Confluent(CFLT) - 2022 Q1 - Quarterly Report

PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) This section presents unaudited condensed consolidated financial statements and notes for periods ended March 31, 2022, and December 31, 2021 Condensed Consolidated Balance Sheets Total assets and liabilities slightly decreased from December 31, 2021, to March 31, 2022, with cash reducing and marketable securities increasing | Metric | March 31, 2022 (in thousands) | December 31, 2021 (in thousands) | | :-------------------------- | :---------------------------- | :------------------------------- | | Cash and cash equivalents | $1,047,589 | $1,375,932 | | Marketable securities | $943,048 | $640,085 | | Total current assets | $2,195,249 | $2,226,073 | | Total assets | $2,317,501 | $2,342,729 | | Total current liabilities | $330,729 | $348,188 | | Total liabilities | $1,481,432 | $1,492,448 | | Total stockholders' equity | $836,069 | $850,281 | | Accumulated deficit | $(861,841) | $(748,854) | Condensed Consolidated Statements of Operations The company reported significant revenue growth for Q1 2022, primarily in subscriptions, but increased operating expenses led to a larger net loss | Metric (in thousands) | Three Months Ended March 31, 2022 | Three Months Ended March 31, 2021 | | :-------------------------- | :-------------------------------- | :-------------------------------- | | Total revenue | $126,139 | $77,028 | | Subscription revenue | $113,920 | $67,992 | | Services revenue | $12,219 | $9,036 | | Total cost of revenue | $45,777 | $23,838 | | Gross profit | $80,362 | $53,190 | | Total operating expenses | $191,844 | $98,334 | | Operating loss | $(111,482) | $(45,144) | | Net loss | $(112,987) | $(44,526) | | Net loss per share (basic & diluted) | $(0.41) | $(0.41) | - Total revenue increased by 64% year-over-year, from $77.0 million in Q1 2021 to $126.1 million in Q1 2022. Subscription revenue grew by 67.6% YoY, while services revenue grew by 35.2% YoY[17] - Operating expenses increased by 95.1% year-over-year, from $98.3 million in Q1 2021 to $191.8 million in Q1 2022, leading to a 146.9% increase in operating loss[17] Condensed Consolidated Statements of Comprehensive Loss Total comprehensive loss significantly increased in Q1 2022 due to a larger net loss and increased unrealized loss on marketable securities | Metric (in thousands) | Three Months Ended March 31, 2022 | Three Months Ended March 31, 2021 | | :------------------------------- | :-------------------------------- | :-------------------------------- | | Net loss | $(112,987) | $(44,526) | | Unrealized loss on marketable securities | $(4,712) | $(185) | | Total comprehensive loss | $(117,699) | $(44,711) | - Unrealized loss on marketable securities increased significantly from $(185) thousand in Q1 2021 to $(4,712) thousand in Q1 2022[19] Condensed Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders' Equity (Deficit) Stockholders' equity decreased in Q1 2022 due to net loss, partially offset by increased additional paid-in capital from stock-based compensation | Metric (in thousands) | January 1, 2022 | March 31, 2022 | | :-------------------------------- | :-------------- | :------------- | | Additional Paid-In Capital | $1,599,962 | $1,703,449 | | Accumulated Other Comprehensive Loss | $(830) | $(5,542) | | Accumulated Deficit | $(748,854) | $(861,841) | | Total Stockholders' Equity | $850,281 | $836,069 | - Stock-based compensation contributed $58.9 million to additional paid-in capital during the three months ended March 31, 2022[21] Condensed Consolidated Statements of Cash Flows Cash used in operating and investing activities significantly increased in Q1 2022, while cash from financing activities also rose | Cash Flow Activity (in thousands) | Three Months Ended March 31, 2022 | Three Months Ended March 31, 2021 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Net cash used in operating activities | $(55,031) | $(19,989) | | Net cash (used in) provided by investing activities | $(311,734) | $13,845 | | Net cash provided by financing activities | $38,468 | $13,460 | | Net (decrease) increase in cash, cash equivalents, and restricted cash | $(328,343) | $7,308 | | Cash, cash equivalents, and restricted cash at end of period | $1,048,339 | $45,114 | - Cash used in operating activities increased by 175% YoY, primarily due to a larger net loss and changes in operating assets and liabilities[23][169] - Investing activities shifted from providing $13.8 million in cash in Q1 2021 to using $311.7 million in Q1 2022, largely due to increased purchases of marketable securities[23][171] Notes to Condensed Consolidated Financial Statements These notes explain accounting policies, financial instrument valuations, debt, revenue, equity, and tax positions for the financial statements 1. Organization and Description of Business Confluent, Inc. provides a data infrastructure platform for 'data in motion,' offering self-managed software and a fully-managed cloud-native SaaS - Confluent's core business is a data infrastructure platform for 'data in motion,' deployable as self-managed software (Confluent Platform) or a fully-managed SaaS (Confluent Cloud)[28] 2. Basis of Presentation and Summary of Significant Accounting Policies Financial statements are prepared under GAAP, with key policies including marketable