Confluent Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 30, 2024

There are 16 speakers on the call.

Operator

Welcome to the Confluent Third Quarter 2024 Earnings Conference Call. I'm Sheng Zhih 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 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 Q4 of 2024 and fiscal year 2024. These forward looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those anticipated by these statements. Further information on risk factors that could cause actual results to differ is included in our most recent Form 10 Q filed with the SEC.

Operator

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.

Operator

Confluent. Io. And finally, we will post the Confluent earnings report to IR website after our prepared remarks. And with that, I'll turn it over to Jay.

Speaker 1

Thanks, Shane.

Speaker 2

Good afternoon, everyone. Welcome to our Q3 earnings call. Subscription revenue grew 27 percent to 240,000,000 dollars Confluent Cloud revenue grew 42 percent to $130,000,000 Non GAAP operating margin expanded approximately 12 percentage points to 6.3%. And I'm proud to report that total revenue grew 25 percent to 250 dollars 1,000,000,000 surpassing a $1,000,000,000 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.

Speaker 2

More than 4,200 people from 1200 companies participated, making it our biggest and best current yet. Data leaders from Mercedes Benz R and D North America, Viacom 18 and Accenture joined me on the keynote stage to discuss how Confluence 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 1st Confluent AI Day, a one day event designed to help our customers advance ideas into fully built AI applications.

Speaker 2

In partnership with AWS and MongoDB, we brought together hundreds of attendees from companies like Google, PNC Bank, Whirlpool, and Rocket Mortgage. We 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.

Speaker 2

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.

Speaker 2

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 Confluence to set their data in motion. We serve customers broadly across industries, including 10 of the 10 top U. S.

Speaker 2

Banks, 8 of the top 8 global carmakers, 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 2 distinct waves and is now entering a third.

Speaker 2

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 in the 1st 5 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 2nd wave of growth, Confluent Cloud. Indeed, even when we went public 3 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.

Speaker 2

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 base of open source usage.

Speaker 2

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.

Speaker 2

WarpStream is BYOC done right, built directly on top of object storage. WarpStream's 0 disk architecture enables 0 ops auto scaling while making it 5x to 10x cheaper than other alternative systems. And unlike traditional BYOC 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

Speaker 3

our data streaming platform and

Speaker 2

could sustain our business many years on its own, but it only represents a portion of the opportunity ahead of us. We believe our 3rd 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, Table Flow, 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.

Speaker 2

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. 1 of the largest private companies in the U. S, a Midwest grocery chain with over $20,000,000,000 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.

Speaker 2

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 product SKUs 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 percent and can stay a step ahead of the national grocery chains it competes with every day.

Speaker 2

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 telecoms enterprise customers could serve consumers and led to higher churn.

Speaker 2

So the telecom provider deployed a 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 1,000,000 of dollars and significantly reduced churn, boosting its overall margins. In closing, I'm pleased with our strong Q3 results and I'm incredibly excited about the opportunity ahead of us. I'm even more excited for the next 10 years.

Speaker 2

We're in a prime position to win the $60,000,000,000 data streaming category. With that, I'll turn things over to Rohan to walk through the financials.

Speaker 1

Thanks, Jay. Good afternoon, everyone. In Q3, we drove robust top line growth, record gross margin and another positive quarter for both non 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 $239,900,000 exceeding the high end of our guidance and representing 96 percent of total revenue.

Speaker 1

Confluent Platform revenue grew 13% to $110,100,000 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 U. S. Banks with an average ARR of greater than 5,000,000 dollars The substantial majority of their ARR is attributed to Confluent Platform as these banks are still early in their move to the cloud.

Speaker 1

Confluent Cloud revenue grew 42% to 100 and $29,800,000 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 7 figure revenue benefit. Adjusted for this benefit, we still handily exceeded consensus expectations.

Speaker 1

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 1 DSP product and 13 have adopted products across all three categories. Additionally, multiproduct 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.

Speaker 1

S. Grew 28% to $152,400,000 revenue from outside the U. S. Grew 21% to 97,800,000 dollars 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.

Speaker 1

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 9th consecutive quarter of 9 points or more in margin improvement. Free cash flow margin of 3.7 percent was also a record, expanding 10 percentage points. This marks our 3rd 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 $0.10 for Q3 using 353,600,000 diluted weighted average shares outstanding.

Speaker 1

Fully diluted share count under the treasury stock method was approximately 360 $6,800,000 and we ended the 3rd quarter with $1,860,000,000 in cash, cash equivalents and marketable securities. During the quarter, we acquired BoardStream 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 rates. In fiscal year 2024, we do not expect warp stream acquisition to have a material impact on our financials. Over time, we expect warp stream to be a growth driver as it expands our reach into more workloads across customer segments.

Speaker 1

Turning now to other business metrics. During the Q3, 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.

Speaker 1

3x a sequential add of the year ago quarter. New customers include a top 3 U. S. Airline company, a Fortune 50 car maker, 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.

Speaker 1

We added 40 customers with 100 ks plus in ARR and 7 customers in 1,000,000 plus in ARR, bringing the total to 1346 184, respectively. Our 100 ks plus ARR customers continue to represent more than 85% of our revenue. Our new $1,000,000 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.

