# Clearwater Analytics Holdings, Inc. (CWAN) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Clearwater Analytics Holdings, Inc.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1866368/000095017022003915/cwan-20211231.htm
Accession: 0000950170-22-003915
Filing date: 2022-03-16
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/CWAN/
All MD&A years: /company/CWAN/mda/
Next year: /company/CWAN/mda/fy2022/ (FY 2022)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. As discussed in the section titled “Special Note Regarding Forward-Looking Statements,” the following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and in the section titled “Special Note Regarding Forward-Looking Statements” and “Risk Factors” include elsewhere in this Annual Report on Form 10-K.

Overview

Clearwater brings transparency to the opaque world of investment accounting and analytics with what we believe is the industry’s most trusted and innovative single instance, multi-tenant technology platform. Our cloud-native software allows clients to radically simplify their investment accounting operations, enabling them to focus on higher-value business functions such as asset allocation strategy and investment selection. Our platform provides comprehensive accounting, data and advanced analytics as well as highly-configurable reporting for global investment assets daily or on-demand, instead of weekly or monthly. We give our clients confidence that they are making the most informed decisions about investment performance, regulatory compliance and risk.

We provide investment accounting and reporting, performance measurement, compliance monitoring and risk analytics solutions for asset managers, insurance companies and large corporations. Every day, Clearwater’s powerful platform aggregates and normalizes data on over $5.9 trillion of global invested assets for over 1,100 clients. We bring modern software to an industry that has long been dominated by difficult-to-use, high cost legacy technologies and processes, which often lack data integrity and traceability, and often require significant manual intervention. The strength of our platform is demonstrated by our approximately 80% win rate for new clients over the prior four years in deals that reached the proposal stage.

We allow our clients to replace legacy systems with modern cloud-native software. Our platform helps clients reduce cost, time, errors and risk and allows them to reallocate resources to other value-creating activities. Our software aggregates, reconciles and validates data from more than 2,500 daily data feeds and more than four million securities that have been modeled across multiple currencies, asset classes and countries. This cleansed and validated data runs through our proprietary accounting, performance, compliance and risk solutions to provide clients with powerful analytics and daily or on-demand configurable reporting. We offer multi-asset class, multi-basis, multi-currency accounting and analytics that provide clients with a comprehensive view of their holdings and related performance. This allows our clients to make better, more timely decisions about their investment portfolios.

Clearwater benefits from powerful network effects. With our single instance, multi-tenant architecture, every client, whether new or existing, enriches our global data set by making it more complete and accurate. Our software continually sources, ingests, models, reconciles and validates the terms, conditions and features of every investment security held by all of our clients. This continuous process helps to create a single repository of comprehensive, accurate investment data (often referred to within the industry as a “Golden Copy” of data) that benefits all our clients to the extent they otherwise have rights to the data. Through this continuous process, we are able to identify and adjudicate data discrepancies that otherwise could introduce error and risk into our clients’ investment portfolios. We believe that a meaningful competitive advantage of this network effect is that we are increasingly seen as the best and most accurate source of investment accounting data and analytics in the industry.

We have a 100% recurring revenue model. We charge our clients a fee that is primarily based on the amount of assets they manage on our platform, subject to contracted minimums. A majority of the assets on our platform are high-grade fixed income assets, leading to very low levels of volatility and highly predictable revenue streams. When applicable, we charge additional transaction fees for certain alternative asset classes (e.g., derivatives and other financial instruments).

Recent Developments

Initial Public Offering

On September 28, 2021, the company completed the IPO, in which it sold 34,500,000 shares of Class A common stock (including shares issued pursuant to the exercise in full of the underwriters’ option to purchase additional shares) at a public offering price of $18.00 per share for net proceeds of $582.2 million, after deducting underwriting discounts of $38.8 million (but excluding other offering expenses of $5.3 million). The Company used proceeds from the IPO to (i) purchase 34,500,000 common units of CWAN Holdings, LLC (“LLC interests”); (ii) repay approximately $437.4 million of outstanding borrowings under the Previous Credit Agreement including prepayment premiums and accrued interest; and (iii) pay $5.3 million of expenses related to the IPO; with the remaining proceeds intended to be used for general corporate purposes.

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New Credit Agreement

In connection with the closing of the IPO, Clearwater Analytics, LLC entered into a new credit agreement with JPMorgan Chase Bank, N.A. that included a $55 million New Term Loan and a $125 million Revolving Facility. The New Term Loan and Revolving Facility will be used for working capital and other general corporate purposes (including acquisitions permitted under the New Credit Agreement).

Previous Credit Agreement

On October 19, 2020, we entered into the Fifth Amendment to the Credit Agreement with Ares Capital Corporation and Golub Capital LLC. The agreement provided for a total term loan of $435 million and revolving line of credit of $30 million. Under the terms of the Fifth Amendment to the Credit Agreement, we were required to maintain certain customary affirmative and negative covenants, including covenants that limited our ability to, among other things, incur indebtedness, merge or consolidate, dispose of assets, make investments, make acquisitions, enter into transactions with affiliates, pay dividends or make distributions. We were also required to maintain compliance with a consolidated net leverage ratio. The line of credit and term note agreements also included customary events of default.

The outstanding borrowings under the Fifth Amendment to the Credit Agreement of $432.7 million were repaid in full in September 2021 in connection with the closing of the IPO. The repayment of the borrowings resulted in a loss on extinguishment of $10.3 million.

Recapitalization

On November 2, 2020, the Company completed a recapitalization transaction on behalf of existing unitholders. The transaction allowed existing unitholders to sell their units to new investors. In addition, option holders were offered the opportunity to exercise and sell a portion of their vested options, which were accelerated in certain cases (See Note 11, Equity-Based Compensation – Modification of option awards). In total 132,658,542 units transferred ownership. After completion of the recapitalization transaction, entities ultimately controlled by WCAS maintained a majority interest in and control of the Company.

In connection with the transaction, selling unitholders contributed $49.0 million for bonuses paid to employees and related payroll taxes in 2020.

Key Factors Affecting Our Performance

The growth and future success of our business depends on many factors, including those described below.

