Thank you for standing by, and welcome to the DigitalOcean First Quarter 2024 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Rob Bradley, Vice President of Investor Relations. Please go ahead.

Thank you, Rochelle, and good morning. Thank you all for joining us to review DigitalOcean's First Quarter 2024 financial results. Joining me today are Padmanabhan Srinivasan, our Chief Executive Officer; and Matt Steinfort, our Chief Financial Officer.  After our 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 the call today may be considered forward-looking statements, which reflect management's best judgment based on currently available information. I refer specifically to the discussion of our expectations and beliefs regarding our financial outlook for the second quarter and full year of 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 10-Q filed with the Securities and Exchange Commission and those referenced in today's press release that is posted on our website.  DigitalOcean expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements made today. Additionally, non-GAAP financial measures will be discussed on this conference call and reconciliations to the most directly comparable GAAP financial measures are also available in today's press release as well as in our updated investor presentation that outlines the financial discussion on 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 our CEO, Padmanabhan Srinivasan. Patty?

Thank you, Rob. Good morning, everyone, and thank you for joining us today as we review our first quarter results. After my first 3 months in the role, I'm pleased with both the solid execution and durable growth we delivered in Q1 and the early progress we are making to position the company to take advantage of the material growth opportunities that are in front of us. In my remarks today, I will briefly highlight our first quarter results, share some initial observations from my first 90 days, provide several examples of our increasing product velocity, and discuss our progress pursuing the tremendous AI growth opportunity. Before I get too deep into my remarks, I want to highlight our Q1 performance, which was solid across the board. Revenue growth accelerated quarter-over-quarter, and we continue to deliver strong adjusted EBITDA and free cash flow margins, while increasing investments in our higher-growth businesses, demonstrating the strength of our business model. We are also encouraged by the improving growth fundamentals. Net dollar retention continued to slowly rise from our low last summer, increasing as expected to 97%. Our core product usage grew faster in Q1 than it did in Q4 of 2023. We're also seeing a strong uptake of our still early-stage AI and machine learning platforms. While we still have a lot of work ahead, our Q1 results are very encouraging. Matt will walk you through more of the details later in this call. I will start my deeper commentary with some initial observations after my first quarter as CEO. I've spent a meaningful portion of my first 90 days with customers, partners, and employees. The feedback and insights I have received have only increased the excitement and optimism I have for DigitalOcean and our growth potential. More than anything, I've been…

Thanks, Patty. Good morning, everyone, and thanks for joining us today to review our first quarter results. Revenue growth continued to improve quarter-over-quarter. We are seeing positive signals from our key growth drivers, and we continue to deliver attractive adjusted EBITDA and free cash flow margins, while we increase investment in our AI platform to pursue this material growth opportunity. This morning, I will provide a deeper look into the first quarter results before providing our financial outlook for Q2 and for the full year. Revenue in the first quarter was $184.7 million, which was up 12% year-over-year and up sequentially from the fourth quarter of 2023. We had $19 million of annual recurring revenue or ARR in the quarter, which was the largest organic quarterly increase we generated since the second quarter of 2022 and was 82% higher than the incremental ARR we generated in Q1 2023. Contributing to this growth was steady incremental revenue from new customers, improving net dollar retention from our existing installed base, and healthy contributions from our managed hosting and AI platforms. Revenue from new customers in their first 12 months remained both steady and a key element of our solid growth foundation in Q1. As we discussed in February, improving our net dollar retention, or NDR, is a major focus area and a key driver for accelerating our overall growth rate as we move through this year. As anticipated, MBR improved to 97% in Q1 and has continued to steadily increase since we reached our low point in July of 2023. We continue to see steady and historically consistent levels of churn, and we are seeing modest month-over-month improvements in our net expansion, which is expansion net of contraction as our customers are slowly returning to growth. The work that we are doing…

[Operator Instructions] Your first question comes from the line of Raimo Lenschow of Barclays.

