Thank you for standing by, and welcome to the DigitalOcean's Q2 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Rob Bradley, Vice President of Investor Relations. Thank you. Please go ahead, sir.

Thank you, and welcome everyone to DigitalOcean's earnings call. Today, we will be highlighting our results for the second quarter of the fiscal year 2021. With me on the call today is Yancey Spruill, our Chief Executive Officer; and Bill Sorenson, our Chief Financial Officer. As we did last quarter, we will begin with commentary from Yancey and Bill, and then we'll answer questions we've received from our analysts. Our goal, as always, is to help investors understand our business model and outlook in the most efficient way possible. After we address those questions, we will turn the call over to the operator to manage an open Q&A period. Turning now to our safe harbor statement. I'd like to remind everyone that during this conference call, we will be making forward-looking statements, including our financial outlook for the third quarter and full year of 2021 as well as statements about goals and business outlook and industry trends and market opportunities, expectations for future financial performance and similar items, all of which are subject to risks, uncertainties, and assumptions. You can find more information about these risks and uncertainties in the Risk Factors section of our filings with the SEC. We remind everyone that our actual results may differ and we undertake no obligation to revise or update any forward-looking statements. And finally, we will be discussing non-GAAP financial measures today. Reconciliations between our GAAP and non-GAAP financial results and discussions of the limitations of our non-GAAP financial measures can be found in our earnings press release, which was issued earlier this morning. With that, let me turn the call over to our CEO, Yancey Spruill. Yancey?

Thanks, Rob. Good morning, and thank you for joining us today. We are excited to review our strong second quarter results with you. A quarter in which we saw acceleration across all key metrics. We see continued opportunity to accelerate revenue growth. And as important, we believe we will sustain a 30%-plus growth rate in the near to medium term. Now let's turn to our second quarter results. Simply put, it was an outstanding quarter. Total revenue was just under $104 million and grew at 35%, a 1,000 basis point improvement year-over-year and 600 basis points sequentially. ARR was up 36% to $426 million, a 1,200 basis point improvement year-over-year and 600 basis point improvement sequentially. And importantly, was higher exiting the quarter, pointing to continued growth acceleration in the second half. We generated $31.4 million of adjusted EBITDA, which represents a 30% margin and continues to highlight our ability to generate strong margins even as we invest to accelerate growth. We will continue to drive operating leverage in adjusted EBITDA, while continuing to make targeted investments to sustain our strong growth rate. I'd like to share some insights into our revenue performance as well as highlight a customer example that demonstrates how we enable entrepreneurs to build their businesses on DigitalOcean. Three pillars to accelerating and sustaining our business trajectory, our customer growth, net dollar retention, and average revenue per customer. I'd like to walk you through the progress we are making on all 3 pillars, beginning with customer growth. In Q2, we increased total customers by 9% year-over-year to 602,000. We see customer growth as key to setting the table for robust long-term growth as we bring in thousands of customers per month who start relatively small in terms of revenue, but they test and learn, and over…

Thanks, Yancey, and good morning, everyone. We appreciate you joining us today as we review our strong second quarter performance and our first full quarter as a public company. We continue to be pleased with the progress we're making against both our 2021 plan and our medium-term objectives. At DigitalOcean, we're convinced that the strength of our offering is perfectly suited to address the needs of the developers and SMB users of the cloud, and we look to capitalize on the massive global market in front of us. To that end, I want to elaborate on some of the key points within Yancey's remarks and share with you additional detail on the progress we're making in the key areas of our company. All of us at DO are highly focused on accelerating our business, capturing market share, and ensuring the durability of our top-line growth efficiently and profitably. So how are we doing? At DigitalOcean, we track our progress by focusing on the key indicators that Yancey mentioned ARR, NDR, and ARPU, along with free cash flow. In each of these key metrics, we've made material improvements and see continued improvement ahead. At DO, annual recurring revenue, ARR, is the leading indicator of the company's trajectory. In Q2, ARR grew 36% year-over-year, up meaningfully from the 30% growth in the prior quarter and 24% growth in Q2 of last year. Through another lens on a sequential dollar perspective, ARR increased $38 million from Q1. Looking back over the last 2 years, this is by far the largest sequential dollar increase we've had. And the next closest was the prior quarter where we added $31 million. This means we saw a 23% increase in the amount of ARR that we added in just the last 3 months. Key to the acceleration…

