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spk08: 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.
spk18: 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.
spk13: 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.
spk08: Thanks, Rohan. To join the Q&A, please raise your hand. And today, we will take our first question from Matt Hepper with RBC, followed by Morgan Stanley.
spk11: Great. Thanks for taking my questions, guys. I'm in the airport, so hopefully the background noise is okay. Jay, you know, I noticed, you know, the strong customer logo ads stood out to me. I think you noted on your prepared remarks the quality was also higher. I guess, does that imply that you could see faster expansion from this cohort as they continue to, you know, advance with the platform?
spk18: Yeah, over time. So, one of the measures we, you know, first of all, I would say as we undertook this consumption transformation, one of our key goals was to accelerate customer acquisition. So that's played out as we desired. The second thing that we were aiming for was be a little more targeted in which customers were landing in. And so we, you know, we built a model to try to predict the opportunity in these customers and tagged a set of accounts we felt were high propensity. So the measure we use internally is what percentage of these new customer lands are in that high propensity segment. And so, you know, obviously it's on us to go drive the growth in the accounts. But one of the things we think is promising is that that percentage has gone up substantially when we look at the first half of this year versus last year in the customers we're landing in.
spk11: Got it. Thank you. And then maybe one for you, Rohan. You know, you noted some of the NRR pressure and the potential for lumpy confluence platform business in the second half. It seems like that's contemplated in your guidance. I guess I'm curious, you know, after you saw, you know, it sounds like a little bit of slowness in June. You know, how do things trend in July? I mean, have you seen things kind of stabilized a bit or just maybe a little bit more on the linearity on the cloud side? Thanks. Yeah.
spk13: Thanks for your question, Matt. Thanks, Matt. Yeah, I mean, you know, from an overall guidance perspective, as you rightly pointed out, we've considered two factors. Our Confluent Platform business tends to be lumpy, primarily because of how the rev rec is and the timing of some of the larger deals. So that's incorporated in the guide. And the second one that you mentioned was around the digital native customers. So for digital native customers, Q1, we saw stabilization. And as we entered Q2, we did see a continuation of that stabilization. However, I would say towards the latter half of the quarter, we did see cost efficiencies and focus on just driving some cost efficiencies from some of these customers, which actually continued into the month of July. So as we think of the back half of the year, we think taking a thoughtful and prudent approach to guidance would be the right thing to do. Thanks a lot, guys.
spk08: Thanks, Matt. We'll take our next question from Sanjay Singh with Morgan Stanley, followed by Barclays.
spk09: Thank you for taking the question. I want to return back to that sort of go-to-market transformation. You know, I think there was, you know, an approach to, you know, utilize, you know, similar sales motions like MongoDB who've done modern cloud sales. One of the things that they've been seeing is that as they try and consent for more volume and higher volumes of workloads, the quality 12 months, down the road wasn't what they expected. I was wondering, Jay, I'm happy to see the new customer logos really accelerate, but if you look at it on a workload basis, how are you guys thinking about ensuring quality of the workloads and not just seeing that increased volume?
spk18: Yeah, you know, that's obviously on us to ensure that we're kind of getting the growth and expansion out of this customer site. You know, the first indication is just are we getting into the right customers? I think that we've seen. You know, as we think about it over the course of this year, we want to see those grow. Part of our objective was definitely to get into customers earlier in the lifecycle, earlier in the development lifecycle, where they're actually setting up the architecture, where they can use more of our DSP, you know, in the first application they're planning. I think that's been successful, and that's allowed us to take up the volume of customers. But, yeah, really showing how those play out and spill into the $100K plus and $1 million plus that will happen over time.
spk09: Great. And then just as a follow-up, how are you guys thinking about when you look at the pieces of a real-time on data infrastructure? I think OpenAI bought what's called like a real-time database, and you guys have sort of talked about the streaming platform, the stream processing platform. Where does a real-time database sort of fit in, and is that something that another service offering that console may get involved with over time?
spk18: Yeah, you know, we actually partner very closely with a number of providers of similar functionality. So I think Rockset was the company that OpenAI announced having bought. There's probably half a dozen to a dozen companies in that segment where they're taking streams of data and serving different types of queries against those streams. And that's a great set of partners for us. And we work with them around a whole set of applications, including some in the Gen AI space, you know, use cases around search, use cases around real-time analytics, use cases around aggregating and storing other key information sets that power workloads. So there's definitely kind of a nice integration there between some of the, you know, real-time databases or streaming databases and the rest of the streaming platforms.
