Q2 2022 DigitalOcean Holdings Inc Earnings Call

Another point to make is that we build our customers and they pay us in U S dollars.

Although we don't have a direct way to tie FX impacts to our revenue we can't ignore the likely headwinds on our customers' businesses due to the significant strengthening of the U S. Dollar in the first half of 2022.

We added nearly 3000 high spend customers that are spending more than $50 per month.

In total they now number just over 105000 and generate 85% of total revenue, which is up 300 basis points from a year ago.

Importantly revenue from this cohort of customers grew 34% year over year, continuing to pull up our overall growth rate.

Despite the weaker environment in the quarter revenue from these customers is growing significantly faster than GDP and the markets in which we operate.

As we move through Q2, we managed our business prudently.

We slimmed, our spending to focus on our critical few initiatives that we expect to have the greatest impact on growth.

Delivered on operational improvements that drove efficiencies and put our procurement engine into full gear driving Florida their leverage in core areas of third party spend.

These focus areas will pay dividends well beyond the near term economic challenges driving operating leverage as we continue our progress to 20% are free to hit better free cash flow margins as we achieve our first $1 billion of revenue.

The results of our managing spend where strong operating margins of 17% of revenue.

We also demonstrated the powerful cash generation capabilities of the of the company in the quarter with free cash flow that was 10% of revenue.

Given this period of uncertainty, we will be very cautious in adding new spend and we will prioritize delivering strong margins and free cash flow until we have better clarity about the growth outlook.

The key takeaway from our Q2 results is that in a challenging environment. We deal we delivered a solid top line and continued accelerating margins and free cash flow.

One last thing about Q2.

You've now bought approximately $15 5 million shares back since our March 2021 IPO.

No mistake, they make no mistake, we are principally focused on investing to drive revenue growth while.

While generating meaningful free cash leverage.

However, we are also focused on doing so with an efficient balance sheet that provides flexibility to achieve our long term strategic goals.

While also honoring our deep commitment for driving value for our shareholders.

Driving significant leverage to earnings and free cash flow, while maximizing shareholder value are highly compatible goals and this is how we will always run this business.

Okay.

As we shared at our Investor Day in June we have a number of growth initiatives that help us achieve our higher revenue outlook for 2022, despite the macroeconomic challenges.

To share some insights into each of them now.

Beginning with the pricing changes that we announced in May and that went into effect last month.

We are already seeing meaningful impact to date in Q3.

A few early indicators of the impact of our recent changes to pricing first.

Since the announcement and since July one effective date for new pricing, we have been we have seen dramatically lower churn.

We accounted for in our base case and that new customer acquisition has been unaffected.

Second downgrades to our four dollar droplet remained modest and much less than anticipated with roughly half of new $4 drop whats being used in complement.

With the new six dollar droplets.

Finally, our large customer usage and three.

Remain in line with historical averages with exception of the prior mentioned a blockchain customers.

I'm excited about these pricing changes they have created a new dialogue with our customers and the broader market that clarifies our value proposition.

That is to say, we offer a highly performing cloud computing platform with simplicity community support.

Our commitment to open source software is core differentiators, enabling a great customer experience and.

And our service.

<unk> value price when factoring what you'd get versus what it costs.

Our platform is tailor made to serve the $70 billion F&B and developer cloud market.

Next we continue to see strong results from our sales investments.

We mentioned in May in Q1, we exceeded our plan nicely and we're pleased to see that trend continue in the second quarter with average <unk> in Q2 deals just below $20000.

Which is up approximately 50% year over year.

Obviously this is highly accretive to our total company or <unk> and with the continued progress we are making in Q2, we prioritize additional investment to continue to drive growth acceleration through our sales channels.

We remain confident that accelerating growth from our sales channels is on track as it represented 5% of total revenue in Q2 up from just over 3% of revenue in the first quarter.

Finally, we continue to make investments to drive our top of funnel of customer acquisition.

In June we acquired the website journal depth.

Developer Rich resource has tutorial contact for Java, and Python, along with other web development frameworks.

Content from Journal Deb will soon be found at our community site, where millions of learners visit monthly defined quality content from a source. They trust, we're thrilled to expand the breadth of our content offering to help even more developers benefit and continue building a community that leads to highly efficient customer acquisition.

I want to make a critical point regarding the efficiency of our go to market model.

