network effect, efficiency, and features, which are advantageous for both new and existing clients.

Undoubtedly, we should consider functionality in our growth strategy, as Sandeep articulated. Our competitive edges—like our multi-tenant model and single security master—make a difference, and we maintain a high bar for quality. We continuously strive to improve our responsiveness to our clients' requirements.

Great. Thanks for squeezing me in. Most of my questions have been asked, but I just wanted to highlight win rates. You've historically had impressive win rates, and I wanted to know how things have been trending over the past few months.

Thank you, David. This is such a nice question. No, our competition question aside, our win rates have remained very stable. When we compete, we generally win, with no significant changes in overall win rates. While it varies in newer markets, we've maintained strong results overall. The continued positive commentary complements our belief that we have a disruptive platform and a large target addressable market, allowing for continued organic growth at a satisfactory pace.

That concludes the question-and-answer session. I will now pass the conference over to Sandeep for any closing remarks.

Yes, I just want to thank you all for your interest in Clearwater. We know you have many things to do and appreciate that you took the time to cover us. We're thankful for your ongoing interest. We believe we have a solid and durable story.

Thank you.

That concludes Clearwater Analytics' first-quarter and full-year earnings conference call. Thank you for your participation, you may now disconnect your line.