DigitalOcean Holdings, Inc. (NYSE:DOCN) Q4 2023 Earnings Call Transcript

DigitalOcean Holdings, Inc. (NYSE:DOCN) Q4 2023 Earnings Call Transcript February 21, 2024

DigitalOcean Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, good afternoon. My name is Abby and I will be your conference operator today. At this time, I would like to welcome everyone to the DigitalOcean Fourth Quarter 2023 Earnings Conference Call. Today’s conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you and I will now turn the conference over to Mr. Rob Bradley, Vice President of Investor Relations. You may begin.

Rob Bradley: Thank you, Abby. Good afternoon and thank you for joining us today to review DigitalOcean’s fourth quarter and full year 2023 financial results. With me on the call today are Paddy Srinivasan, our newly joined Chief Executive Officer; and Matt Steinfort, our Chief Financial Officer. After prepared remarks, we will open the call up to a question-and-answer session. Before we begin, let me remind you that certain statements made on this call today may be considered forward-looking statements, which reflect management’s best judgment based on currently available information. I refer specifically to discussion of our expectations and beliefs regarding our financial outlook for the first quarter and full year 2024. Our actual results may differ materially from those projected in these forward-looking statements.

I direct your attention to the risk factors contained in the company’s annual report on Form 10-K filed with the SEC and those referenced in today’s press release that is posted to our website. DigitalOcean expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements made today. Additionally, non-GAAP financial measures will be discussed on this conference call. Reconciliations to the most directly comparable GAAP financial measures are also available in today’s press release, as well as in an updated investor presentation that outlines the financial discussion in today’s call. A webcast of today’s call is also available on our website in the IR section. With that, I’d like to turn the call over to Paddy.

Paddy Srinivasan: Thank you, Rob. Good afternoon and thank you for joining us today. I’m very excited to be here with you on my first call as the CEO of DigitalOcean. As today is my first opportunity to talk to you, I would like to start by sharing a bit about my background, why I was drawn to the DigitalOcean opportunity before providing an overview of our priorities for 2024 and highlighting the focus I will bring to the company. To start, I’m thrilled to be here at DigitalOcean. Having worked my entire career in technology companies and having a professional art that spans engineering, product management, and C-level positions, I have a deep appreciation for the opportunity that DigitalOcean has in front of us and strongly believe that I’m well positioned along with the DigitalOcean leadership team to help the company reach its full potential.

I started my career as a developer and spent my formative years of my career at Microsoft, where I worked on various products, including Windows Server, a variety of developer-centric distributed technology, and finally the Microsoft Office Server team. As I progressed in the leadership ranks at Microsoft, I had hands-on experience building platforms aimed at developers working with independent software vendors and managing businesses with tens of millions of users. From Microsoft, I moved to Oracle to help launch its Asia R&D center focused on innovating products for the unique needs of that market. As an entrepreneur at Oracle, I picked up experience identifying market opportunities and developing platforms like mobile embedded databases with extremely small footprint and near real-time performance in a very low bandwidth network environment to meet those unique emerging market requirements.

After Oracle, I co-founded Opstera, an application monitoring and managed cloud services platform. This experience, again, reinforced the importance of having a deep understanding of developer needs and using that to drive innovation as we worked to keep up with the evolving needs of nearly 500 early adopter cloud companies, including most of Microsoft’s top Azure customers at that time. Following the successful sale of Opstera, I spent the majority of the last decade at GoTo, formerly known as LogMeIn, a SaaS pioneer delivering cloud-based software applications with a global footprint with a stint of Amazon in between. At LogMeIn, I experienced 10x growth as we took the company from a little over $100 million at the time I joined to over $1.3 billion in revenue through both organic and inorganic expansion.

As part of this journey, my team built an Internet of Things platform, which was later acquired by Google to form the foundation of its IoT strategy. After leaving for Amazon to be the general manager of the data and machine learning platform that powers Alexa, I returned to GoTo as its Chief Product and Technology Officer before ultimately taking over as CEO. At LogMeIn and GoTo, I picked up what it takes to build a product-led growth motion and augment it with a high-velocity sales and customer success machine to attract, convert, and expand hundreds of thousands of growing digital businesses at scale. All these roles and experiences have shaped my perspective and have nurtured my passion to understand customer needs, especially those of developers, innovating on their behalf by anticipating their needs, running modern infrastructure platforms to support global scale products, building efficient customer acquisition and expansion engines, and delivering value for all stakeholders, customers, employees and shareholders.

