Q3 2021 DigitalOcean Holdings Inc Earnings Call
Okay.
Good day and thank you for standing by welcome to the digital Ocean Q3, 'twenty One earnings conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session chassis question. During the session you will need to press star one on your telephone if you require any further.
The assistance, Please press star Zero and now I would like to hand, the conference over to your first speaker today, Rob Bradley Vice President of Investor Relations. Thank you. Please go ahead.
Thank you and welcome everybody to digital oceans third quarter 2021 earnings call with me on the call today is yancey spruill, our CEO and Bill Sorenson our CFO.
They will start the commentary from EMC 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'll turn the call over to the operator to manage an open Q&A period.
Turning 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 fourth quarter and full year as well as statements about goals and business outlook and industry trends market opportunities and expectations for future financial performance of similar items.
All of which are subject to risks uncertainties and assumptions.
Can find more information about these risks and uncertainties in the risk factors section of our filings with the SEC.
I'll remind everyone that our actual results may differ and we undertake no obligation to revise or update any forward looking statements.
Finally, we will be discussing non-GAAP financial measures today, and reconciliations between our GAAP and our non-GAAP financial results 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 yeah.
Nancy.
Thanks, Rob Good morning, and thank you for joining us today.
We are pleased to share our very strong third quarter results with you.
Where we again delivered acceleration and revenue growth adjusted EBITDA and growing cash flow.
As a result, we are increasing our outlook for the balance of 2021, and reiterate our confidence in sustaining 30% or better growth in 2022.
The transformation of digital Ocean is well underway.
And we remain laser focused on achieving our first $1 billion of revenue in 2024.
For the second consecutive quarter, we saw significant improvement in revenue growth versus the year ago period, and an acceleration from Q2.
Relative to Q3 of 2020 topline growth improve nearly 1300 basis points.
And accelerated more than 200 basis points from the prior quarter.
This continued growth acceleration results from strength across our key growth drivers.
Have customers net dollar retention and revenue per customer or our pool.
I'll dive into each a bit more in a moment.
<unk> increased 36% year over year to $455 million.
This represents a 1200 basis point uptick relative to Q3 last year.
Our or was flat on a sequential basis to Q2, largely due to lapping the step up in September 2020 revenue from new products.
We are off to a strong start in Q4, and we are confident in our outlook for the rest of the quarter and feel great about our momentum heading into 2022.
Our profitability is an attractive differentiator for a company whose growth rate continues to accelerate.
In Q3, we generated $36 million of adjusted EBITDA, which represents a margin of 33%.
Underscoring the efficiency of digital oceans business model.
Investors, often ask whether we would be willing to invest even more into the business to grow even faster.
The answer is we are doing so today.
In fact, our margins could have been higher in Q3, but we see opportunities to invest that will enhance our growth in 2022.
And are more than happy to hold back on current adjusted EBITDA margins in order to give us a head start on product innovation and go to market initiatives driving growth acceleration into 2022.
Now that I've shared the headline results for Q3, I'd like to take this opportunity to provide more granular insight into our customer base.
We have a large customer base with a very long tail dynamic where a large percentage of our customers are testing ideas learning how to code and Aranda idea formation stage of launching a business.
A small percentage of our customers emerge to launch and build rapidly growing small and medium sized businesses.
One of the key drivers of our faster revenue growth is that we are nurturing and attracting increasingly larger and more rapidly growing businesses to our platform.
What we would consider the typical SMB.
These larger customers represent roughly 15% of our total customer base, yet generate roughly 85% of our total revenue.
They grow substantially faster than our reported top line growth.
With our <unk> growth of over 50%.
N D are of a 118% in Q3 also better than our company average and up meaningfully from 104% in Q3 of 2020.
These customers have a higher net expansion rate as many of them buy multiple products and churn at a much lower rate.
In the mid single digits versus low double digits for the entire company.
Importantly, the number of larger customers are growing several times faster than our overall customer growth rate.
We expect these trends to continue where these larger customers grow faster have a higher N D. R. And therefore will represent a larger share of our total revenue mix over time.
Our continued investment in product.
Direct sales and focus on customer support is paying off as the size of our customer base gets bigger and we attract more of the SMB market.
Many of these fast growing customers have incubated on our platform for a period of time.
Before their businesses launch and they ramp.
We have an incredible customer ecosystem, where we nurture early stage developers and entrepreneurs until they get lift off of their ideas and support the growth of rapidly growing startups and smbs as they get traction to.
To boot we do this at a very low customer acquisition cost and at increasingly compelling unit economics as expressed by our N D. Our results.
With that context on the nature of our customer mix.
Let's discuss our Q3 performance levers to drive sustained revenue growth.
That is customer growth net dollar retention and average revenue per customer.
