Lede

Today we share a transcription of our one-on-one with the CEO and CFO of DigitalOcean (NYSE:DOCN).

 

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

Ophir Gottlieb:
Congrats on the quarter.

Revenue guidance for fiscal 2023 was 746 million at the midpoint. And if we take Cloudways, is approximately 50 million.

That works out to about 25% organic growth for DigitalOcean in 2023 with the economic headwinds. Is that arithmetic about right for the early 2023 revenue guidance?

Yancey Spruill (DOCN CEO):
746 is right. And we wanted to make sure we had a challenge with analysts who have bearish views on our outlook, have bullish views on their estimates.

Including [] today, going to the high end of the range. So-

Bill Sorenson (CFO DOCN):

Above the range actually.

YS:
Yeah. We wanted to be very clear and very direct with the analyst last night to not screw around with those estimates, so that we didn’t show up in February and have to deal with this.

As we also said, we’re not calling a bottom to where the markets are. We’re feeling a little bit better today than we were 90 days ago about where things were.

Blockchain settled, Russia’s settled. We’re settling into a lower growth environment, which is good. But we don’t know the bottom, so we’re going to be cautious.

One of the analysts last night said we had crappy guidance. I said, “Why in the hell do we ever stretch on guidance, given where we’re trading? What’s our upside to putting some stretch number in the street right now?”

Look, we want to continue to exceed expectations and that’s the basis for the guidance.

OG:
All right, then two more housekeeping things.

When backing out the one-time benefits in Q3, and then an expense from the accounting change in Q4, it looks like DigitalOcean did deliver and has guided to delivering in Q4 about 20% non-GAAP operating margins for both quarters. Which is all time highs.

Is that what we should expect for full year 2023?

Should I be looking at that?

BS:
Well, I think it’s early for us, Ophir, to be giving you guidance up and down the P&L.

But clearly what we’re looking for is a continued trend of improving non-GAP operating income and free cash flow year on year. So the progression would be up and to the right for ’23.

OG:
Okay. And the last thing, obviously all companies are facing the same headwinds that DigitalOcean is. I’ve had this call 15 times this quarter already, war on Ukraine, inflation, recessionary behavior if not a full-blown recession.

Specific to DigitalOcean, blockchain.

I’m curious how that manifests itself in the guidance.

Is it as straightforward as a consumption-based business, will see less consumption because your customer’s customers will spend less?

Or is there another impact, say you’re seeing, let’s say slower IT expansion plans for your largest customers, or new account acquisition is becoming more difficult?

YS:
Well, if you’d have asked us a year ago or at the beginning of this year what we would’ve set expectations for top line in November of this year for next year, it’s less than what we would’ve thought.

A little bit vague.

Our customers have been growing slower, our cohort. The good news is blockchain was 5%, now it’s two percent-ish. And it’s leveled off.

Ukraine was three and a half, now it’s two, and leveled off.

We don’t have the step function downward pressure that we were seeing in Q2, Q3. We just are dealing with slower growth and that’s reflected in our guidance.

Now, we saw massive deceleration in blockchain second half of Q2 and Q3.

OG:
Yeah. And we’re talking on a day where FTX is now preventing withdrawals. Yeah, it ain’t good.

All right, now I want to move forward.

First, let’s talk about the community. I know it had gone from about three million [unique monthly active visitors] a month, excuse me, to over nine million or nine and a half million based on your investor day presentation, and that was before the CSS Tricks acquisition.

Can you share anything about community in Q3, or expectations moving forward? Has that slowed too? Is DigitalOcean now at say 10 million? I’m just curious how that’s going.

YS:
Yeah. I would say new customer signups, certainly at the smaller size customers, has slowed a little bit.

Our conversion rate is lower. Part of that is the macro, part of that’s pricing.

What we’re not seeing is a slowdown in new signups for $50 a month customers. That’s been healthy.

But certainly, if you were coming here to test and had no aspirations to run a business and build a business, I think we are seeing some weakness there.

Still a lot of people signing up, but not proportionate to website growth. I think we focused a lot on top of funnel. Top of funnel’s great, let’s focus on middle and bottom of funnel conversion.

But again, what we’re seeing is that doesn’t really materially impact the revenue growth.

Because if you sign up a customer at 18 bucks a month, how long is it going to take them to get to 50, 100, 200? There’s a lag effect.

And so, we’ve been pivoting to focusing on 50 and up, and driving that.

And that’s obviously very healthy growth organically.

And then obviously Cloudways turbo charges that. 15% of our customers are 50 and up, and Cloudways is a quarter of their customers are 50 and up.

