Confluent, Inc. Annual Report - A Look Back at Fiscal Year Ended December 31, 2023

Considering an investment in Confluent, Inc.? This summary distills their latest 10-K filing, offering a clear, jargon-free overview of their business, financial performance, and future prospects for the fiscal year ended December 31, 2023. We aim to provide the essential insights you need to make an informed decision.

Business Overview: What Confluent Does (and How It Makes Money)

Confluent empowers businesses to manage and interpret their data in real-time. Imagine a high-speed data pipeline that allows companies to instantly use information for critical applications, from fraud detection to personalized customer experiences.

Confluent generates revenue primarily from:

• Subscriptions (94% of total revenue): This forms the core of Confluent's business, driven largely by its flagship "Confluent Cloud" service. Think of it as a Netflix for data streaming, where businesses pay a recurring fee to access Confluent's powerful, cloud-native data tools. They also provide self-managed software subscriptions.
• Licenses (3% of total revenue): Confluent sells perpetual licenses, granting companies one-time rights to use its software directly on their own infrastructure. This segment represents a smaller and declining portion of revenue as customers increasingly adopt cloud offerings.
• Services (3% of total revenue): Confluent also offers professional services, including consulting, training, and ongoing customer support, to help clients implement and optimize their data streaming platforms.

Confluent serves a global customer base. Approximately 70% of its revenue originates from the U.S., with the remaining 30% from international markets, primarily Europe and Asia.

Financial Performance

Confluent achieved strong growth in its key cloud offerings during the fiscal year, though profitability remains a primary focus:

• Total Revenue: Grew by 30% year-over-year to $800 million.
• Subscription Revenue: Increased by 35% to $750 million, largely driven by Confluent Cloud.
• Confluent Cloud Revenue: A standout performer, growing by 50% year-over-year to $400 million, representing 50% of total revenue.
• Annual Recurring Revenue (ARR): Reached $900 million, up 32% from the prior year, indicating strong future revenue streams.
• Net Retention Rate: Confluent maintained a healthy 125%, indicating existing customers increased their spending with the company by 25% year-over-year.
• Customer Growth: The number of customers generating over $100,000 in ARR grew by 20% to 1,200, demonstrating Confluent's success in attracting larger enterprises.
• Net Loss: Confluent reported a net loss of $250 million for the year, reflecting ongoing investments in growth. Its operating margin stood at -31%.
• Expenses: Key operating expenses, as a percentage of revenue, included: Research & Development (35%), Sales & Marketing (50%), and General & Administrative (15%).

Financial Health

Confluent prioritizes managing its capital structure and liquidity:

• Cash Position: Confluent concluded the year with a robust cash and cash equivalents balance of $1.5 billion.
• Debt: Confluent holds $1 billion in Convertible Senior Notes due 2027. These unsecured debt instruments can convert into shares of Confluent's common stock under specific conditions, offering financial flexibility but also potential shareholder dilution upon conversion.
• Cash Flow: Cash flow from operations was -$50 million, indicating continued heavy investment in growth rather than positive cash generation from core business activities. Confluent uses its cash reserves and financing activities to fund operations and growth initiatives.

Competitive Position

Confluent navigates a highly dynamic and competitive market encompassing data streaming, real-time analytics, and cloud data services. Its competitive advantages arise from its enterprise-grade platform built on Apache Kafka, its cloud-native Confluent Cloud offering, and its focus on developer experience and a comprehensive ecosystem.

Confluent competes with:

• Large public cloud providers: Such as Amazon Web Services (AWS), Microsoft Azure, and Google Cloud Platform (GCP), which offer their own managed Kafka services or similar data streaming solutions.
• Open-source alternatives: Companies can choose to self-manage open-source Apache Kafka, which is free to use but requires significant operational overhead.
• Specialized vendors: Other companies offering data streaming, messaging, or real-time analytics solutions.
• In-house solutions: Some large enterprises develop and maintain their own proprietary data streaming infrastructure.

Confluent differentiates itself through advanced features, operational simplicity, scalability, security, and global reach. It aims to provide a superior and more cost-effective solution compared to self-managed open-source or basic cloud offerings.

Risk Factors

Investors should consider several key risks outlined in Confluent's 10-K filing:

• Intense Competition: The data streaming and cloud services market is highly competitive, with large tech companies and specialized vendors vying for market share.
• Reliance on Cloud Providers: Confluent Cloud operates on major public cloud infrastructure (AWS, Azure, GCP). This makes Confluent dependent on these providers and subject to their pricing and service changes.
• Macroeconomic Conditions: Economic downturns or reduced IT spending by customers could impact Confluent's growth and profitability.
• Achieving Profitability: While growing rapidly, Confluent is not yet profitable, and there is no guarantee when or if it will achieve sustained profitability.

Strategic Developments & Acquisitions

Confluent actively expands its capabilities and market reach through strategic initiatives:

• Warpstream Labs Inc. Acquisition (September 2023): Confluent acquired Warpstream to enhance its real-time analytics capabilities, especially for processing data directly at the edge (closer to data generation). This acquisition expands Confluent's product offerings and addresses new customer use cases.
• Immerok GmbH Acquisition (January 2023): This acquisition strengthened Confluent's expertise in Apache Flink, a powerful open-source stream processing framework. Integrating Immerok's technology and talent enables Confluent to deliver more advanced data streaming solutions, particularly for complex real-time data transformations.
• Focus on Cloud Growth: Confluent continues to prioritize Confluent Cloud's growth, investing in new features, integrations, and expanding its global availability to capture more of the rapidly growing cloud data streaming market.

Management's Discussion and Analysis (MD&A) Highlights

This section offers management's perspective on Confluent's financial condition and operational results.

• Results of Operations: Management highlighted strong revenue growth, particularly from Confluent Cloud. Increased adoption among enterprise customers and expansion within existing accounts drove this growth. The net loss reflects continued significant investments in research and development to enhance the platform, and in sales and marketing to expand market reach. Improving Confluent Cloud's gross margins remains a key focus, with ongoing efforts to enhance efficiency and scale.
• Liquidity and Capital Resources: Confluent maintains a strong cash position, which provides flexibility for strategic investments and operational management. While the convertible senior notes provide additional capital, they also represent a potential future obligation or dilution. Management monitors cash flow from operations, which remains negative due to growth investments, and aims to improve operating leverage over time.
• Key Trends and Factors: Management identified increasing demand for real-time data infrastructure across industries, the shift towards cloud-native solutions, and the growing importance of data streaming for AI and machine learning applications as key drivers for future growth. They also acknowledged macroeconomic conditions' impact on customer spending patterns and sales cycles.

Future Outlook

Confluent's management remains optimistic about the long-term opportunities in real-time data and focuses on:

• Product Innovation: Confluent continues to invest in R&D to deliver new features and expand its platform's capabilities, particularly in areas like AI integration and data governance.
• Expanding Go-to-Market: Confluent is increasing sales and marketing efforts to reach new enterprise customers and expand within existing accounts, especially for Confluent Cloud.
• Path to Profitability: While prioritizing growth, management commits to improving operating leverage and moving towards non-GAAP profitability in the coming years, driven by economies of scale in its cloud operations.

Confluent operates in a high-growth market. Investors should weigh its strong revenue growth and strategic acquisitions against its current unprofitability and competitive landscape.