securities valuation and credit loss allowance, with early adoption of new credit loss guidance - The company classifies marketable securities as available-for-sale, recorded at fair value, with unrealized gains/losses in OCI[36][37] - Accounts receivable includes unbilled receivables ($38.1 million as of March 31, 2022) and is reduced by an allowance for expected credit losses, which was not material[39][43] - The company early adopted ASU No. 2016-13 (Credit Losses) effective January 1, 2022, with no cumulative effect adjustment to accumulated deficit[44] 3. Marketable Securities Marketable securities increased to $943.0 million by March 31, 2022, primarily U.S. treasury securities, with a total unrealized loss of $5.5 million | Marketable Securities (in thousands) | March 31, 2022 Fair Value | December 31, 2021 Fair Value | | :----------------------------------- | :------------------------ | :--------------------------- | | U.S. treasury securities | $696,509 | $446,435 | | Corporate notes and bonds | $139,030 | $125,604 | | U.S. agency obligations | $77,245 | $54,007 | | Commercial paper | $30,264 | $10,995 | | Municipal bonds | - | $3,044 | | Total marketable securities | $943,048 | $640,085 | - As of March 31, 2022, marketable securities had an amortized cost of $948.5 million and total unrealized losses of $5.5 million[45] | Contractual Maturities (in thousands) | March 31, 2022 Amortized Cost | March 31, 2022 Fair Value | | :------------------------------------ | :---------------------------- | :------------------------ | | Due within one year | $777,327 | $774,766 | | Due after one year through five years | $171,192 | $168,282 | | Total | $948,519 | $943,048 | 4. Fair Value of Financial Instruments Financial assets, including cash equivalents and marketable securities, are measured at fair value, primarily Level 2, with convertible senior notes valued at $916.4 million | Financial Instrument (in thousands) | March 31, 2022 Total Fair Value | December 31, 2021 Total Fair Value | | :---------------------------------- | :------------------------------ | :------------------------------- | | Cash equivalents | $191,481 | $98,855 | | Marketable securities | $943,048 | $640,085 | | Total | $1,134,429 | $738,940 | - Most marketable securities and U.S. treasury cash equivalents are classified as Level 2, valued using observable market inputs[49] - The fair value of the 0% convertible senior notes due 2027 was $916.4 million as of March 31, 2022, down from $1,206.7 million at December 31, 2021, classified within Level 2[50] 5. Balance Sheet Components Property and equipment, net, increased to $18.5 million, while accrued expenses and other liabilities decreased to $71.9 million | Property and Equipment (in thousands) | March 31, 2022 | December 31, 2021 | | :------------------------------------ | :------------- | :---------------- | | Internal-use software | $10,595 | $8,024 | | Construction in progress | $6,605 | $5,140 | | Property and equipment, net | $18,486 | $14,428 | | Accrued Expenses and Other Liabilities (in thousands) | March 31, 2022 | December 31, 2021 | | :---------------------------------------------------- | :------------- | :---------------- | | Accrued compensation and benefits | $15,685 | $27,703 | | Employee contributions under employee stock purchase plan | $9,146 | $19,247 | | Total accrued expenses and other liabilities | $71,924 | $98,974 | 6. Convertible Senior Notes In December 2021, the company issued $1.1 billion in 0% convertible senior notes due 2027 and entered into capped call transactions to reduce dilution - Issued $1.1 billion aggregate principal amount of 0% convertible senior notes due 2027 in December 2021, with net proceeds of $1,080.5 million[54] - Initial conversion rate is 9.9936 shares per $1,000 principal amount (approx. $100.06 per share), subject to adjustment[55] - Conversion conditions were not met as of March 31, 2022, classifying the notes as long-term debt[59] - Incurred $19.5 million in debt issuance costs, amortized to interest expense over the term at an effective rate of 0.35%. Amortization was $0.9 million for Q1 2022[61] - Entered into capped call transactions for $91.0 million to reduce potential dilution, recorded as a reduction to additional paid-in capital[64] 7. Commitments and Contingencies The company has non-cancelable operating leases and indemnification provisions, with no material legal matters or significant changes to purchase obligations - Non-cancelable operating leases primarily for office space, expiring through 2029[65] - No material legal matters or significant changes to purchase obligations as of March 31, 2022[67][68] - Enters into indemnification provisions with customers and third parties, with maximum potential future payments not determinable but no material costs incurred to date[70][71] 8. Revenue Subscription revenue, including Confluent Cloud, accounts for 90% of total revenue, with Remaining Performance Obligations significantly increasing | Revenue Category (in thousands) | Three Months Ended March 31, 2022 | % of Total Revenue (2022) | Three Months Ended March 31, 2021 | % of Total Revenue (2021) | | :------------------------------ | :-------------------------------- | :------------------------ | :-------------------------------- | :------------------------ | | United States | $78,992 | 63% | $49,279 | 64% | | International | $47,147 | 37% | $27,749 | 36% | | Confluent Platform - License | $18,947 | 15% | $13,961 | 18% | | Confluent Platform - PCS | $56,060 | 44% | $40,112 | 52% | | Confluent Cloud | $38,913 | 31% | $13,919 | 18% | | Subscription Total | $113,920 | 90% | $67,992 | 88% | | Services | $12,219 | 10% | $9,036 | 12% | | Total revenue | $126,139 | 100% | $77,028 | 100% | - Confluent Cloud revenue grew by 180% year-over-year, increasing its share of total revenue from 18% to 31%[72] | Metric (in thousands) | March 31, 2022 | December 31, 2021 | | :------------------------------------ | :------------- | :---------------- | | Remaining Performance Obligations (RPO) | $551,100 | $280,900 | | Deferred Revenue | $265,700 | $246,500 | - Approximately 60% of RPO is expected to be recognized as revenue over the next 12 months[73] | Deferred Contract Acquisition Costs (in thousands) | Three Months Ended March 31, 2022 | Three Months Ended March 31, 2021 | | :------------------------------------------------- | :-------------------------------- | :-------------------------------- | | Beginning balance | $78,824 | $47,599 | | Capitalization of contract acquisition costs | $12,080 | $10,866 | | Amortization of deferred contract acquisition costs | $(8,470) | $(5,535) | | Ending balance | $82,434 | $52,930 | 9. Stockholders' Equity The company maintains Class A and Class B common stock, with significant stock-based compensation expense recognized under equity incentive plans - Class A common stock has one vote per share, and Class B common stock has ten votes per share. Class B shares are convertible to Class A under certain conditions[78][79] | Shares Reserved for Future Issuance | March 31, 2022 | December 31, 2021 | | :---------------------------------- | :------------- | :---------------- | | 2014 Stock Plan (Options & RSUs) | 58,866,631 | 65,399,423 | | 2021 Equity Incentive Plan (Options & RSUs) | 9,361,114 | 2,961,468 | | 2021 Employee Stock Purchase Plan | 7,145,776 | 5,162,575 | | Total | 116,393,943 | 106,320,711 | | Stock-Based Compensation Expense (in thousands) | Three Months Ended March 31, 2022 | Three Months Ended March 31, 2021 | | :---------------------------------------------- | :-------------------------------- | :-------------------------------- | | Cost of revenue - subscription | $5,313 | $975 | | Cost of revenue - services | $1,862 | $544 | | Research and development | $20,085 | $3,511 | | Sales and marketing | $21,062 | $4,976 | | General and administrative | $9,047 | $3,347 | | Total stock-based compensation | $58,896 | $13,451 | - Unrecognized stock-based compensation expense was $735.6 million as of March 31, 2022, to be recognized over a weighted-average period of 3.3 years[92] 10. Income Taxes The company recorded a $0.7 million income tax provision for Q1 2022, primarily due to a valuation allowance on deferred tax assets | Income Tax Metric (in thousands) | Three Months Ended March 31, 2022 | Three Months Ended March 31, 2021 | | :------------------------------- | :-------------------------------- | :-------------------------------- | | Provision for (benefit from) income taxes | $689 | $(110) | - The company maintains a full valuation allowance against its U.S. and U.K. deferred tax assets[94][162] - Gross unrecognized tax benefits were $13.8 million as of March 31, 2022, not expected to significantly change within 12 months[95] 11. Net Loss Per Share Basic and diluted net loss per share remained at $(0.41) for Q1 2022 and 2021, despite increased weighted-average shares outstanding | Net Loss Per Share Metric | Three Months Ended March 31, 2022 | Three Months Ended March 31, 2021 | | :------------------------ | :-------------------------------- | :-------------------------------- | | Net loss | $(112,987) | $(44,526) | | Weighted-average shares | 272,890,829 | 108,731,605 | | Net loss per share | $(0.41) | $(0.41) | | Potentially Dilutive Shares (Anti-dilutive) | March 31, 2022 | March 31, 2021 | | :------------------------------------------ | :------------- | :------------- | | Stock options | 55,684,668 | 79,624,342 | | RSUs | 12,543,077 | 14,000 | | Shares issuable upon conversion of 2027 Notes | 10,992,960 | - | | Total | 81,564,691 | 197,891,609 | ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management discusses financial performance, condition, and outlook, highlighting revenue growth, increased expenses, and strategic investments Overview Confluent's cloud-native platform, built on Apache Kafka, drives 64% YoY revenue growth and 62% customer growth by setting data in motion - Confluent's mission is to 'set data in motion' using a cloud-native platform built on Apache Kafka[102][103] - Revenue is primarily generated from subscriptions to Confluent Platform (self-managed) and Confluent Cloud (fully-managed SaaS)[104] | Metric | March 31, 2022 | March 31, 2021 | YoY Growth | | :-------------- | :------------- | :------------- | :--------- | | Total Customers | 4,120 | 2,540 | 62% | | Total Revenue | $126.1M | $77.0M | 64% | Impact of COVID-19 COVID-19 caused service delays and longer sales cycles but accelerated digital transformation, leading to increased travel and event expenses in Q1 2022 - COVID-19 caused delays in professional/education services and lengthened sales cycles, but also accelerated digital