I’m really looking forward to bringing these experiences, focus and operating discipline to DigitalOcean. Switching gears now, there are a few compelling reasons that drove me to join DigitalOcean, but three stand out that I would like to share with all of you today. First is the market that DigitalOcean is focused on, the cloud computing market, and especially the one that serves developers, is one of the largest and fastest growing markets in the history of technology. This market, consisting of Infrastructure-as-a-Service and Platform-as-a-Service is a $114 billion opportunity, which IDC is forecasting to grow in excess of 23% through 2027. This growth should continue well beyond the timeframe as the market benefits from ongoing migrations to the cloud, acceleration of new business formation that cloud computing enables, and the still very early impact of AI and machine learning and the new generation of applications that these capabilities are already unlocking in a variety of different industries.

Second reason is the strong position that DigitalOcean has in this market. DO is the cloud leader focused on developers, startups, and growing digital businesses. DigitalOcean has more than 640,000 customers, a global footprint with revenue in over 190 countries, and serves customers across a wide range of industries and use cases. Our brand is beloved with a large and loyal developer community that leverages our extensive library of content, including tutorials, Q&A, product how-tos, video guides, and articles. DigitalOcean has carved out a compelling segment in this market, providing a simple and easy-to-use developer cloud with transparent and cost-effective billing, and a level of support that small growing businesses will not get from the larger hyperscalers.

DigitalOcean has also steadily expanded its array of offerings, starting with core infrastructure-as-a-service with its compute technology called Droplets object and block storage, and networking capacity with a global footprint to power our customers’ apps and services. These are complemented and extended by platform-as-a-service products, including managed databases, managed Kubernetes, app platform, and managed Kafka for those customers that need to leverage high volumes of data streaming. In addition to our core infrastructure and platform offerings, with cloud base, we offer managed cloud hosting that is used to power digital agencies, e-commerce storefronts, and a variety of other online businesses. Finally, to take advantage of a generational technology shift, we acquired a leading AI machine learning application development platform, Paperspace, last year, increasing our addressable market and adding a very valuable growth level.

This further extends our platform by enabling developers to test, develop, and deploy AI and machine learning centric cloud applications that harness the power of GPUs in ways that have been predominantly available only to large enterprises. I just talked about the vast and growing market that DigitalOcean is in and the strong position we have with our platform and customers – customer trust that we have earned over the years. But now let me talk about the third compelling reason that drew me to DigitalOcean, the growth and value creation opportunity that is still ahead of us. DigitalOcean has the opportunity to reach even more developers and expand the services we provide to these customers, driving higher revenue growth, while maintaining our strong profitability, enabling us to generate compelling investor returns.

The plan for achieving this growth centers on understanding and addressing the needs of developers as they build growing digital businesses. We will achieve our near-term growth objectives and position ourselves for higher sustainable long-term growth by focusing on these very specific growth levers. First, we are enhancing our platform with global load balancing, data resiliency, granular identity and access management, storage enhancements, and many other new features that will enable our customers to operate and scale globally. Number two, we are investing in both network and infrastructure, providing increased diversity, lower latency and enhanced speed on our core IP backbone and edge to enhance the performance of our platform to benefit our customers and allow us to migrate more customer workloads from other providers onto our platform.

On top of these product offerings and platform foundations, we will continue to expand our managed services offering to serve customers that want an assisted experience with robust scaling capabilities on our platform. As an example of this, just a few days ago, we announced Autonomous, a new cloud-based offering that enables growing businesses to scale their hosting needs dynamically without having to over-invest in infrastructure. Next, building on our recent Paperspace acquisition, we are investing in our AI/ML strategy to take advantage of this market opportunity by bringing simple, easy to use AI/ML capabilities on both hardware and software to developers, machine learning engineers, and application builders across a broad range of business types as we have done successfully with our core DigitalOcean cloud services.

And finally, point number five is we will augment our durable, self-service customer acquisition model with direct sales and customer success motions to acquire, retain, and expand customers and amplify our reach through our vibrant partner ecosystem. For these reasons, I am very excited to have joined DigitalOcean at this critical time of inflection. The company begins 2024 having weathered a challenging macro demand environment where, like many large platform providers, top line growth slowed from historical highs. Recognizing early in 2023 that near-term growth could be pressured, we successfully accelerated the attainment of long-term target margins to build a durable cost structure that will generate attractive free cash flow. With plans to improve net dollar retention, or NDR, through increased customer engagement and continued product innovation and driving higher growth opportunities across Cloudways and our new AI/ML platform, we are positioned to establish a foundation to deliver low double-digit growth in 2024, while setting ourselves up for the future.

