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

Thanks for joining us for our next session. I'm really happy to have the team from Confluent here.

I'll start with you, Rohan, a lot of things happened over the -- since you reported Q3 results, and just to kind of ground everyone, just kind of maybe talk a little bit about like what you've been seeing out there like Q3 and since weaving in that classic hedge fund question of post election, how are things playing out, et cetera? Like maybe we start with that one.

We'll be happy to, Raimo. Good to see you, and thanks for hosting us.

Yes.

So our Q3 results were something that we were very pleased. When you look at the headline numbers for Q3, we grew our total business, subscription revenue at 27% year-over-year. On the heels of our Confluent Cloud performance of 42%. And when you take a step back, that's at $0.5 billion run rate, so high growth at scale. And we did that while growing our operating margins and free cash flow margins north of 10 percentage points. So headline numbers we are pleased with. What are the puts and takes for the quarter? Well, I mentioned that one area of focus for us over the last 12 months was the digital native segment. And we did see stabilization in the digital native segment from a consumption standpoint in Q3. And that was on the heels of stabilization coupled with some of our larger digital native customers starting to look at net new use cases and adopt our DSP. So that was data point number two. And data point number three, what I'll say is since the beginning of the year, we've been talking about our data streaming platform. And what we've done over the first 9 months from our data streaming platform perspective is we've had a series of technology innovations, be it GA of Flink, the private networking for some of our other products. And that has continued through the year. So we are pleased with the momentum of the technology innovations that we're trying to put out there in the market. And our focus in the first 9 months has been around adoption. And I'm sure Erica will touch on it. It's also building that muscle to sell a multiproduct platform. And that's been the focus. And over the first 9 months, we are pleased with the progress that we've made. A lot of wood to chop, but we feel good with where we are in the first 3 quarters. To your other question, I don't want to break new ground in this meeting around in quarter progress, right? But so -- but hopefully, that helps set the stage.

And then not to talk about your numbers, Erica, but like when you go to the clients and talk about with customers about it, like how does it feel out there in terms of excitement, kind of better, like what's the mood out there from a customer perspective in that [indiscernible] conversations?

Yes. Happy to share that. Thank you for having us here. I had a lot of customer meetings last week at AWS Reinvent, for example, meeting with a lot of the executives that customers and prospects and key partners. And I say that, first and foremost, there's a lot of enthusiasm for and kind of acknowledgment that real-time data streaming is becoming more and more core. So having bigger conversations, which is really exciting. We're talking to CTOs and Global SIs about the transformational power and the unlocks of leveraging real-time data streaming and a value of a complete data streaming platform. I think that's becoming well understood. We talk to our customers about the benefits of a technology strategy or data architecture where we shift left and shift the governance, the processing, the connections between different sources and things of data. We shift that left in the environment so that our customers can produce data products that can be reusable across the operational state and the analytical estate. And that's a message that's really resonating and it's a strategic message and thing that CTOs want to partner with us on. And so I think that's the difference over the last year plus is that this is just becoming much more transformational and core, and we're super excited about that.

Rohan, back to you, you did mention the digital native already a little bit like in terms of like more stabilization. Like can you talk a little bit more bigger picture about them, like how important audit for you? Like what's the -- like how are they thinking about it? And how are you sitting in there?

Yes. I get this question all the time. All right. What do you mean by digital native.

I didn't want to ask it that simply, but yes.

But the digital native is essentially, you can think about customers who are technology forward leaning towards the latest technology. And as you can think that those are the customers that are going to be adopting real-time data. So let's do like 3 lenses. Let's go back, let's talk about Q3 and then I'll talk about like going forward. If I look at the last 18 to 24 months, this digital native segment for us has been a growth driver. But you've heard us talk about it that has the growth always been linear? Probably not, we've seen a little bit of a sawtooth pattern, which is not surprising. But when you take it over a period of time, it's been a growth driver for us. Q3, we said that the broader digital native segment, we did see stabilization in the consumption. And primarily, we also started seeing some of our customers adopt new use cases, that was Q3. And looking ahead from my perspective, digital native is a segment that we are underpenetrated and it is going to be a growth driver for us. I also -- if I just step back, I'd also like to provide a little bit of a time line. Raimo, when you look at Kafka as a technology, that's about 13 years old, 13, maybe 14. Confluent, we are about a decade old. And our cloud native product that we are selling at scale is a little over 6 years old. So -- and our DSP were -- 2024 is the year of the DSP for us. So as you think about technology innovations and how we can actually make a difference for our digital native customers not only from a technology perspective, but also from an ROI TCO perspective, we're continuing to make progress in the right direction. So that's how I would frame the opportunity.