Speaker 1

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 Q4 of 2024, we expect subscription revenue to be in the range of $245,000,000 to $246,000,000 representing growth of approximately 21%, non GAAP operating margin to be approximately 2% and non GAAP net income per diluted share to be $0.05 For full year 2024, we are raising subscription revenue to be in the range of $916,500,000 to $917,500,000 representing growth of approximately 26 percent non GAAP operating margin to be approximately 2%, non GAAP net income per diluted share to be $0.25 and free cash flow margin to be between 0% 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.

Speaker 1

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 $1,000,000,000 revenue run rate in just 10 years since inception, including growing Confluent Cloud revenue run rate less than $50,000,000 to more than $500,000,000 in just 4 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.

Speaker 1

6.3% operating margin now within the range of our midterm 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.

Speaker 1

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 and A, I would like to announce that we will host Investor Day 2025 in San Francisco on Thursday, March 6. Management will provide an update on driving profitable growth for the next few years.

Speaker 1

Please save the date. Now Jay and I will take your questions.

Operator

Thanks, Rohan. And today, our first question will come from Sanjit Singh with Morgan Stanley followed by RBC. Sanjit, please go ahead.

Speaker 4

Yes. Thank you for taking the question and congrats on a very solid Q3, particularly the revenue acceleration and the margin expansion that you're seeing year over year. So, Jay, I guess, when we look at the past couple of quarters, there's been sort of fits and starts with, the Digital Native Group, and it looks like those stabilized. Do you are you at a point where you're starting to see more confidence from your digital native customers in terms of bringing on new use cases, getting past optimization? Or is it still kind of touch and go quarter by quarter?

Speaker 3

Yes. Look, I think each quarter is kind of a mixture of optimization activities and new use cases. I do feel like we felt like, in conversation with the largest set of customers, they've kind of done the bulk of what they need to do in terms of larger changes in their environment. And so we did see better growth this quarter and feel that puts us on a good trajectory going forward. So yes, I do think we feel pretty confident about that segment when we think about the year ahead.

Speaker 4

Thanks. And I really appreciate the 2 customer examples on Flink. As we look at kind of this stage of where Flink is, do these customers sort of represent the early sort of beta customers that are now exploring these use cases? And where are we in terms of getting like the broader base to start to onboard Flank use cases in their environments?

Speaker 3

Yes. Yes. I think they're very representative. So we've seen a ton of enthusiasm. We've had a bunch of product unlocks as we've released the private networking support across some of the clouds and getting it out to all of them.

Speaker 3

We've announced the programmatic support, so you can write direct on a Java and Python programs, and that'll be going through EA and GA. And so, yes, we're starting the ramp of production use cases. And these are some of the early ones. It was nice that we've been able to land not just Confluent Cloud customers, but also Confluent platform linked customers, even though that product is still in limited availability and just going towards GA. And so, yes, we're actually seeing a ton of enthusiasm in the customer base, and we're really excited about where that takes us in the year ahead.

Operator

All right. That's it for me. Great to hear. Thanks. Thanks, Sanjit.

Operator

We'll take our next question from Matt Hedberg with RBC followed by JPMorgan.

Speaker 5

All right. Thanks, Shane. Congrats all for my congrats as well. Maybe as a follow-up to Sanjit's question, it was great to see the acceleration in cloud and the digitally native stabilize. I guess my question is on the go to market.

Speaker 5

You guys made some changes to start the year. It really looks like they're paying off in terms of the kind of the record customers that you guys keep adding. Can you talk a little bit more about that process and maybe comment on the level of consumption that you're seeing? I know you're trying to land fast and then accelerate those that consumption trend, but maybe talk about what those customers are looking like when they land?

Speaker 2

Yes. Yes, I'm happy to

Speaker 3

do that. So one of our goals this year, both in what we were doing with the sales team and sales compensation, as well as on the product led side of the building, was to really broaden our reach into the large set of open source Kafka users and land more customers more quickly. And I think that's an ongoing journey. We've made a ton of progress this year. We're really pleased with that.

Speaker 3

I think we'll continue to work on that in the years ahead. We feel like, look, there's 150,000 organizations using Kafka. We want to go get them all. So, yeah, the sales focus on these lands has been really important. It's both about numbers, but also about targeting.

Speaker 3

I think we're much more intentional about the customers we wanted to land with. We have this idea of the Confluent 2000, which are the highest propensity or potential accounts, and those are the ones that we're targeting on the sales side. On the product led side, it will fluctuate. We try out different things to try and land more customers, but also track them through and making sure that we're getting to high ROI customers, not just landing university students with their projects, but really getting into the bright companies. And so that total customer count will fluctuate quarter to quarter as it has.

Speaker 3

But we do think we're on a better trajectory in terms of landing more customers at a faster pace. And then, of course, we follow these customers all the way through their adoption. Our goal was getting to more customers earlier in the journey. We've definitely done that. We've now been able to see a lot of these companies kind of start that ramp towards production usage and expansion out into other use cases.