Congrats from me for a great quarter. First question on AI. If you think about the speed or the evolution of AI adoption, there is like training, inference, sorry. And what are you seeing at the moment on the platform side? And how do you think that will kind of evolve for you? And then a number of questions on NRR. If you think about it, it's obviously a lagging indicator. How do you think the weaker periods coming out kind of impacting NRR going forward?

Okay. Great. Thank you for the question, Raimo. I'll start with the AIML question, and then I'll let Matt chime in with the NRR question. So from an AIML perspective, as I said, it is a very exciting traction, but I have to remind that we are in very early innings, not just at distillation but as a market as a whole. So I think for us, we are super focused on the needs of our customers. And our customers are a little different, as I described in my prepared remarks. A lot of our customers are tech businesses that build and run software applications on the DO platform. And they need a variety of different AI models, not just LLM, and they are mostly AI extenders. So if you take the example of LLM that a lot of people are familiar with these days, you can inject data and fine-tune and extend current AI models. So that's a lot of what our customers are looking to do, not just in LLM but in other models as well.  And typically, our customers are AI extenders and AI consumers. Our AI value proposition is twofold, as I explained. We have recently introduced the Infrastructure as a Service. The dominant use case right now is model building and model extension and fine-tuning and also model inferencing across different parts of our data center infrastructure. We also have a very robust platform-as-a-service offering with Gradient, the platform we acquired through Paperspace, which is also undergoing considerable enhancements as we speak. So this platform as a service has a much wider aperture in the sense that it deals with AI and machine learning throughout the life cycle of software development.  So we have both that as well as the raw infrastructure as a service to fine-tune and build and train and infer these AI models. So as I said, we are very happy with the progress in Q1. We will be focused on serving our customer segment, primarily with our AI strategy, and we feel very confident that we are now starting to really understand the evolving needs of our customers and what they are actually looking for, both in model training and inferencing. And as I said, these are very early innings. A lot of attention is now on model building and fine-tuning and training. But the long-term use case is going to be super heavy on inferencing, and we have both those faces covered with our Platform as a Service and Infrastructure as a Service.

And then, Raimo, on the net dollar retention. Again, we're encouraged by the, I'd say, the steady -- slow but steady increase in net dollar retention that we've seen basically on a monthly basis from July of last year. And as we've said historically, the churn hasn't really been the challenge for us over that period and even in the prior year. The issue had been net expansion, which is expansion minus contraction. And we've seen slow and steady improvement there, which is driving the improvement in NDR. Contraction continues to kind of get better, a little bit better every month.  Expansion, again, was the last of our kind of drivers of NDR to hit the bottom last year, and it is holding steady at the levels it's been over the last several months, and we see positive indications, but it's, I'd say, going to be slow and steady growth for us to get that NDR up, and we're encouraged by the progress that we're making. And the product development work that Patty described and the heightened focus on customer success. Those will all contribute to the improvements. And we're banking on only the things that we control, so those improvements. We're not banking on any macro improvement or kind of market shift to higher growth in terms of what we're guiding.

Your next question comes from the line of Pinjalim Bora with JPMorgan.

Great. Congrats on the quarter. I wanted to ask you, Patty, the AI strength is definitely possible here. But I want to ask you if you are seeing attach rate of the core digital ocean offering as people create applications around the AI workloads. Is that flywheel AI driving more core DOs starting to happen?

Good question, Pinjalim. Nice to hear from you. So the way I'm looking at it is that there are 2 ways that this cross-sell or this cross-attach happens. One, our traditional DigitalOcean core customers that are now starting to use our both Platform as a Service as well as our infrastructure to consume some of the AI models that I was talking about. So it is still very early, but we have a handful of examples of some of our top customers that are trying to leverage our infrastructure for things like fraud detection models and things like that. So we are starting to see early signs of that happening.  The other thing which is really interesting is start-ups and other model heavy companies that are coming to take advantage of our GPU as well as our platform infrastructure that we have quickly realized that for them to scale their model and deploy it and as they start getting into the inferencing mode, they need a lot of the core cloud primitives that a platform like DigitalOcean offers from compute, network, storage, bandwidth and having a global geo footprint to get inferencing with the lowest possible latency as close to their customers as possible.  So we are starting to see very healthy early signs of these model-based companies quickly realizing that for them to go live and start getting into the inferencing mode, they need a lot more than just raw CPU horsepower. They need all of the cloud perimeters. Yes, there are idiosyncrasies on how storage or networking works in the world of AI. But these cloud primitives are absolutely essential as the models get deployed and get into inferencing mode. And that's something that we are already seeing a lot of signs.