Beginning with customer growth, we ended Q3 with 598000 customers an increase of 7% year over year.
The slight sequential decline from Q2 was the result of our implementing enhanced security protocols to remove certain low value customers from our platform.
Importantly, although these actions reduced reported customer count by roughly 150 basis points. They had no material impact on our reported revenue.
On the contrary revenue growth, our pool and N D are all accelerated and improved sequentially from Q2.
I'm very proud of our team for leading in the era of trust and security, it's vitally important to our customers as they look to us to be the platform to build a relationship and business with their customers.
We are making D O a more robust and secure platform for all of our customers to have confidence on which to build their businesses, while not impacting our ability to accelerate revenue growth.
Next let's focus on the strong improvement we saw a net dollar retention in Q3.
We believe that <unk> is one of the most important gauges of the health of our business and a critical driver of near term and enduring growth potential.
Our 12 month and older cohort of customers in the endear calculation have historically represented over 80% of reported revenue.
So we are very focused on sustaining this improved N E. R. As it is a key pillar to our overall growth acceleration.
In Q3, <unk> was 116%.
As we continue to see customer stay on the platform consume more product and churn less the.
The expansion of existing customer spend and reduce churn combined to drive the improvement in endear in the third quarter.
We have dramatically reduced churn and.
And by keeping more customers on the platform. We are now set up for net expansion to continue to drive and Dr acceleration.
Finally, a key contributor to our strong results in Q3 was 28% year over year improvement in our pool.
As I mentioned earlier, our larger customers are doing well and experiencing their own robust organic growth.
This success not only leads them to consume more deal infrastructure, but also drives then the purchase additional products from us.
Particularly our platform as a service offerings that are well suit suited for these growing smbs.
This dynamic will continue as we broaden our product offering for smbs, creating a stickier customer experience and giving us confidence we can sustain these current levels of growth.
To illustrate just a little over two years ago, we had roughly zero revenue for products outside of our infrastructure as a service.
Yet today, we're at roughly 10% of total revenue.
And solidly on track to achieve our target of 20% of total revenue when we generate our first $1 billion of revenue in a few years.
This is not coming at the expense of growth in our infrastructure revenue, rather our customers inherent organic growth helps increase their infrastructure spend while they also spend more on a relevant platform services.
Turning to our product strategy there were two developments since our last earnings call that we are very excited to highlight today.
First we hired a new chief product officer, who started a few weeks ago Gabe.
Gabe Monroy joined us from Azure and will lead our product development strategy.
Given his expertise and the infrastructure and platform as a service markets and experience, helping significantly scale revenue on those platforms.
We are confident that product innovation will be a much more prominent lever as a component of our growth strategy in the years ahead.
We are excited to have Gabe aboard and look forward to sharing more of our plans for product innovation as we move into 2022.
The second piece of exciting news on the product front occurred with our acquisition of NIM Bella.
This expands our functions as a service or faz offerings SaaS.
Ours is a rapidly growing adjacent market opportunity that complements our ias and paas offerings.
NIM Bela as a cloud native offering that allows developers to build and run applications without having to manage servers delegating that to digital ocean in the background. So they can focus even more on their customers and application development services has been a top five customer request and closely aligns with ours.
Mission to simplify cloud computing and will attract customers focus on increasing their agility and productivity.
Additionally service will be a driver of both N D R and R pool growth as it will create a net new revenue stream as well as increased usage of deals infrastructure services, given the complementary nature of surplus with our other offerings.
Our team is busy integrating them Bella on our platform.
And we're excited to get this product into our customers' hands next year.
In sum we were pleased with the strong momentum with all three of our growth drivers as well as progress on the product front, which we expect to increase as we get into 2022.
These moves continue to give us confidence in our positive trajectory in our and in our ability to sustain topline growth greater than 30% for the balance of 2021 and in 2022.
Next I want to highlight one of our 600000 customers that exemplifies all these growth drivers and action.
That is an SMB customer who has scaled on our platform and is using a breadth of our offerings and as a result their increased spend as it is contributing to our accelerating <unk> and N D. R.
This customer offers advanced training for it security professionals and hackers through Gamify hands on learning experiences, including hacking methodology penetration testing and vulnerability research.
The training is self driven and users advanced by completing a series of challenges where points and rankings her garner by users ability in solving progressively complex scenarios.
Over the last four years, they have grown from three employees to more than 100 and their user base exceeds 750000 platform members representing more than 800 organizations.
Driven by the need for simplicity and performance the customer engage digital ocean.
Their platform was running on a hyper scaler with virtual machines in a relational database.
But their CTO was familiar with digital ocean and appreciated our focus on simplicity community support and are highly performance capability.
They conducted benchmarking test, which confirmed our ability to manage their workloads and migrated them over to digital ocean.
