Confluent, Inc.

Hi, everyone. Welcome to the Confluent Q2 2022 Earnings Conference Call. I'm Shane Z from Investor Relations, and I'm joined by Jay Kreps, Co-Founder and CEO, and Stephan Tomlinson, CFO. During today's call, management will make forelooking statements regarding our business, operations, financial performance, and future prospects, including statements regarding our financial outlook for the fiscal third quarter of 2022 and fiscal year 2022. These following statements are subject to risks and uncertainties which could cause actual results to differ materially from those anticipated by these statements. Further information on risk factors that could cause actual results to differ is included in our most recent Form 10-Q filed with the SEC. We assume no obligation to update these statements after today's call except as required by law. As a reminder, certain financial measures used on today's call are expressed on a non-GAAP basis. We use these non-GAAP financial measures internally to facilitate analysis of financial and business trends and for internal planning and forecasting purposes. These non-GAAP financial measures have limitations and should not be considered in isolation from or as a substitute for financial information prepared in accordance with GAAP. A reconciliation between these GAAP and non-GAAP financial measures is included in our earnings price release and supplemental financials, which can be found on our investor relations website at investors.confluent.io. With that, I'll hand it over to Jay.

Thanks Shane. Welcome everyone to our second quarter earnings call. Confluent delivered another strong quarter, exceeding the high end of our guidance on all metrics. Total revenue grew 58% year-over-year to $139 million. Confluent cloud revenue grew 139% year-over-year and represented 34% of total revenue in the quarter. Confluent Cloud continues to increase as an overall mix of our business and is seeing rapid adoption across our customer base as reflected by strong consumption trends. We're especially proud of our performance given the uncertain macro environment we're currently operating in. I'll start by touching briefly on this topic, why Confluent continues to see strong demand despite economic headwinds. There are two reasons for this durability. First, our product sits in the operational stack, powering applications that directly serve critical business operations and real-time customer experiences. Given this criticality, it can't be switched off without a complete disruption to the operations of the business. Our 2022 State of Data in Motion report underscores this, finding that of the nearly 2,000 IT and engineering leaders surveyed, more than 80% said real-time data streams are critical to building responsive business processes and rich customer experiences. Second, one of the key value propositions of a managed cloud service such as Confluent Cloud is cost savings. Using Confluent Cloud has significant TCO advantages compared to trying to build out internal teams of engineers to attempt to build internal services around open source. SAS Institute is a customer that perfectly illustrates these dynamics. SAS is a marketing analytics powerhouse helping more than 80,000 businesses like Discover, Honda, Levi's, and Nestle transform data into real-world intelligence, making their marketing campaigns more targeted, more personal, and more relevant. SAS initially built its real-time data platform on open source Kafka, but they soon ran into scalability issues from self-supporting open source Kafka that made it difficult to adjust to changing demand. Plus, the operational overhead and complexity were driving significant costs. So SAS turned to Confluent for a complete data streaming platform that scales both compute and storage on demand, even amid unpredictable ebbs and flows of traffic. With Confluent now as the backbone of their next generation Customer Intelligence 360 platform, SaaS can easily stitch together data from multiple sources to find and act on fresh and timely insights for their customers. Key to this ability to serve mission critical use cases and to help customers recognize the cost and agility advantages I described are the underlying capabilities that Confluent Cloud provides. Kafka has become ubiquitous and is the de facto standard for data in motion used by over 70% of the Fortune 500. But Confluent Cloud is not just a matter of putting Kafka in the cloud. In building Confluent Cloud, we rethought virtually every layer of the stack from how data is routed over the network, how it is processed, where it is placed, and how it is stored. This deep engineering investment is necessary to provide a truly cloud-native service that can meet the needs of the most mission-critical use cases and can help customers truly step back from the operations of the service and focus on their applications. To achieve this, over the last five years, we've poured more than 3 million engineering hours into Confluent Cloud. Today, it represents a 10x better Kafka service with a deep competitive moat of hard technology. By making a service that is 10x better than open source Kafka, Confluent lets organizations avoid investments in low-level operations, monitoring, and scaling, and be able to instead rely on a service that can scale elastically with their needs. This is what drives the substantial cost savings customers see when they adopt our service. As we shared last quarter, a recent Forrester study identified TCO savings of more than $2.5 million for businesses that used Confluent, translating to an ROI of 257% in less than six months. Another example that demonstrates both the mission-critical nature of our use case as well as the economic value of Confluent Cloud is ETC, a leading electronic toll collection company. To support next-generation congestion management services, ETC collects real-time sensor input from millions of cars and IoT devices across city transportation corridors, totaling 2 billion toll transactions per year. By collecting and processing this data continuously and in real time with Kafka, ETC produced the first truly predictive dynamic pricing algorithm in the industry. But as their use of Kafka skyrocketed from onboarding new customers, increased traffic congestion, and expanding toll and smart mobility projects, so did their total cost of operating and maintaining