Preface
The earnings results for DigitalOcean (NYSE:DOCN) from 5-4-2022 reiterate our view that the firm is headed to a generational company; one whose very name evokes meaning and imprimatur.

We see account growth abruptly beating estimates, while those accounts are beating average revenue per user (ARPU) estimates, and net dollar retention (NDR) estimates.

This is happening inside of accelerating top line growth (when adjusted for the war), while the company is now driving positive GAAP free cash flow.

The top of funnel apparatus, the DOCN community, has seen unique monthly users go from 3 million in 2020, to 5 million in 2021, to now 9 million.

And, that growth is entirely organic.

The addition of css-tricks (a small recent content acquisition), will, per the words of the CEO on our call, “boost our traffic materially; significantly materially.”

As far as we’re concerned, this is a perfect trajectory — more customers added than estimates, paying more money than estimates, with higher retention than estimates, generating free cash flow while the top line is accelerating.

 

Highlights
We share the full transcript below, but here are a few highlights we were drawn to.

• Near the top of the conversation I asked about DOCN winning customers from the hyperscalers (AMZN, MSFT, GOOGL). The CEO replied that they were winning customers, and he gave an example. He then continued to say this about those wins:

“We’re getting higher ARPU out of the box, which grow faster, use more products. And that complements our early-stage self-serve motion that’s lower dollar value, but we have that option value on those customers growing and scaling over time.”

 

• When I asked about CSS-tricks, and if the 70% gain in community traffic was organic, the CEO noted:

“Yep. This is a top priority for us to get website substantially higher from what they are today. This is a huge lever for us.”

 

• I asked “isn’t that a material change to new account generation?”

To which the CEO replied: “It absolutely opens the top of funnel opportunity for us. It’s going to boost our traffic materially. Significantly materially.”

 

• I asked if CSS-tricks opened DOCN’s market up the world of JAMstack [JavaScript, API & Markup].

(According to Web Almanac, JAMstack is growing at a rapid pace. As of 2020, 0.9% of desktop web pages (50 billion) are powered by JAMstack, an 85% increase from the 0.5% only a year prior.)

 

The CEO confirmed that:

“100% how we think of it, really excited to get that content here because and build a muscle around that aspect.”

• We then discussed the sales motion outside of the community, and asked for an update on it. The CEO said the following:

 

“It’s going very well, got a 200-basis point uptick. And we’re still early in the journey there. We’re setting up an outbound selling motion, targeting certain verticals like web media streaming, e-commerce blockchain. Having a ton of success there.”

We spoke about many subjects, including the potential impact of a recession.

Please find the full conversation below.

One-on-One with the CEO of DigitalOcean (DOCN)

Ophir Gottlieb: 
Thanks for taking the time. I’ll try to get right to it. First, I’m going to start, I think maybe I’m the buffoon in the room, so I just want to make sure I’m not.

So, before we get to details, at a high level it appears to me that DigitalOcean beat consensus estimates for new customers added, ARPU, net dollar retention, ARR. And even though there was an $8 million trim to full-year revenue guidance due to the war, the company was still able to maintain its full-year revenue forecast, issued full-year non-GAAP EPS guidance above the consensus, and will deliver free cashflow. Is anything I just said wrong?

 

Yancey Spruill (CEO, DOCN):
No. [That’s] correct.

A bad time to be a publicly traded tech stock.

 

OG:
All right, so we can get to questions.

Yancey, you specifically called out winning business from hyperscalers. Can you expand on that?

And the reason I say that is it’s always been a reality in my impression. So, in my research, I would say that to investors, but it seems to me that it wasn’t called out so specifically as it was on this earnings call from you.

 

YS:
Well, I’ll just give you an anecdote from earlier in the year.

We got a referral from a Denver based technology company, just raised to series A, five, $8 million in revenue growing rapidly, launching new products.

For whatever reason, years ago, when they started the company, they started on GCP. And as they were adding new products, adding complexity to their use case, they needed support and they didn’t have a big DevOps team.

They didn’t have any real expertise on that. And they were struggling to evolve their use case at GCP at their size, a couple hundred thousand of spend, they aren’t relevant to GCP. Can’t talk to anybody, there’s no documentation.

