Couchbase, Inc. (BASE) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Sanjit Singh. I run the infrastructure software practice at Morgan Stanley. Super pleased to have Matt Cain, CEO of Couchbase, to join us for another round at MS TMT. Thank you for joining us, Matt.

Always happy to be here, Sanjit.

I appreciate it. Before we get started,for important disclosures, please see the Morgan Stanley research disclosures website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to the Morgan Stanley sales representatives.

So maybe it's just a level set, Matt, came off, I would characterize the best quarter of the year. ARR growth finished at 17%. You grew net new ARR 26% in constant currency. Maybe let's review at some of the highlights in Q4. What happened in Q4 that drove what I think was like the best performance of the year?

Yes. Sanjit. We'll certainly appreciate the kind words. And in some ways you could say it was one of our best quarters ever historical net new ARR performance, healthy new logos, a lot of Capella dynamics. I think what made it particularly gratifying as we had experienced dynamics through the year, but I don't think we're indicative of company's potential and performance, and we had this renewal-based dynamic that really sort of set up for the back half of the year, in particularly Q4, and we tried to spend a lot of time with investors articulating that dynamic and that some of the natural business timing was set up for Q4. Despite that, we had a pretty big hurdle to clear optically. And so I think we took a lot of pride in demonstrating that we did what we said we were going to do. And as I think about the business, a lot of balance in that delivery. We had our second customer over $10 million ARR. We had a deal that started as a community addition that went to 7 figures of Capella. We had another enterprise customer that got started with Capella at the 7-figure mark. And so I think a lot of diversity in how we delivered testament to the teams on their execution. But certainly, we're excited about the -- not just the Q4 print, but the momentum that we feel is in the business.

Yes. We were -- this time last year, we were on stage, and we're on a theme of like, if we look at the higher rate environment since we came out of '21 into 2022, 98%, 99% of software companies are slowing down. And you guys were on this path of you guys were sustained. I think it was 23% ARR growth, 23% ARR growth. The [indiscernible] previous year, you did 25% ARR growth. It's like definitely an outlier. This year was definitely a little bit lower growth. Was that just as a function of the macro catching up with you guys? Or was there any other factors that came to bear that cause out a little bit slower growth versus what you have in the stage in the past years.

Yes. I appreciate you asking that. And I do remember you pointing it out last year. Look, macro has been a dynamic that we've been talking about. I think we might have been talking about a little bit earlier than other companies, maybe a function of the customer base that we serve, which is high-end enterprise focus on their most mission-critical applications. And the buying environment has been challenging. I think people are really focused on the investments they're making, deal level approvals at the highest levels. People really focus on the economic value of the solutions that they're investing in. And so I'd say that has persisted. I don't know that, that was -- we sort of anticipated that dynamic going into the year, so I wouldn't say that was a big factor in the swing. Look, the first half of the year, in particular, Q2, we had some isolated loss and downsell, which is not indicative of the business going forward. And I think if you isolated for that and layered that back in and normalized, we're back above the 20% mark. We talk a lot about the health of the renewal pool going into any fiscal year. And a big part of our business is arriving at a compelling event for an enterprise to move into a strategic platform, knowing they need to go build applications on top of that platform which can be a little tricky because there are factors outside of our control. The point of renewal is the most predictable, compelling event where we have time built in where we sit down with customers and say, what is your kind of path going forward, and we enjoy very healthy expansion at the point of that renewal. Last year's renewal pool had a few dynamics that I think made growth a bit more challenging, which we talked about. So all those things, I think, factored into -- into the year. We're obviously focused on executing over the short term. But really focused on building for the long term. As we turn the corner on this fiscal year, we have a very healthy renewal pool and one of the many things that underpins our confidence on returning to that 20-plus percent growth over time, which we articulated at the Financial Analyst Day.

Awesome. Just to tie the bow on some of those isolated headwinds when you see maybe a customer that goes from paid to community or free. What gives you guys confidence that those are, in fact, isolated events and that something that doesn't become a recurring part of the story year-on-year.