Today, the customer takes full advantage of our product portfolio and runs approximately 95% of their infrastructure on digital ocean.
As they continue to grow they're leveraging our manage kubernetes.
Our database as a service and App platform and their architecture as well.
10% of their overall spend is coming from our platform services and 90%.
From our infrastructure.
Similar to our overall company product mix.
They spend over $220000 in annual run rate today, and that's up from zero since launching our platform just three years ago.
A powerful demonstration of how we help developers in early stage businesses get lift off.
And then ramp up their businesses with our set of relevant products that support their rapid growth.
This is just one example of a customer leveraging digital oceans platform and quickly scaling as they experience rapid growth.
It's a perfect illustration of the customers driving our accelerating revenue and the supporting metrics there.
There are tens of thousands more just like this.
And I look forward to sharing more about others in the quarters ahead.
In summary, the third quarter was strong across the board.
As we are transforming digital ocean into a durable high growth and free cash flow generating business.
A massive $50 billion market growing to over $100 billion in the next few years.
We are confident in our trajectory and we expect a strong finish to this year that will take us into 2022 with a great deal of momentum.
I wish to express my thanks, and gratitude for the hard work of each member of our D. O team who is driving this success.
I'd now like to turn the call over to Bill Sorenson, Our Chief Financial Officer, who will provide details on our Q3 financial results and our updated outlook for the balance of this year.
Thanks, Nancy good morning, everyone and thanks for joining us today to discuss yet another quarter of strong revenue growth and continued acceleration in our key operating metrics.
The initiatives that our management team undertook for this fiscal year are clearly paying off and showing continued traction.
This provides a great foundation for next year as we look to continue to deliver our sustainable and durable, 30% plus revenue growth.
Yes, he covered many of the key points in his remarks, but I'd like to provide some additional detail on the results and the key drivers to our growth.
Following that I will provide our financial outlook before taking your questions.
Management is keenly focused on the three levers of growth that Nancy highlighted which really are the most critical metrics in our monthly dashboard.
Revenue growth, our pool and N D R.
Each of these metrics clearly demonstrate the progress that we have and continued to make.
In the last four quarters, all indicators have shown consistent and meaningful improvement.
For the third quarter revenue grew by more than 37% up from 35% growth in Q2 and up over a thousand basis points from last year, when we grew 24%.
Our <unk> was $61 97 up 28% year over year and up from $58.07 just last quarter.
And N D or continues to grow we averaged 116% in Q3 up from 113% just last quarter.
These results clearly reflect the strength of our offering in both infrastructure and managed services, giving our customers easy access to the tools and technology that they need to grow their business.
What is particularly exciting for us is the growth we see in our larger customers those who spend multiples of our average ARPA and many of whom consume several of our products.
Investors have heard us discuss this trend before but as these consumers consume more of our managed service products and database and kubernetes. They in turn consume more of our core infrastructure product as well.
These customers are spending more expanding at a faster rate.
Our churning substantially less than our average customers.
And with the development of additional offerings, such as App platform Mongo DB and the future launch of our recently acquired service offering them Bella, we see the opportunity for further growth.
This trend is driving healthy growth in our pool and as importantly M. D. R. Because as these customers grow and expand with us they stay with us driving the expansion side of the N D, our equation and reducing the churn side.
And that was clearly evident in the third quarter as N D or accelerated further to 116%.
This was a 300 basis point improvement from Q2 and is a critical component for durable, 30% plus revenue growth we're.
We're seeing this uplift in N D are coming from a combination of net dollar expansion and a reduction of overall churn, particularly in the larger customers I just mentioned.
While we remain focused on the customer and their experience. We've also continued to focus on further improvements in terms of profitability and capital efficiency, while at the same time investing for the future to capitalize on the large growth opportunity in front of us.
Cost control along with a focus on return on investment has allowed us to maintain adjusted EBITDA margins above 30%.
In Q3, adjusted EBITDA reached 33% due to our revenue and gross margin over performance.
But we expect that will moderate in Q4.
We will continue to invest across our business focusing on new customer acquisition, both from self serve and increasingly through direct sales.
In Onboarding and customer support and finally in new product development.
One item to note is that during the quarter, we were able to release of that liability of $3 $2 million.
The elimination of this reserve increased operating income in the quarter, but is excluded from the adjusted EBITDA calculation.
This reserve was established over three years ago and after discussions with European tax authorities. It was determined that no additional liability was outstanding.
Also during the quarter as part of our ongoing security best practices, we removed a number of low value customers from the platform, which slightly reduced total billable customers.
Our security measures have allowed digital ocean to achieve a meaningful reduction in bad debt, while improving the value and quality of our customers overall as reflected in our continued growth in our proven and D. R.
Customer growth is continuing in Q4 with early indications that recent investments in paid advertising a refreshed brand campaign and the introduction of additional payment options are accelerating customer acquisitions.