open source Kafka. After conducting an internal TCO analysis, ETC moved to a fully managed Kafka on Confluent Cloud. By making the move to Confluent Cloud, ETC saved an average of 20% on infrastructure costs, significantly reduced their downtime risk, and was able to reallocate about 50% of their engineering and development talent that was dedicated to managing Kafka to more strategic projects that accelerate innovation. Our relationship across the software and data landscape remain core to our everywhere pillar of differentiation and are a key part of our go-to-market. We made a few notable announcements on the partnership front that deepened our key partner relationships. First, we are thrilled to announce the launch of a Confluent Cloud reseller program. Organizations can accelerate their adoption of data in motion by purchasing Confluent Cloud directly from the consulting partners they already work with, who know their business and can offer localized support. To start this program, we expanded our strategic collaboration agreement with AWS by joining the marketplace channel program, consulting partner, private offers. Now we can work with 17 leading data streaming partners, including slower mega zone and SBA to make it easier for our customers to unlock the full value of data streaming throughout their business. This quarter, we were also recognized by both Microsoft and MongoDB as one of their top partners for 2022. We're incredibly proud and thankful for our strong partnerships with cloud service providers and technology partners. I'd also like to spend a few minutes on work we're doing to accelerate usage for customers at the early stages of their data in motion journey. We've previously discussed our customer growth go-to-market model that builds a product-led, consumption-oriented journey down the data in motion adoption path. The early stage of this journey is particularly critical for customer acquisition and for making Confluent Cloud the default starting point for developers. This early stage of adoption often starts with developers experimenting with pilots and proof of concepts or simply learning the new technology. At this stage, it's critical for the onboarding process to be low friction so a developer can instantly gain full access to the power of our platform with minimal disruption. To make this process even easier for developers, I'm very pleased that towards the end of our first quarter, we removed the requirement of entering credit card information for the free trial of our product. This paywall removal is a strategic move that aligns well with our customer growth go-to-market model. allowing us to reduce the friction for developers to test our product, grow usage, and progress to the production stage. And we are already seeing strong returns at the top of our funnel, as evidenced by the accelerating growth in Q2 signups, which are up more than 130% year over year and up more than 50% sequentially. This paywall removal has been incredibly successful in increasing signups, but it has also created some short-term noise in our total customer count metric. Users who would have incurred small amounts of spend and been previously counted as customers in their initial trial phase will now show up as just signups, not paying customers, which impacts our customer count growth in Q2. This means that the change has eliminated a large chunk of pre-production customers paying us an average of less than a few hundred dollars per quarter, creating a reset of our pay-as-you-go customer count. Reset of customer count aside, it's unquestionably the right strategy for our business as our customers can now test drive Confluent risk-free. And for us, the reduction in developer risk and friction drives easier land and ultimately more paying customers as the larger cohort of trials leads to sticky production applications that grow and expand at scale. And finally, I'd like to share that after a four-year impactful run at Confluent, Ganesh Srinivasan will be stepping back from his role as Chief Product Officer. I will be acting as Interim Chief Product Officer as we search for a new leader. Ganesh, we wish you all the best and thank you for your many contributions. Thanks again for joining us today. We remain very confident in our market opportunity and positioning headed into the second half of the year, and we look forward to seeing many of you on the road in the coming months, including at Current, a new data streaming industry event we're hosting in October. With that, I'll turn the call over to Stefan to walk through the financials.

Thanks, Jay. We delivered a strong second quarter, exceeding the high end of our guidance for the fourth consecutive quarter. Key highlights include strong Confluent Cloud growth, best-in-class net retention, and significant margin improvements, which are a testament to the team's performance. RPO in the second quarter grew 81% year-over-year to 591.3 million. Current RPO, estimated to be 62% of RPO, was approximately 364 million, up 62% year-over-year. Total revenue grew 58% year-over-year to $139.4 million. Subscription revenue grew 62% year-over-year to $127 million and accounted for 91% of total revenue. Within subscription, Confluent Platform revenue was 80 million, up 36% year over year, and accounted for 57% of total revenue. With Confluent Platform, we're positioned to address the broader opportunity around hybrid cloud, where customers bridge between on-prem and multi-cloud environments, using Confluent Platform and adding Confluent Cloud over time. Confluent Platform subscription model also adds more visibility to our revenue streams. Confluent Cloud revenue in the quarter exceeded our expectations, up 8.1 million sequentially, representing our largest net revenue growth to date. On a year-over-year basis, Cloud revenue grew 139% to 47 million and accounted for 34% of total revenue, compared to 22% of revenue a year ago. And for the third consecutive quarter, Confluent Cloud accounted for more than 50% of new ACV bookings. Our strong cloud performance was driven by healthy consumption across industries with particular strength in technology and financial services. Turning to the geographic mix of revenue, revenue from the US grew 54% year over year to 87.6 million. Revenue from outside the US grew 64% year over year to 51.9 million. Turning to customers, the growth