Clearwater Analytics Holdings, Inc. (NYSE:CWAN) Q4 2024 Earnings Call Transcript
Clearwater Analytics Holdings, Inc. (NYSE:CWAN) Q4 2024 Earnings Call Transcript March 2, 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).
Operator: Good day, everyone. Thank you for standing by. Welcome to Clearwater Analytics Fourth Quarter 2023 Earnings Conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the call will be open for questions. I would now like to turn the call over to Joon Park, Head of Investor Relations at Clearwater Analytics. Joon, please go ahead.
Joon Park: Thank you and welcome, everyone, to Clearwater Analytics Fourth Quarter and Full Year 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 Factor section of 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 statement included in our earnings press release. Before the market opens tomorrow morning, we plan to file with the SEC a Form 10-K for the fiscal year ended December 31, 2023. Lastly, all metrics discussed on this call are presented on a non-GAAP or adjusted basis and include the results of JUMP technologies 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'll turn the call over to our Chief Executive Officer, Sandeep Sahai.
Sandeep Sahai: Thank you, Joon, and thank you all for joining us. Let me start by saying that I'm incredibly proud of what we have achieved as a company over the last five years. We are on a mission to be the world's most trusted and comprehensive technology platform that simplifies the entire investment management lifecycle, and eventually, revolutionizes the world of investing. While we are very ambitious, we want to build a durable business that grows consistently while improving unit economics, margin, EBITDA and cash flow. That's why 2023 was a great year. Revenue grew 21.3%. Gross margin was 139 basis points better than the previous year. Adjusted EBITDA was 203 basis points higher than the previous year, and finally, our cash flow for the year increased by 57.2%.
We have often talked about the power of our single instance multi-tenant platform and the network effect it produces, but the growth in Europe and then in Asia, and finally, new asset classes have masked the true impact. We're delighted to note that in 2023 we grew our revenue 21% without adding a single net new employee to our operations team, reflecting the true power of the network effect aided by Gen AI. We have always insisted that it was not just about cost efficiency. Clients would be happier because the network effect made our data better and they would get their data faster. No surprise then that even though we did not add any operational headcount, we grew NPS and improved our employee satisfaction score. Finally, we are taking the Gen AI powered technology we have been using internally to our customers, and we launched Clearwater's Intelligent Console this month.
Clearwater's success starts with disruptive technology. At our core, we believe that the level of complexity across the investing world is incredibly high and is a moving target. The emergence of new asset classes, new geographies, new rules and regulations, surrounding investments, and finally, regulatory reporting, all continue to add to complexity. You simply cannot solve this effectively with patchwork legacy technology. That is why we believe that our prospects need to move to a modern technology like Clearwater. And our platform which is truly disruptive, has never been more ready to scale. We completed the transition to the public cloud in less than a year, with little to no disruption to the operating teams or clients, thereby meaningfully altering our ability to scale the business.
And because it is a single instance multitenant platform, there is no migration. All, not most, but all of our clients are automatically on the public cloud. Let me pause here. For much of our industry, such a migration would have been a multi-year endeavor. Not for us because we are a single instance multitenant platform. Make no mistake, this endeavor took much of last year and involved more than half of our R&D team. With that completed, we are really excited that we can now devote more than 60% of all R&D capacity to growth-related product development. And while new products take some time to build and take to market, we have the track record with Prism and LPx to show that we know how to innovate effectively. We view the journey towards NRR 115% as an incredibly strategic endeavor, and investing in new products that we deliver to our current customers is absolutely integral to our plans.
More specifically, we are working jointly with our customers to innovate in five different areas. Number one, Investment Data Consolidation, which includes our Clearwater Prism product that offers a centralized hub of Investment Data which can then be used for client analytics and reporting, thereby helping our clients grow faster. An example is a win with a large private investment firm. They were struggling with custodial feeds, reconciliation and accurate tax slot data, and wanted a holistic view of their custody, brokerage and alternative assets. By pulling data from their accounting system, their CRM and their journal ledger, we proved that Clearwater's combined offering of an accounting platform and our next-gen Investment Data Hub has the capacity to make their business much more efficient and competitive.
