Confluent, Inc. (CFLT) Earnings Call Transcript & Summary

We're just delighted to have Confluent joining us for a fireside chat, they're also doing one-on-ones. Steffan to my left is the CFO and Rohan is the SVP of Finance. When I checked this morning, the stock was between $25 and $26. We have a $33 price target, $8 billion market cap, trading at 7x revenue, grew 51% last year, right? We have it at 30% growth this year, which I'm guessing is the midpoint of your guidance, burned $172 million in '22, we're going to talk about that, right, because the multiple would be higher otherwise. And then we have you burning $90 million in '23, cash flow positive some time in '24. Did I just do that? Or did you guys tell us cash flow positive some time in '24.

You did that.

I just did that. Okay. So let's start -- we'll start at the top, how's business, what would you say -- and by the way, for some context, I had Atlassian here yesterday and they're very uncomfortable position, hopefully, never had this happened, where they announced a layoff right after the close. And so that's just a tough situation to be in, right? It's hard to get that right. But when we asked how's business? The answer was we continue to be challenged in the short term. We're really bullish in the long term. There's 2 areas where we're challenged. But how's business? What would you say?

I would say it's resilient.

Good.

And it speaks to the secular trend that we're seeing across every industry, which is data needs to be put in motion, and Kafka and Confluent are -- is really the solution. That doesn't mean to say that there aren't near term, call it, challenges that we've worked through. We've been public since June of 2021. Every quarter that we've been public, we've been delivering on our commitments in a tough environment. We've been appropriately course correcting along the way. But I would say the signal remains very strong relative to not only our existing customer base but the prospective customer base around the need for data streaming and data streaming platform. And I'm sure we'll get into this, but the recent acquisition that we did of Immerock gets us into the open-source project Flink, which is about stream processing and application streaming and that will be another leg of growth for us out in the future.

We'll get to that last. All right. So first of all, just for the benefit of the audience, what are we talking about here? What is streaming? What is Kafka? How does Confluent fit in? Just a very big picture.

Yes. So big picture, you think of Kafka as -- Kafka and Confluent as the connective tissue that connects databases and applications in order to have data be transferred in real time, stored in real time, processed in real time. And that is completely different. It's a completely different paradigm than the legacy solutions that are out there that were doing ETL in other -- call it, the TIBCO [ of the ] world, et cetera. Those are all good companies, but those companies were unable to deliver on the vision of having a real-time streaming architecture. And so what does that mean? Well, a real-time streaming architecture enables every company in every industry to run their business in real time, think of a retailer who has both brick-and-mortar and also kind of e-commerce platform. In order to have their point-of-sale system connect to their inventory management system to connect to personalized promotions, the batch processing paradigm that used to exist that people would try to run their business at the end of the day or end of the week to make decisions, that just doesn't work anymore. And in this day and age, having all of the data flowing in between systems and applications, enables companies to make better decisions to run their businesses more profitably, to serve their customers better and ultimately enables commerce to run faster and more efficiently. So we could go through each different vertical. But if you think about taking a step back, even the thematic things that you're hearing about today, machine learning, AI, generative AI, these are things that have been core drivers of our business even from day 1 when Jay, Jun and Neha created the company. And so those are also thematic themes that will be helping having put more data in motion, and that will accrue to our benefit.

Let's do a couple of the use cases. So the one that cracks me up, do you remember that show on HBO, the 100-foot wave. Did you see that?

I did see that.

Yes. So I figure when I came out like a year ago, right? And I was on vacation in Italy with my wife, right? And ourselves like, can I watch [indiscernible] at first. I was like, you got to watch 10-foot wave. And so great. So we -- but we subscribed to Xfinity. And so I'm like, I'm just going to -- whatever the right word is, enabled HBO through my Xfinity. So we're in Italy, I go into Xfinity, right? I click, I want HBO, right? And then I immediately want to be able to launch the HBO app and watch the 100-foot wave, right? And it worked, which is incredible. And then we did a customer call with HBO, right? I gave him that example because you know why that worked at, right? The only reason that worked is because all the stuff that we've been doing with Confluent but also with some different databases, too. And it's been a huge investment on our part to make it so that, that will work. And it's not just for the use case. You described it, it's really important for advertising be able to deliver advertising at the right moment in response to -- so there's like a media example. Give us like a financial services example because you know -- you were owned by Citizens Bank now.