Let me now finish by articulating the key focus areas that I’ll be driving. While I am excited about the company’s long-term growth plans, as CEO, I will leverage my product and engineering background and deep cloud experience to bring an elevated focus to two critical priorities in the short term, product innovation and efficient go-to-market. Let me explain quickly. First and foremost, we will obsess over the developer experience on our platform. We will develop an intimate understanding of their needs, whether the use case is in SaaS application deployment and scaling, running the back end of web and mobile applications, game development or data streaming, e-commerce storefronts, education technology, or any other workload, and we will be unrelenting in our quest to understand how to make their jobs easier and to be a critical part of their growth through our platform offerings.

We will use this understanding to rapidly develop on our product roadmap, which includes several important enhancements in security, resiliency, performance, networking, and storage, which are really critical to our customer scaling on our platform. We will also increase the pace of identification and development of new capabilities that will drive value to our customers and fuel our growth further. Our ongoing investment in AI machine learning capabilities is a perfect example of this. In addition to driving innovation, we will augment our best-in-class self-service or product-led growth customer acquisition engine with an effective high-velocity sales and customer service engine to improve NDR by establishing a trusted relationship with our top customers, drive adoption and visibility into our other offerings in our platform, and continue providing world-class support and community engagement that these customers have come to expect from DigitalOcean.

By obsessing over the developer experience and innovating on their behalf and enhancing our go-to-market, we will take advantage of the tremendous growth opportunity that is in front of us. Our aim is to cement our position in this $114 billion addressable market for Infrastructure and Platform-as-a-Service and be the foundation for developers at startups and growing digital businesses to rapidly build, deploy, host, and scale applications that change the world. In conclusion, over the first several weeks as CEO, I’ll spend the majority of my time meeting with customers, employees, and investors to gather their feedback and sharpen our understandings of the market we serve. While we will continue incorporating this feedback into our ongoing plans, I’m very confident in the immediate priorities that I just outlined.

We will continue to invest in our key revenue growth drivers to achieve our 2024 plan and position the company for further growth in 2025 and beyond. We will obsess over the developer experience and focus on innovating to meet their evolving needs with platform innovation and crisp go-to-market initiatives. We will reignite growth in our core Infrastructure and Platform-as-a-Service offering. We will leverage the strong margins in the core DigitalOcean business to help fund investment in our strategic long-term bets like AI and machine learning-centric cloud application development. We will maintain our long-term focus on increasing operating leverage and delivering attractive free cash flow margins, creating a compelling return for investors.

As you can tell, I’m very excited to be here at DigitalOcean. I’ve got a very busy quarter ahead, but I’m really looking forward to meeting many of you in the upcoming months. With that, I will now turn it over to Matt.

Matt Steinfort: Thanks, Paddy. It’s great to have you on board. I can tell you the entire DigitalOcean team and I are excited that you’ve joined as CEO, and we’re very much looking forward to working with you to achieve DigitalOcean’s enormous potential. In my comments, I will review our Q4 results and cover the full year 2023 financial highlights before sharing our first quarter and full year 2024 financial outlook and our go-forward capital allocation strategy. Q4 2023 was a good finish to the year with revenue, adjusted EBITDA, and net income per share, all exceeding the outlook that we have provided. Revenue was $181 million, which was up 11% year-over-year and was 3 million above the high end of our revenue outlook. This performance was driven by the stabilization of net dollar retention within our core business and strong execution on the Cloudways front, and we got some contribution from our recently acquired AI and machine learning solutions.

We also delivered strong profitability as we continued to appropriately manage our investments, balancing investment for growth with efforts to improve operating efficiency in our core business, which resulted in adjusted EBITDA of $73 million, a 41% margin. Adjusted free cash flow was $29 million, representing 16% of revenue due to working capital timing and increased investments in our AI/ML capabilities in the fourth quarter. Non-GAAP fully diluted net income per share was $0.44, which was up 57% year-over-year as we continued to successfully implement our strategy of increasing operating leverage while executing our ongoing share repurchase program. As Paddy mentioned, and as it was for many players in the industry, 2023 was a challenging year with slowing revenue growth in the face of persistent macroeconomic headwinds.

