Confluent, Inc.

Hello, everyone. Welcome to the Confluence second quarter 2024 earnings conference call. I'm Shane Zee from Investor Relations, and I'm joined by Jay Krebs, co-founder and CEO, and Rohan Sivaram, CFO. During today's call, management will make forelooking 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 third 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 thank you 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 made on a yield-year basis. We use these non-GAAP financial measures internally to facilitate analysis of our 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 IR website at investors.confluent.io. And finally, once we've concluded our prepared remarks, we will post the Confluent Earnings Report to our IR website.

And with that, I'll turn it over to Jay. Thanks, Shane. Good afternoon, everyone, and welcome to our second quarter earnings call. I'm pleased to report a solid second quarter, once again exceeding our revenue and margin guidance despite a continuing volatile macro environment. Subscription revenue grew 27% to $225 million. Confluent cloud revenue grew 40% to $117 million. And non-GAAP operating margin was positive, representing approximately 10 percentage points of improvement. These results underscore the power of our data streaming platform and our relentless focus on delivering success for our customers. Today, I'll start with providing an update on our consumption transformation. Overall, the vast majority of our rollout towards our transformation to becoming consumption-oriented is complete, a step change in how we run our cloud business. One success indicator for our transformation is new logo growth. I'm pleased to share that we increased our total customer count by 320 in Q2, double from the previous quarter and representing our largest sequential increase in two years. In addition to landing a higher volume of customers, we believe we have increased the quality. A strong focus on our target counts has increased the percentage of high propensity customer lands. Though this new consumption motion lands them earlier in their journey, we believe over time, many of these customers will represent the next wave of high consumption accounts for us. We remain as confident as ever in the strategic position of the company and the prospects for durable long-term growth. We have the industry-leading technology, an increasingly critical and relevant category that we believe will be as important as databases. Over the past year, we've made a series of innovations to build out the full set of capabilities of a data streaming platform, enabling us to capture the full lifecycle of data in motion. And as we progress along our consumption transformation, we will be better equipped than ever to rapidly acquire new customers, win new workloads, and fuel the adoption of our full set of product capabilities. Our rapid pace of innovation and ability to land high-quality customers who have the potential to consume more of our product leaves me more excited than ever about the long-term opportunity to capture the lion's share of the data streaming market. Vimeo, a leading SaaS video platform with over 260 million users, is a great example of a customer using our complete data streaming platform. Success for video platforms like Vimeo largely depend on delivering stellar user experiences, but traditional data warehousing and batch ETL processes limited their ability to see real-time customer usage, hindering timely decisions, quick pivots on products and campaigns, and adaptive user experiences without buffering. So they tuned to Confluent to enable real-time data flows that provided the visibility they lacked. Fully managed connectors to Snowflake, S3, and others make it easy to instantly connect data through their business without the hassle of building and self-managing connectors. Stream governance ensures data quality and security and allows Vimeo to safely scale and share data streams. And the team is looking towards Flink to enhance their streaming use cases while freeing up bandwidth across the team. With confluent and real-time data flows, Vimeo can make quick decisions and deliver top-quality personalized experiences that drive growth and profitability. Next, I'd like to discuss the critical role our partners play in our business and some exciting announcements in this area. Partners are essential to our strategy to expand our reach into new markets, improve sales efficiency, and complement our data streaming platform. We're pleased to share a number of notable achievements and milestones across all three pillars of our partner ecosystem. In Q2, we announced Build with Confluent and Accelerate with Confluent, which makes it easier for our global SI partners like KPMG, Accenture, and EY to build specialized offerings as they embed data streaming into their core business. A wide range of use cases have already been established through the Build with Confluent program, including a GenAI bot for airline customer support, fraud detection against AI-powered voice phishing, automated limit increases for credit card users, and real-time telemetry analysis for freight optimization. We're also seeing great traction with Connect with Confluent, a technology partner program that makes it easier for partners to build native integrations with Confluent Cloud. In Q2, we crossed more than 40 technology partner-built integrations, including SAP, MongoDB, Imply, and services at Google Cloud and AWS, giving us coverage across the major segments of the modern data and AI stack to help us drive consumption of Confluent. The success of Connect with Confluent has tripled the amount of data traffic from our partner integration since the start of the year. And finally, on the CSP front, We were pleased to be recognized as partners of the year by both Google and Microsoft. This marks the third year in a row that Confluent won this award from Microsoft and the fifth year that we've been recognized by Google. Together, these recognitions underscore our highly valuable and symbiotic relationship with our cloud partners. As we discussed last quarter, data streaming plays a critical role in fueling Gen AI applications with contextual and trustworthy streams of real-time data. This was underscored by our 2024 data streaming report. 