Confluent, Inc.

Hi, everyone. Welcome to the Confluent Q4 2022 Earnings Conference Call. I'm Shane Z from Investor Relations, and I'm joined by Jay Krabs, 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 guidance for the fiscal first quarter of 2023 and fiscal year 2023. These forelooking 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. Unless stated otherwise, certain financial measures used on today's call are expressed on a non-GAAP basis, and all comparisons are on a year-over-year 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 press release and supplemental financials, which can be found on our investor relations website at investors.confluent.io. References to profitability on today's call refer to non-GAAP operating margin, unless stated otherwise. For planning purposes, we will be holding Investor Day 2023 in New York City on Tuesday, June 13. Please save the date. With that, I'll hand the call over to Jay.

Thanks, Shane. Good afternoon, everyone, and welcome to our fourth quarter earnings call. We ended fiscal year 2022 with fourth quarter results once again exceeding the high end of our guidance on all metrics. Total revenue grew 41% to $169 million. Confluent Cloud revenue grew 102% to $68 million. And non-GAAP operating margin has improved by 20 percentage points. We're pleased with these results, especially in light of the macroeconomic pressure we saw in the quarter. On today's call, I wanted to provide an update on how the macroeconomic environment is impacting our business, how we're adjusting for it, and how we continue to drive innovation and differentiation and capture the massive market opportunity ahead. I'll start with a few things that haven't changed. As we've discussed in previous earnings calls, we began seeing customers institute additional budget inspection in pockets across geographies in June, and this dynamic has continued. The main impact on our business has been elongated deal cycles with customers. Our overall win rate remains robust, our pricing is steady, and we have been able to close a substantial amount of deals pushed from prior quarters. This is quite encouraging because it reflects the strong vote of confidence by our customers in the strategic value and cost savings our platform brings to them. Now here's what has changed. The increased level of budget scrutiny appears to have become the new norm. More deals took longer to get approval, and some expansions were slower than in the past. This is evident in the number of deals that pushed to calendar 2023, which impacted our RPO growth and net retention rate in the fourth quarter. While the vast majority of the deals are still in our deal path, this does indicate that increased scrutiny continues to exert pressure on large deals and new business. We think that this combination of higher interest rates and economic uncertainty puts pressure on the purchasing environment. The result is a substantially different environment for tech than what we were operating in a year ago. We are setting our plans for 2023 in light of this and making some changes in how we operate. We have taken steps to adjust our cost structure to accelerate our time to profitability by one year, while still maintaining approximately 30% revenue growth. Specifically, we've undertaken a restructuring of our workforce, optimizing for top strategic priorities in high ROI business areas. This includes a reduction of our workforce by approximately 8%. We're also taking steps to rationalize our discretionary spend and real estate footprint. We don't take the decision to restructure our workforce lightly. We're saying goodbye to many friends and colleagues across the company. We thank them for their important contributions to Confluent and are making sure that the departing team members are taken care of. I want to be clear that we're making this change without reducing our focus on the long term. It's essential that Confluent dominate the $60 billion market in front of us, and the cuts we have made do not compromise that ambition. While the restructuring will help streamline sales and marketing spend, we're preserving quota-carrying capacity and continuing to prudently invest in our go-to-market to drive new business and durable growth in the years ahead. We will also continue to support appropriate levels of R&D investment to ensure our product is the long-term winner in our space. Despite the difficulty of the change, the resulting efficiency allows us to pull in our target of non-gap operating margin break even by 12 months. This means that exiting Q4 of this year, we will have shown a 41 point increase in non-gap operating margin in just 24 months. Exiting 2023, less than one year from now, we will be a market leader in a deeply strategic space, operating a profitable business and driving sustained high growth in a very large market. This market leadership is driven by our platform differentiation and the significant TCO advantages we deliver to our customers. To better illustrate that, let me share our customer story. Wix is the leading website development platform in the world, which in turn serves around 1 billion unique visitors each month. Data streaming is at the heart of many of the digital experiences their clients create, from online bookings to e-commerce to personalized content. And Wix's data streaming journey, like so many others, began with open source Kafka. They quickly discovered, however, that the open source approach required heavy DevOps resourcing and resulted in challenges with scale, time to market, reliability, and latency. Ultimately, they chose Confluent Cloud to mitigate risk, reduce costs, and increase productivity. That migration quickly resulted in a 90% ROI. This is just one of many examples that shows the strength in the underlying demand for our data streaming platform. This is because Confluent serves operational workloads that are directly