Speaker 3

And so, we feel pretty good about the overall trajectory of these organizations. So that's definitely a positive factor heading into next year.

Speaker 2

That's great.

Speaker 1

Yes, it

Speaker 5

feels like a lot of momentum on the expansion side too. I guess, Jay, you mentioned in your prepared remarks, sort of seeing early Gen AI demand, I think you mentioned some of those comments at current. Can you talk about like how that's actually showing up in the customer conversations? Is it just translating to more consumption? Maybe a little bit more specifics on how you're kind of identifying that within your base?

Speaker 3

Yeah, absolutely. So, I mean, there's 2 impacts. 1 is kind of growth in the set of AI providers, right, OpenAI being an example of that. The second is a new set of use cases in the wider enterprise customer base. There it's really about delivering data to these AI applications.

Speaker 3

And I think there's kind of 2 things happening. The initial thing is a set of use cases really around that. I think the larger push that this is leading companies towards is more thinking and investment in data infrastructure overall. All of this, I think, takes time. I know when I've talked to investors, some people felt this is going to be like an immediate pump in every infrastructure layer.

Speaker 3

I think we were very upfront that we didn't think that would be the case. When I talk to people now, some people think, oh, these AI things are never going to materialize. I don't think that's the case either. There's something very real happening. There's definitely a set of use cases and applications in customers.

Speaker 3

Different customers move at different bases. The tech companies are faster. The more conservative enterprises are a bit slower. But there's definitely a rise of a new set of use cases around this. And I think that's a very positive thing for us.

Speaker 6

Congrats, Jay.

Operator

We'll take our next question from Pinjanumbura with JPMorgan followed by Barclays. Jay, I want to ask

Speaker 7

you on WarpStream. Talking to your channel, we kind of picked up a large opportunity unlocked by WarpStream, it seems like. But I want to ask you in general, is that broadly true? Is WarpStream kind of starting to bring you into conversation, especially as it relates to migration of open source Kafka?

Speaker 3

Yes, absolutely. So the reason we thought that this was appealing was there's a set of large users of open source where the wholesale migration to some fully managed cloud thing is actually a very big jump and often hard to accomplish in one step. Something like this that has a nice cost savings, keeps the team running it kind of in place, but allows you to get kind of halfway there is really beneficial. And we think that this can help us open up some of these larger digital native companies that have been on the open source for a while, in some cases, since before Confluent, the company even existed and start to bring them into the fold. And we're really excited about that.

Speaker 3

We've started to see some progress in some of those companies. These are bigger accounts, so it takes time to land them, but we're pretty confident in where that's going to take us in the year

Speaker 7

ahead. Yes, understood. And one for Rohan. Rohan, the NRR seems like downticked a little bit, but your cloud kind of accelerated. So I'm trying to reconcile the 2, right?

Speaker 7

Was there a downtick in expansion from the non cloud portion? Or were the core inorganic cloud trends a little bit lagging, if you take out Wamsi?

Speaker 1

Yes. Pinchal and thanks for your question. Listen, when you really look at the results for Q3 and you look at the cloud results, we're actually very pleased with our cloud growth. We grew the business 42 percent and it's a $500,000,000 run through business. And when you double click into the NRR dynamics of it, it is the health of the installed base continues to be very solid.

Speaker 1

Our GRR for the overall business is greater than 90%. And there are 2 drivers of performance that we called out in especially on the cloud side for Q3. That was when you look at our digital native customer base, we saw stabilization in consumption. And second, for some of our larger cloud customers, we did see that these customers are taking up new use cases and adopting the DSP. Why is that important?

Speaker 1

That's important because these two trends have kind of moved into Q4. And that's why I made the comment around stabilization of NRR around the current levels. To your specific question, listen, I mean, it's very marginal. So not a whole lot to call out there with respect to the move from 118 to 117. But what I'll call out is the couple of drivers that we are entering Q4 with gives us confidence around the stability of NRR around these current levels.

Speaker 1

Yes.

Speaker 3

And I would just add, when you think about the trajectory, the kind of longer term trajectory, I think we feel really excited about the set of product investments. Like I mentioned this in the prepared remarks that this has probably been the most aggressive period of new product development and release over the last, say, year and a half in Confluence history more or less since it was founded. And I think that's now kind of starting to come to fruition. And we're seeing really good signs in how that's being adopted with our customers. A lot of work to do, but when we think about that longer trajectory, I think that's a really solid driver for us of expansion in the customer base.

Speaker 3

The obvious use case for all of these is growing from just pure Kafka usage in those customers to a broader platform that not only has more items you can spend on, but actually allows you to address a set of use cases that would have been inaccessible otherwise or too difficult.

Speaker 7

Got it. Congrats on it. Thanks.

Operator

All right. Thanks. Ping Poonjalom. We'll take our next question from Raimo Lenschow with Barclays followed by Deutsche.

Speaker 8

Hey, thank you. Congrats from me as well. Two questions. One for Jay. Jay, if you think about WarpStream, could that be actually a bigger opportunity for you guys?

