Confluent, Inc.

Welcome to the Confluent Third Quarter 2024 Earnings Conference Call. I'm Shane Zee from Investor Relations, and I'm joined by Jay Kreps, 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 fourth 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 year-over-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, we will post the Confluent earnings report to our IR website after our prepared remarks. And with that, I'll turn it over to Jay.

Thanks, Shane. Good afternoon, everyone. Welcome to our third quarter earnings call. Subscription revenue grew 27% to $240 million. Confluent Cloud revenue grew 42% to $130 million. Non-gap operating margin expanded approximately 12 percentage points to 6.3%. And I'm proud to report that total revenue grew 25% to $250 million, surpassing a $1 billion revenue run rate in just 10 years since Confluent was founded. In Q3, we hosted Current 2024, the only industry event fully dedicated to all things data streaming. More than 4,200 people from 1,200 companies participated, making it our biggest and best current yet. Data leaders from Mercedes-Benz R&D North America, Viacom 18, and Accenture joined me on the keynote stage to discuss how Confluent sits at the heart of their companies, allowing them to push the boundaries of what's possible for their customers. And some of the most popular sessions focused on how companies leverage data streaming to power transformative AI use cases like creating customer chatbots, building AI and ML pipelines to detect fraud, and delivering hyper-personalized AI customer experiences. We continue to see excitement, interest, and use cases around GenAI growing across our customers and in the ecosystem of AI solutions providers. Last week, we hosted our first Confluent AI Day, a one-day event designed to help our customers advance ideas and to fully build AI applications. In partnership with AWS and MongoDB, we brought together hundreds of attendees from companies like Google, PNC Bank, Whirlpool, and Rocket Mortgage, who joined expert discussions, interactive sessions, and an exciting AI hackathon. At the event, we launched the Confluent for Startups AI Accelerator Program. This exciting new program is about empowering early-stage AI companies with the tools and mentorship they need to lead in the world of generative AI. Confluent for Startups AI Accelerator Program provides startups with early access to Confluent's latest AI tools, expert mentorship, and product credits from Confluent, MongoDB, and Anthropic. We're committed to helping these startups create new breakthroughs in real-time AI. We spoke about our relationship with OpenAI during the Q4 2023 earnings call when we discussed how OpenAI's team uses Confluent to deliver real-time data streams. I'm happy to report that OpenAI has expanded their use of our data streaming platform to help scale with the increased usage of their platform. The momentum and growth further validate the strategic role of data streaming in the generative AI landscape. Last quarter, we also celebrated our 10th anniversary as a company. When we started Confluent 10 years ago, data streaming was just emerging as a nascent paradigm. What started with a small group of companies like LinkedIn, Uber, and Netflix, disrupting the status quo with real-time data streams, has turned into a movement. Today, more than 40% of the Fortune 500 rely on Confluent to set their data in motion. We serve customers broadly across industries, including 10 of the 10 top U.S. banks, 8 of the top 8 global car makers, and 9 of the top 10 U.S. insurance companies. We see significant expansion opportunities across our customer base as we expand from individual use cases to the central nervous system for real-time data. Our growth in capturing this opportunity has gone through two distinct waves and is now entering a third. The first of these waves was built directly on the back of the open source traction and was about commercializing that with our software offering, Confluent Platform. That provided the bulk of our business to the first five years of Confluent's growth. However, we knew that for the long-term platform we wanted to build and to capture the bulk of the opportunity around streaming, we needed to make streaming far, far easier to consume. This spurred the early investment into what fueled our second wave of growth, Confluent Cloud. Indeed, even when we went public three years ago, our cloud business was a small percentage of our revenue, and we were in the early stages of taking our cloud business to scale. That being said, we strongly believe that the secular shift to cloud would present a meaningful long-term driver of growth. I'm proud that our team has successfully executed on our cloud vision, and Confluent Cloud is now more than 50% of total revenue and continues to outpace our Confluent platform business. At the same time, cloud is our most frictionless path to monetizing the thousands of organizations using open source Kafka. But with 150,000 organizations using Kafka, we're just getting started. Already, our cloud product comprises over 90% of our customers, demonstrating its broad appeal as we continue to grow into this space of open source usage. These first two waves aren't done. We continue to work to serve the broad base of Kafka users through compelling pricing and packaging optimizations for Confluent Cloud and Confluent Platform. Our differentiated cluster types like enterprise and freight enable us to deliver data streaming offerings for all customers and workloads with low TCO and strong ROI. Our recent acquisition of WarpStream adds a third deployment mechanism of BYOC to this portfolio. Warpstream's bring-your-own-cloud model offers a deployment model midway between fully managed and self-managed and opens up opportunities in a set of high-volume, high-tech customers that form a good chunk of our digital native customer base. Warpstream is BYOC done right. Built directly on top of object storage, Warpstream's zero-disk architecture enables zero-ops auto-scaling while making it 5 to 10x cheaper than other