responsible for driving the core operations of our customers, making this a key element of their digital strategy going forward. In fact, IDC predicts that by 2025, event streaming technologies will be used by 90% of the global 1,000 to deliver real-time intelligence to improve outcomes such as customer experience. And in a separate study, IDC found that of the companies that are currently using streaming data, over 80% have plans to invest in new streaming capabilities in the next 12 to 18 months. Today, our product is the category leader in data streaming platform technology bar none. A key focus for us is ensuring we continue to stay ahead as this category grows and evolves. One critical element of these investments that I want to discuss today is stream processing. That is technology to enable our customers to build applications on top of the real-time data streams that Confluent provides. A simple way to understand the importance of stream processing is by analogy to the world of data at rest in traditional databases. A database solves two problems. It acts as a store of data and it executes queries that process the data. This combination of data and processing is what makes databases so easy and ubiquitous. A similar combination of capabilities is needed as we move from data at rest to data in motion. In the world of data in motion, data isn't just stored, it's a continual stream that updates as the world changes. The natural complement to this is stream processing, that is, building applications that continuously update, react or respond to changes in the world. The core of Kafka acts to store these streams and to be a hub for connectivity, kind of like a central nervous system that transmits the real-time impulses of what's happening in the business. Stream processing acts a bit like the brain, taking real-time action on the impulses the nervous system conveys. Increasingly, businesses of all kinds are leveraging stream processing to drive the data-driven applications that better serve customers and drive intelligence and efficiency in their operations. Confluent has long contributed to the emerging stream processing ecosystem around Kafka with Kafka Streams, an application development library for stream processing, and KSQL. This quarter, we took a major step in furthering these capabilities with the acquisition of Imrock, a stream processing company that offers a fully managed service for the open source project Apache Flink. Imrock has joined Confluent to help us add a fully managed Flink offering to Confluent Cloud. This is a very exciting step for Confluent, and I want to explain a little bit about our strategy in this area. We've watched the excitement around Flink grow for years and saw it gaining adoption among many of the most sophisticated technology companies in the world, including Citi, Goldman Sachs, Pinterest, LinkedIn, Netflix, Uber, and Apple. This popularity has been driven by a rich feature set, including a powerful processing model that generalizes both batch and stream processing. It is battle-tested at scale on some of the largest real-time processing workloads on the planet. And perhaps most importantly, it has an incredibly smart, innovative community driving it forward. In short, we believe that Flink is the future of stream processing, and by adding it to Confluent Cloud, we can significantly advance our data streaming platform and help our customers get even more value from their data streams. In terms of our product plans, we plan to launch the first version of our Flink offering in Confluent Cloud later this year. We want to follow the same key principles we've brought to our Kafka offering. Building a service that is truly cloud native is a complete and fully integrated offering and is available everywhere across all the major clouds. We think this combination of an open, popular interface offered with a deeply differentiated cloud native core is the key to success for cloud data systems. We think that over time, this offering can be a substantial driver of growth in our business, comparable in size to Kafka itself. Adding this new offering will allow us to better monetize the compute and application development around data streams, in addition to the core stream data, expanding spend of existing customers. Further, by making streaming easier, we pull more workloads into our streaming platform. In addition, the processing of streams generates more streams, helping to accelerate the growth of our Kafka, Connector, and data governance products. In this way, stream processing accelerates consumption in a multiplicative fashion, which we think will be a very positive tailwind for growth as these capabilities come to maturity. To help execute both this initiative, as well as our overall product strategy, I'm pleased to announce that Sean Cloez joined Confluent last quarter as our Chief Product Officer. Sean joins us from MuleSoft, where he served as CPO, and before that, Atlassian, where he served as Head of Growth. Sean is a technologist, passionate about the space, and is the right person to lead the team through the data streaming era. And finally, I'd like to share that Larry Schertz has stepped down from his role as chief revenue officer. Larry, we wish you all the best and thank you for your many contributions in helping us scale and evolve our sales team. We will not be looking to backfill this role. Larry reported into Erica Schultz, our president of field operations, and we'll revert to our prior org structure with Erica managing the theater sales leaders directly. In closing, the demand for data streaming remains strong. We've accelerated our plan to become profitable by the end of the year, and we'll continue to invest in building the data streaming platform that will become the central nervous system of every company. And with that, I'll turn the call over to Stefan to walk through the financials.

