DigitalOcean Holdings, Inc. (DOCN) Earnings Call Transcript & Summary

Hey, good morning, everyone. Ready to kick off this session. I'm DJ Hynes, I'm Canaccord's senior software analyst. We're delighted to have DigitalOcean here presenting for us. This is the 41st Annual Canaccord Growth Conference. Really thankful to all the companies, all the presenters that make this all possible. We're going to do this as a fireside chat session. We have CEO, Yancey Spruill; CFO, Bill Sorenson from DigitalOcean. This is the second year we've had DigitalOcean. Last year, these guys were a private company. This year, public, off to a great start in their public life. We're going to try and make this as interactive as possible. There's a Q&A bar on your webinar session. Please send in some questions, I'll be monitoring what comes in. I can integrate them into the conversation. But let's get right into it. Yancey, my sense is we probably have some folks that are coming up to speed on the story. You guys are still relatively new to the public markets. Maybe just to level set, could we do a quick intro on you, your background and maybe the 2-, 3-minute elevator pitch on the business?

Well, thanks, DJ, for having us this year. I appreciate it -- and last year, frankly, to help us get the momentum to get public. My background, I've been here now 2 years just as of last week. Prior to that, I have been at SendGrid, started at $50 million, grew it to nearly $200 million, sold it to Twilio, took it public. Similar story with DigitalGlobe. Prior to that, long time CFO. $50 million to $700 million, took it public. That will feed into the narrative here on the business. Prior to that, I was a banker, I have an engineering background and really excited to be here. We came here -- Bill and I joined the same week 2 years ago. And what attracted me to this opportunity was I saw a company that was in the post founder transition period but had enormous product market set, have gotten to $200 million, unlike the size of business that I had previously been in, which were at similar sort of emotional and business maturity in terms of process, et cetera. I've never seen a business get this big, and I thought it speaks to -- I thought it spoke to how massive the opportunity was. So we joined, it was a little over $200 million in run rate, burning a lot of cash, EBITDA margin is around 20%. And we came in to transform the company, really, to get it set up for a multibillion-dollar revenue future which we believe is there, given the size of the market, our position in the market, our differentiation, et cetera. And so we really instituted a lot of change, people, team, process, et cetera, prioritization, had to refix our debt to get that in a better place, put some equity in the balance sheet. And really, we've set the business up. And what the foundation of the business has always been is around 4 key differentiators. Simplicity. We target early-stage businesses, software developers, SMBs. And they don't have DevOps and IT. So simplicity is a foundational value proposition for them. It's core. Pricing simplicity. In the time we've already been on the Zoom, you could be up and running as a paying customer on the platform. Price transparency, easy to integrate other apps. We also provide documentation. We call that our second differentiation is around community. We invest in the learning and growth of entrepreneurs and developers. Over 35,000 tutorials free, help people get unstuck, help people learn how to code. And that's the primary source of our tens of thousands of new customers every month. We offer support to every customer without charging. We don't have a threshold. Everybody gets a personalized support experience to the extent they want it. And then we're open source. We promote open source. Our tools are open source. We don't lock people in to a proprietary tech stack that drains them of resources, time, efficiency, et cetera. We're removing obstacles from them. Those 4 differentiators allow us to have a price premium to our smaller competitors, Linode and Vultr. And we're priced at a substantial discount, 20% to 60% to the hyperscalers. So that's all led to us having over 600,000 customers today. As we announced last week, we're growing ARR mid-30s to upper 30s. At this point, over $425 million of ARR and free cash flow. So we got grow -- high growth and real free cash flow, striving for a Rule of -- in sustaining Rule of 50. And our key themes are around growing faster, growing -- accelerating revenue growth, growing smarter, building scale and efficiency to support the multibillion-dollar feature profitably and cash generatively and grow together, build the team and the talent and the culture to support the opportunity to make a really, really important and really, really big business serving entrepreneurs and developers. I don't know if that's 3 minutes, but that's...

No, it's a perfect intro, and I think you hit on a lot of the key themes. Let's keep it kind of macro level for a second, right? I mean the business has seen some nice acceleration over the last few quarters, certainly, and since you guys came in. I think investors, some are wondering about like the durability of growth. Like, how much of this is post COVID kind of digital transformation versus the other big themes that are out there, which are cloud-native start-ups, rise of the developer. Maybe just talk about kind of the strong secular tailwinds that you have and how DigitalOcean is positioned to capitalize on them.

