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.