Thanks, Jay. Good afternoon, everyone. I'd like to start with a brief recap of the full year results. In fiscal year 2022, we accomplished our stated goals of driving high revenue growth and improving annual operating margin. Total revenue grew 51% to 585.9 million. Confluent Cloud revenue grew 124% to 211.2 million with substantially improved unit economics and operating margin improved 11 points. I'd like to take a moment to thank all of our team members at Confluent, our customers and partners for their contributions throughout the year. Turning to the fourth quarter, as Jay mentioned, the results exceeded the high end of our guidance on all metrics, highlighted by strong revenue growth, Confluent Cloud momentum, robust customer additions, and substantial margin improvements. These results are a testament to the mission critical and strategic role of our data streaming platform and our proven ability to drive high growth while improving efficiencies and profitability in a challenging economic environment. RPO for the fourth quarter grew 48% to 740.7 million. Current RPO, estimated to be 62% of RPO, was approximately 456.2 million, up 43%. Both metrics were lighter than we expected. In addition to what Jay discussed earlier, we saw less urgency by customers to sign deals in the last couple of weeks than we typically would see in a calendar Q4, primarily in our enterprise business as some customers evaluated macro and opted to delay their purchases to FY23. We didn't see any material changes in discounting, contract duration, or win rates relative to the previous quarter, and I'm pleased to report that a number of these Q4 push deals have closed in Q1, which points to the underlying demand for our solution. Dollar-based net retention rate in the quarter was also healthy, just under 130%. NRR for cloud and hybrid were both comfortably above 130%, with hybrid NRR continuing to be the highest. Gross retention rate remained strong and was above 90%, reflecting the strength of our product differentiation and TCO advantages against alternative solutions, including open source Kafka. New customer additions continue to rebound since our paywall removal in March. We added 290 net new customers during the quarter, ending at approximately 4,530 total customers, up 31%. New customer additions were driven by Confluent Cloud. The growth in our large customer base was also robust. We added a record 70 customers with 100K or more in ARR in the quarter, bringing the total to 991 customers, up 35%. These large customers contributed more than 85% of total revenue. We also had a record quarter of customers with $1 million or more in ARR, adding 20 customers during the quarter, an all-time high, bringing the total to 133 customers, up 51%. And we ended FY22 more than doubling our $5 million plus ARR customers from a year ago, including a growing number of $10 million plus ARR customers. Turning to revenue, total revenue grew 41% to 168.7 million. Subscription revenue grew 44% to $155.3 million and accounted for 92% of total revenue. Confluent Cloud as a percentage of new ACV bookings was greater than 70% in Q4, which represented our fifth consecutive quarter of cloud exceeding 50% of total new ACV bookings. As cloud accounts for a larger share of new ACV bookings, Confluent Platform will have lower ACV and less upfront revenue. This upfront dynamic was reflected in Confluent Platform revenue, which was 87 million, up 17%, and accounted for 52% of total revenue. Confluent Cloud revenue was 68.4 million, up 102% and accounted for 41% of total revenue compared to 28% of revenue a year ago. This translates to a record sequential revenue add of $11.5 million for Confluent Cloud compared to $9.9 million last quarter and $7 million a year ago. Our Confluent Cloud momentum was driven by our continued focus on use case expansion, decreasing time to value for customers, and supporting their mission-critical workloads with strong consumption across industry verticals. Turning to the geographic mix of revenue, revenue from the U.S. grew 35% to $100.5 million. Revenue from outside the U.S. grew 50% to $68.2 million. Moving on to margins, I'll be referring to non-GAAP results unless stated otherwise. Total gross margin was 73% and subscription gross margin was 78.7%. The unit economics of our cloud offering continue to improve, driving another quarter of healthy gross margin despite a continued revenue mix shift to Confluent Cloud. Moving forward, we anticipate total gross margin to fluctuate between 70% and 72%. Turning to profitability and cash flow, operating margin improved 20 percentage points to negative 21.5%. Through proactive expense management, productivity and efficiency initiatives, and a disciplined investment approach, we drove improvement in every category of the P&L, with the most pronounced progress made in sales and marketing improving eight percentage points and gross margin improving five percentage points. Net loss per share was negative $0.09 using 286.7 million basic and diluted weighted average shares outstanding. Free cash flow margin improved 4 percentage points to negative 18.3%. And we ended the fourth quarter with $1.93 billion in cash, cash equivalents, and marketable securities. Turning now to the MROC acquisition. MROC is a pre-revenue company and will be absorbing the company into our engineering team. We close the acquisition in Q1, and we expect no material impact on our financials in FY23. The additional expenses have been incorporated in our guidance. Looking forward to FY23. As Jay discussed earlier, we've made a decision to accelerate our path to profitability by one year from Q4 24 to Q4 23, while resourcing the company to deliver approximately 30% annual revenue growth rate in 2023. Over the last two years, we've made significant and prudent investments in the business as we address our $60 billion market. We've more than doubled our company headcount, and we've actively been managing the growth rate of spend, and it has trended down from 68% in FY21 to 39% in FY22, and it's expected to go down to approximately 15% in FY23. We're seeing strong returns on our investments as we continue to grow our market share and extend our product lead with a highly differentiated platform. On the go-to-market side, 50% of our sales reps are now fully ramped, and we expect the mix to be in the range of 55% to 60% exiting this year. Additionally, compared to last year, we have improved visibility into our FY23 revenue streams, as approximately 60% of revenue comes from current RPO. Coupled with the strong growth in 100k plus ARR customers, which contribute more than 85% of revenue each quarter. And our NRR remained very healthy, just under 130%, which supports our growth. Given this backdrop, we believe accelerating our path to profitability by one year while continuing to deliver high growth is the optimal decision, especially as companies are now operating in an environment of high interest rates and macro uncertainty. Now I'll turn to our outlook. We believe our guidance appropriately incorporates both the macro challenges we see in the market and the impact of budget scrutiny as a new norm, which elongates our deal cycles in all customer accounts across geographies. For the first quarter of 2023, we expect revenue to be in the range of 166 to 168 million, representing growth of 32 to 33%. Confluent Cloud's sequential revenue add to be approximately 5 million. As we expected, there is a decline in sequential add relative to Q4 and is consistent with what we've seen in prior years. Similar to last year, we expect cloud sequential revenue add to increase every quarter with a more pronounced increase in the second half of the year. Exiting Q4 23, we expect cloud to reach the milestone of approximately 50% of total revenue. We expect non-GAAP operating margin to be approximately negative 27% and non-GAAP net loss per share to be in the range of negative 15 cents to negative 13 cents using approximately 290 million weighted average shares outstanding. For the full year 2023, we expect revenue to be in the range of $760 to $765 million, representing growth of 30 to 31%, non-GAAP operating margin to be approximately negative 15 to negative 14%, and non-GAAP net loss per share in the range of negative $0.28 to negative $0.22, using approximately 297 million weighted average shares outstanding. As discussed earlier, we're now targeting to exit Q4 2023 with breakeven non-gap operating margin. We also expect the timing of breakeven free cash flow margin to roughly mirror that of our operating margin, with the exception of more pronounced seasonality in Q1 of FY23, primarily due to our corporate bonus program and one-time charges associated with our restructuring. Finally, we'll continue to actively manage share count and stock dilution. And on an annualized net dilution basis, we're driving net dilution from 4.7% in FY22 to 3-4% for FY23. Our goal over the long term is to bring net dilution down even further. In closing, we've established a proven track record of delivering on our financial commitments in both stable and uncertain economic environments. With our leading data streaming platform and a unique go-to-market model that's showing increased leverage, we believe we're well-positioned to capture our large market opportunity ahead. Looking forward, we're confident in our ability to drive another year of high revenue growth as we march towards non-GAAP operating margin breakeven exiting Q4 FY23. Now, Jay and I will take your questions.