transformation efforts for customers[109] - Company measures included remote work, suspended non-essential travel, virtual events, and temporary reduction in employee hiring, which negatively impacted near- to medium-term growth[110] - Expenses related to travel, in-person events, real estate, and facilities increased in Q1 2022, with expected continued growth[110] Key Factors Affecting Our Performance Performance is driven by market-leading offerings, 180% YoY Confluent Cloud adoption, global customer expansion, and strong customer retention (NRR over 130%) - Focus on product leadership and increasing brand strength, with rapid growth in Confluent Cloud since its 2017 launch[113] - Confluent Cloud revenue increased by 180% year-over-year, from $13.9 million in Q1 2021 to $38.9 million in Q1 2022[114] - Customer count grew by 62% year-over-year, reaching approximately 4,120 customers as of March 31, 2022, driven by Confluent Cloud adoption[115] - Dollar-based Net Retention Rate (NRR) was over 130% as of March 31, 2022, indicating strong expansion within existing customers[125] - The company prioritizes substantial investments in long-term revenue and profitability potential over near-term optimization[118] Key Business Metrics The company monitors RPO, customers with $100K+ ARR, and NRR to assess performance, with RPO significantly increasing and large ARR customers growing by 41% YoY | Metric | March 31, 2022 | March 31, 2021 | YoY Change | | :-------------------------------------- | :------------- | :------------- | :--------- | | Remaining Performance Obligations (RPO) | $551.1M | $280.9M | 96.2% | | Customers with $100K+ ARR | 791 | 561 | 41.0% | | Dollar-Based Net Retention Rate (NRR) | >130% | N/A | N/A | - RPO is not necessarily indicative of future revenue growth due to varying consumption timing and expansion[121] - ARR calculation was refined in Q3 2021 to include only overages above contractually committed ARR, with immaterial impact to historical amounts[124] Components of Results of Operations Revenue is primarily from subscriptions, with costs driven by personnel and cloud infrastructure; operating expenses are expected to increase with growth investments - Subscription revenue from Confluent Platform (term-based licenses, PCS) is recognized partly upfront and mostly ratably. Confluent Cloud revenue is usage-based[127] - Cost of subscription revenue includes personnel, third-party cloud infrastructure, and internal-use software amortization. Cost of services revenue includes personnel and third-party contractors[131][132] - Gross margin is expected to fluctuate due to sales price, revenue mix (Confluent Platform vs. Cloud), and cloud infrastructure usage/optimization[134] - Operating expenses (R&D, S&M, G&A) are primarily driven by personnel-related costs and are expected to increase as the business grows and invests in its offering, sales force, and public company operations[135][136][137][138] Results of Operations Q1 2022 saw substantial revenue growth, especially in Confluent Cloud, but significantly increased costs and operating expenses led to a larger net loss and decreased gross margins Comparison of the Three Months Ended March 31, 2022 and 2021 Total revenue increased by 64% to $126.1 million, but rising costs and operating expenses led to a net loss of $(113.0) million and decreased gross margins | Revenue (in thousands) | 2022 | 2021 | Change | % Change | | :--------------------- | :---------- | :---------- | :---------- | :------- | | Subscription | $113,920 | $67,992 | $45,928 | 68% | | Services | $12,219 | $9,036 | $3,183 | 35% | | Total Revenue | $126,139 | $77,028 | $49,111 | 64% | - Confluent Cloud's share of subscription revenue increased from 20% in Q1 2021 to 34% in Q1 2022[148] | Cost of Revenue (in thousands) | 2022 | 2021 | Change | % Change | | :----------------------------- | :---------- | :---------- | :---------- | :------- | | Subscription | $33,603 | $15,757 | $17,846 | 113% | | Services | $12,174 | $8,081 | $4,093 | 51% | | Total Cost of Revenue | $45,777 | $23,838 | $21,939 | 92% | | Gross Margin | 2022 | 2021 | | :----------------------------- | :--- | :--- | | Subscription | 71% | 77% | | Services | 0% | 11% | | Total Gross Margin | 64% | 69% | | Operating Expenses (in thousands) | 2022 | 2021 | Change | % Change | | :-------------------------------- | :---------- | :---------- | :---------- | :------- | | Research and development | $57,661 | $24,313 | $33,348 | 137% | | Sales and marketing | $106,702 | $58,509 | $48,193 | 82% | | General and administrative | $27,481 | $15,512 | $11,969 | 77% | - Net loss increased from $(44.5) million in Q1 2021 to $(113.0) million in Q1 2022[143] Liquidity and Capital Resources The company maintains strong liquidity with $1.99 billion in cash and marketable securities, sufficient for current needs despite ongoing operating losses - Principal liquidity sources are cash, cash equivalents, and marketable securities, totaling $1,990.6 million as of March 31, 2022[164] - The company has an accumulated deficit of $861.8 million as of March 31, 2022, and expects continued operating losses and negative cash flows[165] | Cash Flow Activity (in thousands) | Three Months Ended March 31, 2022 | Three Months Ended March 31, 2021 | | :-------------------------------- | :-------------------------------- | :-------------------------------- | | Net