Let's look at the payback period for customer acquisition.

Using Q1, 2022, non-GAAP sales and marketing expense of $15 7 million and net new <unk> in Q2 of $25 million.

Combined with improving gross margins to 65% of revenue.

We're paying back our customer acquisition costs and just in less than six months.

And that's happening while we are ramping spend to build our sales capabilities.

This efficiency is paramount and our ability to sustain our revenue growth targets and drive margins higher over the course of not just this year.

But for years to come.

The next area of growth as our investments in product.

Digital Ocean functions was launched in May and represents our new service offerings as.

As we've shared previously server list as a high growth adjacency that is well suited alongside our Ias and Paas suite and a capability there has been a top request of our customers.

Customers have been adopting functions capabilities at an encouraging rate and through the second quarter. We saw strong traction as more than 3300 customer accounts are using functions.

Which collectively have more than 20 million activations that is how many times a function is invoked.

We are pleased with the adoption and feedback so far.

Function should help us deliver against our second half targets, while propelling greater customer acquisition ARPA growth and net expansion within MBR.

Over the past few years through investments and paths capabilities. This portion of our business now represents 18% of total revenue.

We have a number of additional product initiatives that we expect to launch over the next year that will enhance the value of our platform, giving our customers more applications that can run with us.

This removes friction in that process as they can have a more seamless experience building and managing their applications.

This has been a significant source of <unk> growth, we've seen in recent years and we expect that to continue as we scale to our first $1 billion of revenue and <unk>.

2024.

Yeah.

In summary, I'm proud of our team and the commitment to serving our customers to help them weather the storm in Q2.

We're able to deliver strong financial results. Despite many headwinds and that's a testament to the strength and resilience of our business.

And a powerful demonstration of the durability of our value proposition within the $70 billion segment of the cloud market we serve.

We are excited about the path forward from here and have a number of growth levers that we're pulling to deliver growth sustainably.

Sustainable, 30% or better for.

For the second half and full year, while also delivering significant margin and free cash flow leverage.

Yeah.

Today, we announced that our CFO Bill Sorenson, who will be retiring in 12 months.

I wanted to express my highest gratitude for Bill who came out of retirement to take the CFO role at digital auction.

He has been an incredible partner to me and our leadership team.

As we've refreshed our company to be a high growth and free cash flow in company we.

We are well capitalized with over $1 2 billion in liquidity we.

We have transitioned from a privately held to publicly traded shareholder base.

And we are now set up for the next phase of profitable growth on our March to our first $1 billion in.

In revenue and beyond Bill has built a team and served as a coach and mentor to many including me.

I also want to express thanks to Bill for working proactively with me on this plan.

Especially we can have a smooth transition to our new CFO the hiring process for which begins now.

As leaders of organizations for the long haul orderly transitions, our critical role in aspect of our job and I'm proud we are demonstrating this now.

With that I'd like to now turn the call over to Bill our Chief Financial Officer, who will provide details on our financial results in Q2.

And our updated outlook for Q3 and the full year.

Thank you Nancy.

And thanks for those kind words.

Hello, everybody and good afternoon. Thanks.

Thanks for joining us today to review our second quarter results.

As Ian mentioned Q2 was not without its challenges for digital Ocean clearly illustrated the operational leverage inherent in the business.

Potential material cash generation and the opportunity for further acceleration in our revenue growth.

While we met our revenue guidance targets in uncertain markets digital Ocean was able to soundly beat all of its key financial operating metrics to gross margin non-GAAP op income free cash flow and earnings per share.

Andy covered many of the key operational highlights in the quarter and the growth investments, we're making I'd like to focus on how we were able to drive improvements in our profitability and cash flow before providing our outlook for the rest of the year and taking your questions.

In the second quarter revenue grew by 29% at the midpoint of our guidance excluding those countries directly involved in the cream conflict would have led to a slight improvement in growth rates and while north American held up with growth rates similar to last year at around 30%, we saw slower growth in Europe , and Asia versus what we've seen.

The previous several quarters.

Looking under the Hood, we see the dollar churn in these regions remains stable, but it is the expansion rate of our customers that has slowed so customers are staying and still growing nicely on our platform, but adjusting their spend levels somewhat as they are cautious in managing their businesses as well and even with these trends <unk> is still.

Growing greater than 20%.