Yes. Okay. And then the, Erica I think one for you, obviously, in your conversations last week, I'm sure GenAI came up a lot. How do you think -- how do you think Confluent will fit in there? And how is customer appreciation about like the word that you're going to play there?

Yes. It is a topic in so many conversations and not surprisingly. And in the simplest terms, Confluent can help move data from different company proprietary data from different silos around the company into inference models. And so we can help complement public with real-time contextual company proprietary data, and that's the line of value to companies. And of course, so many companies are in very early stages of figuring out what is the highest value GenAI play for them. But the focus on that prompts a focus on overall data strategy, and that's really where we come in. So it is definitely a topic so many conversations.

So if you think about like -- sorry, I'm trying to sound technical, but probably not more and work. But if you think like the idea is I have my data set, but then I need kind of prompt coming in using [indiscernible]. So are you guys kind of, in a way, you're going to feed, make sure that this is having real time, especially if an agent somewhere trying to do a conversations, I need to have real-time answers or [indiscernible].

Exactly. That's a great use case. I mean we're seeing a number of customers adopt kind of the Agentic types of use cases. And if you think about you have an agent on the phone and maybe a customer service capacity, one of our customers in the insurance industry. We're feeding real-time information about what may have just transpired with that customer. So the agent has real-time data available.

Yes, yes. And where are like -- so that's one example. Are there more stuff like that? And where are customers understanding that because we just had Databricks earlier, they are like, well, we need to get the data in sort of high places for but that's another thing. So where are we on that kind of customer understanding journey?

I think we're early. I mean I think in our traditional companies, we are seeing examples like I just described, we also are seeing examples of leveraging real-time data to assist doctors facing off to patients with more real-time information and contextual information. So there's a lot of those sort of Agentic and interaction type examples that we're seeing great traction with. And then also, we're very focused on partnering with AI companies. And so we're fortunate to call OpenAI, significant customer, Notion, a significant customer. We're working with them to be just core data underpinning for what they offer to the market. So we're kind of coming out the GenAI opportunity from a couple of different angles.

And how do you think -- obviously, the -- like if I'm looking at Barclays, do your footprint, it's -- excuse my language model, it's a mess. Like we said so many different places. Like how do you think about the speed of adoption here?

I think, again, the conversation that we're having with customers is really about looking at the overall architecture and finding the opportunities to -- if you think about that data mass, kind of organize it into -- by shifting left, how can we, earlier in the process govern the data, have data lineage available, process the data so that you're creating these valuable data products with awareness of like what are the different operational and analytical systems that they will feed because a lot of what creates the data mass is your streaming data over into one application or one data lake or data warehouse, but then you're manipulating the data there, and you're not able to reuse it somewhere else. And so if we can shift left and do that work earlier in the process, it helps kind of tame the mess.

Yes, yes. And then Rohan for you then, like, is that showing up? Or what are you seeing in terms of the conversation? Is that showing up more on cloud or more on-premise or both? Or how do you think about that?

I mean, early days -- feel free to chime in Erica. Early days for us. But as we are looking at the pipeline, cloud definitely seems to be benefiting from a pipeline perspective. But I'll call out that, yes, we are seeing early traction in cloud, but you heard me talk about it that we need to be wherever our customers' data and infrastructure lie. So for some of the inference use cases, if the closest data point is on-prem, we'll probably see benefit from on-prem as well. So all I'm saying is early traction is on the cloud side, but we expect our entire portfolio to benefit as we look ahead from GenAI.

Yes, that's right. I think it's been actually -- well, first off, our the Confluent platform business continues to thrive, particularly in regulated markets, but also in traditional companies where, as Rohan points out, there's still data stores and data centers and on-premise environments. And so our ability to meet customers where they are, whether the data is on-premise or in public cloud and across multiple public cloud has been a real advantage for us.

Yes. And I wanted to shift gear a little bit like WarpStream. How do we have the -- like obviously, WarpStream stand-alone had kind of -- it was very vocal about like where they think the world is going and where they fit in. You communicated where you see them? Like how is this playing out for you guys?