•
Adding New Clients in Established End Markets: Our future growth is dependent upon our ability to continue to add new clients, and in 2021 we added over 100 new clients. We are focused on continuing to increase our client base in our established client end-markets of corporations, insurance companies and asset managers, and doing so with increasingly large and sophisticated clients. As we add clients, it takes time to fully onboard their assets to the platform. Our revenue generally increases as assets are added to the platform, while the effort to serve the client is relatively consistent over time. Therefore, we expect revenues and gross margins to increase for a client as the client transitions from the onboarding process to a steady state once assets have been onboarded. In any period, our gross margins may fluctuate based on the relative size and number of clients that we are onboarding at that time.

•
Expanding and Retaining Relationships with Existing Clients: Our future growth is dependent upon retaining our existing clients and expanding our relationships with these clients through increases in the amount of their assets on our platform. We have enjoyed consistent gross revenue retention rates of approximately 98% over the past twelve quarters. The consistency in revenue retention creates predictability in our business and enables us to better plan our future investments. Our relationships with our clients expands as these clients add more assets to our platform, with our net revenue retention rates (as defined below under “—Key Operating Measures”) between 109% and 111% in 2021. Clients may add assets as a result of acquiring new clients themselves or by acquiring new businesses or simply through organic growth, which produces additional assets that they manage using our platform. We believe that our client service model and technology platform are strong contributing factors in our attractive retention rates. As such, we expect to continue to invest in both our operations and research and development functions to maintain and increase our high levels of client satisfaction, which we believe will lead to strong client retention and expansion.

•
International Expansion: We believe that the value provided by our platform is equally applicable to asset owners and asset managers outside of North America, and there is a significant opportunity to expand our client base and usage of our platform internationally. Our future growth is dependent upon our ability to successfully enter new international markets and to expand our client base in our current international markets. Our cost to acquire clients in international markets is currently greater than in North America because there is less awareness of the Clearwater brand and our

40

product capabilities, and we have to date invested less in sales and marketing internationally. For these reasons, we expect to invest more in sales and marketing in international markets relative to North America in order to achieve growth in these international markets.

•
Adding New Clients in Adjacent or Nascent End-Markets: Our strategy is to also add new clients in our more nascent end-markets, which include state and local governments, pension funds and sovereign wealth funds, as well as a variety of alternative asset managers. Traditionally, our existing clients have been among our best resources for referring new clients to us, and we will continue to invest in sales and marketing to build awareness of our brand, engage prospective clients and drive adoption of our platform, particularly as it relates to expanding into new end-markets. As we establish our presence in new end-markets, we expect sales and marketing expenditures will be less efficient than in our established verticals and we will become increasingly more efficient at acquiring clients in new end-markets over time.

•
Expanding Solutions and Broadening Innovation: Our future growth is dependent upon our continued expansion of our solutions in order to better retain our current clients and to develop new use cases that appeal to new clients. While we believe we will be able to reduce our research and development expenses as a percentage of revenues as we achieve greater scale, our priority is to maintain and grow our technological advantage over our competitors. As we identify opportunities to increase our technological and competitive advantages, we may increase our investments in research and development at rates that are faster than our growth in revenues in order to enhance our long-term growth and profitability.

•
Fluctuations in the Market Value of Assets on the Platform: We generally bill our clients monthly in arrears based on a basis point rate applied to our clients’ assets on our platform, which can be influenced by general economic conditions. While 78% of the assets on our platform were high-grade fixed income securities and structured products as of December 31, 2021 and therefore subject to lower levels of volatility, the value of our clients’ assets on our platform varies on a daily basis due to changes in securities prices, cash flow needs, incremental buying and selling of assets and other strategic priorities of our clients. For these reasons, our revenue is subject to fluctuations based on economic conditions, including market conditions and the changing interest rate environment.

Key Components of Results of Operations

The following discussion describes certain line items in our consolidated statements of operations.

Revenue

We generate revenue from fees derived from providing clients with access to the solutions and services on our SaaS platform. Sales of our offering include a right to use our software in a hosted environment without taking possession of the software. Our contracts are generally cancellable with 30 days’ notice without penalty. We invoice clients monthly in arrears based on a percentage of the average daily value of assets within a client’s accounts on our platform during that month. Payment terms may vary by contract but generally include a requirement of payment within 30 days following the month in which services are provided. Fees invoiced in advance of the delivery of the Company’s performance obligations are deemed set-up activities and are deferred as a material right and recognized over time, typically 12 months.

Cost of Revenue

Cost of revenue consists of expenses related to delivery of revenue-generating services, including expenses associated with client services, onboarding, reconciliation and agreements related to the purchase of data used in the provision of our services. Salary and benefits for certain personnel associated with supporting these functions, in addition to allocated overhead and depreciation for facilities, are also included in cost of revenue.

Operating Expenses

Research and development expense consists primarily of salary and benefits for our development staff as well as contractors’ fees and other costs associated with the enhancement of our offering, ensuring operational stability and performance and development of new offerings.

Sales and marketing expense consists of the costs of personnel involved in the sales and marketing process, sales commissions, advertising and promotional materials, sales facilities expenses, and the cost of trade shows and seminars.

General and administrative expense consists primarily of personnel costs for information technology, finance, administration, human resources and general management, as well as expenses from legal, corporate technology and accounting service providers.

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Interest Expense, Net

Interest expense, net primarily relates to interest expense and reflects interest accrued on our outstanding term loan during the course of the applicable period. The accrual of interest varies depending on the timing and amount of borrowings and repayments during the period as well as fluctuations in interest rates. Interest income is also included in interest expense, net.

Loss on Debt Extinguishment

Loss on debt extinguishment related to the early repayment of borrowings under the Previous Credit Agreement with Ares Capital Corporation. The debt was extinguished on September 28, 2021 in connection with the closing of the IPO.

Other Expense, Net

Other expense, net relates to foreign currency gains and losses.

Provision for Income Taxes

Provision for income taxes consists of income taxes related to federal, state, and foreign jurisdictions where we conduct our business. Our effective tax rate may increase in the future as our ownership in CWAN Holdings increases via exchanges from historical partners. In addition, our discrete items may not be consistent from year to year and could cause volatility in our effective tax rate.

Key Operating Measures

We consider certain operating measures, such as annualized recurring revenue, gross retention rates and net retention rates, in measuring the performance of our business.