And they called us asking for help saying, hey and oh, by the way, GCP, which has an incredible set of cloud capabilities as do the other hyperscalers, near early-stage business, you don’t need all that functionality.

So not only were they mismatched in terms of product relevancy, they’re mismatched in terms of need for support and ability to get support, they’re paying 2X the price.

So, we got them in front of our sales folks and a very easy conversation to get them on our platform. That’s happening a lot.

And it didn’t happen five years ago because we didn’t have managed databases. We didn’t have Kubernetes, we didn’t have Serverless. We didn’t have our marketplace. We didn’t have other applications. We didn’t have storage and load balancing, et cetera.

So, as we added to depth and breadth to the platform, we are able to support customers on their journey from just doing testing code in a very simple light use case, to actually running a business on our platform and what’s happened over the past couple years is we’ve created real differentiation against Linode, Vultr, OVH, who are very focused on the simple resell and compute, simple use case.

And we’re at a price parity to them, modest premium, but essentially parity. Yet we have much better capability, breadth of applications.

We have community with our 40,000 tutorial documents. We offer support in a consistent way to all customers, regardless of price point, we’re all open-source.

So, we help lower the barriers and increase velocity for developers to get their ideas on the internet.

So that’s very differentiated against Linode, Vultr, OVH. And by the way, it’s very differentiated from the hyperscalers, not in a sense that the breadth of our applications copies the breadth of theirs.

We don’t intend to, but we have relevant breadth of applications. And we’re at 50% of the price point.

And we offer support documentation, which are vitally important to early-stage businesses who are trying to devote their resources to the customer experience and not to things like DevOps.

So, we have a very differentiated set of capabilities against those folks, the larger players. And that’s why we’re standing up a sales force, a small sales force.

That’s why we’re standing up a partner effort because we think we can peel off existing small businesses today.

And they come in smaller numbers of logos, but they come at 500 times the size of what we can get through the self-serve channel.

So, it’s a great compliment in terms of our go to market.

We’re getting higher ARPU out of the box, which grow faster, use more products. And that complements our early-stage self-serve motion that’s lower dollar value, but we have that option value on those customers growing and scaling over time.

 

OG:
Yeah. You basically just described my company.

We’re going to be moving over to DigitalOcean entirely from AWS. And it’s just exactly what you said and I’ll actually go one step further. If DigitalOcean was the same price, we would’ve still moved.

 

YS:
And by the way, we don’t knock those guys.

They’re actually, we get a lot of, we have Kubernetes because GCP innovated, so we are getting a lot, we have functions because AWS created functions. We’re followers of their innovation.

We create relevant and slim down innovation that our customers can use 80 or 90% of versus the 10% that they can use of what they have.

So those are incredible companies.

They’ve set up after this multi-trillion-dollar enterprise opportunity. We’re very focused on SMB and development.

 

OG:
What I thought might have been actually the most meaningful part of the data in the call and that’s the traffic to the community and the free content.

When we first started covering DigitalOcean, there were about five million visitors a month to the content.

And now there are nine million unique visitors a month.

This seems to be a significant gain in the top of funnel that still today drives the vast majority of new customers.

So, I’ll start with, do I understand that data correctly? And then I’ll actually ask a question about it. So, was that true?

 

YS:
That’s absolutely true.

By the way, it was three million when we got here three years ago. So, this is a huge lever for us.

We have to load the platform with customers because again, they start small, lots of logos, 30,000 plus a month, only at 15 or $20. But like the case study we talked about yesterday, what was yesterday’s 15 or $20 customer month one, month 36 or 48 becomes 1,000, 100,000.

We have an option on those customers.

And we can’t identify who is going to be the breakout customer, but we got this really low-cost acquisition model, which attracts millions of people to the site.

10 million today, hopefully substantially higher than that. CSS-tricks will add substantially to that.

And that wasn’t even in the Q1 number. We’re going to continue to add investing content and other tools and devices to help us bring more people to the site, continue to monetize the funnel more effectively.

And that’s a great feeder because of our 600,000 customers, 100,000 are on the platform, all but probably a few hundred came through the self-serve motion.

And what we’ve proven is those 100,000 we could have identified who they would be eight, nine years ago, but they are driving 84, 85% of the total company revenue.