Well, the biggest single one of the last fiscal year was not one of those. It was actually a company that had been growing in a very healthy way was acquired by a conglomerate and they shut that business down. But it has nothing to do with the database, whatsoever, and those don't happen very often. We had another churn that we talked about where long-standing customer that had been deployed primarily as a cash, where customers don't get quite as much utility out of that as they do when they're fully deployed on the database. That one churned. And I think those are the two sort of isolated dynamics, which we just don't anticipate those on a go-forward basis.

Yes, that's fair enough. So let's talk about the opportunity in front of Couchbase. And I think it's a really interesting, exciting time for the data platform database category overall. Probably one of the those popular questions that our team has been getting is like when we think about the foundational requirements of a database to power the next wave of modern AI applications. What sort of wins out, like NoSQL versus a relational Postgres style implementation. What is your perspective on that? And why is like a kind of NoSQL architecture like Couchbase or you've also actually embedded a lot of relational capabilities I might add. Why is that the right answer for AI applications.

Yes. Well, you use the term kind of exciting market opportunity. We're even more jazzed up than that inside of Couchbase. We think this is probably the single greatest market transition than any of us will ever experience with respect to AI. And I don't think there's been as much attention paid to the role that data platforms are going to play in powering applications in an AI world. And fundamentally, as a database company, as a data platform company. We think about enterprises and the applications that they're building to run their business. And that is our mission to power these to power these applications. And we think about the role of AI and agenetic applications, we do think that people are going to have to rethink their default assumptions on what databases need to do. And so if we think about the application requirements that are going to be put on databases. I'm going to have to manage a ton of data, structured, unstructured, semi-structured. I'm going to have to do that at scale and performance that we've never seen. I'm going to have to do that across every point of the network topology from cloud to edge. I'm going to have to provide an open enough system to integrate with tools that are being created in AI, not just LLMs, but things around the ecosystem. And I want to do that in a consolidated platform, not disparate tools because that provides capabilities that simply aren't available if you go down that approach. And if we look at the fundamental reason why NoSQL over relational solutions, it was that flexible data schema. And you are right to point out that we provide that flexible data schema and combine it with relational attributes. Fundamentally, we believe strongly that a platform approach is going to be required and underpinning our platform approach is scale and performance advantages that we've had over some time. So we believe that the things that have made us great are never more relevant and are going to be that much more required by a broader set of applications and enterprises as we go forward.

Yes. To sort of follow-up on your point and sort of like how does 1 plus 1 equal 3. So there was a lot of focus on kind of a pure-play vector databases. They got a lot of attention in the market. But what's the importance because they pinpoint for us, the -- having a world-class operational database combined with what you guys call AI services, which includes your vector stage capabilities. Why is that important for customers? What's the unlock here?

Well, let's talk generically about any service in the database. Developers have a very complex job. They have to build applications. They need to focus on the utility that, that application provides, and they need a data platform to work on their behalf. If you have to use multiple platforms that don't drop on the same data set, you're introducing complexity that otherwise isn't the case if you consolidate that. And that was the case when we started out as a company where we brought together caching in a document data store. It was a case when we layered in search. It was a case when we figured out a way to make the SQL query language compatible with an unstructured data set. All of this was of the mindset, if I can put these tools in a single platform, it makes the role of the developer that much more productive and focused on building next-generation applications. When Vector came along, I think there was a rush to add it to the platform as a check box item without the understanding of the implications on how that was going to need to play alongside the rest of the capabilities. And so Couchbase, what we said is let's take an architectural approach to solving this problem. And we're going to build Vector inside of our platform so that it works with other services. Because when application owners are writing queries, they're not just Vector searches, there's hybrid search, there's other capabilities. I need to do it across multiple data sets. I may even want to do it at the edge on my mobile device, not just in the cloud. And so like has been the case since the beginning of our company, a platform approach with more utility inside of a single tool gives power to developers that does offer synergy that just isn't the case if you take point solutions or if you don't architecturally integrate capabilities inside your platform. And I think that's going to even be further demonstrated in this AI world because of how much data, because of how quickly it needs to perform and the implications on lesser performance on cost. And I think the TCO dynamic is going to manifest itself much more apparently than has been the case up to this point with databases.