Annualized Recurring Revenue

Annualized recurring revenue is calculated at the end of a period by dividing the recurring revenue in the last month of such period by the number of days in the month and multiplying by 365.

The following table summarizes the Company’s annualized recurring revenue as of the dates presented:

[[GREPCENT_TABLE]]
[["","","First Quarter","","","Second Quarter","","","Third Quarter","","","Fourth Quarter"],["","","(in thousands)"],["2021"],["Annualized recurring revenue","","$","232,467","","","$","245,033","","","$","257,022","","","$","277,780"],["2020"],["Annualized recurring revenue","","$","186,251","","","$","200,492","","","$","214,877","","","$","219,901"],["2019"],["Annualized recurring revenue","","$","158,510","","","$","167,169","","","$","178,220","","","$","185,041"]]
[[/GREPCENT_TABLE]]

Because a substantial majority of the assets on our platform have lower levels of volatility with respect to their market value, the growth in annualized recurring revenue is generally not attributable to the fluctuating market value of the assets on our platform. Rather, the growth in annualized recurring revenue is due to an increase in the number of clients using our offering as well as from onboarding more assets of our existing clients onto our platform.

Revenue Retention Rate

Gross revenue retention rate represents annual contract value (“ACV”) at the beginning of the 12-month period ended on the reporting date less client attrition over the prior 12-month period, divided by ACV at the beginning of the 12-month period, expressed as a percentage. ACV is comprised of annualized recurring revenue plus contracted-not-billed revenue, which represents the estimated annual contracted revenue for new and existing client opportunities prior to revenue recognition. In order to arrive at total ACV, we include contracted-not-billed revenue, as it is contracted revenue that has not been recognized but that we expect to produce recognized revenue in the future. Client attrition occurs when a client provides a contract termination notice. The amount of client attrition is calculated as the reduction in annualized revenue of the client at the time of the notice and is recorded in the month the final billing occurs. In the case of client attrition where contracted-not-billed revenue is still present for a client, both annualized recurring revenue and contracted-not-billed revenue associated with such client are deducted from ACV.

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Net revenue retention rate is the percentage of recurring revenue retained from clients on the platform for 12 months and includes changes from the addition, removal or value of assets on our platform, contractual changes that have an impact to annualized recurring revenues and lost revenue from client attrition. We calculate net revenue retention rate as of a period end by starting with the annualized recurring revenue from clients as of the 12 months prior to such period end. We then calculate the annualized recurring revenue from these clients as of the current period end. We then divide the total current period end annualized recurring revenue by the 12-month prior period end annualized recurring revenue to arrive at the net revenue retention rate.

The following table summarizes our retention rates as of the dates presented:

[[GREPCENT_TABLE]]
[["","","First Quarter","","","Second Quarter","","","Third Quarter","","","Fourth Quarter"],["2021"],["Gross retention rate","","","98","%","","","98","%","","","98","%","","","98","%"],["Net retention rate","","","110","%","","","109","%","","","111","%","","","111","%"],["2020"],["Gross retention rate","","","98","%","","","98","%","","","98","%","","","98","%"],["Net retention rate","","","107","%","","","108","%","","","109","%","","","109","%"],["2019"],["Gross retention rate","","","98","%","","","98","%","","","98","%","","","98","%"],["Net retention rate","","","105","%","","","105","%","","","110","%","","","111","%"]]
[[/GREPCENT_TABLE]]

Gross revenue retention rates have remained consistently at approximately 98% since 2019. We believe the extremely consistent and high gross revenue retention rate is a testament to the value proposition that our leading solution offers.

Non-GAAP Financial Measures

We also consider certain non-GAAP financial measures that are not prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), such as adjusted EBITDA and adjusted EBITDA Margin, in measuring the performance of our business. The non-GAAP measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies. However, we believe that this non-GAAP information is useful as an additional means for investors to evaluate our operating performance, when reviewed in conjunction with our GAAP financial statements. These measures should not be considered in isolation or as a substitute for measures prepared in accordance with GAAP, and because these amounts are not determined in accordance with GAAP, they should not be used exclusively in evaluating our business and operations. In addition, undue reliance should not be placed upon non-GAAP or operating information because this information is neither standardized across companies nor subjected to the same control activities and audit procedures that produce our GAAP financial results.

Adjusted EBITDA and Adjusted EBITDA Margin

Adjusted EBITDA and Adjusted EBITDA Margin are supplemental performance measures that our management uses to assess our operating performance. We define Adjusted EBITDA as net income (loss) plus (i) interest expense, net, (ii) loss on debt extinguishment (iii) depreciation and amortization expense, (iv) equity-based compensation, (v) Recapitalization compensation expenses, and (vi) other expenses. We define Adjusted EBITDA Margin as Adjusted EBITDA (as defined above) divided by revenue.

The following tables reconcile net income (loss) to Adjusted EBITDA and include amounts expressed as a percentage of revenue for the periods indicated.

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(in thousands, except percentages)"],["Net income (loss)","","$","(8,094",")","","","(3","%)","","$","(44,230",")","","","(22","%)","","$","7,732","","","","5","%"],["Adjustments:"],["Interest expense, net","","","25,682","","","","10","%","","","22,854","","","","11","%","","","17,807","","","","11","%"],["Loss on debt extinguishment","","","10,303","","","","4","%","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014"],["Depreciation and amortization","","","3,493","","","","1","%","","","2,271","","","","1","%","","","2,019","","","","1","%"],["Equity-based compensation","","","36,695","","","","15","%","","","24,602","","","","12","%","","","6,233","","","","4","%"],["Recapitalization compensation expenses","","","\u2014","","","","\u2014","","","","48,998","","","","24","%","","","\u2014","","","","\u2014"],["Other expenses(1)","","","4,597","","","","2","%","","","2,555","","","","1","%","","","16,992","","","","10","%"],["Adjusted EBITDA","","","72,676","","","","29","%","","","57,050","","","","28","%","","","50,783","","","","30","%"],["Revenue","","$","252,022","","","","100","%","","$","203,222","","","","100","%","","$","168,001","","","","100","%"]]
[[/GREPCENT_TABLE]]

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(1)
Other expenses includes professional service fees related to settlement of a legal matter, management fees to our investors, income taxes, foreign exchange gains and losses and other expenses that are not reflective of our core operating performance including the costs to set up our Up-C structure and Tax Receivable Agreement.