Net dollar retention in Q2 declined to 112%, which compares to $1 13 in the year ago period and was down from $1 17 in Q1.

<unk> was impacted by several factors slowing expansion and our customers that I just referenced the conflict in eastern Europe , and the impact of a new product launch in Q2 of 'twenty, one which created a tough compare to last year's quarterly results.

Q2, 'twenty to Mark the anniversary of our first quarter with premium droplet revenue, which as you may recall is a high performance offering that we introduced early in 'twenty one.

Dance chip product enjoyed strong adoption last year and contributed to both MTR in ARPA growth from Q2 last year right through Q1 of this year.

Additionally, we have begun to see declines in revenue from blockchain customers around the world from their previous highs.

I'll reiterate e&ps remarks by mentioning that our expectation is for these metrics to improve in the second half of this year based on the growth initiatives that are detailed in our new pricing model, our expanded sales capabilities and the growth in our funnel.

As we began Q2, we tempered our guidance and outlook for that quarter as economic headwinds were clearly blowing in the war in eastern Europe was disrupting not only the combatants, but other countries as well.

Given that outcome management reviewed all of our ongoing investments with a focus on our most critical investment growth theory.

That prioritization helped us exceed both our non-GAAP operating income and free cash flow targets.

As we've repeatedly discussed we continue to see leverage opportunities in our business in Q2, clearly exemplified deck.

Let me provide some more detail starting with gross margin.

Gross margin was very strong in the quarter as we delivered 65% on a GAAP basis up 700 basis points year over year from 58% in Q2 of 21 seven.

Several initiatives led to this improvement starting with our efforts to reduce the cost of our hardware, which we've detailed to you in the past and which has led to a decline in our depreciation and amortization in each of the last three years digital Ocean has purchased over $100 million.

Of technology hardware, making us a valuable customer to the worlds hardware manufacturers. Similarly, as a cloud platform with customers in 185 countries. We are a valued partner to data center operators as well to that and we've been working with our co location partners to match, our pricing to the scope of our relationship and our future.

Growth trajectory, which has led to rate savings.

We pursued a similar strategy with all of our suppliers not only the server manufacturers, but all ancillary equipment as well and the maintenance suppliers are best network in each of these areas. We've achieved savings do we see the opportunity for additional savings in the future with these enhancements along with our forthcoming planned initiatives.

We are targeting gross margins of 65% for the full year, which would be a 500 basis point improvement from 2021 as we go into 2023, we see continued improvement ahead for gross margin, even as we expand our network into other territories, which we will detail for you in future quarters.

Another financial highlight in the quarter was non-GAAP operating profit as you would imagine and improvement in gross margins would lead to improvements in operating margins as well, but at the same time, our management team made the decision to be very disciplined with our spending to ensure delivery on our financial goals and demonstrate the leverage the results were impressive.

As we've delivered a record non-GAAP operating margin of 17% up from 9% in Q2 of 'twenty, one and well above the guidance we provided in may.

This was achieved at the same time that we launched our new service product digital Ocean functions and continued our investments in our growing sales team both part of a multi pronged strategy to drive faster revenue growth and increased cash flow generation.

Aided by an improving gross margin along with more efficient marketing spend lower bad debt and real estate expenses and disciplined hiring we exceeded our financial targets given.

Given the silver deliveries, we're raising our profitability expectations for the year, which I will get to momentarily.

Next I want to highlight that we generated substantial free cash flow in the quarter showcasing our efficiency even during a period, where we were investing in our new data center that we will be opening in Australia. In Q4. This year, even with that investment we generated more than $13 million of free cash flow represented 10% of revenue.

Given our strong first half free cash flow generation and our expectations for our pricing strategy to be a tailwind to both margin and free cash flow in the back half of the year will be raising our outlook for this metric and investors should be confident in our trajectory towards free cash flow target of 20% as we continue our.

Turning towards $1 billion of revenue in 2024.

Finally, I want to touch on earnings per share that came in at 20, <unk>, which was 10 times higher than the high end of our outlook. It may and double consensus estimates on the street.

Higher margins were one factor that helped US. This result, but another driver was the previously announced buybacks.

Year to date digital auction have spent $550 million repurchasing our shares at an average price of $43 83 per share simply put we believe that we have the opportunity to repurchase shares at a substantial discount to the net present value of our strategy and that we have sufficient capital remaining.