One question -- or 2 parts for Matt. The Paperspace, I think the assumption was that it will contribute about 3 points of growth this year. It seems like you're already at about 3 points of growth. So wondering if you're still expecting that kind of contribution a little bit more? And on EBIT, it seems like the beat is not flowing through the full year. I was wondering if there was something around timing of expenses or any catch-up in the second half?

Yes. We're still very confident in our AI platform contributing 3% overall growth to the company. So that, as you said, we remain confident in. And we're encouraged by the early signs that we're seeing in that business. And I think that's what gave us the comfort to increase the bottom end of the guide and to increase the midpoint. From an expense standpoint, yes, the investments as they come on, what drives the EBITDA, some of that will happen in the latter half of the year as we increase our investment in R&D, and we invest in additional space and power to accommodate the AI growth.  So as we said, it's in our business, looking at it on an annual basis is way better than looking at individual quarters for free cash flow and in a certain extent, even gross margin and adjusted EBITDA because our expenses when we take down incremental space or power or it wouldn't hit EBITDA, but for gross margin, if we take down additional equipment, it's lumpy. It has a slight negative impact on the margins, and then we grow into it in the following quarter, which is what you saw from the increase in the EBITDA from the fourth quarter to the first quarter of this year.

Your next question comes from the line of Kingsley Crane with Canaccord.

So I want to touch back on the Paperspace conversations. Well, I believe you have plans to create a more native link a shared dashboard between Paperspace and the core DigitalOcean interface sometime this year. So could you just talk more about what you can do from a product perspective to encourage those potential cross-pollination opportunities? And just what other gating factors you think you could address to encourage this?

Yes. Thank you very much for the question. That's a really good question, something that we are discussing on a weekly basis in our product conversations. Our first goal is to nail the use cases that our customers are picking us for. So we don't want to miss out on that opportunity to make sure that we have the right infrastructure, the right GPU fabrics, the right networking, and different types of storage attached that model builders, trainers, and extenders need, the right infrastructure for inferencing. So we are really focused on that.  Over the next couple of quarters, we will start seeing really good progress on bringing these 2 environments together, both from an infrastructure point of view as well as from a user experience perspective. So we are absolutely thinking about it. But we want that cross-sell and the attach between the 2 worlds to happen more organically. We're certainly not going to rush into getting our customers attached before they're ready to do it. They're not -- that is naturally happening, and I would just add that over the next couple of quarters, you will see a lot of cross-pollination between the 2 worlds because there's just so much natural technology convergence between what the current paper space offering is and the DigitalOcean core platform, including our Platform as a Service called App platform, some of our storage and droplet infrastructure is getting upgraded to also consume the GPU infrastructure.  So you will start seeing a lot of natural convergence over the next 6 months, and we'll keep reporting the cross-sell motions. But as I said, our focus right now is to absolutely nail and address the needs of customers walking in to take advantage of our platform as a service and the GPU infrastructure. So stay tuned, we have a lot of other exciting things to come over the next 6 months.

That's really helpful. And so then either for Patty or Matt, look, to take a step back, you're building an exciting technology business, but you're also highly profitable with a great financial model. That's been core to the digital ocean identity for a long time. I know you just had has for Sharp Day in the past quarter. As we approach the next chapter of your growth story, how is employee sentiment? And then how are you communicating that profitable technology mission internally?