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(in thousands)"],["Legal professional service fees","","$","\u2014","","","$","\u2014","","","$","14,779"],["Up-C structure expenses","","","1,660","","","","\u2014","","","","\u2014"],["Management fees and reimbursed expenses","","","2,367","","","","1,597","","","","1,853"],["Provision for income taxes","","","487","","","","902","","","","73"],["Miscellaneous","","","83","","","","56","","","","287"],["Total other expenses","","$","4,597","","","$","2,555","","","$","16,992"]]
[[/GREPCENT_TABLE]]

Results of Operations

The following tables set forth our results of operations for the years ended December 31, 2021, 2020 and 2019 (in thousands):

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["Revenue","","$","252,022","","","$","203,222","","","$","168,001"],["Cost of revenue(1)","","","67,864","","","","53,263","","","","47,145"],["Gross profit","","","184,158","","","","149,959","","","","120,856"],["Operating expenses:"],["Research and development(1)","","","72,690","","","","55,262","","","","39,275"],["Sales and marketing(1)","","","39,065","","","","22,243","","","","19,082"],["General and administrative(1)","","","43,942","","","","43,874","","","","36,802"],["Recapitalization compensation expenses","","","\u2014","","","","48,998","","","","\u2014"],["Total operating expenses","","","155,697","","","","170,377","","","","95,159"],["Income (loss) from operations","","","28,461","","","","(20,418",")","","","25,697"],["Interest expense, net","","","25,682","","","","22,854","","","","17,807"],["Loss on debt extinguishment","","","10,303","","","","\u2014","","","","\u2014"],["Other expense, net","","","83","","","","56","","","","85"],["Income (loss) before income taxes","","","(7,607",")","","","(43,328",")","","","7,805"],["Provision for income taxes","","","487","","","","902","","","","73"],["Net income (loss)","","","(8,094",")","","","(44,230",")","","","7,732"],["Less: Net income (loss) attributable to non-controlling interests","","","119","","","","\u2014","","","","\u2014"],["Net loss attributable to Clearwater Analytics Holdings, Inc.","","$","(8,213",")","","$","\u2014","","","$","\u2014"]]
[[/GREPCENT_TABLE]]

(1)
Amounts include equity-based compensation as follows (in thousands):

[[GREPCENT_TABLE]]
[["Cost of revenue","","$","4,786","","","$","1,669","","","$","564"],["Operating expenses:"],["Research and development","","","10,409","","","","4,208","","","","1,722"],["Sales and marketing","","","7,059","","","","3,911","","","","922"],["General and administrative","","","14,441","","","","14,814","","","","3,025"],["Total equity-based compensation expense","","$","36,695","","","$","24,602","","","$","6,233"]]
[[/GREPCENT_TABLE]]

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The following table sets forth our consolidated statements of operations data expressed as a percentage of revenue for the periods indicated:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["Revenue","","","100","%","","","100","%","","","100","%"],["Cost of revenue","","","27","%","","","26","%","","","28","%"],["Gross profit","","","73","%","","","74","%","","","72","%"],["Operating expenses:"],["Research and development","","","29","%","","","27","%","","","23","%"],["Sales and marketing","","","16","%","","","11","%","","","11","%"],["General and administrative","","","17","%","","","22","%","","","22","%"],["Recapitalization compensation expenses","","","\u2014","","","","24","%","","","\u2014"],["Total operating expenses","","","62","%","","","84","%","","","57","%"],["Income (loss) from operations","","","11","%","","","(10","%)","","","15","%"],["Interest expense, net","","","10","%","","","11","%","","","11","%"],["Loss on debt extinguishment","","","4","%","","","\u2014","","","","\u2014"],["Other expense, net","","","0","%","","","0","%","","","0","%"],["Income (loss) before income taxes","","","(3","%)","","","(21","%)","","","5","%"],["Provision for income taxes","","","0","%","","","0","%","","","0","%"],["Net income (loss)","","","(3","%)","","","(22","%)","","","5","%"]]
[[/GREPCENT_TABLE]]

Comparison of the Years Ended December 31, 2021, 2020 and 2019

Revenue

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(In thousands, except percentages)"],["Revenue","","$","252,022","","","$","203,222","","","$","168,001"],["Change over prior year","","","48,800","","","","35,221"],["Percent change over prior year","","","24","%","","","21","%"]]
[[/GREPCENT_TABLE]]

Revenue increased $48.8 million, or 24%, 2021 compared to 2020. The increase was on account of growth in our client base as we brought new clients onto our platform and also added additional assets onto our platform from existing clients. Average assets on our platform that were billed to new and existing clients increased 20% from 2020 to 2021 while average basis point rate billed to customers increased by 1.8% from 2020 to 2021.

Revenue increased $35.2 million, or 21%, in 2020 compared to 2019. The increase was on account of growth in our client base as we brought new clients onto our platform and also added additional assets onto our platform from existing clients. Average assets on our platform that were billed to new and existing clients increased 24% from 2019 to 2020 while the average basis point rate billed to customers decreased by 2.7% from 2019 to 2020.

Cost of Revenue

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","Change","","","2020","","","Change","","","2019"],["","","(In thousands, except percentages)"],["Equity-based compensation","","$","4,786","","","$","3,117","","","$","1,669","","","$","1,105","","","$","564"],["All other cost of revenue","","","63,078","","","","11,484","","","","51,594","","","","5,013","","","","46,581"],["Total cost of revenue","","$","67,864","","","$","14,601","","","$","53,263","","","$","6,118","","","$","47,145"],["Percent of revenue","","","27","%","","","","","","26","%","","","","","","28","%"]]
[[/GREPCENT_TABLE]]

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Cost of revenue changed as follows (in thousands):

[[GREPCENT_TABLE]]
[["","","Change from December 31, 2020 to December 31, 2021","","","Change from December 31, 2019 to December 31, 2020"],["Increased payroll and related","","$","7,346","","","$","4,938"],["Increased equity-based compensation","","","3,117","","","","1,105"],["Increased (decreased) outside services and contractors","","","1,002","","","","(89",")"],["Increased data costs","","","990","","","","471"],["Increased facilities and infrastructure expenses","","","797","","","","994"],["Increased (decreased) technology","","","729","","","","(158",")"],["Increased (decreased) depreciation and amortization","","","632","","","","(243",")"],["Increased (decreased) travel and entertainment","","","4","","","","(733",")"],["Other items","","","(16",")","","","(167",")"],["Total change","","$","14,601","","","$","6,118"]]
[[/GREPCENT_TABLE]]

The increase in cost of revenue in 2021 is primarily due to increased payroll and related costs as a result of headcount growth of additional employees across our client services, onboarding and reconciliation teams to support a larger client base as well as increased equity-based compensation due to increased grant-date fair value of equity awards and higher headcount. In addition, higher utilization of third-party contractors, technology and IT services on operational activities, increased data costs to support a larger client base, and increased allocations of depreciation and facility costs increased cost of revenue.