On our balance sheet to invest in growth opportunities.

Based on that our board of directors approved to $300 million authorization. This year and we deployed the capital Accordingly today, we have $50 million remaining on our existing authorization with the repurchase of $12 5 million shares. This year. We've made an important reduction in our outstanding shares and providing a material benefit for growth in earnings per share.

And free cash flow per share year over year in 'twenty, two as well as 2023.

As I said earlier in my remarks, Q2 was not without its challenges, but we made material progress in our financial operating goals, while at the same time investing in our growth initiatives with those initiatives underway in the launch of our new pricing strategy. We expect further improvement in our operating metrics in the back half of the year.

Before updating you on our guidance outlook I'd like to cover my announced transition since joining deal along with the agency back in 2019, My hope and expectation was that for a four year run.

As we approach that anniversary next year, Nancy and I begin our discussions about the best way to manage that handle.

Having sufficient time for public search to find the most qualified candidates and allowed the time to ensure an orderly transition to that end the board and Nancy have provided me with the opportunity to continue in my current role, but at the same time allow the company to the chance to find the right successor without any timing pressure.

So I will continue as CFO until my successor is found and then work with her or him and an orderly transition helping to ensure the ongoing work on our initial mission critical initiatives without missing a beat.

Credibly excited about the prospects for digital Ocean and the path ahead. The strategic framework is in place the key executives on board and the capital resources are there to fulfill our goal of $1 billion in revenue and beyond now is the time to bring on a new financial executive to achieve that goal and I look.

Forward to working with them to do so.

Now, let me provide you with our thoughts on Q3 and the full year.

For the third quarter, we expect revenue to be in the range of $145 5 million to $147 million.

Which reflects 33% growth the midpoint we.

We expect Q3, non-GAAP operating margins to be in the range of 17% to 18% building on the momentum we have from Q2.

For the full year, we are maintaining our revenue guidance to be in the range of $564 million to $568 million, which at the midpoint represents 32% growth.

Given the expectations, we have for improving <unk> and our high spend customers. We are confident in our full year revenue outlook. Despite the macro headwinds that are prevalent and further we expect 'twenty three to benefit as well.

We'll share more about our preliminary look at 2023 on our Q3 call per our usual practice.

From a profitability standpoint, we are increasing our expectations and are targeting full year non-GAAP operating margins to be in the range of 15% to 16%. Finally, we are increasing our free cash flow outlook as a percentage of revenue to between 9% and 10%, which is a 50 basis point improvement from our previous call at the midpoint.

That concludes my remarks.

Let me turn it over for Q&A.

At this time I would like to remind everyone. If you'd like to ask a question. Please press Star then the number one on your telephone keypad again Thats Star then the number one to ask a question, we'll pause for just a moment to compile the Q&A roster.

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

Thanks, guys.

Can you talk about the price increases a little bit what percentage of your revenue stream do you think we'll be seeing a price increase in and how does that kind of get layered in over the next the next couple of years.

Well the pricing went into effect on Theres no phase in.

It went into effect in July .

For all existing and new customers.

And.

For our droplet products.

Most if not all of them saw price increase obviously, we created a new $4 droplet.

That's a lower price point that I referenced earlier.

Our our Paas applications in general we're not.

We did not raise prices against them for example, surplus database et cetera.

And so it was mostly concentrated on our apps products on the platform.

And can you give us a sense of what percentage of revenue that represents.

Or are your largest customers not under determined binding contracts.

One or two year contracts are they all go month to month.

The overwhelming majority of our customers are on a monthly subscription.

Subscription.

And.

We just references roughly 87%.

Our revenue I'm sorry, 82%.

Got it and then doing the math on that it would suggest that the third quarter revenue should be substantially higher on this I'm missing something you can give us some price increase on.

Yeah.

Let's just be clear I mean, this is a very uncertain outlook.

In terms of blockchain.

Which you know in Q2 represented about 5% of revenue.

That vertical is under extreme pressure as you know.

And so you've got this dynamic where you have tailwind of net new customer attract.

Attracted to the platform working well new product with service are working well.

Pricing.

Working well and being offset by weakness in the macro.

Principally in Europe .

In Asia, a lot of that is blockchain, but some of our other customers are growing more slowly on the platform.

So we don't control that we don't control inflation, we don't control rate increases war, all the rest of it and so I think our perspective is.