Yes. Makes a lot of sense. Let's extend the conversation to maybe the incumbents like operational databases, but also embedding Vector search capabilities. How does Couchbase stand out from those competitors and those peers?

You're talking relational legacy providers or just other operational data stores?

Other operational data stores and particularly when you think about the different capabilities that they have, I mean, I think you guys have differentiated yourselves from things like mobile and sort of cloud to edge, but sort of as you think about a world where everybody, frankly, is supporting Vector search. How do you stand out from those sets of alternatives?

Yes. Look, I think we've taken prior to Couchbase from the beginning at setting out to solve database challenges for the most mission-critical applications. So inherent in that ambition is scale and performance. And we've always hung our hat on being able to get more data inside of our data store, running queries at a more efficient and higher scale level in just doing that for operational demand that others can't meet. That's going to be very similar with what we're doing in Vector. And over the next few quarters, we're going to be coming to market with new capabilities that further demonstrate a lead on scale and performance as it pertains to Vector in particular, which has a cost element. You are very right to call out one of our biggest differentiators, which is our cloud to edge architecture. And we are now the only database that has not just a mobile database capability, but we've always been the one with the integrated architecture truly from cloud to edge. In the last couple of days, we've announced an addition to the platform with Edge server for lower compute environments like airlines and things like that, where they want to bring full server capabilities to the Edge. And when we think about where AI is going to play out and the way in which we're going to interface with applications, Edge is going to become even more important. So if you think about that cloud Edge architecture, you overlay that with scale and performance that other solutions aren't going to be able to get to, we love where we sit in the competitive stack.

That's a distinction of being one of the few, if not maybe the only operating database that has significant edge and mobile capabilities. Are you seeing it show up in your sort of win rates or in your sort of bake off or sort of expansion opportunities? Are people specifically highlighting that. Is that driving some initial use cases?

For sure. Well, very simply, one of our competitors announced an end of life and moving out of that business. So we're definitely seeing an uptick of demand there, and we're ahead of the actual end-of-life date. The pipeline of opportunities is pretty significant. I think even more strategically, though, when we talk to enterprises about distributed applications and where they need to go with their platform, understanding how we've architected the solution and we'll continue to do so, I think, is unlocking strategic opportunities on a go-forward basis that has us even better positioned than most people realize.

Awesome. There's been a couple of interesting events happening in the past couple of weeks. IBM acquired Datastacks, Mongo acquired Voyager. What, if anything, do you read into what seems to be a burgeoning wave of consolidation in the database market.

Look, I think first and foremost, it reinforces the point that AI and databases need to be thought of simultaneously. And while we compete with Mongo and IBM and others, they are important players in the data arena, and for both of them to demonstrate with dollars that the pulling together of data solutions and AI is critically important to their future, I think gives validation to those of us that are in the space. As we think about our approach and sort of the competitive game theory, they do represent different dynamics, but we're very comfortable with our strategy. One of them was buying a tool to integrate into their platform where we believe our approach of scale and performance and focusing on the data layer and opening open access to all the tools that are out there is in the best interest of our developers, and that's the strategy that we've decided to take. I think as it pertains to others, we are happy with our win rates against that company, and I think the NoSQL solution that we've picked is the right one. Again, not trying to be disparaging to the competition. But as we looked at it, validation on the space, and we're really comfortable with our strategy as we go forward.

That's great. Let's dive into the Capella opportunity. And Capella is your managed cloud service offering, you launched that a couple of years ago. It now stands at 16% of the business. And if you squint, it looks like about a point or 2 of mix per quarter. I think the mix is up 5 points year-over-year. What's been the strategy and focus around driving Capella adoption? And sort of what's the thesis behind getting Capella to really hit escape velocity.

