DigitalOcean Holdings, Inc.

Matt Steinforth, our Chief Financial Officer. After our prepared remarks, we will open the call to a question and answer session. Before we begin, let me remind you that the statements made on the call today may be considered forward-looking statements which reflect management's best judgment based on currently available information. I refer specifically to the discussion of our expectations and beliefs regarding our financial outlook for the third quarter and full year 2024, as well as our business goals and outlook. Our actual results may differ materially from those projected in these forward-looking statements. I direct your attention to the risk factors contained in our filings with the Securities and Exchange Commission and those referenced in today's press release that is posted on our website. DigitalOcean expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements made today. Additionally, known GAAP financial measures will be discussed on this conference call, and reconciliations to the most directly comparable GAAP financial measures are also available in today's press release as well as in our investor presentation that outlines the financial discussion on today's call. A webcast of today's call is also available in the IR section of our website. And with that, I'll turn the call over to Patty.

Thank you, Melanie. Good afternoon, everyone, and thank you for joining us today as we review our second quarter results. DigitalOcean delivered a strong second quarter, building on the momentum from the first quarter and continuing to execute on all key metrics. In my remarks today, I will briefly highlight our second quarter results, provide an update on the leaders we hired recently, share tangible examples of our increasing product velocity, and discuss how we are capitalizing on our AI growth opportunity. First, I would like to briefly recap our second quarter 2024 financial results. Revenue growth has continued to re-accelerate in the second quarter to 13% year over year, reflecting the growing signs of success we're seeing from both a product and go-to-market standpoint and the continued acceleration of our AI and machine learning products, where ARR has grown over 200% year over year from the paper space ARR we acquired last year. In Q2, We also saw the largest step up in incremental total company ARR in nearly two years, excluding the quarter in which we acquired the AIML business. We also delivered strong adjusted EBITDA margins at 42% and adjusted free cash flow margins at 19%, exemplifying our ability to demonstrate ongoing cost discipline and optimization while continuing to accelerate product innovations. Our second quarter financial results highlight the progress we are making and our ability to execute on the plans we laid out at the beginning of the year. We're also encouraged by the signs of improvement within both our growth profile and our key fundamentals. Net dollar retention was flat versus the previous quarter at 97% as expansion within our customer base continues to be lower than historical levels given we are still navigating a challenging macro environment, which is muting the positive impact of our increased product velocity and the stability we have seen in churn and contraction from our solid execution on the various customer success motions. In addition to the increased momentum from our AI ML products, we received healthy revenue contributions from both our managed hosting products and new customers. Matt will walk you through more details on our financial results and guidance later in the call. In addition to our solid financial performance and accelerating product innovation traction, I'm also excited about the advancements we made in building out the team. We added three critical new leaders to our executive team over the past several weeks. First is Ratan Saha, our Chief Product and Technology Officer, who will lead product strategy product engineering, infrastructure, and security. Most recently, Bruton built AWS's multibillion-dollar AI, machine learning, and data platforms, which together represented one of its fastest-growing business segments. Previously, Bruton worked at NVIDIA and Intel, running many of their software infrastructure platforms. We also announced Wade Wegner as our Chief Ecosystem and Growth Officer, which is a unique role that is highly appropriate for DigitalOcean as we are a very unique company. Our cost-efficient self-service customer acquisition model is one of the most efficient in the industry. As I have said many times, one of DigitalOcean's strengths and a key driver of our customer acquisition model is our passionate community of developers, many of whom have grown or are growing up learning to code on our platform. Wade and his organization will be responsible for supercharging our engagement with this community and for driving our very distinct product-led growth motion. Finally, we recently announced Larry D'Angelo as our Chief Revenue Officer, who will bring his years of experience building and scaling high-velocity go-to-market teams to drive direct sales and partner sales to augment our product-led growth engine. and also to build scalable customer success and support functions to help our customers be successful and expand their footprint on our platform. DigitalOcean's strong fundamentals