Yes. Great question. So outside of spending time with customers, my #2 in terms of time spent over the last 90 days has been with our employees also known as Sharks. And the employee sentiment, I don't want to speak out of turn, but I think it is very robust. A lot of optimism, especially seeing the product velocity pick up over the last several weeks. And I only had time to go over the tip of the iceberg. Literally, I have only talked about 3 or 4 of a dozen or more product releases just in the last 4 weeks. So the innovation pace has visibly picked up across the company, and that is a massive rallying cry for the company. So the sharks are super excited to get back into technology innovation. And as we do it, we get a tremendous amount of excitement from our community. And that is a major force multiplier for us internally to see the community really step up and take notice, and they are our best evangelists.  So you can actually see the action in various threads on X, Discord, and other social media where there is a question from one of our customers. In addition to our employees jumping to answer that question, it is often the community that provides the first level support and engage in a debate with customers and prospects. So that is a major force multiplier for us internally. So I want to say that there's a lot of excitement internally, primarily driven by the pace of innovation. And we're also accelerating some talent addition, especially in the AIML space. We're getting the core DigitalOcean engineering team to also contribute a lot on our AI journey. And just the enhancements that I rattled off in my prepared remarks in terms of our core innovation has really energized.  And then on the go-to-market side, it is still very nascent for us. We have a very robust customer service, customer support motion, and we are just in the early stages of taking all of the innovation that we are pushing out and translating that into a sustainable drumbeat of content and community amplification. So overall, I would say the company is energized and we are starting to grow in the same direction across the company.

Your next question comes from the line of Joshua Baer with Morgan Stanley.

I did want to ask about the sequential downtick in the learner customer cohort segment just for any context there. And then as a follow-up, somewhat related, just wondering more broadly if sort of doing any strategy shift away from maybe going after some of those smaller customers thinking about moving more upmarket to land more strategic customers that can expand and use more products on the platform.

Thanks, Josh. No, I think the strategy remains the same, which is we have a phenomenal platform for developers and entrepreneurs and small growing technology companies to come and experiment and grow their businesses. I think the shift that you saw in the last quarter was a result of a couple of things. One, we are focused very much on the builders and scalers on our platform, which are still -- that's not upmarket relative to the industry. It's just the larger of our customers because we think there's a lot of expansion opportunity there. And a lot of that feedback that Patty was talking about when talking to customers is consistent with things that we've said in the past is that we think we can get a bigger share of the wallet of our existing customers by eliminating some product blockers and adding capabilities that they find valuable. The decline in the learners, it's -- again, we had 476,000 learners. The decline of 8,700 was like 1.5 points of that. It's not a material decline. And it was likely more driven by the fact that we've tightened our screening of those small customers that -- and if you think about the bad actors that show up on platforms, hosting platforms, you're constantly fighting battles to try to keep them off your platform. They don't typically pay or they pay, but they're doing things that aren't helpful in the Internet community.  So we've ramped that up a bit, and that contributed to a kind of a lessening of the number that we added in the quarter. And so the net of the learners was down a bit. But I don't think that's a long-term trend. I think that's just a result of a heavy focus on builders and scalers during the quarter and some tightening around our security practices.

Your next question comes from the line of Tim Horan with Oppenheimer.

Could we focus on the GPU CapEx spend a little bit? It feels like you're still capacity-constrained, maybe you can go into that a little bit. And can you give us a little color on maybe the payback that you think you'll get for this? And I know you touched on quite a bit the cross-selling capability. It would seem like more spend on CapEx here will help out the overall revenue growth. But any color on what you're thinking with your CapEx spend?