Yes. I think if we go back to the beginning, we were very convicted that we wanted Couchbased server to be our underlying engine. And we want the full power of the platform that I've been talking about to be available in two ways that customers would use that. And we talk about customers managing Couchbase, which would be our traditional enterprise business and us managing Couchbase on their behalf, which would be Capella. And if I go back to that fundamental strategic decision, I think that's paying dividends now and that we give customers choice and they can easily migrate from enterprise to Capella. And so as we executed on our Capella road map, the most important optimization, Sanjit, was making sure that, that was an industry-leading offering that had the full capability set of Capella with one of the best experiences available in the marketplace for developers. And we were admittedly probably a little bit later to market with that, but worked really hard to get to a level that we feel very comfortable about. Now as we migrate people from enterprise to Capella, it does provide a financial uplift as we're managing the service, and it does make it easier for customers to move to the next application. So we've been very mindful about creating a great path from enterprise to Capella and demonstrating to customers the value that they get from that, the better TCO dynamics, the operational agility and being able to focus on application development, and we've seen that value proposition play out. At the same time, we're careful to not force customers into it before they're ready. Maybe they're in highly regulated industries. Maybe there's some other dynamics at play. And we're able to grow our enterprise base, which, quite frankly, creates a bigger migratable opportunity on a go-forward basis. And so -- if we -- the leading indicators that we look at would suggest that we are headed towards that escape velocity. We use this term inflection, and we think we are executing rapidly through that inflection. While 16% of ARR is on Capella. The number of customers using Capella is a much higher number, which we think is a leading indicator for future ARR. And so I think we're taking the right approach to help customers with that offering, providing the appropriate incentives to get into Capella, which all things being equal, we think is the right way for them to consume so they can focus on application development, and then we continue to pour a ton of innovation in the core server capabilities and the Capella experience to stay on the leading edge.

You mentioned the ARR uplift you see when customers migrate over to Capella. Can you -- any sort of range or quantification on that ARR uplift? And what are the factors driving that uplift? Is it just going to the classic, hey, we're managing a service for you and so -- you can charge that higher price because you're bringing to bear those the compute and the storage and the operational heft to drive that higher TCO. Like what are the factors behind that?

Yes. So if we take $1 of enterprise and we move it over, we get pretty conservatively $0.50 to $0.75 uplift just app to app. And that's a few factors. We're monetizing the compute that we're now managing, and we're able to charge for the fact that we're running the service on their behalf. So there are big advantages for us -- and we return that in better TCO for customers, which we've proven out where they don't have humans running that. We're able to manage the environment with the utmost efficiency because it's our product. I think the additional growth that we get though is in more applications. And what I talk about with our field teams is we don't win a customer, we win an application. And so we've got to go fight to win the next application, the application after that. And where we're successful, Sanjit, we're running hundreds of applications inside of customers. Capella makes it easier once people understand what they can do with the Capella and Couchbase offering to add that N+1 application. So there's the initial uplift and then we enjoy growth dynamics after that. For the customer, they've got predictability. They're paying as they use it. So industries where we see flux of demand with our consumption model. We're able to marry our business model with theirs in a better way. Customer feedback has been outstanding, and we think it's huge, huge potential for us as we go forward.

I love how you bring that out sort of winning application by application. So can you give us a sense of what are -- how is the sales engagement interacting with the customers after they go from migrating that initial application and then getting into applications 2, 3, 4, 5 and so forth.

Yes. Let me give you an example over the last 1.5 years. We had a customer that you would know, they're in e-commerce space. We had a very small deployment with them, 10-ish, 20,000 enterprise business, single application. And we got to one of their enterprise architects and said, look, the value proposition that you're enjoying there, scale, performance, flexible data schema, that applies to so many more of your applications in your estate. Let us work with your teams to prove that out. And because of the approach that we've taken, this isn't a rip and replace. You can use roll 1 micro service at a time. We can help you with relational offload. We can provide capabilities that are taking multiple vendors today inside of 1 solution, and we identified demand in multiple lines of business at that enterprise account. Fast forward a year, we were running at almost 7 figures of ARR after 10 months of growth. I had a chance to talk to that architect and he said, "Look, what your teams were telling me at the beginning was absolutely true, but I'm betting my job on you and the company in this platform. So I had to go through a few paces of convincing these others, doing POCs. Now we're at this level pretty comfortably. And now we're looking at the next set of applications. And so we talk about a land and explode model. Part of this is to know Couchbase is to love Couchbase. Once developers get a feel for what they can do, how simple it is, how reliable it is, then we can go after the next set of applications. That dynamic applies on enterprise. It's even more so the case on Capella for the reasons that I mentioned.