Given our improved operating performance, we've been accelerating investments this year in order to get ahead of 'twenty two.
By investing in people as well as the systems needed to support our growth we want to hit the ground running for fiscal 2022.
As noted adjusted EBITDA in Q3 came in slightly above plan at 33%.
For Q4, we anticipate that increased hiring will result in an EBITDA of approximately 31% in line with our initial guidance.
Finally, we continue to invest in capex to support our growth and as importantly to upgrade our existing fleet.
For 2021, we're planning for Capex to be between 25, and 26% of revenue consistent with the guidance we provided at the beginning of the year.
In Q3, Capex represented 24% of revenue or $26 3 million.
This was a significant improvement from Q3 of 2020, where capex was 32% of revenue.
This summer is slightly lower than our guidance for the full year as a result of some shipment delays, which have since been rectified.
It is important to note that in 2020, one we will have invested $100 million in our global infrastructure footprint.
We've made material investments to support our rapid growth, while also modernizing our existing fleet.
Fleet modernization combined with the optimization of our infrastructure architecture is increasing our return on investment as these efforts increase the revenue generating capability per server.
Our disciplined and ongoing investment in infrastructure, However has not reduced our commitment to generating cash flow in the quarter digital lotion generated just over $40 million in cash flow from operations, 36% of revenues, which is up more than 70% year over year.
Now I'd like to provide our Q4 and full year outlook.
For the fourth quarter, we expect revenue to be in the range of $117 million to $119 million.
We expect adjusted EBITDA margin to be in the range of 30% to 31%.
For the full year, we expect revenue to be in the range of $426 million to $428 million.
We expect adjusted EBITDA margin to be in the range of 30% to 31%.
We expect capex as a percentage of revenue to be between 25 and 26%.
Our forecasted results for 2021 provides a great foundation for 'twenty two.
At this time, we're targeting approximately 31% growth for fiscal 2022.
In closing I want to remind investors that digital ocean is well positioned to take advantage of the exciting and large opportunity. We have ahead of us.
We have a product offering that is delighting SMB customers in virtually every country in the world.
We have a brand name that is recognized and respected and we're a major player in the fast growing global developer community.
That along with improving profitability, increasing cash flow combined with no debt.
With all of this we intend to further expand our product set and pursue aggressive growth.
That concludes my remarks, and now let's turn it over to Q&A.
Thanks, Bill and thank you for joining us today as we go over these strong Q3 results, where we saw acceleration across the board.
As our process. We've asked for some questions ahead of time, which will address some thematic issues and then we will open up.
Q&A with the operator.
The first question today came from Tim Moran at Oppenheimer and he asks is there. Some color you can provide on the small competitor landscape how.
How many companies have a focus on your niche and are they catching up with you are falling behind.
At this point in time.
Great. Thank you. The next question came from Brad Rebeck at Stifel and he asked are there any supply chain constraints to purchasing new capex.
This is bill Sorenson good morning, everyone.
As we've talked about repeatedly we take a view for the next six to eight quarters in terms of our requirements for both.
Investing in growth as well as upgrading our overall fleet.
We did reference that we had a slight delay in one of the projects. We had scheduled for this year, which meant that our capex in Q3 was a little bit lower but across the board we have not experienced any material delays and again, because we plan. So far in advance we feel that we're in very good position relative to what our needs.
We are mindful of constraints that are being suffered by a number of industries were in pretty regular conversation with our major suppliers, we give them visibility into what our ongoing requirements are going to be again with that six to eight quarter type horizon.
So given that visibility that they have with us we think it puts us in a pretty good position that if they do indeed experienced any potential delays were well ahead of that and we can adjust accordingly, so feel like we're in a very good position.
We're never want to be in a spot it will not be in a spot where we are caught out relative to meeting the accelerating growth that we're experiencing.
We will continue to invest their as we move forward.
Thank you. The next question comes from Pat Walraven, JMP Securities and he asked can you talk about the hiring of your new cheap product officer gave monroy, what about his background stood outmost and what does he bring to the table how might this change the product strategy if at all.
Thanks, Pat while we're excited to have Dave aboard.
He's a builder.
An entrepreneur started the company was able to sell it to Azure and then.
Stated Azure and has had significant success.
And leading teams there.
Leading product and.
Building, a really large business sort of on the same trajectory that we're on.
Understands developer and that migration that journey that developers take to start a business and then scale and so we're excited about the relevant experience and the scale.
And we're just camping pull her delighted to have him come in here with.
With a very strong point of view already on our marketplace, our customer base our market opportunity.
And we'll there'll be responsible for helping us to lay out the product roadmap ahead, the priorities and we look forward to sharing that with you all as we get into next year, but.