Given that we can't.

Control those factors that we're going to be very cautious on the outlook. That's exactly what we did in Q2 and hit those expectations and at the same time.

What we can control is what money, we spend and we are managing that very aggressively.

Prioritize incremental spend if there is any on the highest and best uses that will drive sustainable growth or drive efficiency on the platform. So that we can deliver against margins and free cash flow. We are absolutely focused on that and we're working with our customers to help them through tough times and and.

And that'll be our operating principle until there's a better clarity in the outlook.

Which we don't necessarily see certainly into Q3 and thats reflected in our guidance.

Understood very helpful. Thank you.

Okay.

Your next question comes from the line of pendulum Bora with J P. Morgan.

Oh, great. Thank you for taking the questions and congrats on a stable quarter.

I wanted to ask you I think you said something like.

Based on the traction you've seen in Q3.

It sounded like you're seeing some.

Green shoots maybe I don't know.

Could you help us understand kind of the top of the funnel activity so far in July and August .

Across your various categories does that.

Steve will then.

Alright.

Help us understand that.

Yep, Thanks, a pendulum.

Let me clarify so what I meant was that on balance our outlook for Q3 is for growth acceleration against Q Q2.

And so on balance we expect the initiatives that we have in place the product portfolio, we have in place pricing actions we've taken.

On balance to outweigh some of the uncertainty and that's reflected in our in our guidance. So that's a little bit more fill in the blank to my point earlier.

Understood. Okay, and then the follow up is I guess the guidance you're maintaining it help us understand.

What are the various components.

It is possible.

What are you assuming for price increases versus what is the macro headwind.

Any way to kind of put a final point and what do you mean.

Uh huh.

For the full year.

Sure.

Yeah and are you do you mean kind of a deteriorating environment from here or are you assuming kind of a state.

State of course environment.

Second half.

You know when we look at our full year estimates that we set in February .

Before the war hours before the war, but before the war.

We had an outlook that suggested that we would do better than that and then we'd be raising.

If you would've told me eight months ago, we'd be having the same outlook for the year that we had that we would set for investors in February of that what's not in the base case.

And so by maintaining the outlook what we're what we're saying is the headwinds there has been headwinds to our full year outlook.

That would've been above what can float with X.

<unk> estimates we set in February .

And those headwinds continue on.

It doesn't mean, we can't grind through the quarters as we are.

And it doesn't mean that we still feel that we can we will achieve.

Which is why we're maintaining that outlook.

But there are headwinds and we're managing against that and I think what we came into this year expecting for a full year revenue.

And let's say beaten race.

Set of scenarios.

That's not occurring obviously, we haven't raised our outlook for the full year yet.

And that reflects uncertainty that we're seeing in the tradeoffs between the green shoots which there are many.

And the offset which is macro weakness across.

Many of our cohorts and principally focused in blockchain. So that's the context, our original guidance that we set for the year, we expect it to be making progress against that and raising that over the course of the year, we are not doing that.

And.

And that's that's reflected in the color that I just provided.

Understood. Thank you I'll get back in the queue.

Your next question comes from James Breen with William Blair.

Thanks for taking the question.

Had good growth year over year can you just talk about where in the <unk>.

Strengthening from there how much of that was attributable to pricing increases versus.

Your customers taking more product.

Well Arco pricing did not impact Q2.

So it went into was announced in the middle of Q2, but actual.

The change to the pricing that people are paying for.

Droplets networking storage et cetera didn't begin until July one so had no impact so the continuing trend we see.

On ARPA growth is volumetric on our infrastructure as customers grow their business on our platform.

Fact that they can adopt more other services.

Like our managed databases or manage kubernetes now our server lists are our marketplace. All of those collectively are extending wallet share for us as our customers ramp and that's a big tailwind towards ARPA growth.

Great. Thanks.

Your next question comes from the line of a nod train a robot ghassan with turquoise.

Hi, This is Chad.

From Barclays just two questions.

Analyst day, you talked about your customer cohorts within re buckets.

Wariner as builders and scalar.

Can you frame the new logo growth and expansion during the corner within these buckets Dan.

Any color and your thoughts on the price increase impact.

Each of those cohorts.

<unk>.

And what would be helpful. Thanks.

Well we.

Talk about $50 up customers are builders and scalar so we spoke to the growth there.