Can you give us like when we think about the Capella growth and as it's starting to mature the sort of growth contributors between the migration piece, the expansion piece and then sort of new logos, how is that sort of -- how do those 3 components evolved over the last year?

Look, I think, first of all, we need to take care of our existing customers. They understand the solution of what it can do the best. And so our biggest lever of growth is expanding within that. We obviously need to plant seeds with new logos and get into that motion. I think those dynamics have been applicable over the course of the history of the company, the big dynamic that's changed is Capella. And it provides potential uplift and acceleration on every one of those dynamics. First and foremost, as we think about acquiring new customers, the ability for a developer to get into a perpetual free trial, understand all of the capabilities that we have, especially with the added on AI services. I mean they can get up to speed on the tool with data and test that POC testing phase, just we shorten that, that's going to enhance our ability to land new customers and expand new logos. The uplift with the service, the ability to expand to new applications at lower risk and lower operational friction. Those are the reasons why we're so excited about Capella because we've got this predictable business that demonstrates the value of the couch based platform and now we have a more efficient way to expand and monetize that.

Yes, sounds super exciting. One of the business metrics that kind of popped out of the page when we think about fiscal year '25 is customer base growth. Customer base grew 26% the prior year was like 10% or 11%, right? So big [indiscernible]. I imagine Capella has to be a big driver of growth for that. At the same time, when I look at Q4, you guys added a really impressive number of logos, 44, but only 10 of them came from Capella. So I guess the question is like, why was Capella not a bigger factor in the Q4, Q4 new logo adds? And then as we think looking out into next year and the years ahead, what's a reasonable amount of new logos that you're striving for?

Two dynamics at play. Let me cover them one at a time. One of the things that we're doing to generate new logo demand and kind of get into that flywheel with the developer is even lower entry points with the offering. So a little over a year ago, we came to market with 1,000, 5,000 starter packs, where we want people to start using the product, get into production, and hopefully expand them. We're on the anniversary of that, and we expected to see more churn. Q4 was the first quarter where we had a full quarter of some of those churning off, which affected the Capella number. Now with the work that we're doing with the free tier and the indicators that we have on trials, some of that churn isn't even that bad because they now know the product and they can come back to us. That was a factor in Q4. The other dynamic is we can land an ISV in a quarter, and that ISV can have many end customers that they're bringing into the Couchbase offering. If we land an ISV that has a lot of end customers that are on enterprise that can disproportionately change the optics of the quarter, which would be different if they were on Capella. So in Q4, it was a function of those 2 dynamics and some of the ISV activity happened to be enterprise, which drove that number up.

Understood. Understood. Let's move the conversation a little bit over to the financial side of the house and maybe even talk about -- a little bit about go-to-market in the last couple of minutes that we have. If we go back to the last Analyst Day in 2023, you guys provided a midterm outlook. I'm talking roughly about a 20% growth CAGR, positive free cash flow fiscal year '26, operating income positive by fiscal year 2027. The update that we got last week was free cash flow maybe pushes out by year, but operating income is still on track. How do you feel about the 20% CAGR on ARR growth that you guys laid out on the Analyst Day. Is that still something that's aspirational? Or what's the right context on that?