Thank you, Bill, and thank you all for joining us again today as we go over this strong second quarter performance. And similar to our last earnings call, we asked in advance for some questions from analysts on some of the larger themes and longer-term objectives of DigitalOcean. And after these, then we'll turn it over to the operator to conduct a more standard Q&A. But to begin, our first question is from Tim Horan at Oppenheimer. And he asked to know more about DigitalOcean's typical customer and how that is changing and some of the details on how we grow ARPU as well as an update on success that we're having, adding and retaining larger customers?

Thanks, Tim, for the question. A couple of points. First, we add thousands of customers per month through our self-serve channel and our sales effort. Typical it is hard to characterize, given that we don't target industries and geographies. But I'll characterize typical, and I'll put that in quotes. We have 2 types. About 80% of our customers by logo are early in the journey. They're similar to the customer example we cited earlier in the script. They're testing, they're learning, they're spending low levels of dollars, they're consuming our infrastructure, et cetera, trying to get lift-off on their idea. They represent under 20% of our revenue. And the key to our business is having a steady supply of them because it's an optionality on the few that become larger customers over time. And then about 15% of our customers by logo, they've been on the platform. They're exactly like the customer we just cited in the case study. And they've been on for a number of years, and they're growing now very rapidly as they've evolved to running and managing and scaling the business of DigitalOcean. They represent about 85% of our revenue. The important thing is our business is built to handle the life cycle of our customers, from a developer, from an entrepreneur, a start-up entrepreneur into the larger scale business. So that's typical for us is customers in the life cycle through SMB. The smaller customers, the earlier stage customers tend to concentrate mostly consuming infrastructure, the storage, the compute access to the Internet. And then as they grow, they consume more of that as they are building customer bases on our platform. And then they also use managed services like a database Kubernetes as their teams grow, as their workflow evolves. So that's typical for DO. It's supporting developers through their journey to become entrepreneurs and leading businesses. In terms of our sales effort, we're making very good progress in terms of the contribution that they're providing to our revenue growth. They tend to bring in much larger customers that are SMB or businesses day 1. So they have a higher ARPU, they're multiproduct, obviously, they're much stickier. That was about 2% of revenue last year coming from direct sales. It will be over 3% of our total revenue this year. We are investing in adding capabilities across the globe, both in terms of direct sales, the support, the solutions, engineers, et cetera, that help our customers onboard an existing business. So we're investing there, very optimistic about the ability to see a lot of leverage and much more contribution as a percentage of our overall growth and revenue portfolio over time.

Great. Thank you very much. And the next question is from Brad Reback at Stifel. And he asked what percentage of DigitalOcean's revenue comes from premium products? And if we can provide a sense of how much larger this can become on a percentage basis over the next few years?

Well, if you look at our total revenue today, about a little over 90% of it comes from our core infrastructure as a service, our compute network and storage tools, and the multiple variants that we have on that. And then just under 10% and growing very rapidly come from our managed services, things like our app platform, our Kubernetes as a service, our database as a service in our marketplace. And so collectively, those are contributing to a much higher growth rate. But we also -- it's important to note that customers that are ramping on the platform are businesses that are using some of our managed services. There's also a significant pull-through in growth of our infrastructure. So collectively, we see over time, a mix more like 80% infrastructure and 20% of our managed services. We'll continue to add new managed services, add options. We also add capabilities on the core infrastructure. So collectively, we'll support our customers' journeys, and we expect to have an 80-20 mix over time.