And customer and the revenue growth.

So that continues despite the challenges around us to be pretty strong 34% revenue growth.

Mid teens, 16% customer logo growth and that's 85% of our revenue so people who move up on the platform from learner and testing.

The product testing an idea to launching a product in running our business the $50 up customer.

It's roughly 85% of our revenue.

Again, they spend a lot of proportion on infrastructure that did see pricing impacts.

Those went into effect beginning in Q3 and on the on the learners. Aside we continue we talked to I referenced the journal Dev Dot Com acquisition, where which reflects building more content in our library.

Now over 40000 digital pieces of digital content that drives a pretty substantial people.

Number of people each month to the platform and between nine and $10 million and and then those are ripe for conversion onto the platform is as learners.

And those contribute the vast majority of our logos.

About 15% of total revenue.

Got it thanks, and then can you just give us an update on how Oh.

Employing a greater degree of AI, if within the business both internally.

Better target potential $50 per month customers and then also whether maybe product timing and AI offering is kind of on a long term roadmap for the company. Thank you.

Well the second piece it absolutely is a product.

Priority for us to offer that to customers to help them target their customers better serve their customers. So it's something that we are evaluating as part of our product strategy as it relates to.

US using data science and other analytics tools to better target learners.

Early or early stage builders as they are ramping or potentially could ramp we've developed certain triggers certain signals with.

We developed whole workflows.

A critical aspect of the sales.

Our progress is this area exactly of.

Using those triggers and those signals.

And it's early there we can go much deeper into our cohorts than we currently do with the with the.

Capabilities, we have I mentioned earlier, we are investing in capabilities and sales. It's one of the few areas. We are prioritizing right now and that is a critical area for us analytics being very good at analytics.

And principally to help us better target.

High potential customers early we've seen enormous success with.

With these early stage businesses, who are ramping very rapidly they're not an optimization mode. They're not a best practices mode. There just trying to grab every customer and we've had a high degree of high success rate when we engage with them.

To get them to think about where they're heading and to think differently about how they could use our platform to better drive their growth more efficiently and that's been a big success factor in how were driving $50 up customers in terms of logo growth and the revenue growth and I expect that to be.

A critical area for us to continue to invest in as we go forward.

Thanks I appreciate it.

Your next question comes from the line of Michael <unk> with Keybanc.

Okay.

Hey, guys. This is Eric on for Michael today, Congrats on delivering a solid quarter, despite the macro headwinds.

So yes.

Kind of mentioned on the last remarks, but just given the focus on margins for this year and just how are you thinking about maybe any alterations that outbound sales strategy. If at all and then do you see.

We'll kind of see that sales and marketing line thing that kind of low double digit range that it's been.

Yes, I think that.

We have as I mentioned, we have incredibly efficient.

You know payback on our customers pay from the Bill is it just referenced in how we acquire those those learners the balance the vast majority of our logos and also the leverage we see from our sales motion principally our inside sales motion of our partner motions, where we're able to.

Sign up a customer at a substantially higher orders of magnitude higher ARPA 20000 last quarter.

Versus the average for the company and so that offsets.

The dollar investments and it continues to be efficient so, although we may see sales and marketing as a percentage of revenue.

Move up over time, it did move up last quarter.

Yet, we still made investments because of the leverage we see in this business.

I think it's a really important.

Attribute of digital Ocean, and it's a powerful contributor to why we're generating meaningful free cash flow that's ramping from here and so we're going to continue to be efficient and at the same time balanced.

Balance the portfolio of investments to invest where the growth is and it's in sales and.

And it's also in top of funnel.

Which is why we bought journal Deb and we'll continue to do the balance of those two investment priorities.

With the goal of driving sales as a higher proportion of revenue over time.

Great. That's helpful. And then just on the net expansion rate I mean, I know you talked a lot of the banks in Europe , and kind of a tough comp and what have you, but just curious maybe how we should think about that metric going forward given some of the macro headwinds and the price increase.

Well, we expect the expansion to be higher in the second half than it was in Q2.

And we're not going to provide any specific guidance on that but the <unk> around that our pricing some of the growth and the efforts of sales again sales is up proportionally pretty materially from Q1 to Q2 in terms of overall percentage of revenue and that helps.

Especially when were doing inside sales and managing and helping builders grow faster and get a better optimize on the platform that drives our growth in the base and contribute to the expansion. So we.