We ran out we ran a search we had an incredible amount of people interested in the role which is particularly exciting.
As a validation of where we're taking our business and.
I think gave is going to be an intrepid incredible.
Driver of value for our customers and our investors over the next several years.
Thank you and the next question came from Michael tourists at Keybanc and he asked investors are still trying to understand how customers evolve and grow with digital Ocean could you help us understand how as they grow mature and have more requirements. How old is deals support those customers.
Do you ever see customers as they become larger either move existing workloads or add net new workloads to one of the major public cloud vendors.
Thanks, Michael we we have this unique ecosystem, where we attract.
Tens of thousands of customers every month, who are just here to test test ideas Tesco learn how to code.
Learn and grow as developers and entrepreneurs.
We have a very low acquisition cost very low friction to get those customers here generate nearly 5 million visitors to our website, where seeking to read our tutorials and other documentation.
And they.
They say come here they test they learn that could be here for a month two months eight months and the last earnings call. We gave an example of a customer who was doing that for five years before they launched their business and then we have that unique ability to support their scale.
As they go from zero customers to 10 customers thousands of customers et cetera.
And what the infrastructure scales, we have a global network of infrastructure services that support their needs.
And then increasingly with our.
Manage databases are managed coover natalie's, our app platform soon to be our service our marketplace, we have incremental applications that as their workflows of all their customers grow their product sets grow their geography's grow their number of employees grow.
We have incremental tools and services in the software platform side that enable us to grow with them and the example of the customer we just cited.
Is a powerful demonstration of how we can serve those customers on their journey and we're really excited about the opportunity to do that and that's driving our Pooh that's driving our net dollar retention and that's those customers are driving our revenue growth and at the front and we have this.
Engine, that's fueling longterm revenue growth by having customers come here in a very low friction low cost way and and then we can nurture those customers over time.
Thank you. The next question comes from Wamsley Mine and Bank of America, and he asked year growth has been accelerating well beyond 25% over the last few years now over 10 points better than that can you talk about the drivers of growth is a function of one.
<unk> penetrated you are in the target customer base and to opportunity to drive blended asp's double digits.
Thanks, <unk>, well first and foremost for playing in a massive market. There are 30 million software developers go into $50 million by the end of this decade is 100 million small medium sized businesses in the world today 14 million new added each year collectively those groups spend.
Out $50 billion in the cloud today and that is heading to $120 billion by 2024, so a massive market opportunities and given our penetration 600000 customers roughly $450 million a run rate.
We're really early in the journey here and the opportunity in terms of penetration and our go to market strategies in our product strategies are designed to help us catch at.
It really high growth rates at Great unit economics.
And to sustain better than a double digit.
Revenue growth per customer at really strong expansion net of churn rates expressed it N D R and a robust customer growth.
Right over time, so we're early.
And we've made a lot of progress in improving the core metrics and the attractiveness of our business in terms of growth rates in terms of the unit economics on <unk>, and then the or operating margin free cash flow and and we just have an incredible sea of opportunity ahead of us so early in the opportunity and <unk>.
Excited and well positioned to go.
Wrap a big chunk of that and again, we've said we're on track for that first 1 billion revenue by 2024, and CFC of opportunity beyond that as well.
Excellent and the last question, we have before we open up the line is from Ramo Lynch L at Barclays.
Asked you pricing has consistently been cheaper than Amazon light sale and Microsoft Azure, how can you afford to keep prices lower given the scale advantages the hyperscale cloud providers offer.
Is lower pricing the primary reason and SNB chooses dlcs over the Hyperscales providers.
Thanks, where I am.
We have a really highly differentiated setup.
Capabilities, but the the primary reason our customers come and stay with us is because of the simplicity.
Just in the time, we've been on this earnings call you could be up and running as a customer it's easy simple intuitive even as we add more products and services the nature of our offerings Simplicities foundational, which for an early stage small business is incredibly valuable. They don't have teams of people to get up and running with it solutions.
Needs to be easy.
Our community investment.
We have tens of thousands of tutorials digital pieces of documentation that drives millions of people to our website, we help people learn and grow.
Whether they're a big customer today or somebody just on their journey to be coming a big launching a business. We help enable our customers success I think thats foundational to the value proposition third we give support.
Human support to every customer regardless of size, that's highly differentiated from many of the other alternatives out there were all open source. We facilitate open source. We just concluded October fest, the largest hackathon in the world 150000, plus people in virtually every country.
In a room participate we evangelize open source software is a force multiplier for early stage entrepreneurs too.
<unk> code and launch businesses at a low cost improve their velocity. So we are ecosystem helps few.
Fuel and enable entrepreneurs so those differentiation and then we offer a set of relevant services.
Not innovating for the broad breath.
Complexity of enterprise, we are targeting simplicity the basic tool.