Speaker 8

Because I remember when those guys started out, they were like, okay, we want to be even the more modern Kafka or like be more in serverless, etcetera. Is that kind of in theory actually like a opportunity for you in terms of like using that more than where you were at the moment? And then the one for Rohan, like you called out the little bit of extra help you got this quarter in cloud. Can you kind of help us there a little bit because cloud in theory is like subscription, like how do you get that as a one off thing? That will be helpful.

Speaker 8

Thank you.

Speaker 3

Yes. Yes. Let me try to address that. So the way I would say it is this, open source Kafka is a very good kind of open source project. You can take it and download it and use it.

Speaker 3

What we look for is in each of these deployment models that we try and support, do we have the best possible product in that area? So if we think about our self managed customers, there's a set of things that they need. We've built an offering with Confluent Platform, which is really good at that. When we look at a fully managed cloud offering, we put a ton of investment in Quora, which is the back end for that. It's an amazing piece of software.

Speaker 3

It's extremely sophisticated in making something that runs itself, balances data, expands elastically, all the really hard things in a full cloud service. When we looked at this kind of bring your own cloud opportunity, we thought, well, is there something there? We felt there was a segment of the customers that would be easier to access if we had an offering there. We looked at like, hey, should we take Confluent platform and try and turn it into that? Should we try and take Quora and try and push it into the customer's account in some way?

Speaker 3

The reality is neither of those would have been very good. Like we could do it. We could check the box, but it wouldn't really be a good product. What made us excited about WarpStream is it actually done that in the right way. They actually had something that was designed from scratch for that deployment model.

Speaker 3

And that's kind of a deep enough architectural divide that I think you need to do it that way to have a really good product. And so now we feel really good where we have something that's kind of best in class across each of these deployment models. And so across customers, across customer use cases, across different parts of the company, we can now really span everything they want to do in the streaming world, kind of without hesitation or reservation. And I think that's a really powerful position to be in. And that's always been our goal with customers is make this something that's a ubiquitous technology across the business.

Speaker 1

I'll take the second part of Raimo's question. Raimo, as it pertains to the one time revenue benefit, one of our existing customers had plans to basically expand into a new international market, which did not end up materializing. As a result, we took some revenue at the end of the quarter as unused credits. As we speak, this customer is a very strategic partner of ours and we are working on multiple use cases with them. So, if you take a step back and I know you commented on the Q3 performance, our Q3 performance, which was very solid, the underpinnings of that performance was, I'd say, twofold primary drivers.

Speaker 1

The first one was the stabilization of the digital native segment and the second one was some of our larger cloud customers actually adopting DSP and starting to look at net new use cases. So, this the 3rd benefit which you called out was one time. But if you adjust it out, we still handily beat our consensus expectations.

Speaker 8

Okay. Perfect. Thank you. Very clear.

Operator

All right. Thanks, Raimo. We'll take our next question from Brett Zelnick with Deutsche Bank followed by William Blair.

Speaker 9

Thanks very much, Shane, and good to see you all. It's great to hear all the excitement coming out of current and the improvements you're seeing in win rates. And I appreciate it takes time for wins to turn into revenue. But is it too early to be characterized in what you're seeing out there as perhaps green shoots? And how does it inform your early thinking about sales capacity as you gear up for next year?

Speaker 3

Yes, I can address some of those and Ron, you may want to address some as well. So, yes, we've definitely seen positive signs in the customer base. We don't typically draw that line too far forward. So we don't try and make some kind of big pronouncement about IT spending next year. But yes, we've seen, I would say, stabilization and maybe some acceleration in investments in the digital native segment, which is, I think, very positive.

Speaker 3

We've seen continued expansion across the broader base of cloud customers, which is great. So, yes, all of that gives us confidence. When we look at the sales capacity that we have in place, we feel very good about that. So, this is a quarter where we saw kind of good ramping of new sales reps, lower than target attrition. Overall, that puts us in a good position as we think about what we're entering next year with in terms of both our sales motion and kind of systems as well as just ramped sales reps to go execute.

Operator

Hey, Brad, you're on mute.

Speaker 9

Thank you very much. Still trying to figure the Zoom thing out. Rohan, maybe just in follow-up. As we think about the range of outcomes for next year, I appreciate that you're not giving us guidance just yet. But is there anything you can tell us about perhaps the visibility that you have coming out of this Q3 versus the last couple of years where you did give us an early look?

Speaker 9

And I mean, it would seem to me that the bias would be towards acceleration, at least from the exit rate that you're guiding here for Q4 for 21% subscription growth. How are you thinking about that? And how should we as we begin to lock down models and project next year think about that? Thank you.

Speaker 1

Yes, Brad. We're not early guiding for fiscal year 'twenty five, I'll say, which is very consistent with most other software companies out there. But what I will tell you is the momentum of the business in Q3 was solid. We entered Q4 with a similar momentum which shows up in our guidance. So and we also spoke about stabilization in our NRR.

Speaker 1

So as you kind of look at the second half of the year, in general, we feel good with where we are. So to your question around looking ahead, I'll kind of reiterate a couple of points that Jay made. I mean, in general, you've heard us talk about it. DSP has been a big focus for us this year. With respect to the number of product innovations we've had this year has been, I would say, the highest in the history of the company.