While top line pressure lasted longer into 2023 than we had originally expected, we saw a bottoming of the headwinds in Q3, and with stable net dollar retention and steady growth in Cloudways in the second half, we exceeded the revised full year revenue outlook. For 2023, total revenue increased 20% year-over-year to $693 million. This growth came from over 18,000 new customers that joined our platform through our durable self-serve funnel, and that came from increased spending from existing customers as well, as overall revenue per customer increased 6% year-over-year. Growth also came from the steady performance of our managed hosting platform Cloudways, which increased revenue to $80 million, growing 43% year-over-year, and from our recently acquired Paperspace AI/ML products.

On the operating leverage front, acknowledging the growth headwinds early in 2023, we proactively accelerated our long-term margin profile, positioning the business to generate attractive free cash flow regardless of the economic growth environment. We successfully achieved that objective, increasing adjusted EBITDA margins from 35% in 2022 to 40% in 2023, and free cash flow margins from 13% in 2022 to 22% in 2023. We accomplished this through difficult but necessary cost management of headcount as well as non-headcount related spend and by expanding our global workforce, setting ourselves up structurally to improve margins in our core business as we grow. These strong margins in our core DigitalOcean platform enabled us to absorb Paperspace and invest in the generational growth opportunity that we see in AI/ML while still exceeding our full year profitability guidance.

Now I want to come back to the solid growth foundation that we have established as we launch into 2024. We have a high degree of confidence in achieving double-digit growth on the back of several growth levers. First, we expect new customer revenue, which includes revenue growth from any customer that’s still in their first 12 months on our platform that’s incremental to the 2023 revenue, to contribute 8% growth in 2024, with the majority of that growth coming from self-serve as we are still in the early innings of our direct and partnership motions. Second, we continue to invest in our managed hosting capabilities, having for example, recently launched our Cloudways autonomous service that Paddy had mentioned, which enables customers to automatically scale their businesses on Cloudways, and we anticipate Cloudways contributing two to three points in growth in 2024.

Third, our AI and machine learning solutions will be another key growth driver. We see tremendous long-term growth potential in the AI market, and we are increasing our investment in both operating expenses, adding engineering resource to advance our AI software platform, and capital, adding incremental GPU capacity to take advantage of this opportunity. We recently announced initial availability of H100s and expect additional offerings and further capacity to come online over the course of 2024. We anticipate our AI/ML solutions contributing 3% revenue growth in 2024. Our fourth and final major growth lever is net dollar retention. As we have discussed, NDR declined over the course of 2023 with a bottoming beginning in Q3 at 96% NDR as we lapped the 2022 price increase.

NDR increased several basis points in Q4 but remained at 96% due to rounding, and we anticipate NDR continuing to improve as we move through 2024 as we are working aggressively to return NDR above 100% in the latter half of the year. As an early indicator of our progress on this front, in January, we saw increasing month-over- month growth in customer usage on the core DigitalOcean platform, and we are seeing similar higher usage growth trends in February as well. With that context, I will now share our financial outlook for the quarter and for the year. For the first quarter of this year, we project revenue of $182 million to $183 million with adjusted EBITDA margins of 37% to 38% and diluted net income per share of $0.37 to $0.39. As you may recall, we do not provide free cash flow guidance on a quarter by quarter basis given it’s heavily influenced by working capital time.

With that said, our 2024 plan is front-loaded on capital as we navigate a constrained supply chain and build critical mass in our AI/ML capacity. So we expect free cash flow margin to dip in Q1 and then increase over the balance of the year. For the full year 2024, we project revenue between $755 million and $775 million, which represents year-over-year double-digit growth at the mid-point. This range takes into account the early stage of our AI/ML offerings and the timing-related risks of a constrained GPU supply chain, but it doesn’t require any further improvements in the broader macro demand environment. With our 2024 investments, we will see modest declines in both adjusted EBITDA and free cash flow margins as we invest to generate a higher growth trajectory as we exit 2024.

Adjusted EBITDA margin will be in the range of 37% to 38% for the year as improved margins from our core DigitalOcean platform are offset somewhat by increased investment in our AI/ML capabilities. Non-GAAP fully diluted net income per share for the full year will be in the range of $1.60 to $1.67. With our increased investments, we expect to invest north of $50 million alone on the AI/ML machine learning capabilities, free cash flow margin will be in the range of 19% to 21%. We strongly believe the potential growth opportunity of this new market warrants the near-term investment of one to three points of free cash flow. Before concluding my remarks, I’d like to reiterate our long-term capital allocation strategy. Growing average free cash flow per share remains our ultimate goal and what we believe is a primary shareholder value creation lever.