Fuels and building blocks that our customers need and.
And so that enables us to do that as a compelling value, but it's simplicity and community or support model and the fact that we are able to we have annualize.
Open source those principles of differentiation or why people come stay and grow on digital Ocean.
Great. Thank you very much and Ah.
Paul if you could.
Open up the lines for instructions and Q&A, we'd appreciate that.
<unk>. Thank you to all participants if you would like to ask a question. Please do sell my paintings are one on your telephone keypad again.
<unk> one on your telephone keypad.
However, if your question has been asked me you wish to remove yourself from the queue. Please press the pound key standby, what we compiled kunai roster.
Your first question is from the line of Mark Murphy with J P. Morgan Your line is open.
Thank you very much.
And then.
Alright.
So.
Mark we cannot hear you.
Paul It sounds like they have a problem maybe with their connection when we go to the next question and then get back in the queue.
Definitely.
Two Mister Murphy. Please press star one again in order for you to ask a question.
Our next question is from Djing Hind Smith.
Canaccord your line he says.
Hey, good morning, guys. Thanks for taking my questions.
Yeah, I want to put a finer point on the customer accounts dynamics, that's where I'm getting some questions. This morning. So you mentioned 150 basis point headwind to customer accounts based on the enhanced security protocols you put in place. If my math is right. That's about 8400 customers that were turned off the platform maybe just talk about what the issue was with those customers.
Was this a one time, saying can we see more impacted in queue for it and then I have a follow up.
The the nature of why we did that and you know the Internet is a place where people come to do good things and people come to do bad things and so we have to constantly monitor our platform.
For customer activity.
We took the opportunity to increase some dials in Q3 that led to a number of customers.
First month customers, so not basically no revenue impact, but a customer count issue.
We don't change our journals every day, but we do periodically assess what's happening in.
And the Internet and the world in general and on our platform and we we routinely will exit people I'd say in.
We exit many customers a month normally this was a little bit higher because we did change of protocols.
We will change some of the market below locations. We go to get people Bill referenced some of that in his remarks, and we expect to to lap this relatively soon.
We're off to a really good start in terms of growth, we put some new initiatives in place to broaden the customer set. So this is part of what it takes to to run a business that is.
Running on the Internet.
And we.
We feel excited about the fact that we are taking a proactive stance.
Because trust is fundamentally what we sell.
Other people come here to just tested idea or to build a business. They have to have trust that the platform is going to be secure their IP reputations will be intact and.
And that requires us to manage the customer base.
Of certain types of customers.
Who would come to the Internet come to Dio to do things that we don't want them to be doing.
Okay. It makes sense that the follow up would be like.
Even if we normalize for that change.
I get net new customer adds that are kind of below the run rate, we've seen over the last year or so and again I realize.
Customer ads are not the relevant metric are often these customers, but but folks pay attention as matrix. So.
Maybe just talk a little bit.
About what you're seeing in terms of top of the funnel and conversion and maybe you could bridge that's kind of what your expectations are for Q4, I think there was a common in there that mentioned some potential acceleration anything along those lines would be helpful.
Yeah. So first let me say, we've talked previously about a 10% customer annualized customer growth.
Holding to that target.
Obviously, we've made some changes near term, but we think that as we get into next year, we should start to see acceleration of customer growth our top a funnel.
Is healthy.
And we're working a lot on driving conversion.
As we get through the funnel, we make all sorts of changes to the customer experience the customer journey, obviously, adding products.
Adding payment options, we as we did this quarter helps to improve mid funnel conversion. So no change in the thesis again, we we.
We increased some of the dials that increase the number of people.
Removed from the platform, but every month, we will remove quite a few customers off the platform. They don't tend to impact revenue, it's a customer count issue and I focus you on our poop.
And net dollar retention, our retention and expansion metrics.
In terms of where they are today vs, where they were a quarter ago are certainly a year or two ago have seen tremendous.
Improvement and that's through our nurturing the customer experience in that.
And their journey as they come first day customer over and over the life of the customer that's what drives the economics of the near term, it's metallo retention and and <unk>. What we've always said was a customer growth as a longer term indicator of the health of the business because of the nature of us, bringing so many customers in the self serve.
Tens of thousands of months and many of them start small and they are testing they're learning their growing we nurture them over time.
And over time one.
One or more of those each day will will launch a business that scales and then we support that scale.
And so it is a longer term indicator longer term, we're confident we can sustain get too and then sustain a 10% customer growth and and in the near term you would look to endear in our food to support near term revenue growth and revenue results.
If I could just give you a call.
DJ just one data point is it's early in the quarter.
Our first month is is really consistent with what we've been seeing historically over the last three or four quarters. So.
We're really some of these anti mentioned, particularly around the payment methodologies that were opening up for some of the developing economies is certainly starting to help so.