The increase in cost of revenue in 2020 is primarily due to increased payroll and related costs as a result of headcount growth of additional employees across our client services, onboarding and reconciliation teams to support a larger client base, and higher equity-based compensation expense related to the equity award modifications that took place in January 2020 and November 2020. Data costs increased to support a larger client base. Facilities and infrastructure expenses also increased due to the opening and expansion of offices in Edinburgh, United Kingdom and Noida, India in late 2019, and New York in September 2020. These increases were partially offset by a reduction in travel and entertainment in response to the COVID-19 pandemic, and decreased allocation of technology costs and depreciation expense.

Operating Expenses

Research and Development

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","Change","","","2020","","","Change","","","2019"],["","","(In thousands, except percentages)"],["Equity-based compensation","","$","10,409","","","$","6,201","","","$","4,208","","","$","2,486","","","$","1,722"],["All other research and development","","","62,281","","","","11,227","","","","51,054","","","","13,501","","","","37,553"],["Total research and development","","$","72,690","","","$","17,428","","","$","55,262","","","$","15,987","","","$","39,275"],["Percent of revenue","","","29","%","","","","","","27","%","","","","","","23","%"]]
[[/GREPCENT_TABLE]]

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Research and development expenses changed as follows (in thousands):

[[GREPCENT_TABLE]]
[["","","Change from December 31, 2020 to December 31, 2021","","","Change from December 31, 2019 to December 31, 2020"],["Increased equity-based compensation","","$","6,201","","","$","2,486"],["Increased payroll and related","","","5,085","","","","9,135"],["Increased outside services and contractors","","","3,050","","","","47"],["Increased technology","","","2,187","","","","3,604"],["Increased depreciation and amortization","","","576","","","","654"],["Increased facilities and infrastructure expenses","","","255","","","","623"],["Increased (decreased) travel and entertainment costs","","","92","","","","(310",")"],["Other items","","","(18",")","","","(252",")"],["Total change","","$","17,428","","","$","15,987"]]
[[/GREPCENT_TABLE]]

The increase in research and development expense in 2021 is primarily due to increased equity-based compensation due to increased grant-date fair value of equity awards and higher headcount, increased payroll and related costs as a result of headcount growth of additional employees to focus on new offerings, increased technology costs from higher utilization of third-party cloud computing services and other third-party IT services, and increased allocations of facility costs and increased depreciation due to impairment losses related to abandoned capitalized software projects.

The increase in research and development expense in 2020 is primarily due to increased payroll and related costs as a result of headcount growth of additional employees to focus on new offerings, increased technology costs from higher utilization of third-party cloud computing services and other third-party IT services, higher equity-based compensation related to the equity modifications in January and November 2020, and increased allocations of depreciation and facility costs. These increases were partially offset by a reduction in travel and entertainment in response to the COVID-19 pandemic.

Sales and Marketing

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","Change","","","2020","","","Change","","","2019"],["","","(In thousands, except percentages)"],["Equity-based compensation","","$","7,059","","","$","3,148","","","$","3,911","","","$","2,989","","","$","922"],["All other sales and marketing","","","32,006","","","","13,674","","","","18,332","","","","172","","","","18,160"],["Total sales and marketing","","$","39,065","","","$","16,822","","","$","22,243","","","$","3,161","","","$","19,082"],["Percent of revenue","","","16","%","","","","","","11","%","","","","","","11","%"]]
[[/GREPCENT_TABLE]]

Sales and marketing expense changed as follows (in thousands):

[[GREPCENT_TABLE]]
[["","","Change from December 31, 2020 to December 31, 2021","","","Change from December 31, 2019 to December 31, 2020"],["Increased payroll and related","","$","10,926","","","$","1,572"],["Increased equity-based compensation","","","3,148","","","","2,989"],["Increased (decreased) marketing","","","903","","","","(579",")"],["Increased outside services and contractors","","","709","","","","730"],["Increased (decreased) facilities and infrastructure expenses","","","443","","","","(4",")"],["Increased technology","","","303","","","","23"],["Increased (decreased) travel and entertainment","","","297","","","","(1,429",")"],["Other items","","","93","","","","(141",")"],["Total change","","$","16,822","","","$","3,161"]]
[[/GREPCENT_TABLE]]

47

The increase in sales and marketing expense in 2021 is primarily due to increased payroll and related costs as a result of additional employees to expand sales coverage as well as increased equity-based compensation due to increased grant-date fair value of equity awards and higher headcount. In addition, sales and marketing expense increased from higher marketing costs due to increased focus on public relations and branding, higher utilization of third-party contractors on marketing activities, increased allocation of facility and technology costs, and increased travel and entertainment costs due to a reduction in travel restrictions related to the COVID-19 pandemic.

The increase in sales and marketing expense in 2020 is primarily due to higher equity-based compensation related to the equity award modifications in January and November 2020, higher payroll and related costs due to headcount growth of additional employees to expand sales coverage, and higher utilization of third-party contractors on marketing activities. These increases were partially offset by a reduction in travel and entertainment and marketing costs in response to the COVID-19 pandemic.