spk05: Thanks, Jack.
spk08: Thanks, Andrew. We'll take our next question from Raimo Lenschar with Barclays, followed by Deutsche.
spk12: Hey, thank you. Two very quick questions. First, we had a bit of a change in the sales leadership, and I wanted to see if you could give us some additional comments there. And then, Jay, on Flink as well, we kind of have it in the market for a few months now, and you kind of mentioned some of that on the call, but what's your experience so far in terms of adoption, what people are using for versus what you expected from the user side? Thank you. Yeah.
spk18: Yeah, both good questions. So, yeah, you know, we did have, you know, one departure on the sales side. You know, the structure of our team is the larger field effort, the, you know, reps, technical folks, BD folks, consulting, is all under Erica Schultz. So she's kind of at the top of the sales organization, it reports to me. She remains in charge of that and has been at Confluent for over four years. So there's a fair amount of continuity there. Under her, the managers, you know, management structure for the reps just kind of bounced back and forth between something where she manages the individual theater leaders, like APAC or EMEA directly, or as somebody who, you know, manages that set of theater leaders. And so we did make a change in that structure. You know, I won't comment on the departure in detail, but, you know, we're not planning on immediately backfilling it. We're comfortable with the arrangement we've had. And, you know, that's worked well for us in the past, and we feel good about that, you know, in the near term. On Flink, yeah, it continues to go well. This is, you know, a ton of excitement from our customers. I think last quarter we said on the order of around 600 prospects and customers that tried it out. You know, that's up to over 1,000 now. You know, we're starting to see really nice growth in the revenue from that, but, of course, it's still – Early days, small numbers. What we want to see is see that ramp to a larger percentage of the business, see more of the kind of large-scale production use cases come online. You know, that's what we're looking for over the course of this year. And if we're successful in that, that will be a very positive tailwind for the business overall as it gets to a larger portion of the business heading into next year. Okay, perfect. Thank you.
spk08: Thanks, Ryan. We'll take our next question from Brett Zellig with Deutsche, followed by William Blair.
spk02: Thanks very much, Shane, and great to see the progress in new logo and the path to profitability. Rohan, you characterized digital native customers as volatile. What's the behavior that you're seeing specifically? Are they downselling? Are they churning? And is this more cloud or confluent platform? How much of a risk is this going forward and the extent to which you're embedding it in the guide?
spk13: Yeah, thanks for the question, Brad. I mean, when you really look at the digital native segment, and customers, and if you zoom out and look at it over a longer period of time, the growth has been linear. And growth has been upward, but not linear. So, you know, over a period of time, the segment, we've seen good growth, and the growth rates have been higher than the rate of the company. But when you really look at the last 12-odd months, this segment has been under some kind of cost efficiency pressure. And you do see Every now and then, you know, customers just focusing on the cost side of it and then adding more workloads. So that is a trend that we've seen. But the big takeaway from my perspective is if you step back and look at it over a longer period of time, this segment has been actually a good grower for us. And that's a long-term outlook. But, you know, as you think about how we saw the month of June, we thought it just prudent to bake it into our second half outlook as we look ahead.
spk18: Yeah, I think that's a good characterization. I mean, when we step back and think about the digital native segment, overall, you know, we remain very optimistic. That's an area that's grown for us very nicely over the last few years, and we think we'll continue that way. But as Rohan said, yeah, there is probably more cost pressure there, and that does mean that, you know, if we look at Q1 to Q2, we did see different performance, you know, in that segment between those two quarters where we saw kind of outsized growth in Q1 and, you know, a little bit more optimization in Q2. And I think that's kind of the balance of those two forces. We expect that to play out in the second half of the year as well.
spk02: Thanks, Jay. Maybe just a quick follow-up for you. I see you have a number of open job racks for AEs in the U.S. federal market. Can you just remind us of where you stand in that market and if you see upside in this Q3 that could come from federal, or is this more of a 2025 opportunity? Thanks.
spk18: Yeah, yeah. You know, by and large, you know, open sales hires in the federal space that we're making you know, in this next quarter would impact next year. But, indeed, there's, you know, a very talented team that covers the outlook sector in the U.S. and elsewhere and is a good contributor to the business. So, yeah, we're adding to that team, and we do think that's an area where we'll see growth. Cool. Thanks, and keep up the good work, guys.
spk08: Thanks. We'll take our next question from Jason Ader with William Blair, followed by TD Khan.