In that pursuit, we remain committed to driving top-line growth with increasing operating leverage while continuing to execute a regular stock repurchase program to recurrent capital to our shareholders. Together, we believe these priorities create a compelling return profile for investors. On the buybacks front, the Board has approved $140 million share repurchase authorization that we will execute over the next two years, utilizing the full repurchase authorization by the end of 2025. We made strong progress on our buyback program in 2023, repurchasing $488.5 million in stock and reducing our weighted average non-GAAP fully diluted shares by 11% year-over-year from 118 million to 105 million shares. Stock-based compensation expense also declined materially from 18% to 13% of revenue year-over-year.

With respect to leverage, we continue to believe that 2.5 to 3 times net leverage is an appropriate long-term target. And with our strong free cash flow generation anticipate being in the low 3s by the end of 2024 based on the guidance that we have provided today. We continue to benefit from the $1.5 billion zero coupon convertible debt instrument that does not mature until December of 2026. With that said, we will manage and steadily reduce our net leverage over the remaining three years to ensure that we have an appropriate capital structure flexibility and can take advantage of the company’s growth potential while increasing our levered free cash flow per share at attractive rates. To close my remarks, the company achieved a great deal in 2023 and is well-positioned for profitable growth in 2024.

We have a tremendous and expanding market opportunity and an actionable strategy to capitalize on it. With Paddy now in the seat, we’re eager to execute the plan and deliver strong results for our investors. Thank you again for your time today and I’ll now turn it over to the operator for your questions.

Operator: Thank you. [Operator Instructions] And we will take our first question from Jason Ader with William Blair. Your line is open.

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Q&A Session

Jason Ader: Yes. Thank you. Good afternoon, and welcome aboard, Paddy. Wanted to ask you just as you’ve – I know only been in the seat for a few weeks, but from your perspective and observing, the business so far and talking to folks, where do you see the lowest hanging fruit for the company?

Paddy Srinivasan: Yes. Hello Jason, nice to talk to you and thank you for the welcome. Yes, this is my day seven on the job. Last week, I spent the whole week in Boulder, Colorado with my management team and just taking stock of where we are and the plan ahead for 2024. Yes, I don’t want to comment on low-hanging fruit. For me, everything looks like great targets to accelerate our product roadmap. And as I was saying in my prepared remarks, I think it all starts with really understanding who our customers are and solving their challenges. So I’m super excited given the breadth of offerings we have, the – how much our product is loved by our customers, the community engagement, all of these things are great foundation for us to build on.

And in terms of my priorities, as I outlined, it’s really straightforward. There are two buckets of priorities. One is accelerating innovation and delivering on the product roadmap. And there are several aspects of that, whether it is fortifying our core network capabilities and innovating on our infrastructure and Platform-as-a-Service to the exciting world of AI/ML and everything in between, I think we have so much innovation to do. It’s going to be super, super exciting. The second thing is the experience that I bring in from GoTo and other places, which is how can we not only augment our product-led growth engine that has gotten DigitalOcean to where it is, but drive positive NDR by really establishing a great relationship with our top thousands of customers, exposing them to the breadth of offerings that we have in our platform already, and building a great drumbeat in terms of engaging with them and exposing them of all the great product capabilities that our teams are going to be rolling out.

So all in all, I feel very energized by all of these opportunities. And of course, I’m going to be building a series of operational mechanisms to ensure that we are looking at all these initiatives one by one and driving execution across the Board. So I’m super excited to be here. Thanks for the question, Jason.

Jason Ader: Yes. One quick follow-up on that. Just how long do you think it will take to see the return on some of these initiatives? Do you think it’s like 2025? Do you think we could see some actual kind of material impact later this year? Just to give us a sense of the timeline that you’re thinking about right now.

Paddy Srinivasan: Yes. I think many of these initiatives are going to be long running, right. We will never be done with innovation or fortifying and enhancing our performance, stability, security kind of a thing. So I think a lot of these things are evergreen initiatives in terms of when you’re going to start seeing results. I hope it is sooner rather than later in terms of the outlook that Matt laid out. I think it is a very appropriate outlook for the year given the year that we are coming off of and we will absolutely be laser focused on execution. So there’s a great opportunity ahead of us and you can count on us to be very disciplined and be laser focused on execution.

Jason Ader: Thank you and good luck.

Paddy Srinivasan: Thank you.

