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Confluent (NASDAQ:CFLT) Surprises With Strong Q2, Provides Optimistic Guidance For Next Quarter


Full Report / September 29, 2021
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Data infrastructure software company, Confluent (NASDAQ:CFLT) reported strong growth in the Q2 FY2021 earnings announcement, with revenue up 64% year on year to $88.3 million. Confluent made a GAAP loss of $88.1 million, down on its loss of $26.2 million, in the same quarter last year.

Confluent (CFLT) Q2 FY2021 Highlights:

  • Revenue: $88.3 million vs analyst estimates of $76.8 million (14.9% beat)
  • EPS (non-GAAP): -$0.31 vs analyst estimates of -$0.39 (19.9% beat)
  • Revenue guidance for Q3 2021 is $90 million at the midpoint, above analyst estimates of $79.7 million
  • Free cash flow was negative $45.4 million, compared to negative free cash flow of -$21.23 million in previous quarter
  • Net Revenue Retention Rate: 130%, up from 117% previous quarter
  • Gross Margin (GAAP): 66.3%, down from 69% previous quarter

Started in 2014 by the team of engineers at LinkedIn who originally built it as an internal tool, Confluent (NASDAQ:CFLT) provides infrastructure software for organizations that makes it easy and fast to collect and move large amounts of data between different systems.

More and more data is being collected, a trend driven by both cheaper storage and more users, applications and systems being online. Most companies are capturing data about every single visit, click, input or a transaction made in their app or on their website, and some go even deeper. But as they accumulate more and more data, companies are confronted with the reality that gathering the data on its own isn’t really creating any value, and that it needs to be moved, processed and analyzed to be useful.

Confluent takes a massively popular open source data infrastructure software called Kafka, and provides it as a paid managed service. Kafka acts as a central transportation hub for the data, ingesting it from different sources (websites, mobile apps) and distributing it to all of the destinations it needs to get to (like analytical tools, databases, billing systems). The advantage of Kafka is that it moves the data in real time, which is becoming increasingly important, but is complex to implement and maintain which is where Confluent sees their opportunity.

Businesses have a growing need to access data and insights generated by their systems in real time. In order to achieve that they need to connect the piles of data stored and siloed in separate databases and that drives demand for software infrastructure that can connect, integrate and distribute data fast.

Competitors in the data management space include Snowflake (NYSE:SNOW) as well as the services provided by cloud vendors such as Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT), and Google Cloud (owned by Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG)). Confluent also competes with the self-managed, free version of Apache Kafka, the open-source software from which it was derived.

Sales Growth

As you can see below, Confluent's revenue growth has been exceptional over the last year, growing from quarterly revenue of $53.8 million, to $88.3 million.

Confluent Total Revenue

This was another standout quarter with the revenue up a splendid 64% year on year. On top of that, revenue increased $11.3 million quarter on quarter, a very strong improvement on the $6.7 million increase in Q1 2021, and a sign of acceleration of growth, which is very nice to see indeed.

Analysts covering the company are expecting the revenues to grow 22.6% over the next twelve months, a significant slowdown.

Product Success

One of the best things about software as a service businesses (and a reason why they trade at such high multiples) is that customers tend to spend more with the company over time.

Confluent Net Revenue Retention Rate

Confluent's net revenue retention rate, an important measure of how much customers from a year ago were spending at the end of the quarter, was at 130% in Q2. That means even if they didn't win any new customers, Confluent would have grown its revenue 30% year on year. Significantly up from the last quarter, this is a great retention rate and a clear proof of a great product. We can see that Confluent's customers are very satisfied with their software and are using it more and more over time.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Confluent's gross profit margin, an important metric measuring how much money there is left after paying for servers, licences, technical support and other necessary running expenses was at 66.3% in Q2.

Confluent Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.66 left to spend on developing new products, marketing & sales and the general administrative overhead. This would be considered a low gross margin for a SaaS company and it has dropped significantly from the previous quarter, which is probably the opposite of what shareholders would like it to do.

Key Takeaways from Confluent's Q2 Results

Since it has still been burning cash over the last twelve months it is worth keeping an eye on Confluent’s balance sheet, but we note that with a market capitalization of $16.2 billion and more than $1.04 billion in cash, the company has the capacity to continue to prioritise growth over profitability.

We were impressed by how strongly Confluent outperformed analysts’ revenue expectations this quarter. And we were also excited to see the really strong revenue growth. On the other hand, it was less good to see the pretty significant deterioration in gross margin. Zooming out, we think this was a great quarter and we have no doubt shareholders will feel excited about the results. The company currently trades at $64 per share.

Is Now The Time?

Confluent may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. We cheer for everyone who is making the lives of others easier through technology, but in case of Confluent we will be cheering from the sidelines. Its revenue growth has been exceptional, though we don't expect it to maintain historical growth rates. Unfortunately, its growth is coming at a cost of significant cash burn, and its gross margins aren't as good as other tech businesses we look at.

Given its price to sales ratio based on the next twelve months is 20.5, Confluent is priced with expectations of a long-term growth, and there's no doubt it is a bit of a market darling, at least for some. While we have no doubt one can find things to like about the company, we think there might be better opportunities in the market and at the moment don't see many reasons to get involved.

The Wall St analysts covering the company had a one year price target of $44.8 per share right before these results, implying that they didn't see much short-term potential in the Confluent.

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