Thanks, Stephan. To join the Q&A, please raise your hand on Zoom. When you're selected, make sure to unmute and turn on your video. We'll now pause a few moments to assemble the Q&A roster. And today our first question will come from Sanjit Singh with Morgan Stanley, followed by William Blair. Sanjit, please go ahead.

Thank you, Shane, and thank you for squeezing me in. I guess my first question, and Jay, I think you addressed this in your formal comments just around some of the elongation and sort of the sales cycles that you saw at the end of December. Is there any sort of other patterns that you would sort of call out, whether it's more on the Confluent Cloud side of the house versus Confluent Platform, any sort of market segments, industry segments? on that were notably weaker than expected? Or was this kind of more of an across the board dynamic around budget scrutiny that you saw on the deals in Q4?

Yeah. Hey Sanjay, great question. So yeah, the most pronounced thing for us was it seemed to mostly impact the enterprise segment of our business. The commercial segment didn't really feel it. It was across geographies. So previously, I would say it was more pronounced in EMEA and APAC. We also saw it packed in the Americas. So beyond that, it was probably the larger transactions tend to feel, I think, a little more pressure, scrutiny, et cetera, kind of as you would expect. So nothing beyond that. I wouldn't say that there's a strong industry pattern. I wouldn't say that there was much beyond that that would really show it. We were pleased that gross retention was really strong, yet again, in a difficult environment.

you know we saw no meaningful impact there but it did slow down some of the expansions um as well as some of the the new lands and then stephanie could just sort of connect some of the dots on the financials um the conflict cloud revenue in q4 was you know excellent you know record quarter for conflict cloud revenue the rpo was certainly weaker and then when i look at the 2023 guidance revenue guidance it only came down you know i think five million you sort of narrowed narrowed the range um What gives you confidence that the revenue is set at the right level, just given some of the dynamics you're seeing out in the macro?

Well, we took into consideration our current outlook on the macro, and we really focused on a few things. One is our current RPO exiting Q4. gives us about 60% visibility to our total revenue number in FY23, which is actually five points higher visibility than we had this time last year. We also have more proportionally sales reps that are fully ramped than are ramping. And we see that growing out throughout the year. And then lastly, we just came off of a quarter where we saw a very robust growth in 100K plus customers and million dollar plus customers. And those cohorts contribute north of 85% of revenues. And so we have the right product for the right market. And we feel like 23 will be a decent setup for us.

Understood. Thank you, Stefan.

Thanks, Sanjit. We'll take our next question from Jason Bader with William Blair, followed by Deutsche Bank. Jason?

Yeah, thanks, Shane. Good afternoon, everyone. Obviously, macro issues are affecting everyone, including you guys. I want to talk a little about sales execution. Larry's leaving. I know some other folks are leaving, and then you have this reduction in force. How much has sales execution been a contributing factor here to the performance? And if there are any issues, what are you doing to address those? And I have a quick follow-up.

I think the bulk of what we're seeing is a very different macro environment than what we were operating in nine months ago. That obviously reveals opportunities for improvement, but I think the bulk of what's changed is that.

Then a quick follow-up for you, Jay. Were you seeing something in deals where it was increasingly clear that you needed a Flink solution?

Yeah, there wasn't anything where it was preventing us from winning, if that's what you're getting at, where it's like, oh, we can't land this customer without this. We feel like stream processing is incredibly important to us strategically over the long term. So it wasn't like a defensive move, like, oh, if we don't have this, we're not going to be able to continue growing. based on Kafka, we're not going to be able to continue winning customers. You know, what we felt was, hey, there's an opportunity to go after something that could be as big as Kafka and has a very similar trajectory, has an extremely high attach rate to Kafka itself and fits into our kind of overall vision and where we could get, you know, really some of the key people who had helped drive it forward as part of the company. And that was kind of too good to pass up, even in a tighter environment where we're being thoughtful about each dollar. Thank you.

All right. Thanks, Jason. We'll go to Raimo Lanzcha with Barclays first. We'll come back to Deutsche. Raimo, go ahead.

Hey, thanks for squeezing me in. Can I follow on there, Jay, a little bit? You're all trying to get to the bottom of the same story. If you think about what you're selling, it's very mission critical. These are kind of proper projects. You don't do this for fun, but they're also relatively- It's fun. What are you seeing in your conversation with clients about that need, that urgency to do things? And I had one follow up for Stefan.

yeah yeah you know i i think that one of the things that's really an asset to us in times like that this is exactly what you said right and i think that shows up in the gross retention i think for us it's also showed up in the consumption like we've seen consumption against commitments track really well so the projects are going forward people are kind of getting the value out of it But I think each of these projects now gets more scrutiny, and that is a drag on doing business, and it shows up in a bunch of different ways, whether that's pressure on the kind of analysis of TCO and ROI, whether it's kind of the you know shift of projects around within organizations i think companies are just putting more scrutiny on you know everything they're doing and that that impacts us but yeah i think it's a huge asset to serve production use cases which are in some sense a direct part of how the company you know grows operates makes more money and i think that's one of the good things about this streaming area

And then one quick follow-up on more numbers. So if I think about the, you know, you kind of moved the profitability goal one year forward, which is kind of a big, you know, a big change and takes a lot of effort from the organization. Can you talk a little bit about the compromises you had to think about there? Was that... certain growth projects uh you kind of maybe kind of de-emphasize it doesn't sound like it's the sales reps getting impacted um like just talk a little bit about like you know the the puts and takes you had to kind of go through to get to that because that's quite a big effort thank you

yeah yeah i mean any change like this is a little bit disruptive and so i think that's the you know probably the biggest impact for us is just making sure that we get off to a fast start at the beginning of the year we're not so disrupted that that impacts execution um it's obviously also just a harder thing to go through we felt like look after a couple years of very fast growth where you know we kind of roughly doubled headcount that time period there was opportunities for efficiency right and you know despite being very thoughtful in planning and you know where we were deploying resources we thought there was opportunities to get more efficient so for us it was kind of a question of how do you do that are you going to do it more slowly kind of in place are you going to do it more quickly as we got i think a better read on just hey what's the environment for 23 what's the environment overall in tech what makes sense for us we felt like it made sense to do it more quickly And, you know, that kind of, I think, shows a little bit of what's possible, you know, for the business in terms of efficiency or at least one good step in that direction. And it seemed like in the environment, it just made sense to do that now.