Yes. So financial services, first off, very meaningful industry to us. They were an early adopter of Confluent Platform actually. But the use case there started with fraud detection -- real-time fraud detection that happens -- that needs to happen in real time. And that fraud detection use case was a great entry point for us. And then we saw multiple different departments of large banks adopt us from private wealth management to equity capital markets, real-time trading, inflow analysis, balance sheet management, the list goes on. And -- in fact, it was the fraud detection piece that was the entry point into many of the largest banks that are out there.

Okay. Did you talk to us while you're here?

Yes, of course.

You did. Okay. Good. Is there something we can do with you? We're starting, right?

Yes, absolutely.

Yes. Okay. Okay. All right. So the real question is, why is the stock not already worked better, okay? And so we're just going to tick through some of the bear cases. So while I [ say ] you came up, I asked what's -- so like what's the bare case? And one investor is like just too expensive and they're burning too much money. What would you say?

I would say that we're an 8-year-old company, and we're looking at balancing growth and profitability. We are of a younger vintage than some of our peer group companies that are out there that have been around 10, 12, 15, 17 years. And we've been all about managing growth and profitability. We have not been about growth at all costs. So the level of investment that we've made to date is reflective of the decisions we've made on the product side of the house. There are very few companies, especially if you are 8 years old that had started with an on-prem offering and then added a cloud offering. In fact, if you were to read any business 101 book, they're like, "Hey, don't divide up your resources and try to do 2 things at once, especially if you're a small company." I give the founding team of Confluent so much credit for the courage it took to take what was a Confluent Platform, which is an incredibly robust business, and it still is. But to add Confluent Cloud to be on all 3 cloud service providers to do that because the recognition is you have to be wherever the data and applications reside, that means on-prem and in the cloud. And that level of investment is meaningful and significant. Because we've made that decision, the level of investment over this past 8 years has been significant. But what we've been able to do, Pat, is, over the last 1.5 years as a public company, we've been delivering high growth and improving profitability. In fact, in Q4, we just delivered record revenue growth in a 20-point operating margin improvement year-over-year. And we went through the difficult decision around restructuring and doing a reduction in force, not because we were in a position of weakness, it's quite the opposite. We're in the position of strength. We have forever capital. But we decided to pull in profitability by a full year because the unit economics support it. If you look at our Cloud gross margins, our LTV to CAC, the productivity, we have a very large opportunity in front of us, and we pulled in profitability by a full year, while still maintaining a 30% growth rate. So by the end of this year, and I know you started out with this around the free cash flow being positive for the full year for FY '24, operating margin and free cash flow will trend directionally together. So by the time we get to operating margin breakeven in Q4 of this year, free cash flow will be very close to that as well.

How did you -- two questions on the -- so as you're coming to us, you guys obviously had a lot of conversations about where do we want to be, right? And so what were the arguments on both sides? And how did you end up at, okay, where you going to be profitable in Q4?

Yes...

I'm guessing there's a pretty -- not heat is the right wrong word, but I'm guessing it was a pretty intense discussion.

Yes, it was a very thoughtful discussion. We looked at all the different angles around it. To us, we're playing in a $60 billion market today. We are lightly penetrated in it. So we want to make sure that we are all about setting ourselves up to capture that market share, but having efficient growth. And this efficient growth, especially in this environment where interest rates are up, economic uncertainty is higher than it's been in a very long time, we felt like it was prudent that we could go through the process of rightsizing our business to get fit to really attack the market going forward. And you know this, but maybe some others don't, we doubled our headcount in the last 2 years. And we were able to double the headcount, provide really still healthy growth rates and improved profitability, but we felt we could do more. And so in this environment, we felt like getting to cash flow positive and operating margin breakeven was the right thing to do. And we're doing that while still preserving our ability to grow at very healthy rates on a long-term basis.

Did you hear Emily Chang from Bloomberg's interview with Mark Benioff.

No, I didn't.