and future potential drew these three world-class executives to come join us in our journey. Their arrivals have also created further hiring momentum as having top talents such as these three new executives tend to attract additional world-class talent. We're already seeing this dynamic play out as they fill out their respective teams. I'm very confident that we now have the right executive team in place to fuel growth, increase product velocity, help our customers be successful, and to continue to execute on our mission of making cloud and AI simple and accessible for developers. Now, let me give you an update on our products. As we continue to listen to our customers and incorporate their feedback, enabling them to grow and scale on our platform, we released 24 new product features throughout Q2, doubling our product velocity from the prior six months. We also revived Deploy, our virtual developer conference, which was held on July 9th. I'm thrilled about the success of this event and look forward to continuing to engage with our developer community as we intend to increase the frequency of our deploy events and do them on a regular cadence going forward. During our July event, we announced a number of material product announcements in response to customer feedback. First, we announced GPU droplets in early availability mode, and this launch democratizes on-demand access to NVIDIA H100 GPU instances for our customers, enabling them to leverage one eight or more GPUs at a time, providing flexible deployment options tailored to the various use cases and budgets. A lot more on this a little later. During deploy, we also announced our global load balancer product, which we refer to as GLB, which is currently in public beta. This is engineered to bolster application resiliency eliminate single points of failure, and significantly minimize end user latency, and secure GLB traffic from denial of service attacks. It offers global traffic distribution based on geographical proximity of the end user, dynamic multi-regional traffic failover, data center prioritization, edge caching, and automatic scaling of the GLBs. It is intuitive, predictably priced, and tailored to the essential needs of growing technology companies for enhancing their global resiliency. We also recently announced that select digital ocean products can now be used to host electronic protective health information. This allows companies such as telehealth providers, healthcare software applications, and health tech organizations to build and scale sensitive workloads regulated under HIPAA on our developer cloud leveraging select DigitalOcean-covered products. During the quarter, we also launched Managed OpenSearch, a comprehensive solution designed for in-depth log analysis, simplifying troubleshooting, and optimizing application performance. With Managed OpenSearch, customers can now pinpoint and analyze log data with a lot of ease, customize log retention, enhance security of their applications, scale to fit capacity needs, and forward these logs from multiple sources. During Q1, we announced that we offer premium memory optimized droplets and premium storage optimized droplets. And in Q2, we finished rolling this out to all of our data centers, and this was a huge milestone for us. We also announced improvements to our app platform, including auto-scaling, dedicated egress, and an expanded lineup with entry-level dedicated instances, higher data transfer allowances, and reduced bandwidth overage fees. Dedicated egress provides application developers with fixed IP addresses, enabling them to meet the security needs of their customers who run applications that require whitelisting for authentication purposes. Additionally, with the new expanded lineup, customers can now start small and grow on the platform with auto scaling. Reduced bandwidth overage fees helps customers deploying bandwidth intensive applications. These updates allow customers more flexibility and features to deploy their production applications. Now turning to our managed hosting cloud-based offering, we launched malware protection, which detects malware and protects our customers from cyber attacks. This add-on includes critical capabilities such as phishing protection, files protection, database protections for WordPress and Joomla, automated malware cleanup, proactive defense, and cron malware cleanup. These are just a few highlights as we continue to add new capabilities and features to achieve our objective of simplifying cloud and AI infrastructure for our customers. We will continue to listen closely to our customers and accelerate our product velocity so that customers continue to scale and grow on our platform, which is our primary focus as we work to drive up expansion and improve net dollar retention. And now I'll pivot to a part of the business that is seeing a lot of momentum. or AI ML offerings. We continue to see very strong demand for our AI platform. To support that growing demand and to take the first step of our long-term data center optimization strategy, I'm very excited to announce that we will be opening a new state-of-the-art data center in Atlanta in Q1 of 2025. This not only expands our geographic footprint, providing us cost-effective additional coverage across the U.S. for our core workloads, but also gives us near-term incremental space and