Confluent, Inc.

Hello, everyone. Welcome to the Confluent Q4 and Fiscal Year 2023 Earnings Conference Call. I'm Shane Zee from Investor Relations, and I'm joined by Jake Kraps, co-founder and CEO, and Rohan Sivaram, CFO. During today's call, management will make forward-looking statements regarding our business, operations, sales strategy, market and product positioning, financial performance, and future prospects, including statements regarding our financial guidance, for the fiscal first quarter of 2024 and fiscal year 2024. 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 10Q, filed with the SEC. We assume no application 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 made 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 price release and supplemental financials, which can be found on our IR website at investors.confluent.io. And with that, I'll hand the call over to Jay.

Thanks, Shane. Good afternoon, everyone, and welcome to our fourth quarter earnings call. We closed fiscal year 2023 with a solid Q4, exceeding the high end of all guided metrics. Total revenue grew 26% to $213 million. Confluent Cloud revenue reached $100 million for the first time, growing 46%. And non-gap operating margin came in at 5.3%, our first positive quarter, improving 27 percentage points. Since going public two and a half years ago, we have more than doubled our total revenue run rate and driven more than 46 percentage points in non-gap operating margin improvement. These results are a testament to the power of our platform and the incredible growth of the data streaming category. Last quarter, we discussed our accelerated transition to a fully consumption-oriented go-to-market model for Confluent Cloud, including shifting our sales compensation for cloud to be based on incremental consumption and new logo acquisition, orienting our field team towards landing new customers and driving new workloads with customers, and adapting product and pricing to reduce friction and landing customers and maximize the potential for expansion. As we said before, these changes are internal to our go-to-market teams, And don't change our business model or revenue model or any other customer-facing aspect, all of which are already consumption-oriented. We've executed some of the initial changes of our consumption transformation effective January 1st, including a new compensation model and the initial rollout of new systems, metrics, and measures. Last week, I spent time with our sales and marketing teams at our sales kickoff. The initial reaction from the team has been very positive. We will be spending the next few quarters fully adapting and optimizing our business to these changes. We believe our transition to a fully consumption-oriented business alongside our category leadership puts us in an excellent position to capture more of the $60 billion data streaming platform opportunity in front of us. I'd like to spend a few minutes and reflect on the increasing recognition of data streaming as a category and its potential for growth. One way of thinking about data technologies is to break them into two groups, those oriented for handling data at rest the databases and storage systems, and those oriented at handling data in motion. These two areas have very different evolutionary paths. Over the last several decades, data at rest has become highly concentrated around a powerful infrastructure platform, the database, a $90 billion plus category. The landscape of data in motion technologies remained highly fragmented, with technology analysts recognizing disparate technology categories, including message queues, application integration tools, data integration tools, event brokers, ETL products, IPaaS, and more. The reason for this was largely technological. Each of these product categories was defined by its technological limits, whether latency, scale, complexity of processing, or ease of use. The potential for data streaming is to collapse the fragmentation of data in motion technologies and create a new data platform that supersedes each of these limited precursors. Since Confluence creation, that has been our central thesis. that the data streaming platform would be a data platform of similar importance and scale to databases, but acting as the central nervous system, handling all the data in motion. Now that this category has gotten to scale in usage, it's starting to get formal recognition. In December, research published by Forrester validated our thesis that data streaming platforms are a distinct category that has become a mission-critical component of the modern data stack. The Forrester Wave Streaming Data Platforms Q4 2023 recognizes streaming data as the pulse of an enterprise and names Confluent a leader. We were also named a leader in the Forrester Wave Cloud Data Pipelines Q4 2023 and won InfoWorld's Technology of the Year in the Data Management Streaming Technology category. Taken together, these recognitions show us that the data streaming era is here and Confluent is a clear leader. As we've discussed before, this data streaming platform is more than just Kafka. Kafka is the data stream a foundational layer, but it's just the start. To extract the full value of data in motion, organizations need to connect to