So for WarpStream, a big part of our strategy, our mission is to soak up the world's Kafka, and we have over 150,000 organizations using open source Kafka. And when you really think about how this mission will come to fruition, it's more around -- it's less to the customers, more about the individual use cases applications that these customers are running. And for each of these applications, we want to have a solution which has the right amount of ROI and is meeting the needs of the customer is trying to solve. So historically, we've been on-prem. We've been on the cloud. We're trying to meet the customer where they are. We started to see this category emerge where you're bringing your own cloud, that is you're using your customers' infrastructure to provide them with a solution and you're being super invasive with it. And WarpStream basically fits in with that in mind. So WarpStream essentially is -- essentially a Bring Your Own Cloud product where if you have really large data that you are moving large amounts of data, think logging, think observability, think data that you are moving to data lakes or data warehouses, right? So those are the use cases. And typically, these use cases are not as latency sensitive as, say, fraud detection. And so with WarpStream, we can provide our customers with the right ROI and also solve their use cases. So the way I think about it, like wearing the commercial hat on is it does a really good thing about expanding our serviceable addressable market and whereby it gets us SAM much closer to the TAM. So do you want to add anything, Erica?

I think that's right. And I think we're seeing opportunities. Where does that serviceable addressable market show up. Sometimes it's in new logos that are kind of a great fit for the Bring Your Own Cloud offering from WarpStream. Sometimes it's specific use cases within existing customers where that addressable market might has been available to us until we have this offering. So the backdrop is, as Rohan says, we want to soak up all the world's Kafka, 150,000 organizations out there using Kafka, and the best way to do that is for us to have a portfolio of offerings to serve the needs of different customers and different use cases and workloads within those customers.

Good. Yes. So in a way, like I mean I had an industry guy that described it once you're going to be like a real-time platform, but as means different aspects that you need to solve, yes. And I mean is that like a big part of the market potentially? Or how do you think about -- I mean, obviously, you bought it must have been exciting enough, but like how do you think about that opportunity in comparison to the others?

We're excited about the opportunity. When we think about -- and if you look at the acquisitions that we've made, be it Immerok, be it WarpStream, 2 things are common. One is best-in-class technology. And the second is really high-quality teams and WarpStream checks the box on that. So obviously, as Erica mentioned, it provides us with an opportunity whereby we are kind of expanding our surface area for more of these use cases to come to Confluent. And we expect this to be a fairly big opportunity over the long term, but it's a product that's a year old. And our focus at this point is hardening the product. It is, we are selling it, but hardening product, and that will be the focus as we head into next year.

So then if it's a year old, it's tiny -- sorry, from like under revenue guide. So it's still tiny as a product in a way.

For Q3, I did mention that for Q3, both from a revenue and an expense perspective, it was not material to our financials.

Yes, yes. But in accounting terms, not material?

Let me put it. It was de minimis, right?

Okay. Okay. Good, okay. Perfect. And then the other big product where we're a little bit further down the line is Flink, can you talk a little bit about -- we start with Erica maybe like from a customer perspective, like I went to your conference like a year or 2 year ago, like Flink was kind a lot. Because it's like it's very -- it's difficult to do and people wanted hand holding. So you finally have it now? Like what has been the customer reaction since you launched it on the cloud?

We continue to see a lot of enthusiasm and excitement for Flink and really robust what we might call top of the funnel activity. And then we're partnering with customers to make sure -- because it is hard to make to partner with them to get them into production. And so I think we're at -- we've kind of thought of 2024 is the year of adoption of getting customers into the cycle with us around Flink with further opportunity monetization opportunity into '25. But so far, a couple of highlights that we'd call out in terms of customers leveraging Flink and what are they doing with it? We have a major grocery retail chain, who's leveraging Flink for real-time, dynamic pricing and promotions, different in different markets. A Fortune 50 telecommunications company is leveraging Flink pretty significantly. So we're excited about the kind of early indicators of the value of the use cases.

And then how do I think about it when you say adoption? So is this year in a way, find an old classic software, I would say, like the reference customers kind of adopt them and then you can go out and show like, look, here is the retailer, here's the telco. And then you just brought it like next year than the broadening or like -- is that the way to think about it?