Operator: And we will take our next question from Gabriela Borges with Goldman Sachs. Your line is open.

Paddy Srinivasan: Gabriella, we can’t hear you.

Gabriela Borges: Can you hear me now?

Paddy Srinivasan: Yes. Yes.

Gabriela Borges: Okay, great. To Paddy, I want to pick up on the comment that Matt made about generating a higher growth trajectory exiting 2024. So, Paddy, either for you or for Matt, how do you think about what the sustainable growth rate is for this business and the sustainable margin profile that’s alongside of that?

Paddy Srinivasan: Yes. Gabriella, thank you for your question and nice to meet you. So you’re absolutely right. My overall philosophy is to find the right balance between long-term growth and profitability. I’m a firm believer in the concept of growth at a reasonable price with growth being the ultimate value driver for all of us. And you heard Matt talk about this. I don’t want to put an exact exit trajectory growth rate. I think it is too early for me to do that. But given where our core market is and where our developer customers are going, I think there’s a tremendous opportunity in front of us in terms of participating in the AI/ML market and make the right responsible investments to help us accelerate our growth going into next year and beyond.

I think you will find us be very active and busy in our product roadmap, not just on the AI/ML front, but also you saw just in the last few days, we announced the auto scaling capability of cloud-based called autonomous. You will start seeing a string of announcements and string of releases on our core infrastructure and platform as a service offering. So I think our job is to focus on delivering for our developer customers. And then once we do that, and we become very disciplined at doing that, I think the rest is going to take care of itself. There’s no shortage of growth opportunities here, right. There’s just so many different problems that developers face today that I’m super excited to start solving. And I think it’s really setting ourselves up for the future.

And I think we have the luxury of having such a strong foundational financial profile to be able to make quick, thoughtful, calibrated investments to help us lay the right foundation for next year and beyond.

Gabriela Borges: Okay, that makes sense. And then the follow-up I have is a strategy question on how you think about AI/ML. If I were to oversimplify and think about DigitalOcean’s value proposition, so much of it is tied to the bread and butter offerings, the ease of use, the getting SMBs and developers off the ground with straightforward configurations and usability. Help me understand where AI and ML fits into that. How do I reconcile the classic value proposition of simplicity with something that could arguably be much more sophisticated and target perhaps a different customer set from where you’ve traditionally participated?

Paddy Srinivasan: Yes. It’s a great question, Gabriela. And that’s one of the main reasons why I was so excited to come here and work at DigitalOcean, because I feel like the rest of the market is just making it a lot more complicated than it needs to be. And I’m a fundamental believer that the future of any kind of application development on the cloud is going to be AI and ML centric for the years to come, right? I’ve had a lot of background in the last few years, both at GoTo as well as at Amazon. And I’m a firm believer that we are in the very early innings in this space. And to your point about, hey, this is a market for very sophisticated developers, that’s because everyone is talking about large language models and the GPU forms that you need to power them.

But I believe that there’s a lot more to this than just building and training LLMs. So there’s obviously a hardware part to it, but I think the power of this is again going to default back to software. That’s where the magic is going to happen. And we at DigitalOcean firmly believe that the durable competitive differentiator for us long-term is going to be in the software layer. And you rightly mentioned that developers are finding it extraordinarily hard to say, okay, where do I believe or where do I start my AI/ML application development from? Should I build a model? Should I train a model? What is fine tuning? What is RAG? Just so many buzzwords in the market today, we have a phenomenal opportunity to do what DigitalOcean’s founding principle was, which is deliver the best cloud computing experience for developers, so that they can forget about the infrastructure and worry about the software that is going to change the world.

We have that exact opportunity to do it in AI/ML. And we are going to unleash the same playbook in a different domain of AI/ML. So having said that, I feel the Paperspace acquisition is very strategic to us. The gradient experience, and I personally played on with gradient over the last few weeks, it is phenomenal. This is exactly what the market is missing today. And we have a lot of work to do to integrate. And we are very busy doing that integration between the gradient experience and the core DigitalOcean offerings. But as I said, this is super early innings in the world of AI/ML, despite all the hype cycle. So I think this is an opportunity that we are in the very early innings of, and I feel super energized that this is exactly in the wheelhouse of DigitalOcean.

And every developer in the world that is going to build a cloud application will have to consume and make sense of the complex AI machine learning landscape today. And that’s a great opportunity for us to add value to them.

Gabriela Borges: Thank you for the thoughts.

