DigitalOcean Holdings, Inc.

Good morning. My name is Rob, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the DigitalOcean fourth quarter 2022 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you'd like to withdraw your question, again, press the star one. Thank you. Rob Bradley, Vice President of Investor Relations. You may begin your conference.

Thanks, Rob. And thank you and welcome everybody to DigitalOcean's Q4 2022 earnings call. Joining me today is Yancey Spruill, our Chief Executive Officer, and Matt Steinfort, our Chief Financial Officer. Before we begin, I want to cover our Safe Harbor Statement. During this conference call, we will be making forward-looking statements. including our financial outlook for the first quarter and full year, as well as statements about our goals, business outlook, industry trends, market opportunities, and expectations for future financial performance. All of these statements are subject to risks, uncertainties, and assumptions. You can review more information about these in the risk factor section of our filings of the SEC. We remind everyone that our actual results may differ, and we undertake no obligation to revise our update any forward-looking statements. Finally, we will be discussing our non-GAAP financial measures on our call, and reconciliations between our GAAP and non-GAAP financial results can be found in our earnings press release, which was issued earlier this morning, and in our investor presentation, which can be found on our website. With that, let me turn the call over to our CEO, Yancey Sproul. Yancey?

Thanks, Rob. Good morning, and thank you for joining us. I'd like to welcome Matt Steinford, who joined as our CFO in early January and is integrating nicely with our team. And as you'll see shortly, he's coming up to speed quickly. I'd like to start with a recap of 2022, then share our initial thoughts on growth and profitability for 2023, including detailing our key initiatives for the year. I'll then turn it over to Matt to provide more Colorado results and on our financial outlook for 2023 and share more about our capital allocation strategy. To say the very least, 2022 was an odd year. While the first quarter was strong, by early Q2 we saw an emerging dynamic where both new customer acquisition and expansion in our cohort of customers began to slow. Despite executing initiatives throughout the year to boost growth, we saw continued slower growth in our existing customer cohorts and new customer acquisition. And that has continued into 2023. The three key headwinds that drove this slowing growth were, first, general softness across our existing customers in terms of slower expansion and more volatile new customer additions, particularly among smaller customers. Expansion decelerated 400 basis points across the year. Importantly, churn largely remained in line with prior periods. We've consistently heard from our customers through formal surveys that despite their businesses having slowed, they continue to see us as a critical part of their business operations and that they aren't looking to move from DigitalOcean. Second, the collapse of Bitcoin's valuation and its impact on our customers in blockchain, which represented 5% of total revenue at the peak in Q2, but declined to 1.5% as we exited the year. And finally, fall off from the war in Ukraine, as customers in Russia and Ukraine combined represented nearly 3.5% of total revenue at the peak in Q1 of last year, but declined to less than 2% as we exited 2022. We see the consumption-based revenue model as a strength of our business long term, particularly in driving customer loyalty because of the flexibility it offers them in good times and challenging times like these, when their volumes decline. Having said that, our model does enable more volatility with existing and new customers in times of deceleration, a pattern we've experienced beginning in 2022. Yet, despite these headwinds, we delivered strong revenue growth with significant increases in operating and free cash flow margins. These improvements were the result of our pulling multiple levers, including introducing new product capabilities, raising prices for the first time in our history, prioritizing investments, and expanding our product set with the highly strategic acquisition of Cloudways. For the year, we delivered $576 million in revenue, which represented 34% year-over-year growth. We were also able to make meaningful progress on our profitability and cash flow profile during the year. To get ahead of the softening macro environment, in Q2 2022, we began to rein in spending by narrowing our investments to those that we expected would have the largest impact on growth managing the business to higher free cash flow while weathering the uncertainty those decisions paid off as we both increased improved free cash flow margins throughout the year and position ourselves to see the growth from those reprioritized investments in 2023 we delivered adjusted ebitda margins of 34 which were up 200 basis points year over year. And additionally, non-GAAP operating margins were 18% up 600 basis points year over year. We also made continued progress managing our capital spending footprint as we delivered CapEx of 21% of revenue down 400 basis points from 2021, while balancing investments across the shorter and longer term. An example of longer term capital investments was the launch of the Sydney Data Center in Q4 last year. We are already seeing strong revenue traction in Sydney, and that will be a meaningful boost to 2023 growth. As a result of the strong revenue growth, improving margins, and leverage on capital, free cash flow increased 217% year over year to $78 million, or 13% margins, a 700 basis point improvement from 2021. and a major step towards our longer-term margin target. With a solid four-quarter and full-year 2022 performance behind us, in light of the challenging macro conditions, we have reassessed our near-term revenue growth and margin targets. Since our 2021 IPO, we shared targets of delivering $1 billion in revenue and 20% plus free cash flow margins in 2024. While growth was 30% or better, we were comfortable ramping to a 20% or better free cash flow margin target over a number of years. Given the lower growth environment, we are accelerating free cash flow margins to our longer term target range this year. And at the same time, we are pushing out the billion dollar revenue target by one year to 2025. In response to the softer growth environment, yesterday, we announced the difficult decision to reduce our team as part of a broader initiative to right-size our cost base. The actions we have taken better align our cost footprint to the current and expected growth reality and will enable us to deliver a compelling balanced growth and profitability profile regardless of the economic climate as we continue to pursue our goals of scaling this business. As we contemplated these difficult decisions, we reviewed all aspects of our business with a goal to improve focus, efficiency, and operating velocity. From this review, the actions we are taking will help us simplify our structure and also will rebalance our talent to more closely align with our global customer base. While the overall impact to the broader DigitalOcean team, a net decrease in our headcount of 11%, makes the decisions difficult, They result in a more nimble organization, enabling a much stronger operating profile now, while also freeing up investment capacity for targeted growth initiatives as we move forward. As a team, we have relied on a return on invested capital framework to determine how we allocate resources. That's an important context for why we've emphasized our balanced orientation to deliver strong growth with consistently ramping free cash flow. Our strategy's ultimate goal is to drive compelling returns, as we believe it's the ultimate North Star measure of the performance of every business in any sector in any economic environment. To be crystal clear, growth is core to our strategy, and we continue to invest to drive rapid and durable top line growth. What we are clarifying today is our approach will be to continuously improve the returns on invested capital in the context of balancing our investments in revenue and free cash flow growth.