We’re focused on that, and that’s healthy.

And a lot of the initiatives we talked about, packaging, storage, our go-to market, our mining the cohort, our paid support.

Our Cloudways synergies are all about SMB. They aren’t necessarily about developers, if you will, the learners. More about people building and scaling businesses on a platform.

OG:
Taking out Cloudways, even without it, the customer count of those over $50 a month was still essentially radically higher. Again, even taking out Cloudways.

Was a part of that the price increase, or was there just a major step function in new customers at that level, or customers revving up to that level?

YS:
No, I think it continues to be healthy. And then if you were a $48 customer, you got pushed over it because of pricing.

A combination.

OG:
Okay, before I ask about Cloudways and storage, I’ll just go backwards a little bit. How’s Nimbella going, the rollout of FaaS and microservices, things like that?

YS:
We’re seeing a lot of adoption. I actually don’t have the current number; the last quarter, but we’re seeing adoption. And we feel good about it.

And we continue to roll out new feature functionality to enhance it. But those are long tail.

We got to build thousands of customers in the waterfall of revenue.

We’ll start to see that become more meaningful as a contributor, both in terms of direct revenue of serverless, but more importantly indirect revenue through more compute, more database, more Kubernetes especially.

The pull through there is going to be really important, and the trends on that are good.

OG:
All right, let’s talk about Cloudways. The first part is what you referred to as their intimacy with their customers, since they’re obviously providing a managed service as opposed to just IaaS [infrastructure as a service].

Can you share anything about churn rates for DigitalOcean with respect to the first month trends?

The first month tends to have the steep churn, that’s to be expected.

But is there a portion of early churn which you referenced was because customers actually wanted a more managed infrastructure than what DigitalOcean had previously offered, and now together with Cloudways it does.

Do you have any early markers or metrics, even if qualitative, about how the combination with Cloudways has impacted that early churn?

YS:
Yeah. We won’t quantify what percentage of first 60, 90 day churn is, people looking for a managed service. It’s meaningful.

And we’re doing some things early on, it’s been two months now.

One of the things we’ve started is win back campaigns, people that left because they said they were looking for managed.

We go to them with, hey, here’s a credit, we have managed now with Cloudways, you want try it?

Actually, the result of that has been incredibly encouraging.

Not ideal to go after people quit and to go after them, but we’ve actually seen them come back.

I was reading a churn survey recently where a customer said, “I love DO, it’s just not what I need. I need managed.”

What we’re now going to go the next leg of that is know that there’s latent demand for managed on a platform. What we’re now going to do is on the front-end engage with them to let them have a choice, or offer them a choice.

So that before they’ve made a decision that they’re going to ultimately not like, let’s give them a decision and be thoughtful about where they would best be played.

And we think that could be very meaningful. We sign up thousands of $50 and up customers.

Challenge the team and say, why don’t we have a goal to sign all of them up and sign them up on Cloudways? Right? And at least experiment on, 50%, 25%, any of it’s better because the uplift is 2X the price.

So, we’re very optimistic.

The revenue synergy potential with Cloudways for things like this, we’ve materially improved their conversion rate of digital because of our FTO tools.

We’re selling Cloudways through our direct sales force. We put some great training together for our team. Six weeks ago we’re up and running selling that.

We’ve created a ton of incentive for sales people to sell Cloudways because of the leverage in terms of pricing is so much higher that we want incentives.

We want as many customers as possible to go into managed, to be candid. Because it’s a better fit for what they actually need to build their business, and allows us to support them in a more scalable way.

And obviously, it’s much more profitable. I can’t say enough about how encouraged, excited we are about Cloudways.

OG:
Yeah, that was a really good color, Yancey, going back to the customers who thought DigitalOcean was great, they didn’t want to run their infrastructure themselves. And you just go back to them and say, well, now you can use DigitalOcean and have it managed and they’re coming back.

All right, I’m going to ask you about storage, and I’m going to try not to commit the great faux pas that some analysts do, which is somehow get into offering advice on strategy.

But you mentioned storage. I don’t know if any other analysts have asked you about this, or I didn’t see a lot of stories about it, but that’s one of the most exciting things you said on the call.

That is a large opportunity for DigitalOcean.

Because first of all, DO’S storage isn’t a great offering right now, the pricing isn’t really great yet.

But storage users spend a lot more money and they churn far less often.

That’s what I would guess.

Can you talk to me about on the product side, on the pricing side, and maybe the timing side of the progress you’re hoping to make with storage?