Number two, Asset Class and Fund Expansion. Like our Clearwater LPx and MLx products and other solutions that allow clients to dive deeper into those assets and analyze the underlying assets in much greater detail. Let me give you some real-life examples for Q4. We have continued to win LPx and LPx Clarity deals. As you know, late last year we launched Clearwater MLx, a comprehensive all-in-one solution for mortgage loan investors. In 2023, we partnered with one of our REIT clients who is now transitioning their business purpose loans to MLx. Before choosing Clearwater, this client struggled with a competing product that couldn't handle draws on construction loans. After reviewing the available solutions in the market, they opted for Clearwater MLx, and we are delighted to count them as another satisfied REIT client.
Number three, Front and Middle Office solutions that allow customers to get a full front-to-back solution from Clearwater in a modular architecture by including Clearwater Core, JUMP Performance Plus and Risk Plus. This opens new TAM within and outside our current customer base. An example of this is our recent win with CCR. CCR is a leading reinsurer in Europe that selected Clearwater's platform for the entire investment lifecycle. Number four, Platform Innovations that provide our existing clients specialized add-on modules for their accounting and reporting needs. These include region-specific, country-specific GAAP accounting customized data feeds and toolkits that support our clients' unique period-end close requirements. Number five, New Frontiers that allow us to apply advanced technology like Generative AI and machine learning to the investment world, both for internal benefit and for client use.
These solutions take the manual work out of things like book heel calculations, perform income validations, verify lockdown procedures are correct, and more. You can think of this as the intersection of process and technology that empowers people to move faster while still ensuring quality. And while it is early days for the innovative products we are bringing to market, there are some very good initial signs. Let me begin with a leading insurer in the North American insurance market. This client is an excellent example of successfully integrating the Clearwater platform with our JUMP OMS solution to provide a comprehensive platform. During the search for an OMS to comply with new regulations mandating a T+1 trading system, this insurer evaluated other solutions in the industry.
The Clearwater JUMP OMS proved how it can optimize each step of the trade workflow, specifically with our accounting system as an ideal connection point. We met all the requirements for this insurer, instilling the confidence and trust necessary for them to partner with us. Another example is the progress we have made in the stable value funds domain. In Q4, a global investment management firm operating with fully homegrown systems faced significant strain on their IT resources and the manual work from their operations team. With the rapid expansion into new contract types, asset classes and clients, their teams operated on different platforms and relied heavily on email for data exchange. The front office group lacked insight into the underlying investments of their contracts, hindering the ability to evaluate new potential strategies and differentiate themselves in the market.
The back office teams struggled to meet the demands of the front office group in a timely manner, resulting in a flood of emails reaching issuers, subadvisors, internal trade desks, fund accountants and other stakeholders. Clearwater provided the best-in-class solution they needed. Both teams now operate on the same system, enabling easy access to data for end users and significantly reducing the strain and risk across the organization. Our client sought a vendor whose platform would become an industry gold standard, and they identified Clearwater as precisely that. Our ability to showcase our stable value product capable of supporting front, middle, and back office functions outperformed other competing products they evaluated. In Q4, a leading retirement and life insurance company chose Clearwater to power and automate their solution for the European Taxonomy Reporting, thus fulfilling its ESG reporting requirements.
This client is working with Clearwater to integrate their new data sets including non-native Clearwater abort portfolios, and further streamline the client's ESG reporting process. Clearwater Prism ingests portfolio data, including separate account investments not on Clearwater, enriches it with ESG data, runs calculation, and generates the required ESG reports. The client is very pleased with our world-class client services team and we consistently demonstrate the agility and commitment to address our clients' custom requirements, thereby achieving their goals. Looking ahead we want to do the following. Number one, focus on innovation leading to increased back-to-base sales, and thereby continue to make progress on our path towards NRR 115%.
We are investing heavily and expect to see some results in 2024 and a more robust return on investment in 2025. Second, grow our presence in Europe and Asia more aggressively. Towards that end, we are excited to welcome Keith Viverito to our Executive team. Keith has a deep understanding of the industry, has over 20 years of experience in high-growth companies serving financial markets, and is a perfect fit to lead Clearwater's expansion internationally in EMEA and APAC. Number three, investment accounting technology accounts for roughly 1 bp client spend and we want to add capabilities and products that allow us to address the other 3 bps, which constitutes the full investment management space. To help that transition, we are very happy to welcome Shane Akaroyd to our team.