We feel good about that.
Great. Thanks, Thanks for the call again.
Your next question is from the line of Michael.
Keybanc queue line you something.
Hey, guys. So a couple of things first of all first of all.
Maybe a billion dollars you can you be specific at all about what kind of minutes. We should expect next quarter I mean have you.
Follow up and the laws are you done with this.
Let's call involuntary Chen.
Well, what I would say is the last couple of quarters, we've been about 89% customer growth annualized.
This quarter, 7% net of 150 basis point impact so.
In the near term, we're going to lap this.
And start to ramp as we get through this quarter and into next year and again, we expect too.
Get back to or get too and then sustain a 10% annualized year over year customer growth. So you should see customers ramping this quarter.
Off of the bounce off of last quarter and.
And we will take that into next year and we feel very good about what we're doing both top and bottom of funnel, what we're doing on direct sales inside sales and outbound sales.
What we're doing on the product side to attract customers et cetera, and again.
28% <unk> growth and neck dollar retention of 116%.
I would remind you that was in the low hundreds just this time last year. So we are nurturing customers were driving expansion we're fulfilling.
A much higher level of customer support and success with them today, that's driving the cohort.
And we still grew customers, 7% year over year despite.
Increasing the dials.
Last quarter and feel confident we will get back to 10% or get to 10% and then sustain it to.
So you should start seeing us ramp from Q3 back.
Back to where we were in recent quarters, and then get above that hump at 10% and sustaining.
Okay, and then my pop is about.
Estimate.
You talked about investing for the opportunity and reference that in fact, the people ask you could you be spending more I mean, you're in the game.
Roughly 10% range sales and marketing margin in question is critical higher than I think most recently sounded like it was pretty stable near so what are your expectations I'd.
As soon as we get into next year for that sales and marketing margin.
Yeah, well at this growth rate sales and marketing spending growth 37%.
And and still stay at 10% of revenue.
So we are investing heavily in sales and market, we'd love to invest ahead of revenue growth.
Meaning at a faster rate the revenue growth, we constantly talking about that as a as an executive team where are the opportunities and and we evaluate them. So we are biased towards growing faster. We don't think we're done at 37% growth can do better.
We're investing to do so both on the go to market sales and marketing side and the product side and so.
We have a bias too too we have a lot of room from 10% of revenue to go higher if you look at other players in our sector and we look to do so so we like the fact that we have strong EBITDA margins and we're generating free cash flow at this growth rate.
We're going to generate cash flow because that's our philosophy, but.
But at the same time, we don't need to peg the needle on free cash flow and EBITDA today, we're looking to invest some of that when we can to drive and accelerating and sustained and a higher growth rate, that's our bias and that will continue to be our bias. Thanks.
Thanks Nancy.
Your next question is from the line of one female hand with Bank of America. Your line is open.
Yes. Thank you you're you're <unk> growth was was very strong in the quarter and I think in your palm and she noted that the increase in our food.
There was a significant contribution obviously from a larger customers.
Any way to disaggregate, how much of those are both worlds came from the the 15% of the customer base, that's driving the 85% of offer Avenue.
Sort of how much is coming from from the remaining.
And what are what are some of the underlying.
Product.
Option trends more.
Usage or is it more sort of.
Increased.
Usually just like higher configurations.
What is sort of the underlying trend that you're seeing within those customers.
So.
So I think a couple of points.
When you look at those that 15% of our logo customers that represent about 85%.
Our revenue growth there, so they're growing substantially faster than the company total that 37%.
The customer growth is growing substantially higher than the 7% several multiples higher than the 7% annualized run right. So we're adding more of those customers their customers are moving through our ecosystem and scaling and launching businesses and then they rapidly grow their revenue per customer. So they have organic growth just the <unk>.
Natural if you think about our business getting launched it goes from 100 Grand a 500000 1 million to 2 million to 3 million to $5 million not big numbers in aggregate, but huge percentage growth will that say indicated that they are using more infrastructure as a service just because they are added customers are adding.
Products et cetera around the world and then as they are adding employees and those customers. They need other services they need to have more deployment tools. For example, as they add more people that write software. So they use an app platform. They use akubra natty civilians are serverless.
Capabilities, they need to manage the ecosystem of those customers annulment is targeting et cetera, they need databases.
We have other tools in our marketplace that they're able to leverage so that has.
And software as a service that now represents 10% is allows customers that they ramp on our platform to have more things to do with digital Ocean and then they have a floor on that just strong organic growth because they have organic growth and that.
Synergy between the infrastructure of the service and the platform of services that were growing platform is a service software services at the expense.
As a as a black rose that grows very robustly because of that organic growth and those that small cohort of customers. That's growing we're adding to those because every month somebody graduates on our platform from a two first the developer team to launching a business and then they scale rapidly and and that's what's <unk>.