cash used in operating activities | $(55,031) | $(19,989) | | Net cash (used in) provided by investing activities | $(311,734) | $13,845 | | Net cash provided by financing activities | $38,468 | $13,460 | - Cash used in operating activities increased due to net loss and changes in operating assets/liabilities, including a $22.9 million decrease in accrued expenses and a $12.1 million increase in deferred contract acquisition costs[169] - Investing activities used $311.7 million, primarily for purchases of marketable securities ($403.9 million), partially offset by maturities ($95.5 million)[171] - Financing activities provided $38.5 million, mainly from employee stock purchase plan proceeds ($22.5 million) and stock option exercises ($16.8 million)[174] Critical Accounting Policies and Estimates Financial statements rely on significant management estimates for revenue recognition, deferred contract costs, and stock-based compensation, with no material changes reported - Significant estimates and judgments include revenue recognition, deferred contract costs, and valuation of stock-based awards[397] - No material changes to critical accounting policies and estimates since the Annual Report[177] Recent Accounting Pronouncements Information on recent accounting pronouncements, including early adoption of ASU No. 2016-13, is detailed in Note 2 of the financial statements - Refer to Note 2 for details on recent accounting pronouncements, including the early adoption of ASU No. 2016-13 (Credit Losses) effective January 1, 2022[44][178] Jumpstart Our Business Startups ("JOBS") Act Accounting Election As an emerging growth company, Confluent uses the JOBS Act's extended transition period for new accounting standards, potentially affecting comparability - Confluent is an 'emerging growth company' and has elected the extended transition period for new/revised accounting standards under the JOBS Act[179][425] - This election allows delay in adopting certain accounting standards until they apply to private companies, potentially impacting comparability of financial statements[179][425] ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK This section outlines the company's exposure to interest rate risk on its investments and convertible notes, and foreign currency risk on international operating expenses Interest Rate Risk The company faces interest rate risk on its $1.99 billion in cash and marketable securities, and $1.1 billion convertible notes, though a 10% rate change is not material - As of March 31, 2022, the company held $1,990.6 million in cash, cash equivalents, and marketable securities[182] - A hypothetical 10% change in interest rates would not have a material impact on the fair value of cash equivalents and marketable securities[182] - The fair value of the $1.1 billion 0% convertible senior notes due 2027 is subject to market risk due to its conversion feature, but changes do not impact financial position, cash flows, or results of operations due to the fixed nature of the debt[183] Foreign Currency Risk While revenue is U.S. dollar-denominated, international operating expenses expose the company to foreign currency fluctuations, though a 10% change is not material - All sales contracts are denominated in U.S. dollars, so revenue is not significantly exposed to foreign currency risk[184] - A portion of operating expenses is incurred outside the U.S. and denominated in foreign currencies, creating exposure to foreign exchange rate fluctuations[184] - A hypothetical 10% change in foreign exchange rates would not have a material impact on financial condition, results of operations, or cash flows[184] - The company does not currently use hedging arrangements for foreign currency risk but may consider them in the future as international operations grow[184] ITEM 4. CONTROLS AND PROCEDURES This section details management's evaluation of disclosure controls and procedures, confirming their effectiveness and no material changes in internal control Evaluation of Disclosure Controls and Procedures Management concluded that the company's disclosure controls and procedures were effective at a reasonable assurance level as of March 31, 2022 - Disclosure controls and procedures were evaluated and deemed effective at the reasonable assurance level as of March 31, 2022[186] Changes in Internal Control over Financial Reporting No material changes in internal control over financial reporting were identified during the quarter ended March 31, 2022 - No material changes in internal control over financial reporting occurred during the quarter ended March 31, 2022[187] Inherent Limitations on Effectiveness of Controls Management acknowledges that control systems provide reasonable, not absolute, assurance and may not prevent or detect all errors and fraud - Control systems provide reasonable, not absolute, assurance and may not prevent or detect all errors and fraud due to inherent limitations[188] PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The company is not currently involved in any legal proceedings expected to have a material adverse effect on its business or financial condition - No current legal proceedings are expected to have a material adverse effect on the company's business, financial condition, or results of operations[191] ITEM 