And I know compound questions suck, but I’ll just compound it.

Is my view of the optimism around storage, if it’s a successful move into storage, a better storage product, that’s one of the very, very large needle movers?

YS:
If we double storage from high single digits to approaching 20% of our IaaS revenue, that’s as large as revenue opportunity as we have.

Direct revenue that we’re looking at.

But more importantly, the pull through on more databases, it’ll allow us to be a much more competitive threat to pull larger workloads off of hyperscalers.

It’ll allow us to pull larger workloads off of on-prem.

Obviously, once people have their data on your platform, I think that they’re 25 times more ARPU than customers that don’t use our storage.

It is the keys to the kingdom.

Your point about our storage is, if you are a small customer, maybe a couple million dollars of revenue and depending upon your business model and use case, you love our storage because you’re not hitting the volumetric limits.

If you’re ramping the nature of your businesses, you have lots of data, very dynamic and real time, which a lot of digital business models are, it’s not scaling to your use case.

And what we find is lots of customers use our compute, but they go to S3 [Amazon].

And one thing that we’re also excited about with Cloudways, it’s not the immediate priority, is can we productize the multi-cloud journey?

Because they are one of the two providers on Cloudways that we will not replace and leverage our infrastructure just because they have the breadth of capabilities that we think we can offer customers.

And where we are is, we’ve been investing in it, we’ve been accelerating investment building a bigger team. We’ve been making modest improvements.

And what we said this summer is just that it’s not fast enough.

And we don’t need an AI/ML service if we can only use 50% of the functionality because we’re not above threshold on storage. We don’t need these other apps.

Let’s fix enhanced storage to serve the breadth of the customers. And that’s a big opportunity, it’s got big pull through on the pads.

It’ll be bigger customer conversions and adoption. I’m excited that we finally got our team to focus, and there’s nothing like that.

As Rahm Emanuel said, “Never let a good crisis go to waste. Good economic crisis.”

This is the time to focus on delivering enhanced storage capability.

It’s a growth lever, it’s better for the platform, it’s better for existing and new customs, and the pull through opportunity is massive. We’re excited about it.

And your instincts are right about the growth potential being pretty substantial.

OG:
It’s everything from compute to churn, to usage. It’s such a big deal. Managed databases.

That’s also part of the reason I was asking about Nimbella.

All right. Yancy, Bill, is there anything I didn’t ask or anything that you wanted to say but I didn’t give you a chance to say because I didn’t ask the right questions?

Those are the end of my questions. I want to give you the opportunity to share what you would like to share with investors.

YS:
No. I think what’s important to know, we doubled free cash flow this year.

We’re going to double it next year.

We’re well on our way to generating at least 20% free cash flow in 2024.

We feel comfortable with our growth outlook because… we were just meeting with our team before this, we don’t need to go reinvent the wheel to go deliver for our customers.

We’re looking at storage, it’s the right thing to look at. Go deliver it.

We’re looking at solutioning and packaging security and other features and functionality to differentiate on the platform [inaudible] have a customer make a choice.

That represents real revenue.

We’ve created a partner program, that’s real revenue.

We’re going deeper in the cohort to get deeper in our relationships so that we can… We’re doing all of those things now, we just have to deliver.

And for better or for worse, nobody hands you $100, $200 a share [stock price], we have to earn it.

Good news is, the things that are in front of us, we have them, we’re touching them, we’re doing them.

Let’s just go deliver for customers.

And then obviously, we got a significant opportunity from Cloudways.

And in the meantime, let’s just keep being efficient and smart about how we spend our money so we can deliver free cash flow leverage to push in some of the sentiment around risk and the top line growth.

OG:
Yeah, absolutely.

YS:
And it is a winning formula. It’s interesting for me to look at some of these research analysts downgrading our stock prices while they’re putting turns on equities in their model of 100%, 1,000%.

You can tell equity holders, you get 1,000% return on money, I don’t know how the stock price is going lower. But anyway, that’s fine.

That’s the disconnect we’re living in, and we own it in terms of execution, and we can control that.

And over time the stock price will reflect the value we’re creating for customers and our employees and our investors.

OG:
I agree with that wholeheartedly. I guess one last question, which hyperscalers are available on Cloudways that you’re keeping? Have you talked about that?

YS:
It’s AWS and GCP.

OG:
All right, gentlemen, thank you so much for the call. We’ll talk next year.

YS:
Talk to you soon.

OG:
Bye guys.

BS
Thanks, Ophir.

Conclusion

Thanks for reading, friends.

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

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