Speaker 1

And we're seeing good adoption with respect to our DSP products. And 2025 is where we're expecting monetization. And when you look at the different DSP products, all three of our DSP products, be it Connect, be it Governance or be it Stream Processing, they are in their earlier stages of their S curves. So that's one area of growth driver as we look ahead. The couple of others that Jay briefly touched on was GenAI, although timing exact timing is still a TBD, but we feel that in general streaming as a category will benefit from GenAI.

Speaker 1

And then we have a couple of other ones like CableFlow and FedRAMP, which are also lower in the list, but again, growth drivers. So overall, a decent amount of growth drivers as we look at next year. But again, we'll be providing a more formal guide for 2025 in our Q4 call.

Speaker 9

Understood. Lots to be excited about. Keep up the great work. Thanks, guys.

Operator

Thank you, Brad. We'll take our next question from Jason Ader with William Blair followed by Wells Fargo.

Speaker 6

Yes. Good afternoon. Thanks, Shane. Good to see everybody. My question is on the Q4 guide.

Speaker 6

It implies a sequential growth rate on the revenue that is well below kind of typical seasonal patterns. If I look over the last few years, I know you're a bigger company now, but is there something specific to call out in Q4 that might cause a lower sequential growth rate than normal? Just wanted to unpack that a little bit.

Speaker 3

You want to check that Ron?

Speaker 1

Yes, happy to. Jason, good to see you as well. Yes, so for our Q3, I'm assuming your question is specifically around the cloud revenue?

Speaker 6

Total subscription revenue of like a 2.4% sequential versus a year ago was 7% and the year before that was 12% in Q3 to Q4?

Speaker 1

All right. Yes. So there are a couple of puts and takes as you look at. I mean, obviously, when you look at our Q3 performance, we feel very solid and Q4 guide is also solid. I called out 2 drivers in last call.

Speaker 1

1 was, in general, Confluent Platform business tends to be lumpy and purely because about 20% of revenue is recognized upfront and the timing of some of these larger deals can have an impact. So that's something that I called out in our last call. And the second, I would say a smaller driver is the one time benefit that we spoke about in Q3 makes it a little bit of a tough compare for our cloud business. So when you isolate the cloud business and you take out that one time benefit, it very much falls within historical trends and more normalized patterns. So that's probably the 2nd driver.

Speaker 1

But in general, if I kind of take a step back, we're seeing this momentum with respect to some of our larger digital native customers adopting new use cases and adopting DSP. We just don't want to get ahead of ourselves and we want to be prudent with our outlook as we look ahead.

Speaker 6

And then one quick follow-up, maybe for you, Jay, just talk about the federal business. We've heard kind of through the grapevine and some other companies have talked about it, but it seems like federal spending was kind of weaker than expected for a lot of companies in Q3. What did you guys see in the federal vertical? I know that's an important area for you guys. Did you see some of that kind of budgetary pressure that others saw?

Speaker 3

Yes. Federal was reasonable and is a decent sized chunk of the business. It's limited today because it's only Confluent platform. So we're still kind of waiting to open up the Confluent Cloud side of that, at which point I think we would see a bigger overall impact, both positive and negative with the kind of trends you're describing. So, yes, I would say it was not particularly noteworthy.

Speaker 3

We saw reasonable performance, but nothing to write home about.

Speaker 8

Thank you.

Operator

Thanks, Jason. We'll take our next question from Michael Turrin with Wells Fargo followed by Oppenheimer.

Speaker 10

Hey, thanks very much. Good to see everyone. Jay, appreciate the video at the start. Commentary throughout the call is helpful. I was hoping we could go back to AI and specifically use cases you see there for streaming.

Speaker 10

Where do AgenTek solutions, which we're getting a whole host of announcements around fit within that discussion, it would be great to just get your view on how this AI focus we're getting everywhere impacts competitive positioning for Confluent within streaming the overall DSP landscape.

Speaker 3

Yes, that's great. Yes, so there's 2 primary use cases that we're seeing around AI. 1 is really gathering all of this context data for the AI. So all the enterprise data that wants to be used in decision making. The second is really a Flink use case, which is actually taking some of the processing that you want to run as a background task and actually operationalizing that, turning it into something that runs continuously.

Speaker 3

Every time something happens to the business, it reacts or processes. That's very much the kind of agentic background work that you're talking about. That's earlier in terms of what we've seen. If I look at customer adoption patterns, I would say that that whole category of use case is a little earlier. I think it's very dependent on the quality of the models.

Speaker 3

We think that's going to be a big thing over time, and we think we're very well positioned to do it. I think ultimately the goal for AI isn't just to build these chatbots. It's actually to take some of the background work in the company and turn it into something that just happens. And maybe there's some amount of human oversight or maybe there's not, but it's something that's just kind of working in the background. If you think about what does that translate to in terms of the infrastructure or computational model, it's very much stream processing.