No, look, we're confident that we restated that at the Financial Analyst Day, we did talk about that being a CAGR. So I think that's playing out as we expected. And for all the reasons that we talk about enterprise Capella, the amount of our base that's more ready to migrate, the win rates that we're seeing, the demands of the platform, we are convicted in that number. The free cash flow was important for us to articulate. There were a few different dynamics as we do the math on the year. One of them we benefited from earlier collections where we had a great free cash flow this year, which changed a little bit of the a little bit of the timing. It was important for us to call that out because it was a change, not that we're giving up on trying to get there this year and as far as op income, completely committed to it. Look, fundamentally, we believe in our ability to grow. At the same time, we're investing in a generational market opportunity while driving the Capella inflection, and we are absolutely committed to doing all of that with more efficiency, which we take great pride in. So the way in which we're running the company has not changed, and we're still working hard to exceed those commitments.

Great. Another popular question that we get, and we've touched on this on our earnings calls before several times, but I think it's important since it is still a popular question, that delta and that's spread between ARR growth is sustaining sort of high teens, if you normalize, maybe it kind of looks like 20% versus the slower revenue growth. The factors driving that and sort of the time line for those to start to converge.

Well, here's the good news. Hopefully, next year, we won't be having this question on the list. We do think next year is the point of convergence. And the simple answer is Capella is creating that divergence where the way we recognize revenue is different when we move to Capella. So the more migration we do. We have seen some of that revenue push, which is why we've pointed to the ARR growth rate as the most important one. And again, next year, we see the convergence. And obviously, if we're calling that out, we're going to see progress throughout the year.

Awesome. I always say said full pay attention to the ARR. So great. You made a couple of like headline grabbing announcements on the partnership front. Talk to me both about like the NVIDIA partnership, what does that mean for Couchbase in the business? And then the evolution of your partnership with AWS, where does that stand today? And where is that going?

So let me take those 1 at a time. Yes, we're incredibly excited about the NVIDIA partnership. And I made reference to us focusing on the data layer. Let's get as many capabilities into the platform. Let's continue to improve scale and performance. Let's take that out to the edge, let's add AI services and our approach on AI services has a lot to do with allowing customers to bring tools to use against the data platform. And the partnership with NVIDIA is a big example of that where developers now have a more seamless integration point between all of the tools and capabilities in the NVIDIA ecosystem and marrying that up with the highest-performing database in the industry. And that's going to be our mindset that we take going forward. How do we focus on the job that we're uniquely suited to do, but open up tools and capabilities in a very fast and emerging ecosystem. No one better to partner with than NVIDIA that -- to make that marriage a great one for our developers. As it pertains to other parts of the partner ecosystem, you mentioned AWS and cloud providers. That's a big point of distribution for us. We do a lot of joint selling. Obviously, the more success we have with Capella, the more relevant we are with those CSPs. I've been saying that we've been punching above our weight with the level of strategic alignment that we have with AWS in large part because they see the success that we have with some of the biggest customers on the planet as a leading indicator for the future. But we're not stopping there. ISV continues to be a healthy channel for us as our regional resellers and GSIs. So when we think about where we sit, our capabilities probably exceed the full extent of our Couchbase distribution, and we are going to invest in the partner community to expand that distribution and bring the full power of Couchbase to as many enterprises as we can.

Awesome. Maybe we'll end on the DeepSeek news over the last month. What does that -- them from a foundational model perspective being able to be close to some of the state-of-the-art models today at lower training costs. How do they perceive the DeepSeek moment in terms of the industry, maybe for your customers and maybe for Couchbase itself.

Yes, a couple of observations. One of my favorite ones, which I haven't had a chance to talk about publicly, is that it came a very little surprise to our engineering team. I said I can't believe this caught everybody by such a surprise because we've been seeing some of the work that they've been doing for some time, which I think speaks to the leading-edge nature of our innovators and understanding what's happening with the transition of technology. Second to that, I would say I think it speaks to the level of pace of change in the AI ecosystem. We already have that integrated into Capella. So our ability to respond with this open mindset -- and I think it gives a small indication of how big this market transition is. And going back to my fundamental point that you don't have applications without a data platform. We are on the cusp of one of the most exciting market transitions we've ever seen, and Couchbase has never been better positioned.

Well awesome. We'll leave it there as we're out of time. Matt, thank you so much joining us.

Thank you.