Operator: And we will take our next question from Brad Reback with Stifel. Your line is open.

Brad Reback: Great. Thanks very much. Paddy, given everything you just laid out there around the opportunity, why not invest more and faster, especially given some of the people you’re competing against or investing on for some that we’ve never seen before?

Paddy Srinivasan: Yeah. Thank you, Brad for the question. That is a really important question. So I’ll start, and then I would love for Matt to give us a little bit of color as well. As I said, Matt – Brad, it is very early innings, right? And I’ve only been here for a week. So I think the strategy that we have is a very responsible strategy that balances the right mix of investing for our future while not being getting carried away by the hype cycle of today. And as I said, our long-term competitive differentiator is going to be in the software experience we provide to the developers. And we absolutely have to invest responsibly in the hardware that powers this experience. But we have to be careful not to, to try and become a hardware provider, which is not our long-term strategy.

But we have to find the right balance and I am a firm believer that we are going to be very focused on looking at our value proposition, how developers are consuming our services, and we have the ability to calibrate the investment as we go along the year. So that’s – those are my early thoughts. But Matt, why don’t you chime in?

Matt Steinfort: Yes. I completely agree that it’s a very similar model to the model that we have versus the hyperscalers today. I mean, we have a very small footprint of locations and a very small capital budget relative to any of the three hyperscalers. And it’s because we target a different market that doesn’t require that level of sophistication or that level of scale. And what you’re seeing when you see a lot of these companies raising massive dollars, they’re basically just providing bare metal solutions of renting the GPUs, and in some case renting them to the hyperscalers. That’s not a model that we’ll ever compete in at scale. It’s just we don’t have the cost structure for that. What we do have is what Paddy described is we have differentiation in the target market, and we have differentiation in the software layer, and that’s where we’re going to devote our investment.

So we’re investing more in R&D and in the software layer, we clearly need GPU capacity. And as I said, we’ll spend $50 million this year in GPU alone in 2024, which is a big third of our capital budget. And that’s an appropriate amount I think given that we think that we’re taking a slightly different angle that we think is perhaps, I don’t want to say more durable, but it’s certainly got a lot of legs from our perspective, and we see a lot of long-term growth potential in that strategy.

Brad Reback: That’s great. And then just one quick follow-up, Matt, it may be sort of splitting hairs, but the Cloudways contribution, I think you said 2% to 3% for next year. I believe last quarter you put it at 3%. So any specific changes there or is it just rounding? Thanks.

Matt Steinfort: No, Brad, it’s just rounding. As you would expect coming out of the year, we wanted to establish a baseline growth rate that we and everyone can count on, and we’re going to build from there. And we’ve tried to be real clear on that and we’re not expecting any kind of major recoveries in the market. So when you look at the exit growth rates of the various businesses and products we have, that’s kind of what you get. And again, the NDR that’s assumed in the guide is we’re not assuming any macro improvement that all the NDR improvement that we have, which is still not much, we won’t get in the baseline plan to above 100 NDR to the latter part of the year. It’s all tied to discrete products and initiatives that we’re driving. So I just say it’s there’s no message in that number. It’s a little bit of rounding and it’s based on the December’s exit run rates that we’re seeing.

Brad Reback: Perfect. Thank you very much.

Operator: And we’ll take our next question from Raimo Lenschow with Barclays. Your line is open.

Raimo Lenschow: Hey, thank you and all the best from me as well, Paddy. I just wanted to ask more about expansion into new areas and how you think about that. I mean, if you look at the last few quarters, it was more over M&A to get you into AI with Paperspace and Cloudways et cetera. Like, how do you think about that balance of kind of having internal product development and you talked that you’ve been at AWS and Microsoft versus kind of buying expertise from the outside. Can you speak to that please? Thank you.

Paddy Srinivasan: Yes. Hello, Raimo, nice to be here. And I think my philosophy is, we have to do both in a market that is evolving quickly. And I don’t want to make this sound like it is all about AI/ML. I think we have a lot of core innovation left, both in our infrastructure platform as a service as well as in our Cloudways hosting offering. I think we have a lot of innovation left within the core DigitalOcean. And also, as I mentioned, we are still building the bridge between the gradient experience at Paperspace and the core DO offering. So we have enough to keep us very busy organically. But as you would expect, we are very diligent in scanning the landscape, whether it is to buy talent, as you’re talking about or buy new capabilities, which our customers will appreciate, expand from a geographical footprint perspective, there’s so many dimensions that we could add inorganic capabilities into our offering.