And we're also doing it, preserving our ability to drive top line growth and continue to invest in our innovation engine. And we're able to balance the moves that we made to preserve our long-term sustainable competitive advantage.

Yeah, I think that's exactly right. I mean, as we went into this, the kind of key analysis is, you know, would you have to give up on something that's going to make the company great, whether that's in the development of the product or how we're growing the business, how we're kind of capturing the opportunity. And we felt like we could do it without doing that. And I think that was one of the big things that was necessary for us to act on. Okay. Thank you.

All right. Thanks, Raimo. We'll take our next question from Brett Zelnick with Deutsche Bank, followed by Bank of America. Brett.

Great. Thank you so much. It's nice to see you all. I've got one question for, I guess, first for you, Jay. Jay, just as we think about the changes that you've made and you've got Larry moving on, what is it that gets you comfortable that there's not risk to exiting this year

with 55 to 60 sales rep productivity and it might inspire some additional unanticipated turnover and then I've got to follow up yeah I think we continue to have a kind of steady hand uh running the go-to-market organization so you know Erica Schultz has run the larger field organization Larry reported into her she previously directly managed the the three sales uh theater VPs and is kind of taking them over directly and so actually I feel like in a time where there's a fair amount of macroeconomics uncertainty, that org structure is actually good. You want to have a short path between leadership and what's happening out on the street. So I feel pretty good about that.

Okay, that's good enough. And maybe just for you, Stefan, I'm just trying to reconcile Confluent Cloud Q1 guidance versus the really strong result that you're coming off of in Q4. Is there any reason to think that consumption was perhaps unusually strong in Q4 in some way that might not repeat? And or are there any reasons to be more concerned and conservative about consumption rates in Q1?

Well, the dynamic that we called out relative Q4 to Q1, where the net sequential ad is lower in Q1 than Q4, is a natural dynamic that happens in consumption models. You look kind of across the board at companies in our peer group, you see similar fact patterns. We did see a very strong Q4. It candidly came in higher than we expected. And that goes back to the mission criticality in what we're driving in terms of consumption for our customers and the value that we're driving. When we look at the the progression for cloud throughout the year we are looking at seeing increased sequential net ad throughout the year post q1 and for confluent cloud um exiting q4 to be um roughly 50 of total revenues and so we're doing all that in an environment that is just it's just more challenged to to do business in so we've reflected all of that in our guide both in our total revenue guide and our cloud guide. And we're adding effectively the same amount of revenue that we did Q1 of last year. And Q1 of last year, that environment was a lot different than where Q1 of this year is. So nothing to be concerned about. We're looking at incredibly high growth rates for Confluent Cloud for the year. And that continues to show up in our numbers.

And just to pile on that, one of the aspects, we talked about this last year when we were in Q1. One of the aspects that leads to this is just the kind of lifecycle of software projects. They tend to get funded at whatever the company's beginning of the year is and developed and then kind of roll out. And so obviously there's expansion and consumption happening throughout the year, but it is more things, more new things come out in call it whatever, Q3, And then, you know, a little bit less at the beginning of the year as kind of the new things are getting built. And so you would see this, I think, for like a MongoDB and some other companies as well, where it has a little bit of that pattern.

All right.

Thank you, Brad.

We'll take our next question from Brett Sills with Bank of America, followed by Piper Sandler.

Great. Thanks, Shane. Good to see you all. Question for you, Jay or Stefan. on just investment priorities. Obviously, you're saying that this reduction will not affect those strategic investment areas. I think at the analyst day, you'd outline security, data compliance, enterprise, just any update on those cycles. How does this change that at all? Or are those still very much the focus areas?

Yeah, absolutely. So like on the product development side, there's no change. There wasn't a big product area that we cut or stopped developing. We're able to maintain the major investments that we had. with what we planned for this year and those cuts taken into account. This did cut across different areas of the company, and there's a number of factors that were included in making cuts. But our priority, as I said, was really making sure that we had full funding for what we considered the key strategic priorities, both on the product side and on the go-to-market side. in terms of markets we wanted to get into, that we wanted to drive growth, both for this year, but also for setting ourselves up coming into next year and beyond.

Great. Thank you.

So yeah, no major change.

Understood. No, that's great. Thank you. And then one on Confluent Cloud, please. Exiting the year at 50%, just a tremendous trajectory. I think in fiscal 20, you exited the year at 15%. So just a remarkable result there in the cloud. If you could just articulate for us, why have you seen such success in the cloud? What is it about Confluent Cloud versus, say, other categories where we've seen perhaps a slower ramp in public cloud infrastructure and these types of mission-critical workloads that you guys are supporting?

Yeah, I think that one of the things that's easy to miss is how... You know how high the bar is for a cloud product, and so, if you look at our investment, you would have seen a similar pattern where you're like hey they're putting a lot of work into this thing and it's driving some small business we're doing that for many, many years and. You know the reason for that is that this kind of cloud infrastructure, like a lot of the iceberg is below the water and until you kind of meet. Certain minimum criteria in terms of security and scalability and operations and availability in different clouds around the world it's just very hard to capture the market, and so you know coming into an area. that's a big you know wall to climb you know once you're on the other side of the wall then it protects you i think from competition who make them up and you know want to do the same thing so so i think it's i think it's been a great thing for us but yeah it was i think just kind of reaching that critical threshold and then in terms of you know how we operated that led to that you know i would say it was mostly just full commitment like we um you know, the myself, some of the other people who founded the company or joined earlier had a background in running kind of, you know, data systems internally as a service. And we just kind of knew that that was going to be the model in the public cloud, that there was no future for a licensed software as the delivery model once people had access to these kind of cloud services. So we knew it was kind of do or die on the conversion. And so we leaned in early on in a very significant way where really the whole uh engineering team moved to that you know every cloud metric was kind of elevated in importance to match um a much larger number uh you know on the software side of the business and really kind of held to that internally even though you know we're really pushing one part of the business up and i think that was necessary early on it's very hard to get what's effectively a very different product going in an early company because you have to effectively build two successful products. So I think that helped us kind of get it to that, you know, whatever, escape velocity, where it could then kind of grow and capture a lot of the opportunity that was, you know, I think always there for folks operating in the cloud.