spk16: Thanks, Shane. Good afternoon, everyone. I just want to ask about go-to-market. It seems like it's been a bit of an evolution over the last several years, and you guys are still kind of figuring it out. Beyond the change to consumption and the management structure that you alluded to, what else would you call out that you've learned that could help move the needle on your go-to-market motion and, you know, where the best bang for the buck investments are going forward?
spk18: Yeah, it's a good question. You know, if I think about the first half of this year, it was mostly that, you know, shift to consumption. It was kind of rebuilding what you had on a new foundation around a different set of metrics, you know, oriented on something new. You know, if I think about the balance of the year and beyond is really taking advantage of that structure. I do think that's the right setup for the type of cloud infrastructure company that we are. If you look at both peer companies and what the cloud providers have done over time, to drive growth of workloads. It really hinges around that. And so I feel good about the progress we've made and some of the early results from that. But I think it's even more exciting when we think about how we can use that to drive the adoption of these expansion product areas and the expansion of new workloads in the customer base.
spk16: And then just a quick follow-up on the consumption transition you talked about. I think you said smaller WANs. Jay, is that right?
spk18: Yeah, yeah, if I think about, you know, what we've shown, we've kind of taken up the volume of lands, but we will be catching these kind of earlier in the build cycle. We think that's largely good, but it does mean, you know, in that first quarter, the contribution from a given customer will be smaller than it was in the past, just because we're, you know, earlier in that project lifecycle.
spk08: Thank you. Thanks, Jason. We'll take our next question from Derek Wood with TD Collin followed by DA Davidson.
spk14: Great. Thanks, Jay. In terms of the new motions of cross-selling DSP to the base, can you talk about what parts of that portfolio are seeing the strongest uptake when you look at governance, connectors, processors? Is there anything you'd highlight getting more traction? And when you sell into a core customer, what's often the ASP uplift when you cross-sell one of those components?
spk18: Yeah. Yeah, it's a good question. Yeah, I would think of each of those products as being in a kind of S curve where, you know, it's on some ramp. The, you know, earliest of those was our connector ecosystem where we continue to make improvements and drive growth with it. We think there's a lot of opportunity there. The governance portfolio was next, and Flink is the newest addition to that. And so, you know, I think there's interest and traction around all three, but Connect is, you know, the bigger business out of those three just because it started earlier. You know, when we think about kind of percentage growth, of course, you'd see the highest percentage off-link because it started from the small space. And so we want to continue to ramp all three of those, but we expect the attach from those components to increase quite substantially in the year ahead as we open that up to more customers. What drives that is, in part, maturity of the product. You know, a lot of the security – kind of private networking functionality, other things that are important for our largest revenue customers to use those components are either just added or just being added over the course of this year. And that really opens up a lot more of the large-scale production usage to the rest of our customer base. And so that's a critical focus for us when we think about the balance of the year. And then, you know, we haven't given an exact kind of uplift number. We shared a little bit of kind of sketch of the shape of that business, you know, so far. I think, you know, to be honest, I think it's still early days as these components ramp. Even a customer that's adopted connectors, there's more of them they can use. Even if they have their first few Flink queries, you know, we would like to take over a substantial portion of their applications in the stream processing layer. And so I wouldn't think of that as a dynamic uplift of like, oh, you'll see X percent and it's binary either on or off. I would see, you know, this is kind of unlocking an adoption cycle that drives growth, not just in core Kafka, but now in these components as well, which will themselves produce more growth in the underlying Kafka usage.
spk14: Yeah, that makes a lot of sense. Thanks. Rohan, for you, last quarter I think you highlighted targets of getting to 125% NRR next year. Given that NRR dropped below 120 and you're seeing some different behavior, How does this kind of change your view on where you think you can get to in fiscal 25 on NRR?
spk13: Yeah, Derek, I mean, when I really look at the medium term, as Jay highlighted right now, you know, the outlook has not changed at all. I'll basically talk about three things. First, you know, data streaming platform. And as Jay just pointed out, the products within our data streaming platform, we connect – stream processing or fling or governance, they're all early stages of adoption. And 2025 is going to be the year where there is going to be monetization and material contribution to revenue. The second is around consumption transformation. By the time we finish the year, we'll have completed a full year of the transformation and a full year of fine-tuning our go-to market, all things consumption. So we expect to get tailwind from that. And the third category is Gen AI. We've been talking to customers, and Jay highlighted also in his prepared remarks, real-time data is going to be a key component and key part of this broader ecosystem. So when you really take a step back and look at some of these drivers and vectors of growth, our view around NRR getting back to our medium-term targets has not changed.