It's really good. And there's a lot of these kinds of interviews in normal, but this one is really, really good because she won't let him off the hook, right? So she's like, will there be another layoff? And he talks in talks of talks. And then she goes, okay, but Mark, you didn't answer my question. Will there be another layoff? He still avoids it, but the second time he actually said something helpful. He says, "Look, 2021 was the best year ever for Salesforce. He says, I'm not talking about [ fiscal year ] but calendar 2021 was the best year ever. And so we staffed up expecting 2022 to be like 2021 and really pretty much from the beginning of 2022, it wasn't. And the deeper we got into it, it just became more and more painful and more and more obvious that we had to do something interventional, we finally did it, right? But is that a fair assessment? Was that similar for you guys?

It's actually the opposite.

Oh, really?

2022 was a record year for us. Record across the board. Record cloud consumption, record revenue, record operating margin improvement. We're talking about records literally across the board. So we did this from a position of strength. And it goes back to the financial discipline and operational discipline this management team has around building a profitable business over the long term.

I feel like that actually makes it harder.

It does.

Yes.

Yes, because it's like -- well, do we actually have to do it? Well, we went back and forth on it. But the answer that we landed on was we're moving forward with this plan. We're committed to it, and we're going to go off and execute against it.

Okay. Great. All right. So there we go, bear case is #1, right? So number two, -- so number one was burning too much cash responses. Q4 this year will be operating profit breakeven and we were on plan, at least.

Yes. And we were on plan.

Okay. Number two was, hey, there's something wrong because of the open-source element of this product. And in the end, the fact that there's open source out there is going to mean that's commoditized, and there's going to be competition that's going to come up and this could be ugly.

Well, we embrace the open-source community. The fact that there's little, if any argument out there that Kafka is the de facto data streaming platform out there. And we want to nurture that community. The reality though is Kafka open source is an on-prem data streaming platform. And the world is moving to cloud and to hybrid. And with that as the dynamic at play, the feature and functionality that we have put into play around security, data governance, data streaming, our Confluent Cloud offering is something that you can't get from the open-source community. We believe that it's only a matter of time for those open-source customers to flip over to Confluent. In fact, we've made it incredibly easy. We've removed the paywall capability from Confluent Cloud. So we want developers to have their first taste of what data streaming can be with Confluent Cloud. And we've built off a proprietary technology stack on top of the open source, which provides massive differentiation. And then I know we'll get to Immerock in a moment and to Flink. But when we add another open-source project into the mix, it becomes even a more compelling opportunity for us to sell to not only the developer community but increasingly, this is a strategic priority where CxO-level folks are getting involved around understanding the streaming side of their business.

Why was there ever a paywall?

Well, there was a paywall...

Like you guys look at it -- you look back at it and you're like, "Oh, we shouldn't have had it or times change?"

Start-ups, there's always going to be experimentation, right? And back in Q3 of 2018 when Confluent Cloud was originally offered, the -- I think the starting point was, well, let's have a paywall, people can swipe their credit card and get started. By removing the paywall, what we've seen is really just a robust number of unique sign-up users that are coming in without having to do the paywall. So -- or swipe their credit card. So this is an -- like I think it was an experimentation, and we made the decision to remove the paywall, and we think that will be benefiting us down the road.

Yes. Insight Ventures wrote up this summary of product-led growth. There's 1 chapter, which is about MongoDB. I don't know if you see this. And the big thing that the cloud version of MongoDB did for -- Atlas did for them is for the -- you don't really know who's downloaded open-source software as kind of bad manners to make people identify themselves, right? But when you add a cloud user, no matter how small, you knew who they were, right? And then secondly, you could see who is consuming and that was the huge thing for them, right? So they're like, "Oh, my gosh, this bank is starting, and you call them up, and they -- and you'd say, you guys are starting to consume a ton of Atlas. Do you want to talk to us? We might be able to help you optimize it. And then they ended up selling a lot more of the on-prem to the people who are consuming cloud. Is that dynamic happening for you guys with the Confluent cloud?

We definitely see that happening. And the onboarding of customers through our Confluent Cloud has multiple benefits. The ones that you just mentioned for sure, but also just the cost of customer acquisition goes down a lot. And so we're able to really see a very healthy dynamic with Confluent Cloud around customer acquisition and the ability to really go after those customers and see what the expansion opportunity can be over time.