Makes a lot of sense. Great to see you. Thanks, Jay.

All right. We'll take our next question from Rob Owens with Piper Sandler, followed by Google High.

Thanks, Shane, and good afternoon, everybody. Obviously seeing pressure worldwide here, but just curious if there was anything unique to call out, positive or negative, from the various theaters that you're participating in.

Yeah, it's mostly what I described. The biggest unexpected thing for us has been just the continued strength for us of the commercial business. We kind of ascribe that to the fact that we think we're just still severely under-penetrated in that segment. So even though I think they're also feeling lots of pressure, there's just lots of opportunities. And I think it's also has very good product market fit with our cloud offering. And so it's been nice to see that continue to grow because it was a part of the business we were very excited about. um coming into this year and it's nice to see its continued growth um you know but beyond that yeah it was across different Industries um that we saw you know pressure we we were pleased to see that like by and large we're not losing deals you know they're they're delayed they go through more scrutiny they may slip out of the quarter but a lot of the things that we saw delayed in previous quarters did close um you know either in Q4 or or you know in the first part of Q1 and so We've been excited to see that. It just exerts pressure.

Great. And then Jay, I know entering COVID, you saw a few customers actually revert back to an open source solution and then come back to Confluence. And in your prepared remarks, you talked about it requiring heavy DevOps resourcing. So, you know, as we're seeing the global recession happen, are you seeing customers actually choose open source as a viable alternative at this point? Or is that kind of past behavior more so in the past? Thanks.

Yeah, it's past behavior. So that was a concern many people had. And the feeling was, hey, it must be cheaper just to use the open source. But one of the really important things to understand about this area is these cloud services are not like a premium offering of the open source. It is actually more expensive to hire a team of engineers to operate this stuff it's more expensive in terms of people it's more expensive in terms of cloud infrastructure it's takes longer it's just more and so for that reason once you have a really good cloud offering it's it's not very appealing to downgrade unless for whatever reason the customer is not like actually succeeded with it or you know somehow not getting the value um but but you know just based on the kind of basic TCO of the two things, it should be a big win. And we've been pleased to see that actually play out in practice. That was the theory early on. As we had, I think, a pretty immature cloud offering, we didn't always see that. We did see some customer losses earlier as there was pressure. We felt like we were in a very different uh situation as we were kind of coming into harder times uh this year and you know we were we talked about that you know on these calls uh but it's been nice to see that play out that we haven't seen the the kind of you know uh churns um of you know at all the same magnitude and in fact gross retention is held very steady throughout this right we'll take our next question from Howard Ma with uh Guggenheim followed by Colin great thanks Shane

So my question is for either Jay or Stefan. And it's a clarifying question about, Jay, a comment that you made in your prepared remarks about near-term spend rationalization not impacting confluence long-term growth opportunity. Because it seems like, so cloud is holding strong. And in your response to an earlier question, you said rationalization, it was really about optimizing operational efficiencies that you identified, but not necessarily impacting growth. So despite the pulled forward profit target, is your baseline growth assumption over the midterm now, is it necessarily lower than before? Or could there still be a scenario where your midterm growth expectations are unchanged, but you just figured out how to do it more profitably?

I definitely think that there's an aspect of us just figuring out how to do things more efficiently and willingness to make adjustments faster in that respect. There's obviously areas where there's trade-offs, and so nothing in life is free. But yeah, we felt that we were able to make this change without significantly changing. Now, I would say, look, there is something impacting growth, which is we are in a macroeconomic environment that's very different from a year ago. That's a headwind. I think when we were considering what we were going to do on the expense side, we were taking into account that we were going to be facing this headwind and likely growing slower than we would be if that was not the environment that we were operating in.

Okay, thanks. I just have a quick follow up for Stefan. On the platform side, Stefan, I forget if you mentioned this in your prepared remarks, but I might have missed it, but was there any notable change in contract duration on the platform side that resulted in lesser license revenue recognition than in prior quarters? And also, is there any migration from platform to cloud that's worth calling out? Thank you.

Thanks, Howard. There was no material change in contract duration, but what you're seeing drive the change in license revenue is really the profile of new ACV that's coming in the door. And the new ACV is Confluent Cloud. It was very, very healthy this quarter. and we saw just less less new platform deals come in because as the industry is is all heading towards cloud with that said confluent platform is still an important part of our portfolio um and and we're going to continue to see contribution from from from platform but it is it's really about like cloud is the story here uh and even going back to a prior comment that was made. Even in a tougher macro environment, we just came off of a quarter where we posted record cloud sequential growth, and we're calling for very meaningful cloud expansion over 2023. And that goes back to the testament of the value that we're delivering in our Confluent Cloud model.

Great. Thanks, guys.

Yep. Thank you.

All right. We'll take our next question from Derek Wood with Colin, followed by Wells Fargo.