spk14: Thank you for the comment.
spk08: Thanks, Derek. We'll take our next question from Rudy Kessinger with DA Davidson, followed by Wolf Research.
spk04: Hey, guys. Can you hear me okay? I'm having a bit of an activity issue. Yeah, loud and clear. Okay, great. I'm curious on international. The growth has actually slowed there quite a bit relative to U.S. growth, and in some of the sales attrition I've seen, it seems like it's been more weighted towards folks and Australia, APAC, more so than the U.S., relative to your revenue split. So any color you can provide there just on some of the slowdown in international?
spk13: Yeah, do you want to speak to that, Rahul? Yeah, happy to. Rudy, candidly, not a whole lot to read into it. When you see the relative, I would say, difference in growth rates between international and U.S., more often than not, the driver is timing of some of these larger confluent platform deals. And, I mean, Q2 was exactly the same. We called out two large eight-figure deals. Both of the deals were in North America, and hence the delta, I would say, relative difference in the growth rates. So not a whole lot to call out. On the sales attrition, I'd say, again, no specific trends that we'd like to call out. Just two comments I'll make on that front. First is, as we kind of went through the consumption transformation, Obviously, as we stand right now reflecting back, we feel really good with the overall sales capacity we have on board. The first half of the year, we've had strong hiring from a sales organization perspective. And that just sets us well as we look ahead for the rest of the year. I'd say we have the right capacity in place to deliver on our forecasts.
spk04: Okay. And then secondly, just on the model, I know you guys are guiding to just total subscription revenue. It sounds like platform is probably tough to compare against second half versus first half, maybe down a bit in Q3. Do I have that right? And secondly, on cloud revenue, just any directional color you can give in the sequential expectations in cloud, it sounds like with maybe some of the headwinds in June and July, maybe the sequential add in Q3 is a bit lower than Q2.
spk13: I lost you a little bit on the first part of your question, but I'll answer it. If it's not covered, let me know, right? Well, when we look at the second half guidance, I'll say I called out two drivers. The first is around Confluent Platform. And in general, when you have these large deals, the timing of these deals matter. And the timing of these deals, not only from a renewal perspective, but also from an expansion perspective. Renewals tend to be a lot more predictable than the expansions. And hence my comment around the second half, you know, with respect to platform. On the Confluent Cloud side, again, what we are essentially modeling out is we're thinking that the dynamics that we saw in the digital native customer segment will kind of continue into the second half. So, yeah, starting this quarter, we've obviously stopped guiding total revenue and the focus will be on subscription revenue. But just to help with the transition from an overall modeling point perspective, We expect cloud mix for the full year as a percentage of total subscription revenue to be approximately 53% in that zip code. And that's very consistent with the mix that I shared earlier in the year, so not a whole lot has changed, but I just wanted to provide that color as you think about the second half, Rudy.
spk03: Yeah, that's helpful, and you hit on both parts. Thank you. You hit on both parts. Thank you.
spk08: Thanks, Rudy. We'll take our next question from Alex Zukin with Wolf Research, followed by Gorman.
spk01: Hey, guys. Thanks for taking the question. It's great to be on with you. I guess maybe just on the first one, on the digital natives, if you can kind of dig in a little bit there on maybe did you see – was the moderation in consumption or some of the – I'd say modulation of the green shoots. Was that tied to a particular vertical, a particular geography? We heard Microsoft last night talk about how some consumption trends were less than they expected in Europe. So just curious if you could maybe categorize where some of those modulations came from.
spk18: Yeah, there may be some geographical effect. I don't think that's the main thing. You know, we actually saw this primarily in the larger set of digital native customers globally, right? So, you know, U.S., EMEA, et cetera. And, you know, what is it that they're doing? You know, it's not the case that they're cutting projects. You know, it's not the case that they're, you know, switching to competitors or there's any kind of customer loss in that segment. It really was about kind of optimizing their use of the underlying infrastructure. And so, you know, in a lot of these customers, they have a built-out team that's FinOps or something like that that's kind of scrutinizing costs and working with infrastructure teams to figure out, hey, can we consolidate clusters across teams? Can we compress data more? What can we do to kind of squeeze a little bit more juice out of each dollar of cloud spend? It's not unique to Confluent, but we did see a little bit more of that activity. Any quarter in that segment is a balance of that kind of optimization and expansion. We think about last quarter, the balance was definitely on the expansion side. This quarter, you know, a little bit more on the optimization side. That means when we think about the rest of the year, you know, could play out either way, but we're factoring in, you know, more risk when we think about what we'll get out of that.