the systems they have, process data in real time, and govern these flows of data across the enterprise. Each of these capabilities, connectors, stream processing, and governance, is on a path to become a sizable business on their own. One key aspect of our consumption transformation is that it lets our go-to-market directly drive consumption around these additional products. which can be used under the same consumption contract with no additional purchasing friction. Today, I'd like to spend a few minutes covering what's happening in the world of stream processing. Stream processing enables organizations to act on data as it arrives, rather than waiting to process it in batch at the end of the day. For an airline, it could be processing data from streams of flight times, weather information, and customer information. By itself, these streams are powerful, But with stream processing, these streams can be combined and enriched to drive logistics, pricing, scheduling, and cascade that information throughout the system to minimize travel disruptions. For Confluent, this represents a significant growth opportunity. Today, the spend on applications around the data stream is significantly higher than on the stream itself. By making these applications easier to build and bringing that spend into our platform, we believe both adoption of our platform as well as the growth of our business will be accelerated. I'd like to spend the next few minutes addressing the question of why Confluence is uniquely positioned to succeed in stream processing with our Flink offering. There are three key reasons I'll address. First, Flink is the emerging de facto standard. Second, the company with the stream gets the processing. And third is the rise of data products. Let me address each of these in turn. The first reason is perhaps the most obvious. We believe Flink is simply the best technology in the space and has attracted the largest community of developers working with real-time apps. This technological superiority comes from the fact that Flink was designed to have the full processing power of a database, but was designed from the ground up for streaming, addressing batch processing needs as a special case of stream processing. This affects every aspect of the design, from how storage is managed, how failover and fault tolerance works, to the latency of results and interfaces presented to users. This is dramatically better than attempts to bolt streaming features into existing databases or batch processing engines. The result is our ability to offer the most complete platform and ecosystem for stream processing, one that supports SQL as well as native apps in popular programming languages, and that unifies batch and real-time processing. This platform has attracted the most vibrant community doing development in this space. The developers have spoken, and like Kafka, this is the technology that they choose when they need real-time streaming. In 2023, there were nearly 1 million unique downloads of Flink, and a 43% increase in open job requisitions for Flink developers. And like Kafka, it has proven itself with one of the most sophisticated user bases, including companies like Apple, Capital One, Netflix, Stripe, and Uber. Perhaps what's most impressive is that Flink has attracted this broad adoption in Apex users without having significant commercial backing or go-to-market support. This is truly the best engineers picking the best technology. Our investment in Flink gives us a leadership position in the winning technology in stream processing. But our advantage isn't limited to the technology or developer community. As attractive as stream processing is, it doesn't stand alone. It is always adopted along with a stream of data that needs processing. Everyone agrees that Kafka is the standard for the stream itself. As the leaders in Kafka, we are in a prime position for capturing the emerging stream processing market. Indeed, this pairing is very similar to what made databases themselves successful. Databases brought together data storage with data processing into a unified product, driving a vastly simpler experience. Confluent is working towards the same by unifying data streaming with Kafka with stream processing via Flink. We believe the resulting data streaming platform is exactly the product the customers want. This pairing is not just skin deep either. Confluent can make the stream and processing layers work together as a coherent product that is optimized as a single system. from performance to security to data discoverability to transactional semantics. We think the processing layer that is unified with the underlying stream is going to be the easiest, fastest, and most obvious choice for any developer. That makes Confluence Flink offering a kind of default option when it comes to processing data in Kafka. There's a final trend that supports Confluence's position in stream processing, and that is the increasing role of reusable data products in modern data architecture. In classical data architecture, data largely lived in a silo and at most was extracted to a single destination, the data warehouse, where it was processed to clean it up and make it usable for various reporting and analytics use cases. In modern data