I think that's the way to think about it, because it is a hard category, we want to make sure that we have the reference architectures and the right resources of our company -- for customers so that we can help them at scale or get to the market at scale. So that's part of the benefit of that.

Do you need there -- is that kind of -- how much hand holding new clients need from like a services organization? Is there a lot that is still needed, is that needed? And is it like an SI opportunity? How to think about that?

It is an SI opportunity. We have a couple of partners who have really focused and built up specific expertise in this area. So they've been instrumental in going to market with us. So we see it as a great SI opportunity.

Yes. And then Rohan, like other question. The -- like how do you think about that Flink then on the number side? Like I don't know -- and I should probably remember how much you kind of talked about it in the previous quarters or I want to talk about?

Yes. Before I get into the numbers, Erica made a point earlier that I want to underscore around Flink, governance, the data streaming platform. One thing that's resonating with us, was resonating with some of our tech execs for our customers is essentially moving processing and governance earlier in the life cycle of data. So as this data move to the destinations, it is in a place where it's usable. So when you really think about the Flink opportunity, that's how we think about it, right? Is making sure that we are moving higher quality data into different parts of the organization. So beginning of the year, we shared some high-level metrics on DSP. We said that DSP is approximately 10% of our cloud business. And when you break that down, it's primarily the connectors followed by governance and Flink was just launched at this point. So that was the mix. Without getting into numbers looking ahead, when you ask -- if you ask me, where is the largest opportunity, at least where we stand today, where we feel is the largest opportunity, we feel Flink has the largest opportunity, followed by Connectors, followed by Covenants. So if you think about it where it is mathematically, you're in the earlier stages of the S-Curve for each of these products. In general, these products are growing faster than the average revenue, okay? And as we look ahead over the next couple of years, it's going to be a growth driver for us. So that's how I think about it.

And then do I -- can I buy Flink as a stand-alone or Flink is always part of a DSP offering?

You can buy a stand-alone, but obviously, the value of it is as part of the broader portfolio. Yes.

And would that be -- is it -- well, it's -- can I do -- can I -- is it all in cloud? Or can I do Flink also kind of on the platform side?

Yes. I think Erica briefly touched on it. It is primarily on the cloud. And the philosophy, the tenants with respect to how we build this product is very similar to our broad conference cloud product, which is it's cloud native, it's complete and it's available in all clouds. So that's how it is. But you also have an on-prem version of Flink. Flink for CP, which the telecommunications company that Erica was talking about was Flink on CP.

Okay. Okay. Makes sense. And then I wanted to switch gear the last few minutes. Erica, like we had like go-to-market changes, and you wanted to focus sales guys more on consumption. Full disclosure had [indiscernible] in yesterday, and it was a big topic of conversations like how do you sell consumption successfully, and they had like a little bit of a the wrong start because the sales guys are good sales guys. They were selling consumption, but not expandable consumption. And so then at renewal point, you have like a problem. Like you were a little bit later. So obviously, you have a little bit of learning from those guys. How is that playing out for you? Like what was it the same idea? And what got you put in there to kind of prevent it?

Many of the same ideas. And then as you point out, we've had the benefit of learning from some of our peers in the market we're all in touch. And what were lessons learned, what would you do gently? So that's been really helpful to us. And it's been -- as you pointed out, we took on some change at the beginning of this year. We're 9 months in -- more than 9 months in, and we feel like we're the significant change is behind us. You're always fine-tuning and adjusting, but the change going in '25 is less than we took on in '24 and the proof points of the consumption transformation -- and maybe if I just take a step back to remind us why did we do it? Well, it really aligns the customers like moment of value, which is get an application into production and realizing value. It aligns our incentives and our motions with that. Our revenue model for cloud was already aligned with that. We already were recognizing cloud revenue, not by subscription commitments or bookings but by actual consumption. And so we aligned the sales motion and incentive structure to that as well. And we think there's been great benefit, great payoff. One proof point is we look at our total customer count, but really how are we progressing customers to 100,000-plus spenders and million-plus spenders. The 100,000-plus customers account for 85% of our revenue base. And so we see that as a positive, and we've seen consistent growth into those cohorts. And to your point, you have to make sure you have the right guardrails front to the right customers so that they grow through those tiers. Volume at the front end without the propensity to grow is not as valuable to us. So we've been watching that. The final thing I'll say is that -- we also felt that the consumption transformation, in addition to just being the right thing in terms of aligning our incentives with the customer's moment of value, it's the right foundation for now moving from product to platform because as we -- now with our focus being on driving adoption of multiple products in our customer base, we want at motion to be as low friction as possible for the customer and for the sales team. So now you can adopt the new product, you can just kind of turn it on and start using it in your existing environment. There's no contracting process or pricing negotiation before you do that. So we can just move right into consumption and kind of disconnect it from renewing the contract.