Yes, I think it's really important for a couple of stats here. There is over 100 million small medium-sized businesses in the world today. And I did mention earlier, 70% of our -- we're in 185 countries, and 75% of our customers and revenue is outside the U.S. So we're global today. We look like the global Internet GDP, et cetera. But there's 100 million small businesses in the world today. 14 million new are created net of churn every -- or failures every year. And there are 30 million developers going to roughly 50 million by the end of this decade. Collectively, what we track as the SMB cloud is $50 billion today spent just in our segment of cloud, going to $115 billion, $120 billion over the next several years that aligns with our path to 2024 to get to our first $1 billion of revenue. So the global world -- the global opportunity to serve entrepreneurs is massive. And frankly, traditional technology companies, both the current cloud that focus on enterprise and the historical legacy software/hardware enterprise focused, they have underserved early-stage businesses. It's -- early-stage businesses have been an afterthought to them because they're so hard to reach. They're everywhere. The good news is that a lot of them, they're everywhere. The bad news, they don't spend a lot per customer. And so it makes the traditional push model having large sales forces, needing large ticket items, having a complex product, complex contract terms. So this community of people that we serve has been underserved. And as said earlier, this is an important company. It's an important company because we have this opportunity to unleash all of these people all over the world. And you could see the proof point in just a decade, there's 600,000 customers, growing very fast. And I don't think this is transitory. This isn't one time. This is the macro opportunity of -- and people don't realize SMB, small businesses account half the GDP in the U.S., slightly more than in other parts of the world. So this isn't a niche. It's a massive opportunity, and we're purpose-built to serve it.

Yes, it's helpful context. And some of the SMB business creation numbers are just -- it's incredible, really. I want to talk about competition a little bit, right? Like you hit on the key tenets of the moat, right? It's price, it's content, it's support, it's ease of use. The questions that I get from investors sometimes are around the hyperscalers. Like, what keeps them from coming down market and offering like a light version of their service that would compete with a DigitalOcean? Like, what's your take there?

Nothing's stopping them. Amazon did it 5 years ago. In fact, it's called light sale. And we have obviously been able to grow. We were a $100 million business then. We've obviously grown through it and are accelerating. My last company, SendGrid, similar story. Amazon launched an e -- simple e-mail service. We were $6 million in revenue. Obviously, we grew it to $200 million, sold it for $3 billion. They launched a competing messaging service for -- that competes against Twilio when Twilio is sub-$100 million. Obviously, everyone knows the Twilio story. So these markets are massive. You're talking about traditional IT on-premise now migrating -- trillions of dollars over generations, now migrating to cloud. And so this isn't a winner-take-all market. And I think that I got the sense that as we were going through our roadshow, roadshow in quotes, obviously, for this year, and the IPO that people thought that we say simplicity, it's a buzzword. It's not a buzzword. It's foundational to a small business, to developers starting out. Simplicity allows them to have less capital go into an idea, less time, distraction, et cetera, for where they don't have it and they can focus simply on their applications. So we think that those differentiators are durable. But I mentioned earlier, we get a price premium to people who sort of compete in this marketplace as if they're just reselling Dell hardware. It's not a commodity. The simplicity, the documentation, the support, our commitment to open source are all value propositions that unleash entrepreneurs. And if you think about -- we're proud last week to announce that we were a little over $58 in ARPU a month, call it, $700 a year. I think -- and we talked on the script about a customer who's been here for 6 years before they actually generated meaningful revenue to us and consumed support and consumed documentation that's well written as people talk very highly all over the world about the quality of our documentation and support experience. And just imagine $50 billion, $100 billion hyperscalers focusing on a couple of billion-dollar market where they have to change their entire business model. So they can, there's no barrier for them to do it. Amazon did it, and it hasn't stopped us from creating a multibillion-dollar business. And we're just getting started. This is going to be a -- I'm talking about market cap, we're going to be multibillions of dollars of revenue as the years go by here.

Yes, yes. Let me take the other side of that coin, which is, like, you help these start-ups become really successful to grow into big businesses. The other question I get is, like, what's the risk of folks graduating off of DigitalOcean, right, onto one of these bigger platforms? So I guess a few questions, like, A, is that something you see? B, if so, like, why would it happen? What would they get from a bigger platform that they can't from you? And then, like, how often do you see DigitalOcean used as part of a multi-cloud strategy?

So Bill and I have been here 2 years. We're struggling to think of one example of somebody graduating off of DigitalOcean. That's not a word we ever use. Frankly, the study of the customer we talked about last week, that's the graduation we see. People come as developers, best ideas, consume a lot of documentation, learn how to code, figure out an idea that they want to launch. They launch it on DigitalOcean and it scales. And they graduate from being a testing small dollar customer to a large and rapidly growing customer. We have lots of customers who as they get to $1 million, $5 million, $10 million of revenue look at going multi-cloud. We have no churn. Our churn is basically 0 for customers who stay on our platform for a year or more. So -- and most of the customers that stay on the platform through a year or more do grow with us. They're meaningful growers, but they go multi-cloud. So there's all sorts of reasons, risk management, procurement, derisk. The week we went public, Azure was down for most of our first day on the road. So it makes sense to have duplicative providers for a host of reasons, applications. That's one of the benefits of cloud is it makes it -- it's part of the simplicity of it and not locking people in. And so we embrace it. It's part of simplicity for us. But the notion that people leave us, we're the AA team and as they get to AAA or the big lease that they got to go to AWS is just not the reality of the business.