architecture, the data warehouse is no longer the single destination for data. Dozens or even hundreds of other systems feed off critical data streams. Repeating the processing that cleans up data for use dozens or hundreds of times is completely infeasible. The result is that the processing is being pulled upstream from the destination to the source to produce high-quality, reusable data products. That is, rather than having dozens of destination systems all try to clean up the data, instead, the source is responsible for publishing data in a processed, ready-to-use format to all destinations. This means the processing is happening on the stream as data enters the system rather than in the destination. And this is pulling workloads from batch processing in the destinations into stream processing at the source. This is why structurally we expect the bulk of stream processing won't happen in destination systems like databases, data warehouses, or data lakes. We think these three reasons are each powerful enough to draw processing workloads into the data streaming platform. And put together, we'll make the DSP the nexus of next-gen data workloads. We continue to see demand from customers who are building the next wave of generative AI applications, including AI-powered procurement software, chatbots, coding platforms, and even unexpected use cases like predicting and detecting cavities. These organizations turn to Confluent to quickly build and scale gen AI applications that connect their proprietary systems to LLMs so they can deliver trustworthy and contextually rich insights to their customers. We believe this represents a tremendous opportunity for Confluent as customers evolve from experimentation in the short term to production in the medium and long term. We continue to invest in our product and in our partner ecosystem to address the demands we see across customers. Alongside Anthropic, we recently partnered with a vector database vendor, Pinecone, and their new Pinecone serverless offering. Our integration allows customers to build retrieval augmented generation, or RAG, pipelines that allow customers to bring together the real-time state of their proprietary data sources with general-purpose AI models. OpenAI has become the poster child of GenAI. In Q4, OpenAI signed with us to improve their visibility into customer usage patterns. We are still in early stages with this customer, but we have already identified additional use cases, including ways to help reduce costs across their stack. This customer and others like it continue to validate the strategic role of data streaming in the generative AI landscape. Finally, I'd like to close with two more customer stories that underscore our platform advantage. Certus operates the largest automotive logistics company in the United States. It serves car manufacturers, dealers, rental companies, and e-commerce dealers to move, store, recondition, title, and register finished and sold vehicles. However, the data systems that supported its business and customers were old and siloed, creating pricing delays, supply chain bottlenecks, duplicate records, and customers left waiting. So, searchers turned to Confluent Cloud for a data streaming platform to provide real-time access to data across its business. Connectors allow a searcher to instantly connect to data to internal systems, including applications in AWS, NetSuite, Salesforce, and Snowflake and external partners. Stream processing enables them to process data in flight and deliver it to a data warehouse so data is up-to-date and accessible by anyone. Stream governance allows the team to search and tag topics so users can find the data they're looking for and know it's trustworthy. With Confluence serving as its data streaming platform, Ascertis has been able to open new business lines to generate tens of millions in new revenue while delivering internal cost and time savings. savings for the customer, and increased its profit margins. We continue to see strong growth in India, particularly in the digital native segment. A fast-growing e-commerce brand is a great example. By matching the world of fashion to the best technology, this company has experienced massive growth. In 2023, it reached tens of millions of new app users while growing its customer base by 100% in the last 18 months. Previously, their data platform relied on open-source Kafka to power end-to-end e-commerce workflows. fulfillment, real-time inventories, and order management. But with the company's explosive growth came challenges scaling open-source Kafka, resulting in large maintenance overheads and over-provisioning. So in Q4, they turned to Confluent Cloud with a seven-figure deal to power six business services that previously used open-source Kafka and plans to leverage our full platform, including stream governance, connectors, and stream processing to support their ambitious growth goals. In closing, we're pleased with our strong finish to fiscal year 2023. We are more confident than ever that our transformation to a fully consumption-oriented business and continued innovation in our category-leading platform will serve as a catalyst for winning the $60 billion market opportunity in front of us. With that, I'll turn things over to Rohan.