We expect a net dollar retention to be.

Meaningfully higher than it was in Q2.

In the second half of the year.

Right Okay.

Your next question comes from the line of D J Hynes with Canaccord.

Hey, guys.

Came away from the analyst day, feeling like partners, we're a big untapped opportunity for you guys and any update on what Youre seeing with no managed hosting partners digital agencies as it pertains to distribution.

Yeah, those two aspects of the partner channel continue to be.

Very active for us manage service providers are actually managing hosting capabilities for customers, who don't want to manage it themselves.

Which is a lot of people.

So that continues to be a source of that.

A big aspect of the channel opportunity in digital agencies, you know people, who are the outsourced chief marketing officers for startups.

And so.

So we're not prepared to sort of quote stats today on it.

We're making good progress on signing up new partners.

By region and by some of these vertical areas, but agencies.

People, who touch agencies or people, who touch M. S managed service providers or managed service providers.

<unk> are a good op.

<unk> for us to expand channel and again, what that does is for whether it's the agencies or the managed hosting providers. There is a whole set of smbs, who don't want to deal with even though digital oceans as simple and easy and intuitive to use they don't want to spend any time on it and so they are.

Outsourcing that completely and so that doesn't change the fact that as an early stage and ramping small medium sized business, where still the right platform to run your infrastructure and so what what the MSP opportunity in the digital agency opportunity or the channel opportunity in general does as it extends our.

Our addressable our serviceable market within the SMB space.

For people, who even though were simple easy intuitive don't wanted to do have anything to do with it. They just outsourcing so that's going to be a critical aspect of the channel strategy.

We go forward.

That's great color.

And then bill just a follow up for you. So look I think the question. We're all going to get asked tomorrow is how much of the 33% midpoint Q3 growth is being driven by price. We can all take our own staff, but the number but maybe its messages asking you what youre assuming in the guidance.

Well D. J as you just pointed out in his remarks and I pointed out in my remarks.

In a very uncertain macro environment right now we are certainly seeing the benefit of the price increase but we're also seeing some headwinds.

That we had started forecasting for everyone beginning with our Q2 guidance, so that really hasnt changed.

We're approaching this quarter still 20% to 30% plus growth.

Still pointing to improve cash flow.

And we're basically pushing a number of levers to help us get there and hopefully beyond but it's early on.

In terms of the price increase but the summary, we expect a tailwind from that as well as tailwind from our investments in sales and we will deal with the macro headwinds as we did during Q2.

Okay. Thanks for the color.

Okay.

Your next question comes from the line of <unk> Mohan with Bank of America.

Hi, yes, thank you Hum too as well how.

Are you seeing your net expansion rate really.

Price increase in the U S versus international the international obviously.

Yes.

The FX moves.

<unk>.

Ultimate price to those customers, but bosman disproportionately gone up I guess, so are you seeing varying trends over there between U S international on the uptake, but once you have a strategic price increases and I have a follow up.

Well again <unk>.

Price increase went into effect Q3.

<unk> is seeing higher expansion in Q3 than we saw in Q2, but obviously for the first half of the quarter, where we are today.

So we want to be clear about that it's consistent with what I just said that we expect expansion in net dollar retention.

To rebound from Q2.

As a low for this year.

As it relates to U S U S. A.

Has been less impacted by some of the macro than what we've seen in Europe .

In Asia, we have seen a little bit but far less than.

And what we've seen in Europe , and Asia and.

I think theres a couple of points there one I think we see more block chain in Europe and Asia.

Two I do think and I made a point of making this in the remarks that we charge.

U S dollars.

And but.

Obviously, our for all of our customers.

You know obviously with the strengthening of the dollar even though we can't tie directly.

Two.

Some of the macro headwinds, we're seeing in terms of our revenue impact.

We have to believe that 20 ish percent increase in the value of the dollar relative to other currencies.

Over the first half of the year.

Has to have some impact on our customers' business as many of our all of our customers. Our digital businesses. Many of them have a lot of share in the U S. And so I think currency is a headwind not directly for us is as many of our peers and tech who may charge of different currencies have been reporting.

But you know as qualitative matter, it's certainly something that we think about.

Okay. Thanks, and then just a bubble up.