90% of the 4,000 plus IT leaders we surveyed said data streaming platforms can lead to more product and service innovation in AI and ML development, with 63% saying data streaming platforms significantly fuel AI progress by building a real-time data foundation. I'm pleased to share a couple of examples of this. A top five mortgage lender in the United States is turning to Confluent and GenAI to reimagine the home buying experience. This company uses generative AI to listen to client calls, transcribe them, analyze sentiment, and record client patterns and preferences to create personalized experiences for millions of customers and prospects. They turn to Confluent as a key part of their RAG-enabled architecture to quickly build and scale GenAI use cases by tapping into readily usable, trustworthy data streams. Connectors allow them to connect data and systems from across lines of business, while stream governance and stream processing enable the team to create reusable data products that are easy to find, understand, and use. As a result of their GenAI initiatives, approximately 70% of servicing calls can be fully self-served without the need for full team member intervention. By saving the client servicing team 40,000 hours annually, team members can concentrate on cultivating strong, meaningful client relationships. while AI manages the mundane tasks. But this is just the start. In the future, their GenAI platform will learn homeowners' preferences and communication habits so team members can anticipate and solve clients' needs. An international e-commerce company in Germany with 16 billion euros in annual sales is another example of companies turning to Confluent to play a key role in their GenAI stack. When e-commerce products from this company's iconic brands are promoted, their call centers receive massive spikes in call volume. But with only 100 call center reps, customers are often left in long wait queues, leading to failed conversions and unhappy customers. So they turned to Confluent to help power Gen AI applications like voice bots that can scale up in seconds and answer 1,000 calls in parallel. As customers interact with these voice bots, an AI order entry bot enables the order completion process and communicates with ERP systems in real time via Confluent. streaming transactional data such as product, order, customer, payment, and billing information. A key part of this workflow is Confluent streaming KPIs from bots in the operational domain to their analytical systems, capturing data like real-time orders, call metrics, sentiment analysis, and how many AI tokens were used to analyze and measure the efficacy of calls to continuously make their bots smarter and more effective. Powered by enriched, trusted data streams from Confluent, this e-commerce company can now handle unexpected traffic spikes to increase call center capacity on demand to reduce customer wait times and improve order completion rate. In closing, we're excited about the trajectory we're on. With our complete data streaming platform and our transition to a consumption-oriented business, we're well-positioned to attract more customers who can drive even more value from Confluent as they capture the full lifecycle of streaming data from our platform. The future of Confluent is incredibly bright. With that, I'll turn it over to Rohan.

Thanks, Jay. Good afternoon, everyone. In Q2, we delivered solid subscription revenue growth and substantial margin expansions, ending the quarter with positive non-gap operating margin and free cash flow margin. These results, coupled with continued adoption of our data streaming platform, demonstrate our relentless focus on driving long-term efficient growth in a volatile macro environment. Turning to the Q2 results, subscription revenue grew 27% to 224.7 million, exceeding the high end of our guidance and representing 96% of total revenue. Confluent platform revenue growth accelerated to 16%, ending the quarter at 107.3 million and accounting for 48% of subscription revenue. We closed two eight-figure multi-year deals consisting of renewal and expansion with existing customers in the financial services industry. This underscores Confluent as the platform of choice for data streaming among the world's most established enterprises. Confluent Cloud revenue grew 40% to $117.4 million and accounted for 52% of subscription revenue compared to 47% in the year-ago quarter. We are pleased with delivering high growth at scale and continuing to improve the margin profile for our cloud business. Turning to the geographic mix of total revenue, revenue from the U.S. grew 26% to $143.2 million. Revenue from outside the U.S. grew 22% to $91.7 million. Moving on to rest of the income statement, I'll be referring to non-GAAP results unless stated otherwise. Subscription gross margin was 80.8% up 170 basis points. Gross margin performance was driven by strong Confluent platform margin and improving unit economics of our Confluent