And highlighted that part. Okay. Let's do -- because you're excited about Immerock, it sounds like.

Very excited.

Okay. Let's hear -- why are you excited?

Okay. So think of think of things and layers, right? So Kafka and Confluent is the connectivity layer that enables customers to connect their applications in databases to run their businesses in real time. The application layer and the stream processing layer is the next layer up. And if you talk to any developer these days, any new application is being developed with streaming capabilities. In any legacy application that's out there, a lot of those are being retrofit into streaming applications. So with the acquisition of Immerock and Flink, Flink is the second -- it's the second most successful open-source project behind Kafka. If you look at all of the Flink users out there -- that are out there, there's like a 75% to 80% overlap with those Flink users and those customers are using Kafka as well. So there's this complementary nature of the connective tissue and then the applications that are being built on top of it. And that is going to be a very powerful positioning for the company on a go-forward basis. It will enable us to get more wallet share and spend. But more importantly, it will enable our customers to really build out streaming applications, and there's this network effect that will be beneficial because the more data that's flowing through streaming applications helps with the underlying Confluent business as well. So it's a very important step in our company's evolution. General availability of our cloud-based Flink offering will come out in Q4 of this year. And we'll start monetizing it in 2024 and beyond.

Okay. So if the -- if Kafka and Confluent were sort of the old TIBCO, Informatica and IBM MQSeries, right? All the things that connected to you?

What an allergic reaction to that...

I know, I know. I'm just what is the equivalent of what Immerock is?

Yes. So think of it this way...

Is it DBA? Is it like an app server?

If you think of a database...

It's like a database.

If you think of database like the storage layer and the query layer. If you think this is a kind of a crude analogy, but Kafka would be like the storage layer, we do a lot more than storage, obviously. But then the query layer would be like an Immerock or Flink.

Okay. Awesome. We have 2 minutes. All right. Any questions from our audience.

[indiscernible]

I'm sorry, I can't really hear that.

Can I ask you say a little loud.

Cloud growth for this year.

The Cloud growth?

[indiscernible] that for 2023 and what are the key assumptions there you're baking in for Cloud?

Yes. So we just came off of a year where our Cloud business grew triple digits. And we saw really healthy sequential net adds throughout Q2 through Q4. For fiscal year '23, what we're effectively saying is Cloud will be 50% of revenues in Q4. That implies a very healthy sequential growth rate. And part of the dynamic around this is we have current RPO coverage that gives us very healthy line of sight to that. And even in an environment where consumption has been more challenged for other companies, we've been able to show really positive progress on decreasing time to value for customers to get on that ramp. So we feel good about that. And when you look at our guide and you look at the 50% revenue contribution from Cloud, you can imply what the annual growth rate will be, but it will be very healthy.

I'm getting around the last question. All right. Number one thing you think investors don't understand as well as they should about Confluent.

That's a very good question. I'd say when you think about Confluent, people really don't understand how big the open-source community is. We've got hundreds of thousands of organizations actually using Kafka. And people generally think of Confluent as an evangelical sale. It is actually not an evangelical sale. We've got a huge amount of developer love, adoption of the broad technology. And over the last 4 years, we've launched Confluent Cloud, and that's been a meaningful differentiator in how we are differentiating ourselves with the open-source community. And Steffan touched upon it a little on this topic. I think Confluent Cloud with the product differentiation, which we call as 10x better than open source, it's complete as it has multiple connectors that provide great integration. It's cloud native. It's not easy to build a truly cloud-native product. Our Confluent Cloud product truly scales up and down with usage and it's everywhere. That product benefits, combined with the meaningful total cost of ownership that we provide and the ROI we provide to our customers, makes it a very compelling story. So if you think about it, great open source, hundreds of thousands of organizations using it and we've got this cloud product, which is truly differentiating not only from a technology standpoint but also from a TCO and ROI standpoint.

Awesome. All right. Thank you guys so much for coming. We really appreciate it.

Thank you for hosting us.

Nice summary.

Thank you. Appreciate.