General and Administrative

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","Change","","","2020","","","Change","","","2019"],["","","(In thousands, except percentages)"],["Equity-based compensation","","$","14,441","","","$","(373",")","","$","14,814","","","$","11,789","","","$","3,025"],["All other general and administrative","","","29,501","","","","441","","","","29,060","","","","(4,717",")","","","33,777"],["Total general and administrative","","$","43,942","","","$","68","","","$","43,874","","","$","7,072","","","$","36,802"],["Percent of revenue","","","17","%","","","","","","22","%","","","","","","22","%"]]
[[/GREPCENT_TABLE]]

General and administrative expense changed as follows (in thousands):

[[GREPCENT_TABLE]]
[["","","Change from December 31, 2020 to December 31, 2021","","","Change from December 31, 2019 to December 31, 2020"],["Increased (decreased) outside services and contractors","","$","3,767","","","$","(13,742",")"],["Increased payroll and related","","","3,445","","","","2,000"],["Increased Up-C structure expenses","","","1,670","","","","\u2014"],["Increased (decreased) technology","","","919","","","","(313",")"],["Increased insurance","","","852","","","","254"],["Increased recruiting","","","381","","","","588"],["Increased (decreased) facilities and infrastructure expenses","","","306","","","","(1,426",")"],["(Decreased) increased accrued sales tax exposure","","","(10,907",")","","","8,593"],["(Decreased) increased equity-based compensation","","","(373",")","","","11,789"],["Decreased travel and entertainment","","","(129",")","","","(282",")"],["Other items","","","137","","","","(389",")"],["Total change","","$","68","","","$","7,072"]]
[[/GREPCENT_TABLE]]

The increase in general and administrative expense in 2021 is due to higher utilization of third-party contractors on accounting, IT and compliance activities, increased payroll and related costs as a result of headcount growth. In addition, general and administrative expenses increased due to accounting and legal professional service costs associated with creating our Up-C structure and developing the Tax Receivable Agreement, higher utilization of IT services, increased insurance costs for our directors and officers, increased recruiting costs to support growth initiatives and increased allocation of facility costs. These increases were offset by the absence of an expense related to accrued sales tax liability as we recorded $9.1 million of additional liability for sales tax during 2020. Beginning January 2021, we commenced collecting and remitting sales tax to jurisdictions on behalf of customers which has not resulted in additional exposure. In December 2021, we reduced our estimated sales tax liability by $2.0 million as actual amounts remitted via voluntary disclosure agreements were less than estimated as more customers were able to prove partial usage outside of the jurisdiction. Additional reductions in general and administrative expense are due to decreased equity-based compensation as a result of equity award modifications that took place in January and November 2020, and decreased travel and entertainment expense.

48

The increase in general and administrative expense in 2020 is primarily due to higher equity-based compensation related to the equity modifications in January and November 2020, increased expense for the accrual of sales tax exposure of $9.1 million due to a change in our estimate of the liability following the completion of a comprehensive review of sales tax reporting obligations across jurisdictions during 2020, higher payroll and related costs as a result of headcount growth of additional employees and higher bonuses, and increased recruitment costs to support growth initiatives. These increases were partially offset by lower legal expenses, reduction in allocated facility costs, lower utilization of IT services and decreased travel and entertainment expense.

Recapitalization Compensation Expense

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(In thousands, except percentages)"],["Recapitalization compensation expenses","","$","\u2014","","","$","48,998","","","$","\u2014"],["Percent of revenue","","","\u2014","","","","24","%","","","\u2014"],["Change over prior year","","$","(48,998",")","","$","48,998"],["Percent change over prior year","","","(100","%)","","NMF"]]
[[/GREPCENT_TABLE]]

NMF – not meaningful

During November 2020, we completed the Recapitalization transaction on behalf of existing unitholders. The transaction allowed existing unitholders to sell their units to new investors. In connection with the transaction, selling unitholders contributed $49.0 million towards bonuses paid to employees and related payroll taxes in 2020. These amounts have been recorded as Recapitalization compensation expenses within the consolidated statement of operations and as a contribution in members’ deficit within the consolidated balance sheet. The bonuses were paid to employees from departments which have historically been recorded in the below categories in the consolidated statements of operations:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31, 2020"],["Cost of revenue","","$","6,205"],["Research and development","","","8,891"],["Sales and marketing","","","7,951"],["General and administrative","","","25,951"],["Total recapitalization compensation","","$","48,998"]]
[[/GREPCENT_TABLE]]

Non-Operating Expenses

Interest Expense, Net

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(In thousands, except percentages)"],["Interest expense, net","","$","25,682","","","$","22,854","","","$","17,807"],["Percent of revenue","","","10","%","","","11","%","","","11","%"],["Change over prior year","","$","2,828","","","$","5,047"],["Percent change over prior year","","","12","%","","","28","%"]]
[[/GREPCENT_TABLE]]

The increase in interest expense, net in both 2020 and 2021 was primarily due to increased interest expense related to incremental borrowings following our debt refinancing in October 2020, offset by repayment in September 2021.

49

Loss on Extinguishment

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(In thousands, except percentages)"],["Loss on extinguishment","","$","10,303","","","$","\u2014","","","$","\u2014"],["Percent of revenue","","","4","%","","","\u2014","","","","\u2014"],["Change over prior year","","$","10,303","","","$","\u2014"],["Percent change over prior year","","NMF","","","","\u2014"]]
[[/GREPCENT_TABLE]]

NMF – not meaningful

The loss on extinguishment in 2021 relates to prepayment premium and unamortized debt issue costs following the repayment of borrowings under the Previous Credit Agreement in September 2021.

Other Expense, Net

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(In thousands, except percentages)"],["Other expense, net","","$","83","","","$","56","","","$","85"],["Percent of revenue","","","0","%","","","0","%","","","0","%"],["Change over prior year","","$","27","","","$","(29",")"],["Percent change over prior year","","","48","%","","","(34","%)"]]
[[/GREPCENT_TABLE]]

Other (income) expense, net in both 2020 and 2021 relates to foreign exchange gains and losses driven by fluctuations in exchange rates.

Provision for Income Taxes

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(In thousands, except percentages)"],["Provision for income taxes","","$","487","","","$","902","","","$","73"],["Percent of revenue","","","0","%","","","0","%","","","0","%"],["Change over prior year","","$","(415",")","","$","829"],["Percent change over prior year","","","(46","%)","","","1136","%"]]
[[/GREPCENT_TABLE]]

The increase (decrease) in provision for income taxes in 2020 and 2021 relates to change in mix of foreign jurisdiction income in the period.