spk01: Makes a ton of sense. And then maybe the second one, super helpful, by the way, on the cloud revenue component for the second half, But maybe, like, given the fact that you're signing more customers, that you're landing maybe a little bit smaller initially, you've got a number of product vectors starting to gain traction with Flink and a few others, and then presumably some of these Gen AI use cases ramping. Is there the possibility that even though the second half implied guidance for subscription for cloud, there is a bit of deceleration in that guide to account for the conservatism? How do we think about the sequencing of those tailwinds to maybe drive reacceleration? Again, I'll point to Microsoft. You told us, you know, second half of their fiscal year, they're going to see Azure reaccelerate.
spk18: Yeah, yeah. Yeah, I mean, you know, obviously we've kind of given the guidance for this year. It would be, you know, I think early to start describing next year. But just kind of broadly or qualitatively, as we head into that, yeah, we feel like there's substantial tailwinds. And, you know, all the things you just mentioned, you know, I think will start to contribute more materially. And that's definitely a positive factor for us. And then when we just talk to customers, you know, I think this is an area they continue to really bet on and invest in. And it's increasingly, you know, for these larger customers becoming a very substantive part of their overall business. data infrastructure. And so I think, yeah, that gives us a lot of confidence heading into next year about what the trajectory is. Perfect. Thank you, guys.
spk08: Thanks, Alex. We'll take our next question from Cash Rangan with Goldman Sachs, followed by J.P. Morgan.
spk05: Thank you, guys. So, Jay, the motivation behind the transition to consumption was to ultimately get better growth rate acceleration, which was the right thing to do. So as you are halfway through the mark of the year, one of the things that you uncovered as unlocks, what are the things that are working, things that still need work? Because when you look at the, in a fit word, accelerate, which I think is definitely the goal of the company and certainly the right thing, we should be starting to see some leading indicators get better. And maybe it's not the right way to look at the subscription revenue growth rate or the cloud revenue growth rate, which have been slowing down a bit, right, maybe due to a whole host of other reasons. Well, your lands are certainly very impressive. So what needs to happen more for the transition to unlock the real growth potential of the company, which is, you know, the acceleration that you have planned for sometime in calendar 25? And I have a follow-up question. Thank you so much.
spk00: Yeah, yeah.
spk18: I mean, obviously, you know, that when we look at the performance any year, there's a number of factors in play, including just, you know, the fact that we're changing a lot of things when we go to market. The first step is kind of get back to where you were in the new system. And I feel like, hey, we've kind of done that. It doesn't mean that everything is dramatically better, but it means we're now oriented around consumption, tracking each of the individual workloads in each customer, tracking the actual spend by component and the opportunities around that, which is what will drive the DSP growth. So that's a good foundation to build on. So, you know, what is it that we need to do? And we need to really harness that and lean into it, you know, as the driver of growth. And I think that will be a positive tailwind for us as we kind of head into next year, as well as all the customers we've landed. You know, the nice thing is, hey, you know, as we think about halfway into this year, we actually have a much broader base. to grow out of in terms of new lands. And, you know, provided we're able to continue that throughout the second half of the year, heading into next year, that's kind of a cohort to drive growth that will be kind of coming towards their, you know, more production maturity, additional use cases, et cetera, and that'll be a tailwind.
spk05: And one for Rohan. So as you have the net expansion rates, I mean, certainly they came down a bit, but broadly speaking, they're still okay relative to the overall growth rate of the company. Does it mean that you could get more profitability because generating growth within the base is less costly, less time-consuming than going for growth outside? Or are there other puts and takes that offset that consideration, netting out on where you stand in terms of profitability and could net expansion rates be a driver of better profitability?