So, it’s a great efficient go to market. That’s why we only need to spend 12% of revenue. And we’re helping a lot of people learn, grow, test, build, and launch a business on our platform.

 

OG:
Yeah. Yancey, did you just say that the nine million was excluding CSS-tricks?

 

YS:
Correct.

 

OG:
So that was organic growth?

 

YS:
Yep.

This is a top priority for us to get website substantially higher from what they are today.

 

OG:
Isn’t that a material change to new account generation?

I feel like I’m asking stupid questions, but you go from five million. Okay. Three million to five million to nine million a month.

Are you seeing a material change to new account generation? I guess you are, you just reported a very good account additions number.

 

YS:
Exactly.

 

OG:
Okay. I want to talk about CSS-tricks for a second.

DigitalOcean’s content was mostly focused on well, is mostly focused on Linux, things that require servers, Linux administration, server-side software, things of that nature.

CSS-tricks is more about front end web development, obviously.

So, it seems to me that DigitalOcean is now also going after the JAMstack [JavaScript, API & Markup], which opens the platform to a new but large market.

So, is that how you think of it or do I misunderstand the CSS-tricks acquisition?

[According to Web Almanac, JAMstack is growing at a rapid pace. As of 2020, 0.9% of desktop web pages (50 billion) are powered by JAMstack, a massive 85% increase from the 0.5% only a year prior.]

 

YS:
100% how we think of it, really excited to get that content here because and build a muscle around that aspect.

As we’ve gone from just a pure brute force developer testing code and open-source, and the back-end side of the developer stack to those developers now becoming entrepreneurs, running businesses, where they care more about other aspects, including the front-end user experience, user interface, et cetera, we need that capability on the platform to support the breadth of our customers.

And so really excited. It’s opening up and I’ll give you an anecdote.

Just, we’ve been talking to a digital tech company that empowers digital agencies for eight or nine months, trying to figure out how we can partner.

We wanted them in the marketplace. We upgraded our marketplace to make it more relevant, but what really sealed the deal with them was CSS-tricks.

They were buying ads on CSS-tricks because digital agencies are very front end focused.

And so that whole channel effort that we’re investing in on the sales side is about adding more agencies partners into the platform.

CSS-tricks just made that instantly more interesting because although they understand that they’re a conduit for customers before CSS-tricks to run their website on DigitalOcean, now they’re getting even more tools to drive productivity helping their customers get up and running.

So, it absolutely opens the top of funnel opportunity for us. And we’re excited to be up and running with them.

 

OG:
Do you have any estimate or I don’t know, guardrails about what visitor traffic CSS-tricks would bring? I know it’s a different group of people, but do you have a view of that?

 

YS:
It’s going to materially boost our traffic materially. Significantly materially.

We’re not going to, but we’ll start reporting, but you’ll see us exit this year with substantially more website business than we have today.

[inaudible] hopefully another acquisition or two and the other organic initiatives we have in flight.

 

OG:
So organically, it’s basically tripled since you got there.

And now there’s another log on the fire. It’s not even another log on the fire. It’s another fire. This is a different use case.

Can you update investors on now the sales motion?

So, the sales team’s progress going after the larger accounts. We talk about that every quarter.

And so, you gave a little bit of an update into the efficacy this quarter. Can you share how that’s going?

 

YS:
It’s going very well, got a 200-basis point uptick.

I’ll break it into three buckets.

First bucket is inside sales, which is the predominant as we stood up sales efforts three years ago, initially focused on monetizing the cohorts better and also monetizing leads from self-serve through the website.

Not everyone’s set up to onboard on their own, especially existing businesses. They’re a little more complex.

And so, we’re able through digital analytics to shunt certain customers to either by choice or by our analytics to a human being, to help onboard them.

That’s been very successful going into the cohort, which is not something we did prior to us joining, using service triggers and signals to help people get better optimized on the platform.

That’s been very supportive of NDR acceleration, growth acceleration, churn reduction. So that’s a big lever for us.

And we’re still early in the journey there. We’re setting up an outbound selling motion, targeting certain verticals like web media streaming, e-commerce blockchain. Having a ton of success there.