So I’m super excited. And having the financial structure that we have gives us the opportunity to make the right responsible bets to accelerate our growth.

Raimo Lenschow: Okay, perfect. Thank you. And Matt, one for you. If you think about the environment out there, you mentioned in your plans, there’s no assumption of things getting better. But if you think about the linearity in the quarter and the different geographies as well, what has been your observation this quarter? Thank you.

Matt Steinfort: Yes. Again, one of the things I love about this business is how the lack of concentration we have in any vertical or in any industry or use case or country. And so we’re pretty diversified on that front. And we haven’t seen any kind of one sector or region performing materially different than the rest. But what I would say is while the NDR was still 96% in the fourth quarter. We are seeing increased usage on the core DO platform. We saw that continue into January, it’s continued into February, and we are seeing signs of, like we said, we expect NDR to improve over the course of the year, and we’re seeing good leading indicators at this point as customers are starting to pick up their activity on the core DO platform itself, which has been kind of the real headwind of growth over the last several quarters.

Raimo Lenschow: Okay, perfect. Thank you.

Operator: We will take our next question from Patrick Walravens with Citizens JMP. Your line is open.

Patrick Walravens: Oh, great. Thank you. And let me add my congratulations, Paddy. So my question is really basic. What is your philosophy of leadership?

Paddy Srinivasan: Patrick, thank you for your question. So my philosophy in leadership all starts with the customers we serve. I think our purpose of existence as a company is to serve our customers, and if we do that well, and if we understand their needs and we deliver at a risk pace and solve their problems, I think the rest is going to take care of itself. And I think, as I mentioned, those are the couple of things that really excite me here. It’s a large market, and we already have a very, very strong foundation. And it is a market in which our core customers, which are the developers, have an emerging set of very complex problems that are worth solving for. So my leadership philosophy starts with that. Number two is, we need to have, we are a tech business, so our technology has to be world class.

So that’s something that I’m going to be super focused on. And number three is, technology has to come from world class technology should come from world class people. I’ve been very impressed with the caliber of talent we have here at DigitalOcean, and we are really excited to get to work. And my job as the CEO is to, A, help us understand our customers very deeply, and B, put the right people in the right jobs to deliver innovation, to help take care of our customers. So hopefully that gives you an answer, which is not super fluffy or high level, but hopefully I will back up these things over the next several quarters with product innovation and delivery that backs up my leadership principles.

Patrick Walravens: Awesome. Thank you.

Operator: We’ll take our next question from Josh Baer with Morgan Stanley. Your line is open.

Josh Baer: Great. Thanks for the question and welcome Paddy. I was hoping you could give an update on the revenue composition between products, like how much mix is droplets or infrastructure-as-a-service versus platform-as-a-service, what products are contributing most in platform? And I guess I’m wondering if with the net retention rate below 100, like looking at the average revenue per customer, if some of the adoption of multiple products is sort of masked by lower consumption overall, bringing that average revenue per customer, keeping that more modest growth.

Matt Steinfort: Hey Josh, it’s Matt. We don’t disclose the mix of the IaaS and PaaS solutions, but what I tell you is the PaaS solutions are growing faster than the core kind of infrastructure-as-a-service offerings. So database and some of the other products and kubernetes are all growing at a more rapid clip than is the core kind of droplet and compute business. And that’s so the take rate of those services is very healthy. I think when you see that again, the big driver in the NDR challenges that we’ve had has been, as I’ve said, multiple times over the last several calls, its expansion is slowed. Right. The churn has not changed. It’s right around where it was even a year ago. The contraction is a little bit elevated, but it’s been fairly stable over the last, now seven, eight months.

Where we saw the most pressure year-over-year, last year was in expansion. And that expansion was customers owned businesses just weren’t growing as fast, and so they didn’t need more compute. And so we didn’t see as much growth in the core kind of droplet part of the business. And so I think that I’m very excited by the product roadmap that we have. And with Paddy coming on, the ability to even more focus on driving adoption and increased kind of take rate of our existing products into the installed base. Most of the headwind that we’ve seen, though, has been in kind of just the core droplet core compute.

Josh Baer: Great. And just wondering, Paddy, if you’re thinking about all the opportunity in front of you, all the growth levers available to you, how are you thinking about potential for future pricing increases over the medium term? And Matt, just wondering, in your breakdown of growth drivers for the year, is there any contribution from pricing embedded in those different categories? Thanks.