1A. RISK FACTORS This section details significant risks that could adversely affect the company's business, financial condition, and stock price Risk Factors Summary Key risks include unsustainable rapid growth, operating losses, COVID-19 impact, dependence on its platform, Confluent Cloud adoption, and concentrated voting control - Rapid growth may not be indicative of future growth, making future prospects difficult to evaluate[193] - The company has a history of operating losses and may not achieve or sustain profitability[194] - Business is substantially dependent on its data-in-motion platform; failure to satisfy customer demands or achieve market acceptance would be harmful[195] - Significant investment in Confluent Cloud is ongoing, and failure to achieve further market adoption could harm growth[196] - The dual-class stock structure concentrates voting control with pre-IPO stockholders, limiting influence of other investors[203] Risks Related to Our Business and Operations Risks include unsustainable rapid growth, ongoing operating losses, COVID-19 impacts, dependence on platform adoption, intense competition, and financial result fluctuations - Rapid growth may not be sustainable, and future revenue growth rates are expected to decline due to various factors including market maturation and competition[204][205][208] - The company has a history of net losses and an accumulated deficit of $861.8 million, with expectations of continued losses due to significant investments in growth[212] - The COVID-19 pandemic continues to pose risks, including potential delays in customer spending, pricing discounts, and operational disruptions from remote work, impacting financial forecasts[216][217] - Success is highly dependent on the continued market acceptance of its data-in-motion platform and Confluent Cloud, facing competition from open-source alternatives and major public cloud providers[220][221][225][226][229][231][232] - Challenges in managing rapid growth, scaling operations, and optimizing cloud infrastructure costs could harm business and financial results[227] - Financial results are expected to fluctuate due to revenue mix changes, seasonality in sales, and the timing of customer consumption, making future projections difficult[240][241][246][249] - The company may require additional capital to support business growth, which may not be available on acceptable terms, leading to potential dilution or increased debt[268] Risks Related to Cybersecurity and Data Privacy The company faces significant cybersecurity risks, including potential breaches, errors in offerings, service interruptions, and complex, costly compliance with global privacy laws - Security breaches, cyber-attacks, and errors by personnel could compromise confidentiality, integrity, or availability of data, harming reputation and reducing demand[270][271] - The Codecov Breach in January 2021 led to unauthorized access to credentials and copying of private Github repositories containing source code and customer-related references, though no customer data in products was accessed[274] - Real or perceived errors, failures, bugs, or defects in the offering could damage customer businesses, lead to claims, and harm reputation[280][281] - Interruptions or performance problems with the offering, due to vulnerabilities, errors, or cloud service disruptions, could lead to customer loss and reputational damage[282][283] - Compliance with evolving and stringent global privacy, data security, and data protection laws (e.g., CCPA, CPRA, GDPR, PIPL) is expensive and complex, with non-compliance risking significant fines and legal liabilities[285][286][287][288][290][291][295] Risks Related to Our Sales and Marketing Efforts and Brand Growth depends on expanding sales and marketing, maintaining brand strength, and navigating pricing models, while enterprise sales cycles pose challenges - Failure to effectively expand and improve sales and marketing capabilities, including recruiting and productivity of sales personnel, could harm customer acquisition and market acceptance[296][297] - Maintaining and enhancing the Confluent brand, particularly among developers and against competitors like large public cloud providers and open-source alternatives, is critical for customer expansion[299][300] - Limited history with pricing models means adjustments may be needed, potentially impacting revenue, margins, and customer acquisitions[301] - Sales to enterprise customers involve longer sales cycles, complex requirements, substantial upfront costs, and less predictability, which can result in lower than expected revenue[303][304][305] - Estimates of market opportunity and growth forecasts may be inaccurate, and the business may not grow at similar rates even if the market expands[306][307][309] Risks Related to Our Customers Success depends on attracting and retaining customers, with challenges including competition, conversion of free users, maintaining NRR, providing support, and managing indemnity liabilities - Failure to attract new customers or expand the sales pipeline, especially converting free users or pay-as-you-go customers, would adversely affect business[311][312] - Future success depends on existing customers renewing subscriptions, purchasing additional commitments, and expanding use, with the dollar-based net retention