Liquidity and Capital Resources

To date, we have primarily financed our operations through cash flows from operations and financing activities.

As of December 31, 2021, we had cash and cash equivalents of $254.6 million. Cash and cash equivalents primarily consist of money market mutual funds, which are highly liquid investments purchased with an original or remaining maturity of 90 days or less at the date of purchase. We believe our existing cash and cash equivalents will be sufficient to meet our operating working capital and capital expenditure requirements over the next 12 months. Our future financing requirements will depend on many factors, including our growth rate, revenue retention rates, the timing and extent of spending to support development of our platform and any future investments or acquisitions we may make. Additional funds may not be available on terms favorable to us or at all, including as a result of disruptions in the credit markets. See “Risk Factors” elsewhere in this Annual Report on Form 10-K.

50

The following table shows our cash flows from operating activities, investing activities and financing activities for the stated periods:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2021","","","2020","","","2019"],["","(In thousands)"],["Net cash provided by (used in) operating activities","$","3,358","","","$","(6,486",")","","$","(230,029",")"],["Net cash used in investing activities","","(5,025",")","","","(3,806",")","","","(3,372",")"],["Net cash provided by financing activities","","195,288","","","","51,041","","","","237,715"],["Effect of exchange rate changes on cash and cash equivalents","","(112",")","","","85","","","","87"],["Increase in cash and cash equivalents","$","193,509","","","$","40,834","","","$","4,401"]]
[[/GREPCENT_TABLE]]

Cash Flows from Operating Activities

Net cash provided by operating activities of $3.4 million during 2021 was primarily the result of our net loss plus non-cash charges including equity-based compensation, depreciation and amortization, debt extinguishment costs offset by changes in operating assets and liabilities that decreased operating cash flow by $43.4 million. Accounts receivable increased $17.3 million during the year. The increase is comprised of $8.8 million from growth in revenues and $8.5 million from ageing of small receivable balances across several customers due to short term deterioration in days sales outstanding which we have determined to be collectible. Prepaid expenses and other assets increased $13.7 million primarily from the prepayment of management fees to certain affiliates of the Principal Equity Owners in the amount of $9.6 million, insurance for our directors and officers and increased prepaid data costs. Deferred commissions increased $5.2 million due to higher revenue in the year. Accrued expenses decreased $3.5 million primarily due to payment of accrued reimbursement of excess contribution related to the Recapitalization transaction. Accrued sales tax liability decreased $8.5 million as we remitted sales tax payable for prior periods to different jurisdictions, and accrued interest on debt decreased $2.3 million due to lower interest payments due under the New Credit Agreement.

Net cash used in operating activities of $6.5 million during 2020 was primarily the result of our net loss plus non-cash charges including equity-based compensation, depreciation and amortization. Cash flows resulting from changes in assets and liabilities include an increase in accounts receivable, an increase in accrued expenses and other liabilities, an increase in accrued sales tax liability, an increase in deferred commissions, and an increase in accrued interest on debt. Accounts receivable increased as a result of increased revenue and timing of collections. Accrued expenses and other liabilities increased due to accrued reimbursement to members of an excess contribution following the Company’s calculation of actual costs incurred related to the Recapitalization. Accrued sales tax liability increased due to a change in our estimate of the liability following the completion of a comprehensive review of sales tax reporting obligations across jurisdictions during 2020. The increase in deferred commissions is due to higher revenues during the period. Accrued interest on debt increased due to incremental borrowings following our debt refinancing in October 2020.

Net cash used in operating activities of $230.0 million during 2019 was primarily due to payment of legal fees and settlement of outstanding legal matters. The Company secured additional borrowing capacity through amendments to our credit facility and raised additional capital from existing investors to fund the settlement of a legal matter and related fees.

Cash Flows from Investing Activities

Net cash used in investing activities of $5.0 million during 2021 was attributable to the purchase of property and equipment, and internally developed software.

Net cash used in investing activities of $3.8 million during 2020 was attributable to the purchase of property and equipment.

Net cash used in investing activities of $3.4 million during 2019 was attributable to the purchase of property and equipment.

51

Cash Flows from Financing Activities

Net cash provided by financing activities during 2021 was $195.3 million, of which $582.2 million was proceeds from the IPO, net of underwriting discounts, $53.6 million was proceeds from borrowings, net of debt issuance costs from our New Credit Agreement, $2.8 million was proceeds from the exercise of options and $1.6 million was proceeds from the issuance of common units to directors appointed prior to the IPO, which was offset by $434.2 million repayment of borrowings, $5.1 million payment of expenses associated with the IPO, $2.0 million prepayment premium and legal fees in relation to early repayment of the Previous Credit Agreement, and $2.2 million from minimum tax withholding paid on behalf of employees for net unit settlement.

Net cash provided by financing activities during 2020 was $51.0 million, of which $202.7 million was from proceeds from borrowings under an amendment to our credit facility and $49.0 million was from contributions from members for Recapitalization compensation expenses, which was offset by $173.2 million of dividends and distributions to members, $21.6 million for the repayment of borrowings and a $5.8 million payment of debt issuance costs.

Net cash provided by financing activities during 2019 was $237.7 million, of which $137.0 million was from proceeds related to the completion of a rights offering, $2.6 million was from proceeds from the exercise of options and $105.0 million was from proceeds from borrowings under our credit facility, which was offset by a $2.6 million payment of debt issuance costs, $3.8 million for the repurchase of common units and $0.5 million for the repayment of borrowings.

Previous Credit Agreement

On October 19, 2020, we entered into the Fifth Amendment to the Credit Agreement with Ares Capital Corporation and Golub Capital LLC. The agreement provided for a total term loan of $435 million and revolving line of credit of $30 million. Under the terms of the Fifth Amendment to the Credit Agreement, we were required to maintain certain customary affirmative and negative covenants, including covenants that limit our ability to, among other things, incur indebtedness, merge or consolidate, dispose of assets, make investments, make acquisitions, enter into transactions with affiliates, pay dividends or make distributions. We were also required to maintain compliance with a consolidated net leverage ratio. The line of credit and term note agreements also included customary events of default.

The outstanding borrowings under the Fifth Amendment to the Credit Agreement of $432.7 million were repaid in full in September 2021 in connection with the closing of the IPO. The repayment of the borrowings resulted in a loss on extinguishment of $10.3 million.