Thanks, Jay. Good afternoon, everyone. I'll start with a brief recap of our full year results. In fiscal year 2023, total revenue grew 33% to $777 million. Confluent Cloud revenue grew 65% to $348.8 million, and non-gap operating margin improved 23 percentage points to end the year at negative 7.4%. This includes the fourth quarter, where we achieved our first positive non-gap operating margin of 5.3%, far exceeding the breakeven target we set a year ago. As we look back at fiscal year 2023, we are pleased to have delivered on our commitment of driving higher revenue growth while accelerating our path to positive non-gap operating margin by one year. Our ability to achieve 750 million plus revenue and positive non-gap operating margin in just nine years since the company's founding is a major accomplishment. It required substantial effort across every team in the company to achieve this milestone. I'm proud of our incredibly talented teams at Confluent, and I'd like to thank our employees, customers, and partners for their important contribution throughout the years. Turning to the Q4 results, key highlights include robust subscription revenue growth with our first $100 million quarter for both Confluent Cloud and Confluent Platform. Record high non-gap total gross margin driven by strong unit economics of our product offerings. and our first positive quarter for both non-gap operating margin and free cash flow margin, underscoring our commitment to driving efficient growth at scale. Total revenue for the quarter grew 26% to $213.2 million. Subscription revenue grew 31% to $202.8 million. Within subscription, Confluent platform revenue grew 18% to $102.8 million, representing 48% of total revenue. The strength was driven by healthy demand for Confluent platform in regulated industries. Confluent cloud revenue grew 46% to 100 million, exceeding our guidance of 97.5 million and ended the quarter at 47% of total revenue compared to 41% of revenue a year ago and 46% last quarter. We're pleased with the healthy consumption we saw in our digital native customers, despite a still uncertain macro environment. Turning to the geographical mix of revenue, revenue from the U.S. grew 27% to 127.6 million. Revenue from outside the U.S. grew 25% to 85.5 million. Moving on to rest of the income statement, I'll be referring to non-GAAP results unless stated otherwise. Total gross margin reached another record high of 77.5%, up 450 basis points. Subscription gross margin also reached a record high of 81.1%, up 240 basis points. Gross margin outperformance was driven by strong confluent platform margin and the efficiency and optimization we continue to realize in our cloud offering. Turning to profitability and cash flow, we achieved positive operating margin for the first time as a public company, improving 27 percentage points to 5.3%, representing our sixth consecutive quarter of more than 10 points and third consecutive quarter of more than 20 points in margin improvement. Our relentless focus on driving operational efficiency across the company resulted in improvement in every category of our operating expenses, with the largest improvement of 16 percentage points in sales and marketing expenses as a percentage of total revenue. Net income per share was $0.09 for Q4, using 342.4 million diluted weighted average shares outstanding. Fully diluted share count under the treasury stock method was approximately 356.1 million. Free cash flow margin also turned positive in the quarter, improving 21 percentage points to 3.2%. And we ended the fourth quarter with 1.9 billion in cash, cash equivalents, and marketable securities. Turning now to other business metrics. In Q4, total customer count grew 9% to approximately 4,960. customers with 100K or more in ARR grew 21% to 1,229, and customers with 1 million or more in ARR grew 24% to 158. We ended fiscal year 23 with 19 customers with 5 million or more in ARR, up from nine customers a year ago. This reflects our customers' strong confidence in standardizing on our data streaming platform, making Confluent the central nervous system of their technology stack. We believe the completion of our consumption transformation in fiscal year 24 will help accelerate the growth of our total customer count. In fact, we saw good traction in total customer count in January. While early, we believe the transformation will make it even easier for our customers and prospects to try, adopt, and expand across stream, connect, process, and govern in our product portfolio. And our hour in the quarter was slightly above 125%. exceeding our midterm target threshold of 125%. Gross retention rate remained strong and was above 90%. As discussed last quarter, we expect NRR will be between 120% and 125% as we go through our consumption transformation this year. As we exit the transformation and starting fiscal year 25, we expect NRR to revert to Q4 23 levels and exceed our midterm target threshold of 125%. RPO was 919.9 million, up 24%. Current RPO, estimated to be 