rate subject to decline or fluctuation[313][314] - Failure to offer high-quality support, either directly or through partners, could harm reputation and sales[316] - Loss of key customers or failure to renew agreements could significantly impact revenue and ability to acquire new customers[317][318] - Incorrect implementation or use of the offering, or customers' failure to update Confluent Platform, could lead to dissatisfaction and negative publicity[319][320] - Indemnity provisions in agreements expose the company to substantial liability for intellectual property infringement, data protection, and other losses, potentially uncapped for certain claims[322][323] - Failure to meet service-level commitments could result in customer terminations, reduced renewals, service credits, and reputational damage[324][325] Risks Related to Our Intellectual Property Reliance on open-source software, particularly Apache Kafka, and challenges in protecting its own IP expose the company to litigation, competition, and costly disputes - Use of third-party open source software, including Apache Kafka, could lead to litigation, non-compliance with licenses, or requirements to release proprietary code[326][327][328] - The offering's evolution from Apache Kafka means the company does not own exclusive rights to it and cannot control its evolution, allowing competitors to develop similar or superior offerings[331][332] - Failure to obtain, maintain, protect, or enforce intellectual property rights (trademarks, patents, trade secrets) could allow competitors access to proprietary technology and harm the brand[333][334][335][337] - The Codecov Breach resulted in exfiltrated source code, potentially limiting the ability to enforce rights against unauthorized users and allowing insights into proprietary architecture[338] - Intellectual property disputes are costly, time-consuming, and could lead to significant liability, license agreements, or redesigns of offerings[341][342][343] Risks Related to Our Dependence on Third Parties Heavy reliance on third-party cloud providers (AWS, Azure, GCP) and channel partners exposes the company to service disruptions, capacity limitations, and operational failures - Heavy reliance on AWS, Azure, and GCP for Confluent Cloud infrastructure exposes the company to risks from disruptions, capacity limitations, and failures to adapt to evolving network technology[345][346] - Termination or amendment of service agreements with cloud providers, or internet service provider issues, could lead to significant delays and expenses[347] - Inability to develop and maintain successful relationships with channel partners, especially internationally, could harm business and sales opportunities[349][350] - Dependence on third-party SaaS technologies for critical business functions means interruptions or performance problems could adversely affect operations and finances[351][352] Risks Related to Our Employees and Culture Success depends on retaining skilled personnel in a competitive market, and maintaining company culture during rapid growth poses significant challenges - Success depends on retaining and motivating highly skilled personnel, including senior management and engineering professionals[353][354][355] - Intense competition for talent, inflationary pressures, and volatility in equity awards could adversely affect the ability to recruit and retain key employees[357] - Failure to maintain company values and culture during rapid headcount growth and as a public company could lead to increased employee turnover and harm the business[358][359] Risks Related to Our International Operations International expansion faces risks from political/economic instability, regulatory changes, data localization, differing labor laws, and foreign currency fluctuations - International expansion is a key growth strategy, with 37% of Q1 2022 revenue from outside the U.S. and 34% of employees located internationally[361] - International operations face risks such as political/economic instability, regulatory changes, data localization, differing labor laws, and management challenges across diverse cultures[363][364][365] - Exposure to fluctuations in foreign currency exchange rates on operating expenses could negatively affect results, despite U.S. dollar-denominated revenue[367] Risks Related to Our Tax, Legal, and Regulatory Environment The company is exposed to risks from export controls, economic sanctions, anti-corruption laws, changes in internet/tax laws, and limitations on NOL carryforwards - Subject to U.S. export controls and economic sanctions, including restrictions against Russia and Belarus, which could impair international market competition or lead to liability[368][369][371][374] - Compliance with anti-corruption, anti-bribery, and anti-money laundering laws (FCPA, UK Bribery Act) is critical, with violations risking criminal/civil liability and reputational harm[375][376][379] - Changes in laws and regulations related to the internet could diminish demand for software, particularly Confluent Cloud[380][381] - Changes in tax laws (e.g., Tax Act, international proposals) or sales tax obligations could materially affect financial position and results of operations[382][383][385][386] - Ability to use net operating loss (NOL) carryforwards ($1,096.7 million federal, $559.6 