alternative systems. And unlike traditional BYSE offerings, WarpStream prioritizes security by avoiding break glass access to customer networks and systems. Confluent is now the only company with a data streaming offering for everyone, regardless of use case, cloud environment, or deployment type. Kafka is the foundational layer of our data streaming platform and could sustain our business for many years on its own, but it only represents a portion of the opportunity ahead of us. We believe our third wave of growth comes from being a complete data streaming platform, a one-stop shop for all real-time data needs. To do this, we are bringing together the key capabilities to stream, connect, process, and govern continuously flowing streams of data so organizations can power their next generation real-time applications. Over the course of the past year, we have been on our most aggressive pursuit of our vision since we started the company, and that is starting to yield strong traction. Major new product and pricing innovations like Flink, TableFlow, Freight Clusters, AI model inference, and new connectors will extend our already significant category lead. And we continue to see strong traction across our customer base. Our DSP portfolio continues to grow substantially faster than overall cloud revenue. One of the areas we're most excited about is the opportunity around stream processing at Apache Flink. Let me share two examples of how customers are using Flink on Confluent Cloud and Confluent Platform. One of the largest private companies in the US, Midwest grocery chain with over 20 billion in revenue is using Confluent's fully managed Flink offering to accelerate the growth of its e-commerce business, a critical driver of the company's revenue. This retailer had already overhauled its e-commerce solution with Confluent Cloud and wanted to integrate stream processing for all the Kafka topics it had built inside its digital environment. including pricing, promotions, and inventory details, without any lag in production. So the retailer implemented Confluent Cloud for Apache Flink to combine and enrich streams of data flowing across hundreds of retail stores, its website and mobile app, and third-party fulfillment partners like Instacart. This data spans more than 100,000 products used in tens of millions of orders. With our Flink offering, this retailer's real-time inventory and pricing are accurate and customized to each local market so the company can consistently deliver a trustworthy and personalized shopping experience to its customers. Since working with Confluent, it has grown its e-commerce business by 700% and can stay a step ahead of the national grocery chains it competes with every day. A Fortune 50 telecom company in the U.S. and a Confluent Platform customer is using our offering for real-time analytics. Initially, the telecom provider used an alternative stream processing tool, which struggled to meet the demands of real-time data processing. This affected how the telecom's enterprise customers could serve consumers and led to higher churn. So the telecom provider deployed Confluent Platform for Apache Flink, shifting processing to the left and rolling out thousands of Flink instances across its infrastructure to run real-time analytics on data earlier in the data pipeline before it moves downstream. Flink processes and analyzes data such as network performance to help its customers deliver consistent, personalized experiences to consumers and network visibility for threat detection. By using Confluent Platform's Flink offering and tapping into our team of Flink experts, the telecom provider has saved tens of millions of dollars and significantly reduced churn, boosting its overall margins. In closing, I'm pleased with our strong third quarter results, and I'm incredibly excited about the opportunity ahead of us. I'm even more excited for the next 10 years. We're in a prime position to win the $60 billion data streaming category. With that, I'll turn things over to Rohan to walk through the financials.

Thanks, Jay. Good afternoon, everyone. In Q3, we drove robust top-line growth, record gross margin, and another positive quarter for both non-GAAP operating margin and free cash flow margin. These results demonstrate our market leadership in data streaming and our commitment to driving efficient growth over the long term. Q3 subscription revenue grew 27% to $239.9 million, exceeding the high end of our guidance and representing 96% of total revenue. Confluent platform revenue grew 13% to 110.1 million and accounted for 46% of subscription revenue. The strength was driven by healthy demand for Confluent platform in the financial services industry. We serve 10 of the top 10 US banks with an average ARR of greater than 5 million. The substantial majority of their ARR is attributed to Confluent platform as these banks are still early in their move to the cloud. Confluent cloud revenue grew 42% to 129.8 million and accounted for 54% of subscription revenue compared to 48% a year ago. We saw consumption stabilization in our digital native customer cohort during the quarter. While they remain cost conscious, we were pleased with the consumption growth trajectory of our largest cloud customers, many of whom are shifting their focus to implementing new use cases and adopting our DSP products. Q3 cloud revenue also saw a one-time low seven-figure revenue benefit. Adjusted for this benefit, we still handily exceeded consensus expectations. Revenue from DSP continued to grow substantially faster than our overall cloud revenue. While monetization remains in its early days, we are pleased with the adoption of new products by our large cloud customers. 