64% of RPO, was 591.9 million, up 30%. As called out last quarter, RPO-related metrics are less relevant beginning this year, given our greater focus on driving consumption for our cloud business. Next, I'm pleased to announce that we recently acquired Notable, which did not have a material impact on our financials. We closed the ACWA hire in Q4 of 2023 and welcomed a small team of highly talented individuals to Confluent. This team focuses on developing a no-code data visualization capability that simplifies navigation and identifies important insights. Now I would like to discuss Confluent's positioning for 2024 and beyond. Driven by our TAM, technology, and team, we have shown in our 2023 results our success in driving efficient growth at scale. In 2024, our TAM, technology, and team are only getting stronger. First, our $60 billion plus TAM is underpinned by the prevalence of data streaming as more than 150,000 organizations have built around streaming, along with long-term secular tailwinds such as cloud migration and Gen AI. Second, our technology differentiation is expanding rapidly. We have successfully evolved from a single product streaming company to the industry's only data streaming platform company. Our DSP is cloud native, complete with stream, connect, process, and govern, and available everywhere. Our customers are excited about the innovation we plan to bring to the market in 2024, as we have one of the most exciting product release cycles coming up in the history of the company, starting with Flink GA in Q1. Finally, our team has proven ability to execute with the latest accomplishment of delivering high revenue growth annually while improving non-gap operating margin by more than 46 points in just 10 quarters. In 2024, we have strong alignment and commitment across every function of the company to deliver on our consumption transformation. This will put us in a better position, more aligned with our customers to address the $60 billion plus dam in front of us. Given this backdrop, we are focused on sustaining efficient growth in 2024 by delivering our first breakeven year for both non-GAAP operating margin and free cash flow margin. Given our solid Q4 performance, we feel confident in delivering 22% total revenue growth for 2024 and eventually returning to our midterm target growth of 30%. Turning now to our guidance. As announced on our last earnings call, we will be transitioning our revenue guidance metrics to subscription revenue beginning this quarter. To assist the investment community with transitioning to our new guidance practice, we will continue to provide total revenue guidance for the first two quarters of 2024 and for full year 2024. We will fully transition to providing only subscription revenue guidance beginning with Q3. For the first quarter of 2024, we expect total revenue to be in the range of $211 to $212 million, representing growth of 21 to 22%. Subscription revenue, which is our new guidance metric and consists of Confluent Cloud and Confluent Platform revenue, will be in the range of $199 to $200 million, representing growth of 24 to 25%. Non-gap operating margin at approximately negative 4%. representing improvement of approximately 19 percentage points, and non-GAAP net income per diluted share to be approximately 0 to 2 cents. For the full year 2024, we expect total revenue to be approximately 950 million, representing growth of approximately 22%, non-GAAP operating margin to break even, representing improvement of approximately 7 percentage points, and non-GAAP net income per diluted share of approximately 17 cents. Additionally, I'd like to provide some modeling points. We expect Confluent Cloud revenue in Q1 to be approximately 105 million, representing growth of approximately 43%. We expect free cash flow margin in fiscal year 24 to break even, representing improvement of approximately 16 percentage points. Consistent with prior years, Q1 free cash flow margin will continue to show pronounced seasonality, primarily due to our corporate bonus payout, employee stock purchase program, and the holdback payment related to our IMROC acquisition. Despite these headwinds, we expect Q1 free cash flow margins to improve approximately 20 percentage points year over year. Finally, we are pleased with decreasing our annualized net dilution from 4.7% in fiscal year 22 to 3.5% in fiscal year 23. We expect net dilution for fiscal year 24 will be approximately 3%, in line with our midterm target. Our goal over the long term is to bring net dilution down to under 2%. In summary, we are pleased with closing out the year with solid fourth quarter results. Our track record of improving non-gap operating margin is a testament to the power of our innovation engine and our commitment of driving efficient growth. Looking forward to 2024, We are focused on achieving our first positive non-gap operating margin and free cash flow margin for the full year while delivering on our top line commitment. Now, Jay and I will take your questions.