Yes. So as we said, we were definitely capacity-constrained in the first quarter, and we continue to deploy the capital that we had committed in the end of last year that's consistent with our plan, and we'll be turning that up over the course of this year to give us the ability to increase the revenue growth, and that's all part of the plan. And we're watching to see how that goes. And as we learn more, as Patty described about the specific requirements of our target customers, which are different from the requirements of some of the larger customers that are buying from the hyperscalers or the large GPU farms, we'll make good decisions about whether we should be adding incremental capital beyond what we had committed.  The return profile on the business, you got to think about it in 2 different categories. The Platform as a Service offering, which is what we had acquired from Paperspace and is more consistent with kind of the traditional cloud offerings we have, where there are software wrappers and capabilities around the hardware. The payback on that is very similar, a little bit lower gross margins than the core business -- the core digital ocean business, but not that dissimilar. In the GPU as a service or the hardware business, I'm sure you have the same statistics that everyone else on the call has around what H-100 costs when you load on the networking and everything else.  And then when you look at the kind of going rate for GPU or H-100 by the hour, you get maybe $0.50 of ARR for the dollar of CapEx that you put in place. You see paybacks in less than 3 years. And I'd say that, that's -- and that's lower, clearly, the lower margin than our core service but you're in an interesting part of the market where the cost curve hasn't been yet. You've got one supplier who is controlling the majority of the inventory. You've got high demand for that inventory and the market prices are fairly, I'd say, consistent in what you hear across all the different providers that are out there. And so I think that what will happen over time, we'll see what happens to pricing over time, whether people still get the dollars per hour they're getting today for an H-100. But certainly, the cost structure will improve dramatically over the coming years as you have other suppliers come into the market and people just get better at deploying these capabilities at scale.

Well, and I know your pricing can vary from $2 an hour up to $6 an hour. Can you talk a little bit on how the average ARPU is looking for these products or people taking more of the spot market pricing as opposed to more return contracts?

I'd say it breaks into the 2 categories that I described. You have where it's hardware as a service, it's at one end of that range, and where it's more of the platform as a service. It's at the higher end of that range. And again, it's still early. We've only had the GPU as a service as an offering on the hardware side since mid-January. So we, like most of the people in the market are figuring things out as we go.

Your next question comes from the line of Michael Cikos with Needham.

I do just want to circle up on the expansion of the overall portfolio of services that you guys have. I think DigitalOcean, obviously very well-known historically Ford's product with the droplet. But wanted to see just given how this portfolio has expanded, are you actually seeing a shift as far as where you're landing with new customers? Are they landing on products outside Droplet or does it drop to remain that bread and butter when we think about how customers are coming to the DigitalOcean platform?

Thanks, Mike, for the question. It's -- well, Patti, I think, rattled off an impressive list of incremental capabilities that we've offered, it's we don't view it really as a portfolio expansion so much as an enhancement of the capabilities that we have. So the company was started as an infrastructure-as-a-service provider selling droplets, which are basically just compute, bandwidth, and storage. As the company evolved over the last 10-plus years, we got into Platform as a Service and offered managed database and Kubernetes and other capabilities that are really just kind of extensions and additional layers on top of that core infrastructure as a service because our customers grew from individual developers and hobbyists to small technology companies and software providers that are running businesses on our platform.  And so if you went back and listed all of the different products that Patty had articulated, these are just incremental capabilities that these customers need as they leverage our Platform as a Service and our Infrastructure as a Service. They need more flexibility in how the products are configured with different ratios of compute to storage to bandwidth. They need things that make their lives easier because they don't have giant IT organizations. So auto-scaling and other capabilities that enable them to manage their infrastructure better. We don't view really any of the products or services that we've offered as outside the bounds of the core target customer market that we're serving. And it's just as our customers are growing and evolving, we need to grow and evolve with them to keep making it simple for them to leverage the cloud.

Okay. And then the other question, more of a follow-up here on the 2Q guide. We obviously have the 11% growth in hand, which is a slight deceleration sequentially. Can you just remind us what is that, I guess, cloud way price increase that we're going to be lapping? How much of a headwind does that represent when we think about the growth we're looking at in Q2?

Yes. It's interesting. This is why, again, coming from a different market into the software space and observing the let's say, the obsession, but the focus on year-over-year metrics is interesting to me. Year-over-year metrics are both laggy and also what happened a year ago as a function as important in the change in the growth quarter-over-quarter is what happened this quarter. If you look at the progression that we've guided from Q1 to Q2, we're projecting increased revenue -- increased incremental revenue, which implies an increase in a higher ARR than we added incremental ARR than we added.  So the current trajectory is improving. It's not decelerating. But when you look at it, as you said year-over-year, it is a slight deceleration. And some of that, as you pointed out, is because we had a pop in the Cloudways business. It was about a 10% price increase a year ago. And so the 34% growth that we posted in Q1 for Cloudways is -- they've got about 10 points in there of a price increase, and we'll lap that in the second quarter. So that will come out.