Terrific. Josh Baer at Morgan Stanley asked a question about differentiation, which is obviously key to DigitalOcean. He asked faster time to deployment due to ease of use and platform simplicity seems very valuable for an SMB with limited IT resources. How do you maintain this differentiation even as you add more features and products to your platform?

Thanks, Josh, for the question. It's definitely a balance. Obviously, we can't compromise on simplicity. Our customers demand it. As you point out, they don't have the team to support. They don't have an IT or DevOps capability typically. And so simplicity means the product has to stand on its own. And when it doesn't support the documentation can help them along. And so there's definitely a balance of adding more capability that technically adds more options and not -- and make sure that it's a seamless experience for them. So simplicity is core and central to the capability. So we focus on where we expect workflow to evolve given the early stage of our business customers and what are opportunities that are obvious like a database, as customers grow their customer base, they need tools to manage that as they grow their engineering and deployment teams, they need technologies like a Kubernetes or app platform to help them manage it. So we're very focused on adding relevant and core functionality to early-stage businesses and making sure that experience of simplicity is consistent throughout.

Excellent. And next is Pat Walravens at JMP Securities. And he asked, how should we think about your pricing strategy, especially as it pertains to newer product offerings like managed Kubernetes, managed database, and your app platform service?

Well, I think the key for us on pricing strategy is focused on our differentiation relative to the competitive landscape. And so simplicity, ease of use, simple easy intuitive service, what we call community, which is our strategy to provide documentation tutorials to everyone, all of our customers, regardless of price point, support all of our customers get a support experience, regardless of price point, the commitment to open source software, not locking in our customers to any particular tech stack. All of those support our pricing strategy. And in fact, those enable us investing in that broad set of capabilities and the experience for customers enable us to get a price premium to the smaller competitors we compete with. And they -- and we get that because of that differentiation. And that differentiation is also relevant against the hyperscalers, yet we're priced at a deep discount. And so the breadth of offerings allows us to get a premium against a smaller and a discount against the larger players. So we think that that's core to our pricing strategy. We will add capabilities like managed services, et cetera, that allow our customers to do more, but we'll also add capabilities to the core infrastructure. And in fact, we offered a storage optimized, optimized storage option last fall that saw a meaningful uptick. We launched a premium chip first price increase, if you will, in the company's history on core compute. We've now allowed customers to have an option on an AMD or Intel, higher processing power for -- and took that price point from the basic, up about 20%, and we saw a meaningful uplift in people who didn't need to go to the next higher tier droplet which doubles in price, but would pay a premium because the higher processing capabilities for their early stage use case this product was relevant. We've seen significant uplift in not cannibalization, in our core droplets. So I think there are a lot of opportunities for us to add capability and then over time, package that, like we just mentioned here in this premium chip offering. So -- but core to the value proposition and the differentiation is central to how we think about pricing strategy over time.

Thank you. And investors often ask this about churn. And Pat also asked, can you give us an update on customer retention and churn? How should we think about those dynamics? And what are the main reasons of customer churns?

Well, obviously, we're excited with our results for the quarter across the board, but not the least of which is net dollar retention, which was not too long ago, it was at 100, and it's now in the 100 teens, exited the quarter even higher than NDR was for the full quarter. So momentum there. The vast majority of that improvement came from expansion as our larger customers are expanding on the platform. But we'll continue to make progress in lowering churn in the cohort by focusing on retention and expansion initiatives, data analytics to do more proactive outreach to our cohort, make sure that our customers are optimized on the platform. And so churn is now down in the lower double digits. And we still have some improvement to go, but we feel very good with the nature of our customer base to be improving net dollar retention in total and have that come from a combination of more expansion and lower churn. And that's exciting for a couple of reasons. We're serving our customers better across the business, but it also gives us confidence about the durability and the sustainability of a materially higher growth rate, which we obviously demonstrated this quarter, and we believe that's sustainable, and we're focused on driving that higher growth rate and the sustainability of it over time.