Shane is our Chief Strategy Officer and has helped grow market an IHS market, and finally S&P through organic growth and M&A. Fourth, focus on continued operational excellence via increased use of Gen AI. As a summary, we continue to delight our customers and are grateful for the trust they have in us. We have an exciting multiproduct roadmap along the five vectors I just described. We have a team of industry experts who ensure our client success and we are capitalizing on the latest technologies to improve both our internal operations and deliver unparalleled scale and growth opportunities for so many critical companies around the world. With that, I'd like to turn it back to Jim to cover our detailed metrics and guidance.
Jim Cox: Thanks, Sandeep, and thank you all for joining us. On the heels of Q3's strong results, I'm happy to report robust results where we beat guidance on the top and bottom line for both Q4 and the full year 2023. Full-year revenue grew at 21% year-over-year while expanding margin with Q4 EBITDA margin at 30.3% and full-year EBITDA margin at 28.8%, which was higher than the prior year's full-year EBITDA margin by 200 basis points. At our Investor Day, we announced our intent to expand EBITDA margin by 200 basis points in 2024 and by another 200 basis points in 2025. We expect to over-deliver on this margin expansion by delivering over 31% EBITDA margin for the full year 2024. Now turning to revenue in the quarter and full year 2023 results.
In 2023, we're proud to have delivered year-over-year revenue growth of 21.3%, with full-year revenue of $368.2 million despite the challenging macro environment in the overall fintech industry. In Q4 2023, we delivered $99.0 million in revenue, which translates to 19.8% year-over-year revenue growth. In addition, our clients continue to remain with us with a world-class gross retention rate of 98%. This really reflects our best-in-class customer satisfaction. We have achieved this 98% gross retention for 19 out of the last 20 quarters. Our path to NRR 115% is based on our solid as bedrock gross revenue retention. Although the 98% is so routine for us that it's not really newsworthy, these gross retention numbers are truly exceptional across any business.
Our net revenue retention rate continued to remain healthy at 107% as of December 31, 2023, which is higher than last year's 106%. Heading into 2024, we continue to be focused on our path towards NRR of 115% or beyond through upsell of new products and modules to existing clients. The successful rollout of Clearwater LPx, MLx, Prism and the JUMP solutions in 2023 has been a good harbinger of our pathway to the NRR 115% level. And now that we have allocated more than 60% of our R&D capacity for growth, we look forward to reaping the rewards of additional upsell capabilities in the future. Also in 2023, we set the foundation for our go-to-market to more efficiently upsell our product offerings, and our clients are excited about Clearwater's dynamic ability to meet their specific needs in an ever-changing investment world.
Annualized recurring revenue, or ARR, at the end of December 2023, was $379.1 million, representing a year-over-year increase of 17.2%, an increase of 80 basis points over 2022's annual growth rate. As of December 31, 2023, the Clearwater platform processes and reports on $7.3 trillion in assets daily. This represents an increase of almost $1 trillion over the prior year. This reflects business growth both from new clients as well as existing clients. We grew the number of clients with over $1 million in ARR to 86, which represents an impressive 28% year-over-year growth, and proves that we are helping the most sophisticated clients with their most significant problems. Now let's turn to profitability. We're pleased to report that both our gross margin and EBITDA margin remain strong in Q4, following upon the strong profitability from the prior quarter.
In Q4, we achieved gross profit of $76.2 million, and which is 77% gross margin. This shows that we are on our way towards our long-term gross margin goal of 80%, and reflects the operational improvements we have made over the prior two years. In addition, we reported $30 million in adjusted EBITDA, which is 30.3% EBITDA margin in fourth quarter, and comfortably beat our Q4 EBITDA guidance, and improved over the prior year by 80 basis points and 360 basis points better than our Q1 2023 EBITDA margin. Just like in the prior quarter, our outperformance in revenue flowed straight through to EBITDA as we continue to enjoy tangible efficiency gains within the operations and R&D teams utilizing our machine learning and Gen AI technology. We are proud to have achieved 21% year-over-year growth rate and full-year 2023 revenue while increasing total headcount across all our departments by less than 2% during the year.