Great. Thanks for taking my question. So I guess first, Jay, I wanted to touch on the MRAC acquisition. What is Flink Excel at that improves upon the capabilities of Kafka Streams or KSQL DB? And how should we think about maybe the R&D shift as you bring Apache Flink in? Are there some technologies that you'll look to de-emphasize going forward? Or what's the balance across the stream processing technologies that you have?

Yeah, yeah, it's a great question. So yeah, Kafka Streams is effectively, it's a kind of application development library that helps you do stream processing with Kafka. So it's very easy to use and embed in applications. It tends to serve more kind of microservice use cases. You know, what Flink brings to the table is I think really the most complete, well thought out framework for stream processing. It generalizes, you know, batch processing with real-time streaming. So you can kind of run something at a point in time and then have it keep running up into the future. It supports a variety of programming languages, so Python, Java, SQL. It has probably the best scalability and performance. It has, I think, the most active community. So there's really a whole set of things that it brought together, including the sophistication of the types of processing applications it supports. And all of that together made us feel like, yeah, this really does add beyond what we were able to do with Kafka Streams and KSQL and is kind of worth the investment. It doesn't change our support for those technologies. As with any cloud service, we'll continue to... help customers with those uh really indefinitely and uh kafka streams in particular has a nice kind of area as a embedded library for customers but we do see this as you know very much the future of stream processing and kind of the technology of choice uh for customers over time got it very very helpful um couple quick ones for you steph in the um on the restructuring so i can just give us a sense as to where the cuts are coming from and in particular i guess it it'd be nice to

you know, kind of like post restructuring and what, what kind of growth you have in, in, in quota carrying sales headcount kind of year over year and, and how you're thinking about given, given the longer sales cycles, uh, how you're thinking about the glide path for net revenue retention, uh, in 2023?

Well, the restructuring was, um, what was done with, with the lens of preserving our ability to continue to grow high in high growth mode. and really getting to the efficiencies that we think that we can get to. And so what does that mean? We're looking at in sales and marketing, we did have, from a headcount standpoint, the most impact there, but those are primarily like non quota caring folks. We also took a look at GNA, and then lastly, I would say R&D. But we were very much focused on ensuring that all of the decisions we made were in the preservation of us continuing to have high growth with improving profitability and efficiency. And one of the things that we mentioned earlier was If you look at the last couple of years, we have made very meaningful investments across the board in support of us growing into what is a very meaningful company in a very large market. And there's always an opportunity to rationalize and get more efficient. So the theme that we have this year is efficient and profitable growth. And that's what we're driving towards. I'm sorry, what were the other couple of questions?

Just the other one was the glide path of net revenue retention rate as we see longer sales cycles continue.

Yeah. So our network, our net retention rate this quarter came in just a shade below 130. We gave a little bit of color commentary that Confluent Cloud and our hybrid customers were north of 130. We continue to see very strong progress with those two you know products and customer sets uh as we think about the glide path over time we're very clear about being above 125 from a total company standpoint um and also looking at just higher net retention rates for our cloud and our hybrid customers is that as that's like where the puck is going great thanks guys thank you

All right, thank you. We will go to Pendulum Bora with JP Morgan first.

Hey, guys. Hey, thanks for taking the questions. Two quick ones. Maybe update us on just the customer behavior going into January so far towards the end of January. Is it deteriorating? It's kind of stable. You did mention you've closed a few deals. I was just wondering.

Yeah, yeah. I would say that, you know,

results in January so far have been in line with the you know kind of plan we put together for the quarter and guidance so we've been pleased to see that play out as we hope got it uh and and great to see the acceleration um to get to break even why do I ask um I think I was doing the math was about 55 million in terms of cost coming down I believe I was trying to understand how much of that is driven by the riff how much of that is kind of optimization of discretionary spend that you talked about, how much of that is kind of real estate? I would think that real estate optimization probably will take time. So trying to understand those mix, and then I guess, how should we think of that profitability going forward?

Yeah, yeah. So it's definitely a mixture of all those things. We haven't broken out exactly how much is due to each thing, but yeah, absolutely. We're kind of optimizing real estate footprint, just kind of post-COVID, we have a better idea of what we actually need. um we had already a plan you know for the year prior to this action that would have shown you know very meaningful uh operating margin improvement and so then this is kind of added on top of that which is kind of what lets us make you know big improvements and if you look at this last year You know, we had about 20 points of improvement over the last 12 months, you know, from Q4 to Q4 in non-GAAP operating margin. And so this is kind of, you know, roughly that again between the RIF and the existing improvements and the, you know, additional growth in revenue. Got it. Thank you.

All right. As a reminder, if you'd like to ask a question, please raise your hand. And our next question goes to Cash Rangan with Goldman Sachs.

cash hey guys thank you so much so much static here nice to see you guys uh jay uh stefan and shane question for you when you look at uh flink uh jay for you uh How much work needs to be done to Flink to make it as solid as in terms of research and development, product development capabilities as the core platform has taken so many years to come to shape? What is the path ahead for Flink? And when you said Flink could be as large as Kafka, I'm curious to see if there's any pent-up demand that customers have been asking for. I know you highlighted a few customers, including us. What are they saying that you could do better with Flink? that could cause them to allocate bigger budgets. And I have one for Stefan.