That's exciting. And Mark Murphy at JPMorgan asked a question that was -- he said we are repeatedly hearing from customers that bandwidth-intensive workloads are running exceptionally well on the DigitalOcean platform. Can you please speak to your core differentiation and data center strategy, which enables you to provide video streaming and gaining performance, superior to that of the other hyperscalers and at a lower cost?

Thanks, Mark. I think as always, it's typical for us, it always starts with simplicity. So our infrastructure services are highly performing. It's always been our strategy to have really high capability droplets, core infrastructure, compute capability, storage capability, bandwidth capability with just the right set of features. And so we're not feature-rich as it relates to the enterprise use case, which -- but for our customers, it's highly relevant capabilities. We have 14 different locations throughout the world. And so we're able to offer a highly performant global network of infrastructure to our developers and through SMB customers. Because of that simplicity of the offering, and we're able to offer those services at a competitive price. And importantly, and maybe more importantly, for our customers is a predictable price. So price transparency is part of simplicity and the predictability is people have -- they value every dollar in our early-stage business and the fact that they can predict their price and their bill at the end of the month based upon their consumption and the transparency we offer to them is as valuable as the service itself. So it's that combination of simplicity across the capability, but have it also be highly performing. I want to make sure that, that's clear. It's not that simplicity is basic and some scale, we enable highly performing capabilities. And as we noted last quarter, we have huge volumes of customers doing streaming services, et cetera. So our bandwidth-intensive use case, we are highly competitive capability because of the performance and then the price and competitiveness and the predictability of that price. That's core to our strategy around providing simplicity yet high-performance for our customers.

Great. And operator, if you could maybe open up the line for Q&A and provide the instructions, and we'll move to those who are in the queue.

[Operator Instructions]. Your first question comes from the line of DJ Hynes from Canaccord.

Yancey, Bill congrats. Great set of numbers here. Maybe this one is for Bill. So can you help me understand the delta between 25% ARPU growth and 113% net revenue retention? I just wouldn't expect that gap to be that wide. What drives that? Is it that new customers are landing that much larger? Or is it something else going on there?

Good question, DJ. The reality when you're dealing with 600,000 customers is you have a very, very broad dispersion relative to what they're paying. The thing that we are seeing now is in our higher spend customers. These are folks who are spending north of $200, $300 a month. What we're seeing is a higher entry point and a higher spend level quicker than what we've seen in the past. And that really, we point to a contribution from the managed services, which not only is an individual driver by itself. Because if you look at our managed service numbers, just those revenue lines alone, they are growing multiples of our overall growth rate. But that also is driving the underlying consumption of our base infrastructure. So the combination of the 2 in terms of those higher spend is what's causing a draft up. But at the same time, we're still very happy to welcome new customers on the platform that are spending $5 to $10 a month. So you really have to look across the total base of the 600,000 to get an idea of where the impact is going to be overall. But again, the encouraging trend for us is we keep adding new customers up and down the price points, but particularly in the higher spend categories, we are seeing more and more uptake at a higher level and a higher ramp than what we've seen historically.

Your next question comes from the line of Michael Turits from KeyBanc.

[Keith] on for Michael. Congrats on the strong quarter and acceleration. So just given the strong numbers and metrics you guys have been delivering this far. And you previously talked about a wellness to step up sales and marketing spend as a percentage of revenue. So just wanted to get your updated thinking on that and maybe what some of the areas you're seeing good ROI and would like to lean in more.

Thanks for the question. So we are investing in sales, as you mentioned earlier, both to add regional capabilities so that we can support more directly and more volume from new customers. As we've added capability over time, both to the core infrastructure and our managed services, it allows existing businesses to we're very attractive to existing businesses to migrate over to us. And so we're very focused on that. As I mentioned, we expect sales from just 0% of contribution a couple of years ago to be over 3% this year. And we think that, that can go materially higher as a percentage of the overall mix. Currently self-serve, people coming through the website generates the lion's share of our net new revenue. We expect that to be the case for many years. But over time, as we build out the platform, we're going to build out and invest in capabilities on the sales side, so that we can complement and build the business across developers through SMB. So we're definitely investing in sales. We're increasing our sales spend as we move through the year and get more confident in the outlook. And we'll have -- we're optimistic about that over time. And then we're also investing in more product innovation. And we're excited to announce Mongo. We'll have more things to launch later this year and into next year and it be on a more consistent cadence, but we're certainly investing ahead of 2021 in product and so that we could support a durable high-growth rate in 2022 and beyond.