spk13: Yeah, I mean, Kash, thanks for your question. Higher net expansion rates and net retention rates are obviously a driver of leverage over a long period of time, so there's no question about it. But, you know, when I really, I'll probably take the question in two lenses. First, when you double-click into net retention, in addition to the current trends that you see, we spoke about data streaming platform. And for customers that are using multi-products for us, their net retention rates are well above 130%. So, as you think about the next wave of growth, next vector of growth, that's going to be a tailwind to net retention rates. So that's one piece of it. The second piece of it around the margin side, I mean, you know, when we think about our resource allocation philosophy, it is always making sure you get the right balance between growth and profitability, and you're driving efficient growth over a long period of time. And that's our goal. Given the opportunities that we have in 2025 and beyond with respect to the new growth vectors that We're being prudent about it, you know. When you look at the second half, we'll be adding the right amount of capacity in engineering, in sales and marketing to make sure we are ready and, you know, we are in the right position from our overall capacity perspective as we embark on next year. And, I mean, most of the hiring we're going to do between now and end of the year is going to benefit us, you know, next year. And I'll finish off by saying our medium-term goals from an operating margin perspective, which is in the zip code of 5% to 10%, continues to be the same. And we're going to manage that proactively by balancing both growth and profitability. Thanks so much.
spk08: Thank you. We'll take our next question from Pingivin Bohr with J.P. Morgan, followed by Oppenheimer.
spk07: Great. Hey, guys, thank you for taking the question. One question for you, just blurt both of them out. On the Flink market, as you try to kind of execute towards capturing the Flink opportunity, how does the maturity and kind of the understanding of the use cases compare to that of the core market? I'm trying to understand if you're finding customers that have well-defined Flink use cases and there's a pent-up demand, you know, versus the use cases are not as defined as that of the core Kafka market and there's a little bit of evangelization that maybe needs to happen. That's the first question. And second question, how big is the digital native segment for you? Thank you.
spk18: Yeah. Yeah, I would think about the, you know, Flink as being maybe as an open source project, call it maybe three years behind Kafka broadly. And so in terms of maturity, that's probably where it is. Does that mean customers have use cases or don't have use cases? Well, it depends on the customer, right? Typically the way these technologies progress is, is from more technologically sophisticated companies to less technologically sophisticated companies. And so, you know, in maybe some of the banks, digital native companies, they would have, you know, pretty mature, flink practices, maybe not as large scale as their Kafka usage, but, you know, certainly up and running. You get out further into mainstream enterprise, you'd see some of that, but maybe less, right? And so I would think about that as being kind of the vector of diffusion and and very similar to Kafka usage. So I think it follows a very similar pattern, but, you know, several years earlier in that flow. You know, for us, I think the project is a lot easier than the initial Kafka land. You know, if you think about what we had to do getting into these new accounts with a cloud offering, especially early on, a lot of these customers did not have a lot of cloud products for infrastructure outside of the cloud provider. So that kind of initial land was definitely the harder lift. As you think about, okay, great, now they've got these streams of data expansion to things that use the stream of data, I think it's definitely easier than kind of getting Kafka in the first time. And I think that's a positive force for getting that product to ramp quickly. And so we think that's a positive thing. And remind me of the second question you had.
spk07: Just the size of digital natives. Oh, yeah, yeah.
spk18: We haven't broken that out. You know, if we think about the business overall, it's not the largest kind of vertical. It's not even that well-defined kind of broadly in the industry, but, you know, we have a definition internally that we tag accounts with. So it's not the largest vertical for us, but it is sizable. Thank you. Yeah.
spk08: Thank you. We'll take our next question from Itai Kitchum with Oppenheimer, followed by Mr. Hoop.
spk15: Thanks, Shane. Rohan, first question to you. Can you tell me what percent of your platform revenue is associated with cloud customers as well? I'm just trying to think because if there's a significant overlap there, I would think that over time the lumpiness, inherent lumpiness in platform would fade. So we'll have to get color on that.
spk13: Yeah, that's a great question. Well, we've not broken that out, but what I can tell you is there is an increasing set of customers who are using both platform and Confluent Cloud. And, you know, a couple of quarters back, we've been kind of also providing updates that, you know, when customers have both cloud and platform, they tend to be more sticky, and their NRRs are higher than the company average NRRs as well. So that's one piece of it. But to your other point around if you have both platform and cloud, the lumpiness will come down, probably not always because most of these times, you know, you do have complementary use cases that are working in parallel. So when a time for a platform renewal actually comes, there is an event that happens that drives upfront revenue recognition. That doesn't change. So the lumpiness will still be there, but I think to answer your question, yeah, there is a growing number of customers that are using both platform and cloud, and actually that's exactly the direction we want to go because that makes our customers a lot more stickier.
spk15: And, Jay, second question for you. You talked about how the quality of the new customer editions is higher. Maybe you can dig into that a little bit more. What does that mean? Is this a global 2,000 customers more weighted? Any color that would be good?