New Credit Agreement

In connection with the closing of the IPO, Clearwater Analytics, LLC (the “Borrower”) has entered into a new credit agreement with JPMorgan Chase Bank, N.A., that includes a $55 million term loan facility (the “New Term Loan”) and a $125 million revolving facility (the “Revolving Facility”). The New Term Loan Revolving Facility will be used for working capital and other general corporate purposes (including acquisitions permitted under the New Credit Agreement).

The interest rates applicable to the loans under the New Credit Agreement are based on a fluctuating rate of interest determined by reference to a base rate plus an applicable margin of 0.75% or a LIBOR rate plus an applicable margin of 1.75%, in each case with a step-up of 0.25% if certain secured net leverage levels are not achieved. The applicable margin is adjusted after the completion of each full fiscal quarter based upon the pricing grid in the New Credit Agreement. The revolving commitment has an unused commitment fee of 25 basis points, stepping up to 30 basis points if certain secured net leverage levels are not achieved.

Under the New Credit Agreement, the term loan amortizes at a rate of 5.00% per annum, paid quarterly. The New Credit Agreement contains mandatory prepayments to the extent the company incurs certain indebtedness or receives proceeds from certain dispositions or casualty events.

The obligations of the Borrower under the New Credit Agreement are anticipated to be jointly and severally guaranteed by its direct parent and certain of its subsidiaries (collectively, the “Guarantors”, and together with the Borrower, the “Loan Parties”). The obligations of the Loan Parties are secured by a first priority lien on substantially all of their assets, subject to customary exceptions.

The New Credit Agreement contains customary affirmative and negative covenants, including, without limitation, covenants that restrict our ability to borrow money, grant liens, make investments, make restricted payments or dispose of assets, and customary events of default. Specifically, we are required to maintain a consolidated secured net indebtedness to consolidated EBITDA ratio of not more than 4.75:1.00 as of the last day of each fiscal quarter commencing with the fiscal quarter ending December 31, 2021. We were in compliance with all covenants under the New Credit Agreement as of December 31, 2021.

52

Critical Accounting Estimates

Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements and related notes, which have been prepared in accordance with GAAP. We review the accounting policies used in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities.

On an ongoing basis, we evaluate the process we use to develop estimates. We base our estimates on historical experience and on other information that we believe is reasonable for making judgments at the time the estimates are made. Actual results may differ from our estimates due to actual outcomes being different from those on which we based our assumptions.

We believe the following accounting policies contain the more significant judgments and estimates used in the preparation of our consolidated financial statements:

•
Revenue recognition and deferred revenue

•
Equity-based compensation

•
Income taxes

Revenue recognition and deferred revenue

We earn revenues primarily from providing access to our SaaS platform solution to our clients, and to a lesser degree, from services that support the implementation on the platform. We recognize revenue when we satisfy performance obligations under the terms of the contract in an amount that reflects the consideration we expect to receive in exchange for the services. We determine the appropriate amount of revenue to be recognized using the following steps: (i) identification of contracts with clients, (ii) identification of the performance obligations in the contract, (iii) determination of transaction price, (iv) allocation of contract transaction price to the performance obligation, and (v) recognition of revenue when or as we satisfy a performance obligation. Often contracts contain more than one performance obligation. Performance obligations are the unit of accounting for revenue recognition and generally represent the distinct services that are promised to the client.

We typically bill our clients monthly in arrears based on a percentage of the average of the daily value of the assets within a client’s accounts on our platform. Payment terms may vary by contract but generally include a requirement of payment within 30 days following the month in which services were provided. Clients generally have the right to cancel with 30 days’ notice with no penalty.

Our services allow the client access without taking possession of the software. Non-refundable fees invoiced in advance of the delivery of our performance obligations are deemed set-up activities and are deferred as a material right and recognized over time, typically 12 months. After set-up activities, clients typically receive benefits from implementation services prior to the “go live” date, at which point they can use the platform as intended in the arrangement. We have determined these implementation services are generally a separate performance obligation. As our platform must stand ready to provide the services throughout the contract period, revenues are recognized as the services are provided over time beginning on the date the service is made available as intended in the arrangement.

Deferred revenue generally consists of non-refundable fees invoiced during the period in which we are performing set-up activities. Deferred revenue that will be recognized during the succeeding twelve-month period is recorded as current deferred revenue.

Equity-Based Compensation

We measure and recognize equity-based compensation expense for instruments based on the estimated fair value of equity-based awards on the date of grant using the Black-Scholes option-pricing model for options and the fair value of the equity on the date of grant for RSUs. We recognize equity-based compensation expense over the requisite service period on a straight-line basis, which is generally consistent with the vesting of the awards, based on the estimated fair value of the equity-based awards issued to employees and directors that are expected to vest. Equity-based compensation that vests on a performance event, such as annual targets for the Company, begins to be recognized at the date that the performance event becomes probable, and compensation expense is recognized on a straight-line basis over any remaining service period. If there are any modifications of equity-based awards, we may be required to accelerate, increase, decrease or reverse any equity-based compensation expense on the unvested awards. The Company records forfeitures when they occur for all equity-based awards.

53

Income Taxes

We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the extent we believe it is more likely than not that they will not be realized. We consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, carryback potential if permitted under tax law, and results of recent operations.

We record uncertain tax positions in accordance with ASC 740, Income Taxes on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. We consider many factors when evaluating our uncertain tax positions, which involve significant judgment and may require periodic adjustments. The resolution of these uncertain tax positions in a manner inconsistent with management’s expectations could have a material impact on our condensed consolidated financial statements. We recognize interest and penalties related to uncertain tax positions as a component of our provision for income taxes. Accrued interest and penalties are included with the related tax liability.

We account for amounts payable under the TRA in accordance with Accounting Standards Codification (“ASC”) Topic 450, Contingencies. As such, subsequent changes to the measurement of the TRA liability are recognized in the statements of operations as a component of other income (expense), net.

JOBS Act Accounting Election

We meet the definition of an emerging growth company under the Jumpstart Our Business Startups Act of 2012, which permits us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have elected to use this extended transition period until we are no longer an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period. As a result, our financial statements may not be comparable to companies that comply with new or revised accounting pronouncements applicable to public companies.