Your next question comes from the line of James Fish with Piper Sandler.

Patty, in your opening remarks, you guys talked about discovering gaps in the product portfolio with customer conversations. What were those gaps that DigitalOcean needs to focus in on? Or were the release of products like backup and cash and capabilities of those gaps? And really, are those gaps on the AI side too? Or what's the differentiation on this infrastructure GPU as a service launch against some of the larger players out there like the hyperscalers core we land, especially if we start to get supply more balanced in time?

Thank you, Jim, for the questions. So let me answer the first question first, which is some of the learnings that I described in my prepared remarks, from a core distillation perspective. So those are what you're already starting to see in terms of our product delivery. So a lot of enhancements. As Matt just described, our Platform as a Service offering is relatively newer compared to our droplets. And we are -- as we focus more and more on builders and scalers, there are some capabilities that they would love to see from us to help them scale as they grow. So you should expect us to release a lot of additional capabilities in the world of advanced reporting and management and visibility of infrastructure capability, security enhancements, advanced networking, and global load balancing. Those are the types of things that some of our advanced scalers and even builders are looking at DigitalOcean to provide because as their footprint increases and their business scales up, these are some of the things that they're asking from us. In my mind, these are all great opportunities for us to keep scaling our platform as our customers grow. Coming to the second part of your question, which is more around what is the differentiation from AI, very specifically Infrastructure as a Service perspective. As I said in my prepared remarks, this feels remarkably similar to the origin story of DigitalOcean in the sense that we're trying to democratize the accessibility of infrastructure for AI builders, extenders, and companies that are looking to deploy inferencing for their applications. So the ease of getting started is a very durable advantage that we are looking to bring to our Infrastructure as a Service and many customers have already started giving us feedback that it's significantly…

Very helpful and thorough answer and Matt, if I could sneak in one with you. You guys are reiterating your free cash flow margins at this point, which probably means that 15% to 17% CapEx range is still what you're thinking. But GPU purchasing seems to be relatively strong. I'm getting a guess. That's why CapEx was a little bit elevated versus what we were all thinking this quarter. Is it still on pace for that $50 million at this time? Or should we interpret your language around potential free cash flow margins coming down in the coming quarters as this is running ahead of plan? And really, are you thinking about using other GPU providers this year?

So I wouldn't say we're running ahead of plan on what we had said is that we're still deploying the capital that we had committed last year. So we have very good visibility into our capital spend on our current plan. What we had said is we're very encouraged by the progress that we're seeing with the AI business, and we're learning a lot. Patty has only been here a couple of months, and we're evaluating the requirements of our customers, and we're learning about what customers were able to attract, what the requirements are, and what the right configuration is from a technology standpoint. And as we see continued positive signs and as we see continued growth, we'll make the right decisions on whether we want to spend any incremental capital beyond what was in the plan.  But we're not -- we're still on our plan. We're not behind or ahead in any way relative to the capital intensity of our business. We're just signaling that we're encouraged. And as we see more signs of encouragement, we'll come back and provide updates as to whether we're going to increase our spend any more than what we had said we would.

That concludes our Q&A session. I will now turn the conference back over to Padmanabhan Srinivasan for the closing remarks.

Thank you very much. As you just heard, we are accelerating our pace of innovation and delivering new capabilities in a very rapid cadence, which will help our customers grow on our platform. As I alluded to, there's still a lot of work to do to take full advantage of our opportunity, but I'm very excited that we are moving in the right direction and continue to make steady, rapid, and respectable progress quarter-over-quarter. So with that, I would like to thank everyone for their time and talk to you all soon.

Thank you. That concludes today's conference call. Thank you all for joining. You may now disconnect.