Yeah, there's a couple of things. I mean, Flink, the technology, I think, is in good shape. It's a successful piece of technology in its own right. To turn it into a managed cloud service is a ton of work. It's just a huge amount of work. That's something we'll work on for many years. And so we'll release a product, but there'll be more and more to do. um you know that kind of cloud native bucket that we talk about for the rest of our offering you know it's a big bucket it really matters to customers and so yeah there'll be ongoing work in um in that dimension in the years to come that's one of the reasons why it's really important to have these core people who are you know driving that technology forward It's not just a matter of kind of getting the open source and putting it on some servers, which we wouldn't need an acquisition to do. You need to really kind of reimagine the technology as a cloud service and how should that work? What would that be like? That's what kind of creates the good product. And then in terms of, yeah, the reception from customers has been fantastic. People are very excited about Flink. They're very excited about Confluent. They're very excited about the pairing together. For many of our customers, they were already using Flink with Confluent. And so, yeah, absolutely people are excited. Some people are like, well, it took you so long. So yeah, it's great to hear. We think that there is, as with Kafka, there is an... know substantial existing install base and in an environment like this where there's some pressure and there's less kind of net new software projects overall coming out having that existing install base to grow into is obviously a really nice second dimension of growth beyond just kind of landing with the new things

Got it. One for you, Stefan. Well, how do you look at the, given the headcount reductions, how do you think about cost of customer acquisition, lifetime value? It looks like the commercial business did well. Cloud is definitely inflecting away from the platform. Given all that, how should we look at those metrics? Are they getting better or about the same pre-cloud? Thank you so much.

Yeah, thanks for the question, Cash. As we look through 2023 and beyond, as more of our business is coming from cloud and there's the self-serve option around onboarding, et cetera, our LTV to CAC should be improving over time. We've made some progress this year, the year that just ended in terms of optimization. But when we look at LTV to CAC over the longer term, we see that improving on an annual basis. And that's a reflection of both the restructuring that we're doing, but then also the profile of the revenue streams that are coming in that are just a lower cost of customer acquisition. Wonderful. Thanks. Thanks so much. Thank you.

Thank you. Our last two questions today come from Eric at KeyBank First, followed by Fred at Credit Suisse. Eric?

Great. Thanks, Shane. Jay, just for you, I wanted to get your thoughts on kind of how you keep that net expansion rate pretty strong in that 130% range going forward, just giving what is kind of a more technical sale as you kind of evaluate kind of the lower workforce going forward. Just how do you keep customers keep expanding at this pretty impressive rate while also trying to balance that profitability?

Yeah, I think there's a number of things that go into that. One is just we have a consumption model, so it's very possible for customers to use either other parts of the product or use the product for new uses and making that as easy and frictionless as possible. There's a lot we can do and are doing to continue to drive that. making sure that that folds well into the motion that the sales team has. We're actually at our sales kickoff event right now, and that's one of the big focuses for us is making sure people understand how to play well with that consumption motion, have the product help drive them into new use cases, help drive that expansion. I think that's a huge area of opportunity for us. And then making sure that we have the right use cases, that we have the right senior connections and organizations. That kind of blessing is critical to really get broad in organizations and get to larger dollar spend in organizations, especially in this environment. People need to know what it's for. And then we're coupling that with this, you know, we've really gotten very good in the last year. And I think getting better still at the kind of TCO and ROI story, what is it that you're getting out of this? I think all of that helps you kind of continue to expand in an account in a way that the customer feels good about and wants to accelerate rather than something that they see as a problem that has to be stopped. Great.

Thanks, Jay.

All right. Last question goes to Fred Lee with QuettaSpace. Fred?

hey Jay Stefan thanks for taking my question and Shane thanks for fixing my zoom just now. This is my question is also on the pull forward of profitability and you know big picture, considering how early we are in streaming. Is you the confidence that you're addressing the market as completely as possible, not compromising any growth prospects. I know you've touched on this a little bit, but it sounds like you're reducing some sales and marketing coverage. It's because if you think back to the GFC and you ask software companies then back coming out of 2008, the most they talk about the fact that they slowed down their investment. So again, the question is just around your confidence level that this is the right thing to do.

Yeah, you know, what gave us confidence was just looking at it project by project and investment by investment in a very thorough way. You know, and having, you know, I think a very clear picture of what we want the company to be, you know, in a year, but also in three years, in five years. and making sure we can solve for that and that we have enough people to go do it you know i i think you could look at this the other way you know companies that have been on this very fast growth trajectory there is some opportunity for optimization you know if we were cutting 20%, I think we would be giving up quite a lot. Cutting a little bit, I think, makes sense given the environment. It's a hard thing to do. It's hard to have people leave the company, but I think it makes sense given the larger environment. I think it's possible to do that without making big sacrifices in terms of what we need to build and the product that we want to have, and also in terms of how we want to go to market and where we want to be set up to expand.

I see. And then just on the product side, I know it's new, but can you talk a little bit about some of the early adoption trends of Stream Design or Stream Governance?

Yeah, yeah, yeah. We've seen great results. They're a little different, right? So Stream Governance is a paid offering, the Stream Governance Advance that we just announced. And Stream Designer is free, so customers just use it. It accelerates their usage of... uh ksql of connectors of copy itself and so yeah we've seen a ton of early adoption of stream designer that's been very exciting for us to get to see people playing with this you know we think that that kind of easy to use interface is one of the keys to really making stream processing go broad whether it's with ksql or flink or whatever that that interface on top is a really critical investment for us that you know makes this stuff really easy to deploy within within customers and kind of take the stream processing area beyond these apex companies that have already really gone big with it And then governance is just one of these topics that's top of mind for every customer. And we've seen really, really great results for that now emerging product as a business. We've seen a lot of consumption driven by that. And that was a little bit unexpected. We thought that was going to satisfy a need and maybe unblock customers and other things. But in fact, we've seen it actually really outperform our expectations so far. And we're excited about what's possible for that in the year ahead. And it's not surprising. I think the kind of two pressures on organizations, on one hand, they need to do more with data and put it to use to be successful. On the other hand, they have just increasing numbers of restrictions and how they do that and the risk associated with it. So if you give them tools that help balance those two pressures, it obviously meets with a great reception.

All right. Thanks, everyone. This concludes today's earnings call. We really appreciate you joining us. Take care.