Your next question comes from the line of Wamsi Mohan from Bank of America.

Yes. Yancey, can you share a little more color about this core droplet uplift from the premium chip offering? What type of workloads are using this enhanced offering? And where are you in terms of penetration, where the number of customers that have a use case that supports this? What percent of those customers are currently using this? And where do you think that will go over time? I have a follow-up.

Yes. Thanks, Wamsi. So what you see in -- there's such a diversity of use cases. It's hard to characterize one bucket or another. But at certain earlier stage companies will have the need for more processing than other. It just depends on what the nature is, and I hesitate to even give an example because there's so many across the board. But just think, some use cases need more processing than others even at small scale. And historically, we had a $5 droplet or you can upgrade to a $10 droplet. Sometimes the $10 too much overall size and spend relative to the earlier stage use case. And so the uplift to a $6 droplet with this premium chip allows somebody who has an earlier stage business that from a volumetric in terms of customers is still small, but get the processing performance they need to be able to execute for their customers. So we've seen a very significant uptick. That's almost a mid-single-digit million in just a matter of months sort of size without at all cannibalizing other portions of the business. So I think what we're learning is as we study, learn and observe the customer journey and the diversity of the types of customers, we're learning a lot about how to optimize our capabilities to support the different use cases. And we've done a similar thing with the premium ship as we did with an optimized storage use case we launched last fall, that also has seen quite a bit of uplift without cannibalizing other aspects. And so we're better matching the portfolio to the use cases in terms of the customer journey, and that's allowing us to get uplift. And as a result, when you see customers buying other products, it has a tailwind effect on things like churn. Churn goes down dramatically for customers that buy multiple products and are on the platform longer. So it's an incredible ecosystem that we're building. It starts with understanding, learning a customer, and we're investing heavily in that. And that will inform product innovation and the pipeline of products that we prioritize and launch over time, both on the core infrastructure and our managed services.

Okay. That's helpful, Yancey. And then as my follow-up, when you sort of reported your quarter, you showed some very strong acceleration in customer adds. Would you say that there is some function of that correlated with your Deploy conference? And do you still expect that pace to persist here as we look out over the next few quarters?

Well, we're targeting 10% year-over-year customer growth. We're at 9%. That's from low double digits a year or 2 ago. So we are seeing significant progress in adding customers. The big share of that comes from improving the outcomes of our self-serve. So we're bringing more people over 5 million, a month come to our website. And we're converting many, many thousands more today than we were a year ago into paying customers. And then -- so that's point one. We're supplementing that with a sales effort, which we've talked about. The other aspect of that is we talked about this churn dynamic of the lion's share, the vast overwhelming majority of customer churn happens in the first year with a disproportionate amount of that in the first 3 to 4 months of the customers like with us. And so we refactored a lot of our workflow from support, from our digital revenue marketing efforts, our data science teams to support customers more proactively through direct engagement, digital engagement, to better help them have a better experience as they onboard. That's allowing us to retain a lot more customers in that first year. So that's also a boost. So we're bringing more people in, but we're also focused on that first year experience in retaining them. And the combination of those are what's leading the customer acceleration. Obviously, deploy another activities we have to do outward engagement at larger scale, help to build awareness, help to build brand, help to build community, which is foundational for us. But the customer growth is from direct efforts around scaling up our self-serve, scaling up sales, and then scaling up the fulfillment of customers once they put the credit card down and become paying customers to have them have a better experience in that first 3, 4 months and first year, which is allowing us to retain, enabling us to retain a lot higher customers than we historically have that's contributing to the customer growth.