power to support our AI strategy and growth. This new data center is also a key part of our medium-term strategy to reshape our data center footprint, including consolidating workloads from DCs that are currently in expensive locations, including New York City. San Francisco, and Toronto, enabling us to improve our gross margin profile over time. As a reminder, opening a new data center gives us ample runway to grow into the additional capacity, and we only add equipment and spend capital as needed to meet demand. As such, the financial impact of this long-term investment will appear steadily over time as we ramp capacity and leverage it for consolidation of our core workloads. and also for AI training and inferencing as that demand evolves over time. We will share additional details over the next few calls as we start building our new data center out and make further progress on our data center optimization strategy. Given this DC expansion and with the modest increase in AI-related capital that Matt will detail in his remarks, It is worthwhile for me to spend a little bit of time providing some context on our AI strategy and how we view this market opportunity. Today, the majority of AI action across the industry is in the foundational infrastructure layer, with a handful of companies providing GPU infrastructure to a relatively concentrated set of customers that require GPU compute for foundational model training. But over time, we expect generative AI, and AI overall to follow a similar progression that the market has seen with other technology evolutions, with the action shifting up stack from infrastructure to platforms to eventually applications in the coming year to deliver actual business value to customers. The heavy users of infrastructure layer today are those building foundational Gen AI models or those extending those foundational models by injecting their own data. This requires a lot of deep expertise in machine learning, data, and foundational models. This restricts AI and associated innovation to well-funded startups and large enterprise companies with very skilled staff, given the limited talent pool and high costs associated with this emerging technology, leaving behind the vast majority of companies who don't have access to these capabilities. Our mission at DigitalOcean is to change this paradigm by democratizing the access to GenAI and AI infrastructure for all customers, just like we did with core cloud computing services, using simple-to-use software platform components rather than expensive, CapEx-heavy hardware infrastructure. As a significant step in this direction, we announced the launch of GPU droplets, allowing customers to seamlessly leverage AI technology into their workflows and applications using as few as one or eight GPUs in an on-demand mode. GPU droplets remove the burden of managing the full lifecycle of GPUs and the orchestration associated with its usage. This type of fractional on-demand access to GPUs is not widely available in the market today. We have seen very robust demand for this capability, which is still in early availability mode. Additionally, applications that consume AI also need the usual cloud primitives like compute, storage, databases, security, and so on to be deployed in the real world and deliver real business value. Unlike applications that are built on pure GPU forms, Software that consumes AI through GPU droplets can seamlessly take advantage of DigitalOcean's core cloud computing platform, making it easy for customers to transition from R&D mode to production very seamlessly rather than having to go through redeployment. Let me give you some specific examples of customers that are building on our AI platform. First example is an advanced state startup building a lightweight but very fast AI code completion tool for developers with a very large context window using native neural network architecture on our platform. Another example is an AI infrastructure management company that offers a middleware layer to enable rapid training and inferencing for Gen AI models on the DigitalOcean platform. To recap, Our longer-term AI vision is more software-centric with the mission of making it easy for our approximately 638,000 current customers and other companies that look like them to leverage AI in their application stack without needing super deep AI and machine learning expertise. Now, with Bratin Saha, one of the most accomplished AI leaders in the industry leading the charge for us, We will build on this momentum we have generated over the last couple of quarters and fulfill our mission to democratize AI and make it accessible to all companies. In conclusion, I'm very pleased with the team's performance in the first half of the year. We have seen growing signs of success in our AI machine learning business, growth in our core business is re-accelerating, and I'm excited about our near and long-term growth potential across all areas of our business. We have the right leadership team in place and are focused on accelerating our product roadmap and deliver new capabilities that we announced this year at Deploy and enhancing our go-to-market motion the second half of the year. I will now turn the call over to Matt to provide additional details on our financial results and for our outlook in Q3 and the remainder of the year. Over to you, Matt.