million state as of Dec 31, 2021) may be limited by ownership changes or regulatory changes[387][388] - Effective tax rate could increase due to shifts in income across jurisdictions, changes in tax laws, or audit outcomes[389][390][391] Risks Related to Our Accounting Policies and Internal Controls Changes in GAAP, incorrect management estimates, or ineffective internal controls could adversely affect financial results, investor confidence, and stock value - Changes in GAAP or interpretations could significantly affect reported results of operations[394][395] - Incorrect estimates or assumptions related to critical accounting policies (e.g., revenue recognition, deferred contract costs, stock-based compensation) could adversely affect results[396][397] - Failure to develop and maintain effective internal control over financial reporting as a public company could harm investor confidence and stock value[398][399][401] Risks Related to Ownership of Our Class A Common Stock The dual-class stock structure concentrates voting control, potentially affecting stock price volatility, future sales, dividend policy, and investor attractiveness as an emerging growth company - The dual-class stock structure (Class B with 10 votes, Class A with 1 vote) concentrates voting control with pre-IPO stockholders, limiting influence of Class A holders and potentially affecting stock price[402][403][404][405] - Exclusion from certain stock indices (e.g., Russell 2000, S&P 500) due to dual-class structure may limit investment by passive funds and adversely affect trading price/liquidity[407] - The Class A common stock price may be highly volatile due to financial fluctuations, competitive announcements, data breaches, future stock sales, and general market conditions[408][409][410] - Future sales of Class A common stock, including conversions of convertible notes and exercises of equity awards, could depress the market price[413][414][415][417] - The company does not intend to pay dividends, so investment returns depend solely on stock price appreciation[421][422] - As an 'emerging growth company,' reduced reporting requirements may make Class A common stock less attractive to some investors, and significant costs are incurred operating as a public company[424][425][429][430] - Anti-takeover provisions in charter documents and Delaware law could make acquisitions more difficult and limit stockholder influence over management[431][432][434] - Exclusive forum provisions for certain disputes restrict stockholders' choice of judicial forum, potentially increasing costs and limiting influence[435][436][438] Risks Related to Our Convertible Senior Notes The company may lack funds to settle convertible note conversions or repurchases, risking default, liquidity issues, and potential reclassification of debt - The company may not have sufficient cash or financing to settle conversions of notes in cash or repurchase them upon a fundamental change, potentially leading to default[439][440] - If the conditional conversion feature is triggered, the company may be required to make cash payments, affecting liquidity, or reclassify debt as current, reducing net working capital[441] - Provisions in the indenture governing the notes, such as repurchase requirements or increased conversion rates upon a fundamental change, could delay or prevent a beneficial takeover attempt[443] General Risk Factors General risks include potential costly litigation, impact of analyst research on stock price, and business disruptions from catastrophic events - Future litigation, including intellectual property or employment claims, could be costly, time-consuming, and divert management's attention[444] - The market price and trading volume of Class A common stock are heavily influenced by analyst research; unfavorable or inaccurate research could cause decline[445][446] - Catastrophic events (e.g., earthquakes, cyber-attacks, pandemics) could disrupt business operations, cause system interruptions, and harm reputation[447] ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS No unregistered sales of equity securities were reported, and IPO proceeds use remains consistent with prior disclosures - No unregistered sales of equity securities occurred[450] - The use of proceeds from the June 2021 IPO ($828.0 million gross) has not materially changed from the initial prospectus[452] ITEM 3. DEFAULTS UPON SENIOR SECURITIES No defaults upon senior securities were reported - No defaults upon senior securities were reported[453] ITEM 4. MINE SAFETY DISCLOSURES No mine safety disclosures were reported - No mine safety disclosures were reported[454] ITEM 5. OTHER INFORMATION No other information was reported - No other information was reported[455] ITEM 6. EXHIBITS This section lists all exhibits filed with the Form 10-Q, including organizational documents, compensation plans, and certifications - Exhibits include Amended and Restated Certificate of Incorporation, Bylaws, Executive Officer Change in Control/Severance Benefit Plan, various certifications (e.g., 302, 906), and Inline XBRL documents[459] Signatures The report is duly signed by the Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer of Confluent, Inc - The report is signed by Edward Jay Kreps (CEO), Steffan Tomlinson (CFO), and Ying Christina Liu (Chief Accounting Officer)[464]