Your next question comes from the line of Raimo Lenschow from Barclays.

This is [Vinod] on for Raimo. Can you just talk about the trajectory for NDR going forward given the strong expansion you talked about any improvements in churn? Do you see it rising north of maybe a 115% on a sustainable basis?

So we are incredibly excited about the progress we've made with net dollar retention. And again, as I just was talking about the onboarding efforts, the focus on customer retention and expansion, the refactoring of our customer success and support models to be proactive, targeting our data science and data analytics teams to focus on how to address churn risk as well as address upside opportunities for people to better optimize on the platform. That entire workflow is plus the sales effort bringing in larger customers is leading to greater expansion. And at the same time, lowering our churn. Now with the nature of our customer base, I don't know that we'll ever have enterprise-type low single-digit churn, but low double-digit, maintaining that creates a tailwind for net dollar retention, so that the expansion, as customers stay on the platform, again, we have virtually 0 churn after 1 year of a customer's life on our platform. So getting them through that first year and beyond sets us up for significant expansion, and you're seeing that in net dollar retention. So we're excited about it. Can we be at 115% or better, I certainly expect so. And we'll see more acceleration. Again, net dollar retention is that we disclosed is for the quarter. It was exiting at a higher rate than the 113% for the quarter. We'll expect to carry that through in the second half of this year and then create durability around net dollar retention higher than where it is today. I don't want to put a target on it, but 115% or better, we certainly do expect to be demonstrating that relatively soon.

Your next question comes from the line of Mark Murphy from JPMorgan.

Congrats. So Yancey, in addition to that comment that you just made on the retention, I think you emphasized as well that ARR was higher exiting the quarter. And I'm wondering what exactly is underlying that comment? Are you conveying that the month of June and the trend into July were particularly robust? Or was there some other meaning there?

Well, if you look at our last 3 quarters, ARR has been higher than the quarter the total quarterly growth rate. And as you see in the subsequent quarters, the growth rate is higher than that ARR number. So I think what we're saying is we are seeing acceleration and ARR in June was higher than the full quarter growth, and we expect that Q3 will be strong and as low the second half. So we're accelerating. And I think that's very important that people look at that trend historically and think about going forward. Now having said that, our guidance, we provided guidance for Q3 and the full year, and we intend to set expectations that we'd be. But we are seeing acceleration in our business for sure.

Understood. And just as a quick follow-up, Yancey. I think the slides show that the world is heading towards 45 million developers by 2030. And I'm just curious, how many do you think you can address with the core platform, but also as you broaden out the portfolio with database and Kubernetes and other types of platforms?

Yes. I think it's a very important stat. A huge tens of millions of software developers globally, there's 100 million SMBs, businesses of fewer than 500 employees globally. Collectively, that's a $50-ish billion market TAM today, going to over $100 billion by our data over the next several years. It's a massive opportunity. The SMB market in general is a huge percentage of GDP, both in the U.S. and globally. So we think we're relevant to all those software developers who are looking to test and learn and launch applications similarly to SMBs. The capabilities we have with our global set of infrastructure, the incremental set of managed services, certain services we expect to launch over time are highly relevant to all early-stage business use cases as well as software developers. So we're playing in a very large market opportunity. I think the growth acceleration we're seeing is starting to reflect that. Our data sets, the market in SMB cloud is growing 27%. We're now growing materially faster than that. And we think we can sustain that with focusing on our differentiation, enhancing the platform, and enhancing the customers' success and support experience of our customers while they're on our platform.

There are no further questions at this time. You may continue.

So we want to thank everybody for joining our call this quarter. We're excited about the progress we're making, and we look forward to continuing our conversation with each of you. And we want you to know that we're working really hard to realize the incredible potential of this business. We hope you all enjoy this summer and look forward to speaking with many of you in the many upcoming investor events that we will be participating in over the next few months. Have a great day. Thank you.

This concludes today's conference call. You may now disconnect.