spk18: Yeah, it's not exactly global 2,000. You know, we have a couple mechanisms that we include in that, but, you know, it would be broadly aligned to something like that. We would also include certain types of tech customers that, you know, might not be global 2,000 but have high potential. You know, so it's, you know, it's a defined customer list that we've set aside. So it's something like that where we feel like, hey, there's, potential for high IT spend and, therefore, kind of bigger growth for us over time.
spk17: I appreciate it.
spk08: Thanks. We'll take our next question from Gray Moskowitz with Misuho, followed by Nita.
spk10: Okay. Thank you. Rohan, you did a nice job explaining some of the deliberation by digital native customers and what you're assuming going forward. That said, you beat Q2 subscription revenue by about $7 million. guided in line for Q3, which implies a fairly meaningful Q4 reduction. So I did just want to ask if either of these large deals closed sooner than you had expected, or if there's anything you're seeing in the pipeline that has caused you to be a little more cautious with respect to the Q4 specifically.
spk13: Yeah, Greg, I'll say that I'll go back to, like, when we think about the second half guidance, obviously these two drivers that I spoke about on the Confluent platform side, you know, In general, you have Confluent Platform large deals that are either renewals and expansions and new deals. For the renewals, it's fairly predictable. You have visibility 12 months down the road when that's going to happen. And more often than not, it ends up kind of in that zip code. For the newer deals and for the expansion deals, that's where you could see deals kind of shift one quarter plus minus. And that's the dynamic that basically I called out for the second half guidance. And, you know, it's also important to notice that, you know, our backdrop, what continues to be a fairly volatile macro environment, and we want to make sure that we are thoughtful and prudent with respect to as we think about the outlook. On the Confluent Cloud side, Again, not a whole lot of new things to share, but we are basically assuming that the dynamics that we saw towards the end of Q2 will kind of have impact to the second half of the year.
spk10: Thank you. And then just for Jay, can you walk through the rationale of switching confluent cloud pricing for your basic and standard clusters from base and partitions previously to elastic CKUs? And then also, does this change have any impact on revenue over the remainder of 24? Yeah.
spk18: You know, we made a set of pricing changes. Those were some of them. There was also some tune-ups on some of the throughput-related pricing, some of the connector pricing. We talked a little bit about that a few earnings back as, you know, being kind of aligned with this consumption transformation. So, in general, we were looking at things that caused friction early in the buying process and were kind of more aligned to a big upfront purchase than they were to a kind of use case by use case expansion, and we wanted to pull some of that out. If you think about what we're trying to do broadly, You know, there's a lot of open source Kafka usage out there. You know, we've monetized a small percentage of it, mostly sitting out there in open source. We want to go get it. There's a bunch of things we do to make that happen. But part of what we want to do is really cover the spectrum of kind of TCO needs. You know, there are very high volume, very price sensitive workloads. There's very premium high quality workloads. You actually need some different SKUs. to actually segment that market and go after it in the best way. So if you think about the additions to our portfolio, both the new offerings in Kafka for very large scale, some of the tuning at the low end, it really is about trying to properly segment that market and go capture it to kind of soak up more of the world's Kafka. You know, I think has proven successful, you know, in part as evidenced by the higher volume of customer lands. I mean, part of that's a kind of comp and sales practice thing, but part of it is also changes in the product that make it easier to land. Does it have impact on revenue? Yeah, it does have some. You know, whenever any of these things that kind of, you know, give customers more options, it does give them more opportunity to shift around. When, you know, when we look at that, that effectively came out as expected. So we had some model of, like, hey, how much shift are we going to see? Typically what you see when you make one of these changes is initially some shift that may be a little bit negative and then, you know, kind of better expansion as you have more options for customers to plug into. And so, you know, when we were checking ourselves against the model we built in terms of the impact of that, you know, is more or less exactly what will be expected when you take it all together. Of course, individual changes might be a little bit more or less. So the change on those skews was kind of part of that larger vision, which is like simplification, friction reduction, and just kind of soaking up all the Kafka. Is that helpful? Yep, super helpful. Thank you.
spk13: And, Greg, I'll just add to what Jay said, that is, as we look at the second half of the year, some of these dynamics that he called out is essentially baked into our outlook for the year as well. All right.
spk10: Thank you, guys.
spk08: Thanks. Let's go to Mike Seagals with Needham. Mike?
spk06: Hey, thanks for taking the question, guys. But before I dig into mine, just to make sure we're clear on where we were going with Greg's last question there, as far as those pricing changes, that was contemplated when you guys provided us the guide for the full year two quarters ago. Or no, we're making changes now in real time off the Q2 result.