There's another product need to sign for.

Yes. So it's serving us now in our current model and we get the right foundation as we go from product to platform.

And that kind of leads into my next question. In theory, that should make upsell cross-sell more easy to not achieve but then we are the number guys, we're looking at results. Like speak a little bit to the NRR, like the [ 117% ] is healthy for the industry, especially at this point of the cycle, but it still came down a little bit. How do you have to think about that number versus kind of actually you're selling a much broader kind of product set?

Yes. For NRR, at least a lens I look at NRR is 2 things. I think to your point around expansion, that's one lens. But the first lens I look at it is, what's my GRR, what's the health of my installed base. And our GRR has been north of 90% constantly over the last few quarters over a while. So we feel good with the health of our installed base. That's one data point. Second data point around expansion. In our Q3 call, we mentioned that we did see stabilization from the digital native segment and as a result, we are expecting stabilization around the current levels is what I said at our Q3 call. However, if you kind of ask me, all right, long term, what are the puts and takes? The long term, the puts and takes are -- it goes back to DSP, where our ability to sell DSP into our existing customer base is going to benefit to NRR for the long term. And so that kind of drives with the broader narrative that we've spoken about for DSP. So that's how I think about it. GRR and from an expansion standpoint, DSP.

Okay. Perfect. So -- and it's a lagging indicator anyway.

Yes.

Yes. And then the last question for me and then I kind of need to let you go. Operating profit levels have improved quite a bit. Can you speak a little bit about like what you did to achieve it? And because like the question like now that we're going to backhoe focuses like do we cut of growth or what's the implications on the growth side from the changes there. Can you speak to that, Rohan?

Yes. As a company, ever since -- in fact, even before we were public, there was this focus around our philosophy around resource allocation has always been growth and profitability. It's neither -- it's not either or, it's and. And how I think about it is as you are allocating resources, how do you make -- how are you driving durable growth and how you're doing it efficiently? So that's our resource allocation philosophy. You're right. Over the last few years, we improved our margins north of 40 points. And that's something can only happen -- it's in the DNA of the company. I mean we're really very focused on ROI-based investment. But at the same time, we're making sure that we are putting in the long-term bet that we need to put in. 2024 is a classic example with the product innovation that we've come out with. These are investments that we put in years back. And as part of your resource allocation philosophy, I think you need to balance it out. And that's not going to change as we look at it.

Is there -- how do you think about it if we are potentially, and Erica is going to listen very closely now. Like if we are improving on the economy, like you probably want more sales resources, how do you think about that getting ready? Because on the sales side, you need to hire 9, 12 months ahead. And so there is probably -- if you want to take advantage of it, you need to do some more stuff?

Yes, I kind of attribute that to philosophy around continuous planning. You do have knobs that you can move to the right or left. Jay, Erica, myself, we are very close with respect to how we think about that. And you are making those investment decisions as you see things play out. So moving the knob to right or left, I think that's in our control and that we're constantly -- it's a continuous process. It's not an annual or a biannual process.

Yes. I mean where are you on sales productivity at the moment? Like are you happy -- like you have buffer. How do you think about it?

Yes, we're pleased with where we are. We're -- and then also as you say, like we always have an eye towards, okay, how do we continue to get more efficient, but also have the right capacity that we need for future years growth and fund that in the year when the payoff might not be until the following year and continue to improve productivity. So we're pleased with where we are. And as Rohan mentioned, we're in constant dialogue about when is the right time to sort of turn the knob particularly with the DSP opportunity. And as we look out at different markets, different markets will be ready for -- to take on more capacity sooner versus later. So we're in constant dialogue on that.

Perfect. That's a good closing statement as well. I think our time is up. I really enjoyed our conversation. Thank you.

Thank you. Thank you for having us.

Thank you.