Driving our food growth. So there's a floor on <unk> just from the natural organic growth of are rapidly scaling smbs and then we're able to turbocharge that are <unk> by giving them more products and services on the platform and that's why product strategy. So integral to sustaining these rapid rates of.
Growth that we're now demonstrating.
Okay. Thanks Shanty and can you also talk about and then Bell acquisition, you said several lessons top five customer request.
Conceptually what percent of your user base is asking for this are likely to utilize this and I'll order some of the other top customer requests. Thank you.
What I would say is an umbrella represents this generic theme around the.
Simplifying software development at making it more application Configurable App platform was.
A product that we launched a year ago that fits in that category. We we have a low number of our customers who want this flexibility they want the functions capability and.
I'll give you. Another example of Mongo was another top requests for our customers that we launched earlier this year, so you're seeing us be much more responsive to customer needs for scaling on our platform we.
Two months into the Indian Bella integration is going very well if we're really excited to have the team on board.
And we're really excited to get this product and into our customers hands as we get into next year. We think that server lists will be a core pillar of our platform is service.
Capabilities like Coover Daddies and.
Unlike our manage databases and we have a lot of expectation that's going to contribute meaningful the growth is that product search of getting the customer hands.
And the first half of next year.
Thank you so much.
And your last question is from the line of right Malvin shall with Barclays. Your line easily.
Thank you one quick question and one more longer one quick one full bill if you if you look at the <unk>.
The same level as last quarter and you mentioned some reason for that could you just kind of go into a little bit more detailed there and then put <unk>. If you think about the product expansions that you talk about like at the moment that you seem only at the very beginning of that journey with like Mongol with several this et cetera like how do you think that this will play out.
The next few years, because if I look at the portfolio from like an EW <unk> by now like more.
Tens and hundreds of different versions you don't Wanna go that far because you kind of create too much complexity, but what you have at the moment seems like it very very beginning of the journey to kind of differentiate your product more thank.
Thank you for that and congrats on a great numbers.
Okay clicked on the E R.
Remember Rainbow this as a monthly number so it's taking a look at September we had a very strong September last year.
You had a number of.
Improvements relative to the offerings to customers that basically improves our actual pricing per tier in a way we eliminate some tears and effectively what we saw was that customers were purchasing up so that was very very beneficial for us. So so were lapping that we would expect that number is going to be celebrating.
With revenue as we move forward, but it is a monthly count.
And so just a lap against a very good September a year ago.
So in terms of the longer term.
Issue around our product strategy, which I'm really excited.
To have gave here.
Coming up to speed and sort of looking at the landscape.
What you said Ramos first off and foremost is so critical at the forefront of our thinking is simplicity. So we will add relevant features to existing capabilities.
Both on the infrastructure in our platform and software services and new capabilities to the platform will do so in a way that makes them relevant and creates and ensures that simplicity is embedded across.
And because of our customers are early in their journey. These are customers smbs less fewer than 500 employees.
We're talking about businesses tens of millions, maybe as much as $100 million of revenue.
They have a much narrower set much.
More simplistic set of use cases.
The overlap of those use cases is high whereas in the enterprise yours every almost every new customers a corner case, and you're customizing and that's how the comparable products that become so complex on the contrary with us.
Customers go from $1 million of revenue to $2 million revenue and they add more customers. They just need a database service can't use an excel spreadsheet to target their customers anymore and so they all need a database.
And so I think with that theme of their early in their journey.
The level of complexity is nowhere near what and enterprises. It makes our innovation strategy much easier because even when we add a database capability or service. It doesn't have to have the depth of complexity.
Because our customers are so early and they crave simplicity, so simplicity will be we've without having said that there's more innovation. We can do and we're very focused on that and look forward to talking more concretely about our plans.
As we get into next year.
And we've demonstrated depth, adding relevant capabilities to the platform, we've gone from zero to 10% of revenue which is.
Very rapid growth with databases.
With the <unk> with that platform in our marketplace.
Just in the last two years and so we're looking to replicate that.
Over the next several years and that will be a strong incredibly strong pillar.
To buttress growth rates that you're seeing now and sustaining those over time.
Yep, Thank you well.
And that completes the question and answer session for the call I will now hand conference back to <unk> for.
I want to thank everybody for joining us today as you can tell we are incredibly excited about our results and about the opportunity.
In front of us.
We look forward to continuing this conversation in the weeks months and years ahead, and we're working incredibly hard to realize the limitless potential here digital ocean and it's a potential it's driven by enabling developers and entrepreneurs to test their ideas build their businesses and <unk>.
Realize their dreams have a great rest of the day.
This concludes today's conference call. Thank you for joining you may now can I.
Have a great day.
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