And although early, and then the partner opportunity. Some of our largest customers are managed service providers, i.e. people who manage cloud activity for their customers or digital agencies, people who are the outsource CMOs for a startup who manage the website, the marketing for small businesses.

We’ve historically treated them as just transactional customers. We’re now broadening that lens to treat them more like partners; do co-marketing. Help them be successful, bring leads to them.

And that’s a really big opportunity for us.

So, I would say the inbound inside motion, the partner motion, I think are the top two, but outbound is going to be effective over time.

Collectively, they’re at 3% today. You think the point of arrival at a billion, about 10% of total revenue.

 

OG:
Beyond the war in Ukraine, does your full-year revenue guidance have some conservatism also baked in surrounding a potential recession in the United States and Europe?

So how does that impact DigitalOcean if it does occur?

 

YS:
So first our guidance did not contemplate the war or recession when we set it back in February.

 

OG:
Yeah, of course.

 

YS:
We reiterated the guidance, meaning we think we can make, we have a path and very comfortable with our path to make that guidance for the full year.

I would say a big reason not raising it is Russia, Ukraine and given some of the headwinds there.

As we move through the year and see more progress on our go to market motions, getting Serverless and other product initiatives out in the market, obviously the pricing and packaging opportunity, I think we’ll have and we’ll see what happens with Russia, Ukraine, and other aspects as we get to the August call, we’ll have more to update there, but we didn’t see a need to go beyond reiterating.

We did take down Q2 because of the war but our guidance did not contemplate recession or war when we set it out back in February and doesn’t contemplate recession now.

It really reflects the dynamics in Russia, Ukraine.

 

OG:
Okay. So, if the US and/or Europe fall into recession, there could be more bad news essentially?

 

YS:
We went into a recession, we were just starting to wrap up talking to public investors on the road to getting public in 2021, about two years ago.

And we’d meet with portfolio managers, analysts, and as the pandemic was kicking in and well, your business is going to go to zero because you’re SMB and SMBs don’t survive recessions.

And at that time, growth was 25%. Churn was 20%. NDR was 100%. Customer acquisition was 0% and free cashflow is negative 20%.

And what did we see during the pandemic?

Growth acceleration, retention acceleration, ARPU acceleration, free cashflow acceleration.

I think that for some reason, half of GDP, which is derived from SMB is very misunderstood or not understood by media in the street, but it’s very durable.

In fact, new business formation tends to accelerate during times of economic dislocation. I was listening yesterday to people debating on CNBC and Apple, Microsoft, host of tech companies who are giants today were founded in the depth of the 1970s weakness in the US economy.

I think we’re going to demonstrate again, that SMB is more durable.

I think net new signups, people talk about the great resignation. Well, those people aren’t going starving. They’re just quitting their jobs at Cisco as a 200,000 a year engineer.

They’re starting a business that for $10 a month on DigitalOcean. And they’re running a business at half a million, $1 million of revenue and they work from home.

I think that’s the new gig economy that is not as well understood that didn’t exist during the financial crisis that gives people an outlet now and we play right into that.

So, I think that’s why we’re doubling down on content and helping people learn how to do things in open-source on the internet, how to code, how to we’re investing in SMB oriented content, how to run a business and we’re investing in the front-end content.

That’s going to attract more customers in a period where more customers are open to thinking about doing something on their own.

And I think it’ll be quite resilient, but we’ll have to prove that because we were meeting with Fortune a couple weeks ago, he asked me how he could help.

And I said, well, the Fortune 500’s interesting, but I’m not sure that most people graduate from college today thinking they don’t want to go work at a Fortune 500.

They want to go work at a start and you could help us by helping us evangelize SMB and creating real knowledge and learning among your readers about the SMB economy because it’s just so misunderstood.

So, we’re actually doing that with them now, which we’re really excited about, so I think it’ll be more durable, but we just got to hit our numbers and we’ll be a proof point of that.

 

OG:
Yeah. Full-year, I’m talking about non-GAAP metrics.

Full-year EPS at the midpoint was 71 cents, I think. And as I see it, I’m on a buy-sider research place, which it doesn’t matter. The real consensus was 68 cents.

So even though there was a shortfall in Q1 and in Q2, it looks like for full-year, it was actually a beat.