cloud offering. Turning to profitability and cash flow. Operating margin expanded 9.7 percentage points to 0.6%, representing our eighth consecutive quarter of nine points or more in margin improvement. Operating margin performance was driven by our gross margin performance and our continued focus on driving efficient growth across the company. Net income per share was six cents for Q2 using 354.2 million diluted weighted average shares outstanding. Fully diluted share count under the treasury stock method was approximately 362.9 million. Free cash flow margin turned positive and improved approximately 20 percentage points to 1.2%. And we ended second quarter with 1.93 billion in cash, cash equivalents, and marketable securities. Turning now to other business metrics, total customer count was approximately 5,440, up 320 customers sequentially, our largest sequential growth in two years. We are pleased with accelerating growth in total customer count and the quality of customers we have acquired. Additionally, we added 46 customers with 100K plus in ARR and 9 customers in Million Dollar Plus in ARR, bringing the total to 1,306 and 177 respectively. Our 100K plus ARR customers continue to contribute greater than 85% of our revenue. Our new $1 million-plus ARR customers include customers from a variety of industries, including energy, financial services, manufacturing, retail, transportation, and more. Turning to NRR, Q2 NRR was 118% below our target range of 120% to 125% for this year. This was due to continuing consumption volatility within our large digital native customer base. After the stabilization in Q1 and a healthy start in Q2, we saw increased short-term cloud cost controls and focus on driving efficiencies in this customer cohort in the month of June, which impacted expansion of new use cases. While the green shoots we saw earlier this year haven't yet translated to the level of consumption we'd expected, we are pleased to see continued strength in our gross retention rate. GRR remained above 90% at a level consistent with the last two quarters, reflecting the sticky nature of our data streaming platform and our continued focus on delivering strong value and ROI to our customers. As we frame our guidance for the second half of 2024, there are two points I would like to call out before getting into the numbers. First, growth of our Confluent platform business remains lumpy, driven by the timing of large renewal and expansion deals. As a reminder, approximately 20% of our Confluent Platform TCV is recognized as upfront license revenue. This could create short-term variability for growth in Confluent Platform. Q2 was a good example where we benefited from this dynamic, which creates a tough compare for growth for rest of 2024. Second, consumption in our digital native customer base remains volatile. As mentioned, while the green shoots we saw over the last few months continue to take hold, they have not yet translated to the level of consumption we had expected. We have incorporated this consumption dynamic from our large digital native customers into our second half outlook. Now let's turn to guidance for the third quarter of 2024. We expect subscription revenue to be in the range of 233 to 234 million representing growth of approximately 23% to 24% non-gap operating margin to break even representing improvement of approximately five percentage points and non-gap net income per diluted share to be 5 cents. For the full year 2024, we expect subscription revenue to be approximately 910 million, representing growth of approximately 25%. Non-GAAP operating margin to break even, representing improvement of approximately 7 percentage points. Non-GAAP net income per diluted share to be 20 cents. And free cash flow margin to break even, representing improvement of approximately 16 percentage points. Looking out longer term, we remain well positioned to address our market opportunity. As Jay pointed out earlier, we're going after a highly strategic and mission-critical data streaming market, which we believe will be as important as databases. Over the last few decades, history in software has repeated itself many times that platform approach wins. Our industry-leading data streaming platform is the only complete platform spanning stream, connect, process, and govern, enabling us to capture the full lifecycle of data in motion at a lower TCO and delivering strong ROI to our customers. In Q2, we saw continued adoption of our data streaming platform. Connect, process, and govern of our DSP portfolio accounted for a larger portion of cloud revenue. and grew substantially faster than our overall cloud business. Multi-product customers remained our fastest growing customer cohort with NRL substantially higher than 130%. We believe DSP will continue to outgrow our core business for the foreseeable future. And as it continues to scale, DSP is expected to be a strong growth tailwind to our business over a long period of time. Additionally, the rise of Gen AI makes it clear that a modern organization's success is significantly influenced by its data strategy, particularly around data in motion. With a complete cloud-native and ubiquitous platform and secular tailwinds for data in motion, we have never been more confident in our ability to sustain durable and efficient growth over the long term. In closing, we're pleased with our solid second quarter results. As we continue to execute on our consumption transformation, we remain focused on driving efficient growth and delivering breakeven for non-GAAP operating margin and free cash flow margin for 2024. Now, Jay and I will take your questions.