in our large customer base continued to be robust. We ended the quarter with 857 customers with at least 100K in ARR, up 39% year over year, and 107 customers with at least 1 million in ARR, up 53% year over year. Our 100K customer cohort contributed more than 85% of total revenue in the quarter in line with historical trends. Our diversified customer base spans across various industries, including financial services, technology, retail, telecom, public sector, healthcare, media and entertainment, and many more. Total customers ended at approximately 4,120 of 46% year over year in flat sequentially. There are two components of total customer count, pay-as-you-go and committed contract customers. As Jay discussed earlier, paywall removal has driven strong growth acceleration in signups, which is a key indicator for the overall health of our customer funnel, and it's a testament to the strong demand for our cloud product. While paywall removal had a short-term impact on the number of pay-as-you-go customers in our total customer count, we're very pleased to see the continued momentum in our committed customer base. We added 128 net new committed customers in Q2 compared to 113 in the previous quarter and 80 a year ago. The vast majority of our revenue is attributed to our committed customers, which provides a high degree of visibility into our revenue in any given quarter. Dollar-based net retention rate in the quarter remained above 130% for the fifth consecutive quarter, driven by 90% plus gross retention and strong expansion across both of our product offerings. NRR for cloud was substantially higher than the overall NRR for the company, and NRR for hybrid customers continued to be the highest. Moving on to gross margins and profitability, I'd like to note that I'll be referring to non-GAAP results unless stated otherwise. Total gross margin was 70.6% and subscription gross margin was 76.8%. Our platform gross margin remains steady and strong. Our cloud gross margin improved substantially driven by our continued efforts to optimize hosting costs and improve pricing with our cloud service providers, which offsets some of the headwind of a higher cloud revenue mix to total gross margin. The concerted efforts and focus on improving the unit economics of the cloud business have been paying off and will continue to drive efficiencies in the future. In the near term, we continue to anticipate total gross margin to fluctuate near our midterm target of approximately 70%. Turning to profitability and cash flow, operating margin improved eight percentage points year over year to negative 33.5%. The improvement was driven by revenue outperformance, improving sales efficiency, and our focus efforts to proactively manage spend across the organization, such as controlling the rate and pace of hiring. Net loss per share was negative 16 cents, using 278.3 million basic and diluted weighted average shares outstanding. free cash flow margin improved approximately 25 percentage points year over year to negative 26.5%, driven by strong collections. We ended the second quarter with $1.96 billion in cash, cash equivalents, and marketable securities. Now I'll turn to our outlook. We're raising our revenue and profit guidance for Q3 and the year, but the magnitude of the raise has been tempered by the current macro dynamics. Towards the back half of June and through July, we saw increased scrutiny on deal approvals. We believe this is driven by customers' cautious view on the current macro environment, balanced with their need to continue with the digital transformation initiatives, with data in motion being a must-have capability. We're assuming this dynamic continues through the rest of the year and have estimated approximately $2 to $3 million negative impact on our Q3 revenue guidance and approximately $4 to $6 million negative impact on fiscal year 2022. We've adjusted our spending levels in the second half to ensure we meet our operating margin targets, and incremental investments we make will be in the highest ROI segments of the business. We'll continue to monitor and course correct if the conditions change materially and action is warranted. Our goal in the midterm remains delivering high growth with annual margin improvements and turning non-GAAP profitable exiting Q4 2024. Turning now to guidance, for the third quarter 2022, we expect revenue to be in the range of $143 to $145 million, representing growth of 39 to 41% year-over-year. Due to our Q2 sequential outperformance, we expect Q3 sequential cloud revenue net add to be between 8 and 8.5 million. And we expect non-GAAP operating margin to be approximately negative 33%. Non-GAAP net loss per share to be in the range of negative 19 cents to negative 17 cents, using approximately 282 million weighted average shares outstanding. For the full year 2022, we expect revenue to be in the range of 567 to 571 million, representing growth of 46 to 47% year over year. Non-GAAP operating margin to be in the range of negative 35 to negative 34%. and non-GAAP net loss per share in the range of negative 73 to negative 69 cents using approximately 280 million weighted average shares outstanding. Turning to free cash flow, we changed the structure of the payout for the annual bonus from one lump sum payment in Q123 to two payments, one in Q3 2022 of approximately 14 million and the remaining payment in Q123. Due to the timing of these payments, Q3 in fiscal year 2022 free cash flow margin will be lower than originally anticipated, while FY23 free cash flow margin will be better than previously anticipated. Before turning to Q&A, I'd like to invite you to join our investor session at Current 2022 on Tuesday, October 4th in Austin, Texas. We'll provide an update on our strategy, product, and customers. To join in person, please contact IR for the registration information. The program will be webcast live on our IR website beginning at 2 p.m. Central Time. In closing, our second quarter results underscore our ability to drive high growth with increased operating leverage. While the near-term macro environment is uncertain, the secular tailwind for data in motion is firmly intact. With a market-leading data streaming platform and a track record of delivering on our commitments, we're well-positioned to drive durable growth and improve profitability ahead. Now, Jay and I will take your questions.