Speaker 3

If you think about the kind of more work that humans do, they're sitting there and they're answering emails or they're reacting to new customer orders or they're doing whatever it is, that kind of background processing. And so I think having something which takes that directly integrates the LLM models with some of the AI model inference work that we announced at Current allows you to run that in a way that's parallelizable, that's fault tolerant, that's scalable, that's understood and that integrates this context data that you can gather, I think, is very compelling.

Speaker 9

So

Speaker 3

I would say that I would think of this as a couple of directions of growth around AI. One is selling to the AI companies that's kind of off and running. The next lump is these enterprise use cases around RAG. I think that's going well and will be durable. The last is this kind of agent use cases, which is the most nascent, but I think actually maybe the biggest opportunity and probably the thing that streaming is the most well suited to where it's kind of the natural model for running that thing.

Speaker 3

That's I would describe that as unproven, but we're very excited about it.

Speaker 10

That's great. Rohan, just given that 25 shaping up is a fairly significant product cycle for Confluent as you layer on DSP, WarpStream, other capabilities. I'm wondering how you think about or how we should think about margin progression as these newer efforts layer on. Can you keep the efficient growth motion going forward alongside the innovation? Or just how are we thinking about the balance between those 2?

Speaker 10

Thank you.

Speaker 1

Yes. Michael, when you really look at the last 8 or 10 quarters for us, we've improved our operating margins by more than 40 percentage points. So our philosophy around growth and profitability or efficient growth is really part of the DNA of the company. So every key decision that we make is based on ROI based thinking. And that will continue not only into 2025, but in 2025 and beyond.

Speaker 1

So that's not going to change. So as we think about next year, we will continue to have the same philosophy. That is growth and profitability. How can you drive efficient growth? And we are not going to basically take our eye off the ball on that front.

Speaker 3

Yes. I think that's exactly right. And one point I would make that's specific to that, I think what Rohan said that this is kind of a discipline in terms of looking at efficiency throughout the company. I think it's a very important point. But I think you asked specifically around as we're adding these additional product capabilities, how does that impact things?

Speaker 3

I think it's important to understand that the investment around the new products, including the training of salespeople, getting people to be able to sell these things, that's all happening now, right? So you kind of you put in all the effort, you build a cloud platform that can operate many different product areas, you make the investment in engineers to build out the capabilities, you put in all the tools to be able to track and drive revenue targets around these different things, you train up the sales force, You spend a lot of time on these things that are still nascent businesses, right? And then as it has come to scale, that's obviously a very positive thing. But to some extent, we're kind of bearing that cost now. We feel good about that trajectory.

Speaker 3

And obviously, as these are as DSP is a larger contributor to the overall revenue numbers, then those investments are less kind of an added weight and more a natural part of the business. So I don't know if that's clear, but that's the way I would think about it. It's not like we're thinking about, oh, we're going to start investing next year to make that true. We have been investing for some time on the R and D side for several years on the go to market side, certainly heavily this year.

Speaker 10

Clear and super helpful. Thanks.

Operator

Great. Thanks, Michael. We'll take our next question from Ittai Kidron with Oppenheimer followed by Mizuho.

Speaker 11

Thanks, Shane. And hey, guys, nice results. Great to see this. Jay, I'm going to start with you more of a go to market question. There's 2 parts for it.

Speaker 11

First of all, do you still see a lot of low hanging fruit in improving your go to market motion? And maybe tied to that clearly with DSP becoming a bigger focus for you, how do you think about the changes you need to implement in comp next year to better perhaps fine tune the effort around this?

Speaker 3

Yes. Look, we feel really good about the set of changes we made. So this year was a very aggressive adjustment to orient the cloud business around consumption, to drive broader reach, to enable us to actually incentivize some of these individual DSP components at a higher rate. That is I would call that a radical shift, right? Heading into next year, I don't think we did any kind of radical shifts.

Speaker 3

We've got some we do some tuning each year where we look at, can we tweak this thing? Can we tweak that thing? Well, there's plenty of that that we'll do. But I think it'll certainly be a smaller thing. I do think that as some of these DSP components come to maturity and scale, it does open up a new motion around directly landing use cases.

Speaker 3

If you think about Confluent, the motion has been primarily a kind of open source upsell where you take people who are interested in Kafka. There's better Kafka. There's other components around Kafka. I think as we have this full set of capabilities to capture, stream, process, connect, transform and govern real time data, there's suddenly a whole set of business problems you can go after much more directly. And so I think that opens up another vector for the team to which kind of attack and expand within a lot of these customers.

Speaker 3

I think we'll still land in areas where there's interest around Kafka, but I think this kind of gives you another way of going to market. And so I think that's something we'll build over time, not comp related, but just makes it gives us another path into use cases.

Speaker 11

Excellent. Second question is on the win rates. I think you mentioned that win rates have actually increased this quarter, if I'm capturing the comment correctly. But you also commented that the win rates against small vendors is more than 90%. Is that the specific area they improved or they also improved in Yes.

Speaker 2

I think

Speaker 3

we're seeing both that we saw very strong win rates overall. And then there have been questions on this point. So I think we specifically called out, hey, like really strong performance, well above 90%, you don't get startup competition.