We have learned to deliver more efficiently with greater productivity throughout our company to support our clients. With respect to our R&D spend as a percentage of revenue, it increased in the full year 2023 to 26.4%. That's up from our prior year's 24.7%. We expect to continually increase the aggregate amount spent on R&D each year. However, the percent of revenue spent on R&D is expected to moderate down in the future since we've already completed our migration to the public cloud. In Q4, equity-based compensation was $23.7 million, a decrease of $7.6 million from Q3. This decrease was primarily attributable to the reversal of $6.9 million of expense related to JUMP performance shares. Although JUMP grew, it did not achieve the result necessary to vest in the performance awards related to 2023.
In Q4, we recorded an $8.3 million tax receivable agreement expense, bringing total expense for the year to $14.4 million. This compares to $11.6 million in 2022. As a reminder, this expense is paid in lieu of the income tax the company would have paid if the company did not receive the benefit of tax deductions from exchanges from its historical owners. In general, the tax receivable agreement expense is 85% of the income tax the company would have paid, but for such deductions, providing a 15% benefit to the company. Now let me turn to the balance sheet and cash flow. We ended the quarter with $317.7 million in cash, cash equivalents and investments. This represents a healthy 24.3% increase year over year. Total debt was $48 million, thereby resulting in net cash holdings of approximately $270 million.
Free cash flow was $22.5 million in Q4 and $79 million for the full year. Free cash flow for the full year 2023 represented a conversion rate of EBITDA to free cash flow of 75%, higher than our previously mentioned steady-state level of 70%, that accounts for seasonality in free cash flow between the quarters. Our accounts receivable balance remained $92 million, consistent from September to December. These strong collections and lower unbilled AR contributed to our strong Q4 free cash flow numbers. In addition, for the first time, we paid $8 million related to the tax receivable agreement expenses, so those working capital changes offset each other nicely. Now let's turn to guidance. For the full year 2024, we expect revenue to be in the range of $431 million to $437 million, representing approximately 17% to 19% year-over-year growth.
This guidance assumes that our NRR remains in that same 106% to 108% range that we've experienced this year. In the first quarter 2024, we expect revenue to be $100.5 million, representing first-quarter revenue growth of 19%. For the full year 2024, we expect our adjusted EBITDA to be in the range of $135 million to $137 million. This reflects an approximately 250 basis point improvement from 2023. This 28% year-over-year increase in adjusted EBITDA is even greater than our announced improvement of 200 basis points per year that we just announced at our September investor day. This is all the more impressive when you consider that both Q3 and Q4 adjusted EBITDA margins significantly outperformed our guidance. We have this confidence in our margin improvement because of the significant efficiencies we are seeing throughout the business.
These include machine learning and artificial intelligence activities, but truly belie the power of the network effect. In the first quarter of 2024, we expect adjusted EBITDA to be $28.8 million or 28.7% EBITDA margin, which is approximately 200 basis points better than the first quarter of 2023. For 2024, total equity-based compensation is expected to be approximately $106 million, a slight decrease from the $108 million recorded in 2023, and as a percentage of revenue this would be a 5% reduction. Depreciation and amortization expense is expected to be approximately $11 million, and our full-year non-GAAP effective tax rate is expected to be 25%. After a strong year of delivering results in 2023, in 2024, we're focused on driving consistent revenue while flexing our margin expansion muscle.
With that, I'll turn it over to Sandeep to provide some closing thoughts.
Sandeep Sahai: Thanks, Jim. I am very excited about Clearwater's journey through the last five years, and we look forward with renewed confidence and determination. We are building a track record of setting goals and exceeding them. Each goal we set, we meet. We set out to be durable, we are. We set out to demonstrate growth, we have. We set out to drive improved gross margin, EBITDA, and cash flow, and we have done just that. And as we look to 2024, we're committed to continuing these successes. Thank you.
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