How was that happening?

I know that there’s a lot of spending in Q2 and the end of hiring. I think that’s true. How is the company going to essentially beat that prior estimate, even though Q1 and Q2 were a little short?

 

Bill Sorenson (CFO DOCN):
Well, Q1 and Q2, you say a little short, we didn’t provide necessarily guidance through relative profitability and the street similar to what they had done at the beginning of the year, had a much higher growth than the beginning of the year than what we normally would have.

So, we’re bringing them more in line with what we do seasonally.

And in the first half of the year, we usually make the investments that we need to deliver against the budget and the plan for the year.

The biggest individual piece of that is related to head count.

And in the first six months, we’ll hire probably around 75% of the total plan head count adds for the year.

And so, as you move into the back half of the year where we earn the majority of our revenues, we take the last two quarters, your revenue will ramp faster than additional investment spend will happen.

So as a result, you’re going to see non-GAAP Op profit go from 10, 11% in Q3. It’s going to go up to mid-teens in Q, I’m sorry, 10 to 11% in Q2, mid-teens in Q3 and up towards 18, 19% in Q4.

 

OG:
The full-year revenue guidance was reiterated even after the $8M hit from Ukraine/Russia, even after that, it was reiterated full-year EPS even though you didn’t give guidance before it was higher than the consensus.

I don’t think anybody cares how Q1 or Q2 does if Q1 plus Q2 plus Q3 plus Q4 equals more than what everyone thought.

Do you have any idea or are you hearing why the stock is down so much today?

I know we’re having a sell off day, so I’m not trying to be obtuse, but off the report before today, people didn’t like it. I actually can’t find why.

And I’m talking to investors and I can’t find why. They’re actually coming to me and saying, why?

What are you hearing?

What did DigitalOcean say that is not what I think it is because what I heard is not just remarkable organic growth on the engine, right? The monthly active users, but essentially everything is working in spite of the war in Ukraine.

I don’t know of any tech companies that are growing this fast with positive free cashflow that are at your enterprise value. So, what are you hearing?

 

YS:
Look, I think we all have bullet holes in our forehead because they’re shot and they’re not even asking questions in this market. You’ve asked a lot of questions.

The only thing we announced on this call is that the war and we said a week after our earnings call, which by the way, the earnings call in February was the day the war happened.

That morning, we woke up and it was like, oh, they launched an invasion of Ukraine.

So, we didn’t contemplate that in our outlook.

The next week we were out doing webcast interviews with the sales side. And we said, we had over 3% of our revenue in Russia, Ukraine.

What this call is verifying and there’s sanctions on Russia. This call is verifying Russia’s likely to go to zero, a big step towards zero this quarter, which is why this quarter’s guide was below consensus.

But the full-year we’re reiterating because of these other initiatives that are going to enable us to help pace the headwind there.

And that’s it.

Retention improved. Growth rate in line with prior quarters, it was very strong, got a little weaker in the back half of the quarter, but March was a war month and free cashflow rule of 40.

And so, customer growth is strong. I just think that the narrative, no one’s looking at the narrative. They’re just shooting.

Just got to go execute. That’s our focus right now as a tech company. We have to go out and execute and deliver numbers and meet expectations. And that’s what we’re going to do.

 

OG:
I’ve seen dislocation between stock price and business.

Obviously, that’s what happens, but this one is really big.

I still think DigitalOcean is the single best investment opportunity in the entire United States. All of it, not just in tech, the whole thing I would choose DigitalOcean.

This dislocation is confusing to me, but it’s okay. I’ll be confused. All right.

Is there anything I didn’t ask that I could have asked or anything you wanted to say, Yancey, that you didn’t say because I didn’t ask the right questions?

 

YS:
No, I think we’re focused on execution. We got a big opportunity.

Nothing’s changed about that opportunity and we’re going to get after it and appreciate your support.

 

OG:
I appreciate you taking the time guys. Have a great quarter. I’ll talk to you in a few months and until then be well, thank you.

 

BS:
All right. Thanks Ophir.

 

YS:
Thanks.

 

OG:
Bye.

 

Conclusion

Thanks for reading, friends.

The author is long DOCN at the time of this writing. 

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