spk18: Yeah, yeah. I think it was factored in early on. Like, we had a model for what impact that would have, and we haven't seen it deviate from that. So, when we think about, like, hey, what are the factors impacting guidance in the second half, I think it's exactly what Rohan said, which is, you know, confluent platform lumpiness and what we've seen in the digital native segment. The price changes, you know, we think it's net positive, you know, over time, but it's not a huge factor one way or the other right now.
spk06: Awesome. Awesome. So, I wanted to start with, I know the digital natives, we've highlighted that a lot. Is there any way to think about how their spend compares to other pieces or other segments within the Confluent customer base? Like are these, is it a 2X? Like what's the significance of the spend on a per customer basis versus the rest of the Confluent customer base?
spk18: Yeah, you know, digital native itself spans from very small kind of tech companies to very large tech organizations with thousands of engineers. And so, you know, it would be inaccurate to characterize that as a whole. So even internally, we break that into, you know, kind of large tech companies and smaller tech companies. You know, what we saw was more concentrated on these large tech companies that are kind of more actively pursuing optimization. For those large customers, Yeah, they do tend to operate at scale. They have a lot of engineers. They tend to move quicker than the average customer in terms of adoption and expansion, but also in terms of optimization. They're just a little bit more agile than a similarly sized company elsewhere in enterprise. You know, that's probably broadly how I would characterize it. Their kind of use cases aren't vastly different from the rest of the world. They just tend to have a bit more data and, you know, somewhat more engineers than the average company that size.
spk06: Okay. And just thinking about, again, the quality of those new logos that we've highlighted a couple times here as well. We're early days here, but is there any way to think about how the expansion of these new logos has played out versus what you've seen historically? And I guess the second part here, for those new logos, does it skew more heavily towards digital natives, or is there any way to think about the composition of these new logos?
spk18: Yeah, you know, what we've shared is You know, it's kind of broadly more concentrated in that, you know, high propensity customer list, which you can think of as kind of global 2000 plus high propensity tech. Yeah, I haven't looked at the tech composition specifically broken out, so I can give you more color on that, but I'm not aware of that being a factor. And then, yeah, we are catching these use cases earlier. You know, it's just easier in this consumption motion for us to land. You know, we're more flexible on the commitment amount. The product is better optimized for that. The comp is incentivizing it. And so, yeah, it is easier for us to get in early. But the key thing for us will be to kind of show that ramp of consumption over the course of the year with these new customers. You know, what we've seen so far is promising, both in terms of the numbers and that ramp time. I don't think it'll be exactly the same amount per customer, but the customer volume is much higher. And so, you know, we think overall that's a net positive contributor when we think about what the base of new customers that we're acquiring.
spk08: Great, thanks. A final question today will come from Michael Turing with Wells Fargo.
spk17: Thanks for squeezing me on. Jay, between the go-to-market changes and the new product efforts, it seems like you're setting the stage for the next phase of Confluent. When do you think the foundation there is largely set? And we go past talking about some of the transition impacts and more directly to some of the benefits from consumption focus and new products. Is that something we can start to see build towards today? Is that end of year? Yeah.
spk18: I mean, obviously there's no moment in time where, you know, yesterday it was the old thing and today it's the new thing. But, yeah, it's certainly the case that this year we've got a lot of moving parts that are part of kind of setting up where we want to get to, right? The consumption changes are part of that. The new product introductions are part of that. You know, as it becomes more of a tailwind for the business, I think it's definitely as we head into next year. That's where, you know, we have a more stable system that we're executing the go-to-market in that we've had, you know, more history with. And then we have products that have kind of gotten to enough scale of revenue where they can move the overall number. Obviously, these newer offerings, you invest a lot of time in them, but the, you know, the early results, you're just building that initial customer base. So it's not, you know, relative to the amount of effort, you're not getting as much dollars out as you would with the core business. However, any of the big things start small. And so kind of, you know, getting those things seeded and started now I think is very important. You know, both in terms of what we want the business to do over the course of, you know, the next three years, but also in terms of what we want to be in customers, like the capabilities we want to provide them, you know, setting ourselves up to really be a strategic platform in these organizations. So, yeah, obviously that's a key effort this year. I would think about the contribution as being, you know, throughout next year and kind of a tailwind then. Thanks very much.
spk08: Thanks, Michael. This concludes our earnings call today. Thanks again for joining us. Bye, everyone.
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