Speaker 11

Okay. Excellent. Thank you so much.

Operator

Thank you. We'll take our next question from Gray Moskowitz with Mizuho followed by D. A. Davidson.

Speaker 12

Okay. Thank you very much. The net new Confluent Cloud ARR is higher than any other Confluent quarter that we've ever seen and that includes your seasonally strong Q4 periods. And it's an impressive quarterly performance regardless. But Rohan, can you say whether or not this would be a record net new ARR quarter for Confluent if we were to exclude that one time revenue benefit that you called out?

Speaker 1

Yes. Greg, the one time revenue benefit that we called out, what I said was, if you take that out, we still handily beat our expectations. And when you really double click into the performance, which is the vast majority of the driver of the performance, is stabilization in the digital native segment from a consumption standpoint and the net new use case in DSP adoption for larger cloud customers. So we've not broken down that one time exactly. But what I can tell you is, if you adjust for that, we still very handily beat our expectations and the primary drivers were the first two that I called out.

Speaker 1

Hope that helps.

Speaker 12

Okay. Thank you. And then you spoke earlier, Jay, about work stream and potential open source conversions. But I'm wondering if you also foresee many Confluent platform customers adopting work stream potentially over the medium term, whereas perhaps they otherwise wouldn't have moved away from their on prem deployments anytime soon?

Speaker 3

Yes. Yes. There's certainly an opportunity for Confluent Platform customers that are kind of self managing in the cloud to have kind of a progression towards a more fully managed cloud type offering. And we see that as a positive thing as well. It's not the initial target set of customers, but yes, over time that may be appealing.

Speaker 12

Great. Thank you.

Operator

Thanks, Greg. We'll take our next question from Rudy Kelsinger with D. A. Davidson followed by Needham.

Speaker 13

Hey, guys. Thanks for taking my questions. Ron, first, you have very strong gross margins. It looks like if I exclude low seven figures from that onetime revenue, 20 to 30 bps impact. So is 82% kind of a good run rate going forward?

Speaker 13

And just what incremental gross margins look like on the DSP products as revenue in those start to come in more meaningfully next year?

Speaker 3

Yes. Let me take that, Rohit.

Speaker 1

Yes, sure. Happy to take it. Rudi, the gross margin profile for the business, obviously, record gross margins when you look at subscription gross margins. So there are obviously 2 components, Confluent platform, software type gross margins, fairly consistent over a period of time. So the variable is in the cloud side and we've consistently improved our cloud margins over time.

Speaker 1

And I mean, I put it in maybe 3 categories, right? Well, one category is, in general, with volume and with more scale, you get efficient. So that's one. The second area is there's been this focus around multi tenant. And as more of our business becomes multi tenant, which includes the DSP side as well, a lot of the DSP products, right, that's going to be a tailwind to gross margins, right.

Speaker 1

So those are probably 2 drivers. And when you kind of take a step back and look at where we are operating, we're actually operating well above our thresholds that we put out there. So feel good about our gross margin profile and we'll obviously keep an eye on it as we look ahead.

Speaker 13

Okay. And then as a follow-up, I appreciate the commentary on win rates. I guess, does that comment on win rates? I guess, do you include do you factor in renewals where a current customer considers a small startup or going back to open source as well when you calculate those win rates? And And if not, could you just maybe comment on gross churn and gross retention trends over the last

Speaker 3

quarter? Yes. We do include renewals in that.

Speaker 1

Okay. Okay. Yes.

Speaker 3

And I do include renewals, but it would be equally high, not including renewals. So it's not like we're padding it with renewals. Okay. Got it. Thank you.

Operator

Great. We'll go to Needham, Mike Sicos for our next question, followed by Cowen for our last question.

Speaker 3

And just to comment really briefly on what Rudy said, to underline a little bit of what Roland was saying, yes, we don't anticipate the DSP growth to be a significant headwind on margins. The products are largely multi tenant and we see that as a positive factor. We've taken cost into consideration when designing those things. So I know often new cloud products kind of come in upside down and then eventually write themselves. We don't think there'll be a big aspect of that with what we're doing.

Speaker 3

Great.

Operator

Go for it, Mike.

Speaker 14

Great. I just wanted to cycle back to the strength that we're calling out this quarter and into October now for those digital native customers. When did you actually start to see that behavior shift? Just because I know if we cycle back a quarter ago that increased focus on optimization was bleeding from June into July, right? So when did that start to show up as far as that cohort that you're speaking to with the digital natives?

Speaker 3

Yes. Do you want to speak to that, Ron?

Speaker 1

Yes. I mean, that was typically, Mike, when you look at consumption, it is also a business that's driven by momentum. So you did not see this like one particular date or week where things shifted. But in general, we did see a couple of things. The first is, just Jay called out earlier in the call, some of our larger customers, we feel that every customer kind of looks at optimizations.

Speaker 1

For some of our larger ones, that's actually behind us. That's something that we saw and that happened progressively through the quarter. And the second piece is around the net new use cases and some of our larger cloud customers adopting DSP. That's been a huge internal go to market focus for us. And again, early days, but that's also starting to show up little by little in the numbers.