19 of our top 20 cloud customers have adopted at least one DSP product, and 13 have adopted products across all three categories. Additionally, multi-product customers continue to grow at a faster clip and exhibited a much higher NRR profile. Turning to geographic mix of total revenue, revenue from the U.S. grew 28% to 152.4 million. Revenue from outside the U.S. grew 21% to 97.8 million. Moving on to rest of the income statement, I'll be referring to non-GAAP results unless stated otherwise. Subscription gross margin reached a new record of 82.2%, up 210 basis points, while total gross margin also reached a record high of 79%, well above our long-term target. Our gross margin outperformance continued to be driven by strong Confluent platform margin and the improving unit economics of our Confluent Cloud offering. Turning to profitability and cash flow, operating margin expanded approximately 12 percentage points to a record high of 6.3%, representing our ninth consecutive quarter of nine points or more in margin improvement. Free cash flow margin of 3.7% was also a record, expanding 10 percentage points. This marks our third positive quarter for both operating and free cash flow margins and reflects our team's track record of driving margin expansions at scale. Net income per share was 10 cents for Q3, using 353.6 million diluted weighted average shares outstanding. Fully diluted share count under the Treasury stock method was approximately 366.8 million. And we ended the third quarter with 1.86 billion in cash, cash equivalents, and marketable securities. During the quarter, we acquired WarpStream to further differentiate our data streaming platform to include the BYOC native form factor. WarpStream is particularly well suited for digital natives and high-scale workloads with relaxed latency requirements such as logging, observability, and feeding data lakes. In fiscal year 24, we do not expect WarpStream acquisition to have a material impact on our financials. Over time, we expect Warpstream to be a growth driver as it expands our reach into more workloads across customer segments. Turning now to other business metrics. During the third quarter, we saw a notable increase in overall win rates for new business, both year-over-year and sequentially. Our win rates against smaller startups were well above 90% as we compete favorably with our cloud-native complete and ubiquitous platform. This translated to sustained momentum in new logo acquisition and customer expansions. Total customer count growth accelerated to 16% and ended Q3 at approximately 5,680, representing a sequential add of 240 customers, 3x the sequential add of the year-ago quarter. New customers include a top three U.S. airline company, a Fortune 50 carmaker, one of the largest online meal kit providers, a leading lifestyle retailer, one of the world's largest online furniture companies, and many more. The network effects of our data streaming platform continues to take hold in our large customer base. We added 40 customers with 100K plus in ARR and seven customers in 1 million plus in ARR, bringing the total to 1,346 and 184, respectively. Our 100K plus ARR customers continue to represent more than 85% of our revenue. Our new $1 million plus ARR customers include customers from a variety of industries, including healthcare, travel and retail, technology, financial services, and more. Q3 NRR was 117%, while GRR remained above 90%. We saw many of our large digital native customers shifting their focus from cost optimization to new use case implementation and adopting DSP products. This trend has continued into October, which we believe will help stabilize our NRR around current levels in Q4. Turning now to guidance, we are increasing our Q4 revenue outlook in addition to raising full-year subscription revenue, non-GAAP operating margin, non-GAAP EPS, and free cash flow margin. For the fourth quarter of 2024, we expect subscription revenue to be in the range of 245 to 246 million, representing growth of approximately 21%. non-GAAP operating margin to be approximately 2 percent, and non-GAAP net income per diluted share to be 5 cents. For full year 2024, we are raising subscription revenue to be in the range of 916.5 to 917.5 million, representing growth of approximately 26 percent, non-GAAP operating margin to be approximately 2 percent, non-GAAP net income per diluted share to be 25 cents, and free cash flow margin to be between zero to 1%. Looking back at the last 10 years as a company, we have established data streaming as a major category in the tech stack. As the data streaming pioneer, we have continued to extend our market leadership by delivering world-class innovation and business outcomes for our customers. This has enabled our growth and profitability journey at scale. We exceeded 1 billion revenue run rate in just 10 years since inception, including growing Confluent Cloud revenue run rate from less than 50 million to more than half a billion in just four years. We serve 5,680 great customers, including more than 40% of the Fortune 500 across a variety of industries. We sustained positive non-GAAP profitability metrics in Q3, with 79% total gross margin well above our long-term target threshold. 6.3% operating margin now within the range of our mid-term target, and free cash flow generation at a record margin of 3.7%. And for the first time in Confluence history, we expect to exit 2024 with positive non-GAAP operating margin and positive free cash flow margin for the full year. These are fantastic milestones for a 10-year-old company. I'd like to thank our employees and partners for your important contributions and our customers and investors for your continued support. Looking ahead, the intersection of cloud, data and AI reinforces our vision of companies becoming software and AI. Harnessing the power of data streaming will be more critical than ever for companies to deliver differentiated products and services, ultimately driving their success in the AI era. The secular tailwind puts us in a stronger position to drive durable growth while generating significant free cash flow over a long runway. We are more excited than ever about capturing our market opportunity ahead. Before turning to Q&A, I would like to announce that we will host Investor Day 2025 in San Francisco on Thursday, March 6th. Management will provide an update on driving profitable growth for the next few years. Please save the date. Now Jay and I will take your questions.