Thanks, Paddy. Good afternoon, everyone, and thanks for joining us today. In Q2, we continued to execute on the plans we laid out at the beginning of the year. We made progress on key metrics, we continued to see revenue growth re-accelerate, and we delivered favorable adjusted EBITDA and adjusted free cash flow margins. Revenue in the second quarter was 192.5 million, up 13% year over year, and up 4% quarter over quarter. We added 32 million of annual run rate revenue, or ARR, in the quarter. which was 158% higher than the incremental ARR we generated in Q2 of 2023, and was also the highest step up in nearly two years, excluding the quarter in which we acquired our AI ML business. Contributing to this growth was healthy incremental revenue from new customers, increased momentum from our AI ML platform, which saw significant growth quarter over quarter, and contributions from our managed hosting platform, which continues to be one of our faster-growing platforms. All of these together offsetting a flat quarter-over-quarter net dollar retention rate from our existing installed base. Our Q2 net dollar retention rate was 97%. As we saw last quarter, we continue to see stable performance in net expansion, which is defined as expansion net of contraction on our core DigitalOcean platforms. Contributing to this stability was our increased product velocity that drove an increase in ARPU, helping to offset the broader macro pressures on net expansion in our customer base. Our turn levels have also remained very stable for over a year across the business. We are encouraged by the stability in NDR and the modest sequential improvements we are seeing, despite the challenging macro environment, which is muting the pace of improvement in NDR and despite a positive but lower contribution to NDR from our managed hosting platform now that we have fully lapped last April's price increase. We continue to expect stable NDR and expansion levels through the end of the year despite these ongoing headwinds. To further improve our net dollar retention rate, we will continue our solid execution, accelerating our product roadmap, refining our pricing and packaging models, and enhancing our customer success motion. Beyond NDR, we continue to see acceleration within our AI ML platform. Q2 AI ARR has grown over 200% year over year from the ARR we acquired last year. We have also successfully navigated much of the initial supply chain and implementation risk that we had identified earlier in the year and are now working aggressively to keep up with demand. We anticipate this momentum to continue for the balance of the year given the demand for our AI solutions. Turning to the P&L, gross margin was 61%, which was consistent with the prior quarter and up 100 basis points from the prior year. The 100 basis point year-over-year improvement is primarily a result of the success of our ongoing cost optimization efforts, which to date have more than offset our continued investment in AI infrastructure. Adjusted EBITDA margin was 42% in the second quarter, which was ahead of guidance and approximately 200 basis points higher than the prior quarter. This beat was primarily driven by strength in gross margin and our ongoing operating cost discipline. Diluted net income per share was 20 cents, and non-GAAP diluted net income per share was 48 cents. GAAP and non-GAAP diluted earnings per share increased by 19 cents and 4 cents, respectively, on a year-over-year basis. This is a result of our ability to increase our per-share profitability levels by driving both operating leverage and reducing our share count. Finally, Q2 adjusted pre-cash flow was 37 million, or 19% of revenue. Turning to our customer metrics, our total Q2 customer count was approximately 638,000, representing an increase from 637,000 customers in Q1. The number of builders and scalers on our platform, those that spend more than $50 per month, was approximately 161,000. an increase of 7% year over year. The revenue growth associated with builders and scalers was 15% year over year, ahead of our overall revenue growth rate of 13%. The number of builders and scalers on our platform, which represent 87% of our total revenue, increased by approximately 3,000 quarter over quarter. The continued growth of our largest spending cohorts is a direct result of our focusing our product development and customer success investments on these builders and scalers. The increase in our higher spend and higher growth customers also resulted in our total average revenue per user or ARPU increasing 9% year over year to $99.45. With our substantial free cash flow generation, our balance sheet remains very strong as we ended the quarter with $443 million of cash and cash equivalents. We also continued to execute against our ongoing share repurchase program and completed $10 million of repurchases in the quarter. Moving on to guidance, we expect Q3 revenue to be in the range of $196 to $197 million. representing approximately 11% year-over-year growth at the midpoint of our guidance range. For the third quarter, we expect adjusted EBITDA margins to be in the range of 37 to 38%, and non-GAAP diluted earnings per share to be 39 to 41 cents, based on approximately 102 to 103 million in weighted average fully diluted shares outstanding. As a result of the steady performance in our core platform and strong demand we are seeing for our AI platform, we are increasing the bottom end of our full-year revenue guide by $10 million, projecting revenue to be in the range of $770 to $775 million, a $5 million increase in the midpoint of our guidance range, and representing year-over-year growth of approximately 11% to 12%. As demonstrated through the first half of 2024, we remain committed to driving continued operating leverage in our core DigitalOcean platform. Given our solid performance in the first half of the year, we are raising our adjusted EBITDA margins guidance for the full year to be in the range of 37 to 39%. Turning to adjusted free cash flow, we anticipate making appropriate incremental investments through the second half of the year as we continue to capitalize on the AI opportunity to fuel future growth, although we anticipate these investments having only a modest impact on our cash flow margins. We expect adjusted free cash flow margins for the full year to be in the range of 15% to 17%. As a reminder, adjusted free cash flow can vary quarter to quarter given the variability of our capital spend and our working capital timing. From an overall strategic capital allocation perspective, We will continue to be good stewards of our capital and will evaluate opportunities to maximize shareholder return, maintain financial flexibility while continuing to evaluate investments across share repurchases, incremental capacity, and balance sheet management. We are also raising the top end of our prior non-GAAP diluted earnings per share guidance and now expect this to be in the range of $1.60 to $1.70. That concludes our prepared remarks and we'll now open it up for Q&A.