Speaker 1

So that's how I'd call it. And as I said, it's more around momentum. And as we exited Q4, some of these trends actually bled into Q4 as well.

Speaker 14

That's terrific. I guess for the follow-up there and it sounds like you're partially answering this already, but trying to get a sense for that recovery in demand for new use cases or DSP adoption coming from digital natives, is that explained by maybe customers who had been rolling over or pushing out projects that are coming online now? Or is it more a function of that go to market that you guys have and the transformation you've instilled and maybe that's starting to make them make more headway into your existing customers? Yes, it's a

Speaker 3

combination of both. Customers what you would see in any of these digital native customers even going over a long period of time is kind of a sawtooth up into the right, right. It's not a pure graph. They tend to make investments and then they tune and they make investments and then they tune. We did see a little bit more tuning in recent quarter, but that it's not like that pattern hasn't occurred.

Speaker 3

It just we just saw it in more customers all at the same time. Even in that time period, we did see an intention in those customers of making further investments, new projects. So I would say, on the whole, that's in keeping with what we've seen. On the DSP side, there definitely is a comp as well as just intentional focus. Like we are putting a lot of effort into driving these new products.

Speaker 3

There's very specific sales plays. We're tracking pipeline in a very distinct way. There's targets and goals around that. It's very much a new muscle to build. But the consumption comp makes it possible to do this, because in the past, we would have goals that were purely on your committed spend.

Speaker 3

And really, of course, there's no distinction of what the spend is on. Now we can have multipliers on specific components of revenue that's Flink or Connect or whatever it is and drive those in a disproportional way. And so I think that does help a bit in terms of making sure that the smaller products that are kind of newer in the journey still get some focus out of the team.

Speaker 14

Terrific. Thank you.

Operator

Great. Thanks, Mike. We'll take our last question from Derrick Wood with Cowen.

Speaker 15

Thanks. Jay, I'll start with you. You guys called out strength in financial services. We know this is obviously a big vertical for you, but I don't know if you've highlighted it in recent quarters. Anything to call out what drove this?

Speaker 15

Are you starting to see larger deal activity? Or is there some broader industry trend developing that could be more beneficial in the medium term?

Speaker 3

Yes. I wouldn't say it's a sudden shift or even a 1 quarter thing. I mean, I think there's been a broad based build in financial services going back some years. And I think we just thought it was worth highlighting kind of the point that we've got to where this is now a very substantial data platform and the largest financial services institutions in the world. And there's really exciting stuff happening.

Speaker 3

It's not just that it's big in terms of volume. I mean, this is powering some of the most critical systems that they have. And many of these organizations are actually starting to think about how streaming not just enables them to share data internally, but how it enables them to connect into many of the other institutions that they share data with on a regular basis. There's kind of that larger economy within that industry. And we think that's a really positive thing.

Speaker 3

So, yes, it's going very well. We called out the kind of ARR and penetration in the largest customers. We expect that to continue. No sign of slowdown. There's not a particular catalyst this quarter.

Speaker 3

I would say it's more just continued strength. And it makes sense when you think about the nature of those businesses that there's just a huge amount, the largest spenders on IT and a huge amount of kind of real time event driven machinery behind the scenes and as well as a few pushes on the regulatory side towards real time payments, real time reporting. There's definitely some nudges as well as pressure on having a modern customer experience, all of which kind of nudges it forward.

Speaker 15

Understood. Rohan, maybe one for you. The strength of new customers, obviously very impressive. I think I assume that most of these are open source Kafka conversions. But just wondering how you're thinking about the follow on expansion.

Speaker 15

Is this something that could come in a quarter or 2 because of the consumption model? Or do we think of a land that maybe an expand like 9 to 12 months from now?

Speaker 1

Yes. The way I think about the new customer is, of course, the total customers, I think that's top of funnel. And then how successful we are progressing these customers to 100 ks plus ARR, $1,000,000 plus ARR is something that we internally focus quite a bit as well. So on the total customer numbers that you mentioned, it's a combination of 2 things, of course, like as part of our consumption transformation, there's been a big focus around landing new customers, but not just new customers, landing very high quality logos. And I called out some examples there, right.

Speaker 1

So that coupled with our product led growth, the PLG Motion, which is driving some of this customer growth atop. But that can obviously vary quarter over quarter. So the best way to look at that is over a 12 month period. And when you look at the 1st 9 months, you're right. I mean, we are very happy with the momentum that we've seen.

Speaker 1

When you look at 100 ks plus ARR customers and $1,000,000 plus ARR customers, both those cohorts did see good consistent growth. And as a reminder, 100 ks plus ARR customers account for greater than 85% of our revenue. So overall, the focus is across all three, but we are pleased with the progress that we are making.

Speaker 15

Great. Thank you. All

Operator

right. Thanks, Derek. This concludes our earnings call. We know it's a busy night for earnings. We appreciate so many of you joining our call today.

Operator

Have a nice evening. Thanks, everyone. Thank you.

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Earnings Conference Call
Confluent Q3 2024
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