Yes. No, it makes perfect sense. Let's transition and talk about the product a little bit, right? So compute is obviously at the core, but there are a number of other services that you guys offer. So as a customer expands beyond kind of core compute, what's typically the next few products that they adopt? And what does that do to spend?

Well, if you think about 2 people, 3 people, sort of testing an idea, writing code, collaborating, debugging, et cetera, they are pure infrastructure companies using compute, storing their software using, obviously, bandwidth to access the Internet to collaborate. And then as they launch a business and get customers, something happens. They need more flexible options around the compute, storage and so they start to consume more of that. So they'll ramp on that. And then as their customer demands, their engineering model for how they deploy code gets more complex than 3 people, maybe it's 30 people writing code, they'll need tools like the managed service tools that we offer. They'll need a database tool to do more analytics, be tightly better analyzing their customer base, do e-mail marketing campaigns, et cetera. They'll use a Kubernetes or an app platform to help them manage the code base. And we see those as rapid growers. They'll use the marketplace that gives them all sorts of options around security and website and business applications and developer tools as they grow. So we give them -- and those all have grown pretty nicely. All those managed services were launched in early 2019. We've been adding to them with that platform last year and are -- obviously, our Mongo engine for deep database just late Q2, they're over 10% of revenue. So literally in over -- a little over 2 years, we've created a managed service business that complement our portfolio that's over $40 million of revenue and still growing pretty substantially with -- depending on the application, cumulatively, a pretty large number of our customers not equal in each use case, but a large number of our customers use a bunch of these different apps. So we've gotten a lot of penetration, but it's early. And it's the thesis for us is let's add relevant services that early-stage businesses need, and let's add it with the depth of features that's relevant to them. Let's not overwhelm them with lots of features where they only need 10% of them just because we can. We don't do that. We -- let's not launch 100 different products. Early-stage businesses need simplicity in terms of the product offering. But this is a large opportunity, 10% of our revenue today from 0, 2 years ago. And we think over time, it will be 20% of revenue at the point of arrival of our first $1 billion of revenue. It's important to note, though, as customers ramp and they use more database, that's a signal that their business is scaling. So they actually -- the pull through with -- rate on infrastructure services is high. So one doesn't grow at the detriment of the other. They complement each other.

Yes, yes. Yes, it's a good point. Let's talk about kind of where you're going with the product from here? Like, what makes sense next for DigitalOcean? And you talked about kind of balancing the addition of more services with simplicity. So I understand it's probably going to be kind of slow and steady on that front. But talk about kind of where you see the platform going and then maybe how you see M&A fitting into the product strategy?

So I think on the -- we continue to add to the infrastructure. It's been interesting. We launched a premium Droplet in Q1, that's now approaching mid-single-digit millions, has gotten thousands of customers who adopted it. It's more processing power, more availability than the standard $5 Droplet. 20% increase, thousands of customers have adopted it without cannibalizing the core. We've done that with some optimization features on memory, storage, and they've also seen pretty significant uplift, approaching double-digit millions in less than a year. So it speaks to the fact that customers want variety in different aspects of the core infrastructure. So that's an investment area for us, predominantly organic, though. We obviously know our core infrastructure. So we have teams, it's a large team, that do that. So there -- but we are investing. It's important that the infrastructure has to get better, investing in security, reliability and feature functionality that we were able to upsell customers on. So that's one part of the product prioritization. And then on the managed services, there are other things that go around. That platform is sort of step 1 in building out a serverless capability. Serverless is about doing more configuration for customers versus Kubernetes, which is more infrastructure linked to configuration and deployment of applications. So you have to have a denser capability. They're more complex. A lot of people like it. Obviously, it's been very successful. But at the same time, today's developer who can write a lot of code is also starting the business, they're the CMO, the Chief Sales Officer. They want ease and speed of use. And our app platform, which has had pretty rapid adoption, other serverless capabilities to round that out, make a ton of sense. And then things that can leverage our database more, AI or ML tools could make sense to help customers make better decisions faster as their customers grow and scale, again, to remove the barriers and the obstacles of customer analytics to help them grow faster. So I think those are a couple of areas broadly defined around the -- and in the marketplace, we can go a lot bigger. We don't -- we have several dozen apps in there. We could broaden that portfolio. And even without us having as broad a portfolio of apps in there, it's also approaching a $10 million run rate. So there's some a lot of things that we can do that's not -- I didn't give you a list of 40 things. It's a few things that we need to round out the platform, including investing on the infrastructure side.