You said I think blockchain was about 5%, but that what time frame are you talking about is that like a Q2 comment and just for context, how much was that like maybe in 2021, and then and as you think about sort of some of the unwind or they are.

What are you expecting in the back half of the year.

Reasonable amount to think of as a percent of revenue from that particular category.

Well I think it was lower single digits, 5%.

5% was Q2.

It was lower than that last year.

But it's been growing rapidly through early Q2.

And we would expect it to decline as a percentage in the second half.

And we will.

Based upon what we know today obviously.

That's a very uncertain and volatile market segment.

And we'll see how it plays out in the future years beyond where we are now.

Okay. Thank you.

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

Hey, guys. This is <unk> on for Jim fish, Thanks for taking my questions.

Coming on the back of that last question. We appreciate the blockchain disclosure.

Is it fair to assume that.

Largest.

Vertical vertical in terms of percentage of revenue, maybe if you could help us tie exposure between other potential high risk verticals like E Commerce Tech startups or maybe you can just.

Crypto as a whole.

Yeah, we don't do a lot of crypto, it's more on the blockchain I would say.

E Commerce is a big vertical streaming media education gaming.

There are others, where I would say is we're seeing more slowing there that's sort of more in line with what everybody else is seeing obviously what changed just an outlier with whats happening in the volatility of that market.

And we called that out specifically because of that I think in the aggregate is by far the most.

Meaningful.

Vertical that we are seeing real impact or the others is just sort of a slower expansion, but if you net out a block chain its not as meaningful.

Got it that's helpful. And then obviously share buybacks in the quarter were strong can you talk about how the team is thinking about capital allocation moving forward across buyback inorganic opportunities and then actually further data center build outs if customers are asking for additional geos outside of becoming Australia building.

Thanks.

Yeah. So great question, our principal primary use of capital is growing the business, whether it's inorganic through M&A.

Where we've been relatively active.

Over the last couple of years you'd mentioned regional expansion sales investment.

Product investment, we have Australia coming online Sydney, Australia data center coming online later this year, we do have plans to expand beyond that which we'll be disclosing relatively soon so we will continue to invest in that prioritizing that.

Getting efficient and other places to help pay for that investment.

And then as it relates to the balance sheet and our capital return I think we've had a good start on.

On.

Driving the efficiency of the balance sheet, we want to make sure we have adequate capital to drive the growth in our profitable growth strategy of the business.

I suspect over time as margins continue to expand in.

Have a lay of the land on what we're able to do with M&A.

We'll have more to say potentially about a further.

Further actions on the balance sheet, but for right now I think we're in good shape Bill mentioned earlier, there's a little bit left on there.

The last 300 million authorization from the board and and we will continue to.

To find M&A.

And opportunities to invest organically and.

M&A with the typically in the private markets.

You know we are in the public markets correct immediately.

Founders, who raised money at prior valuations tend to correct more slowly.

So we will hope to do some M&A soon but frankly the bid ask is.

It's been somewhat of a challenge recently, but we will keep at it and focus of the capital we have on those opportunities.

Thanks appreciate it.

Your next question comes from the line of Patrick <unk> with JMP Securities.

Oh, great. Thank you.

I just want make sure I understand something first name a broader question, but I just want to make sure I understand yet.

The impact of the FX changes.

Europe and Asia is to effectively raise prices for those customers right and sort of shifts.

On the demand curve and so things are more expensive they buy what it does that that'd be issue, we're talking about well again, we don't we don't charge, we charge of $1. So what we can say is yes. It could have the effect of helping them them decided to manage spend.

Differently.

I just want to make along with that.

Yeah.

So here's my Big picture Big Picture question with all the stuff that's going on what are the one or two most important things for you.

To focus on as CEO and the rest of this year.

We are actually a great question I think.

We have to slim down priorities and get the organization behind.

The areas that will drive growth and are driving growth, we mentioned earlier insight sales analytics.

The whole sales effort getting more productivity and growth out of our cohort and building the partner channel are critical to us.

And and.

In terms of top line, and then driving efficiencies where we can.

And are going to be and we're investing for those two things.

And.

We're gonna have to manage in a challenging environment and I think that.

We're very customer oriented company and so that makes it easier to focus on delivering value for our customers and prioritizing that very firmly.

And that's going to be the focus in the near term and given that Theres a lot out there that we can't control, we can control, where we're going to invest our dollars what activities are above the line and what activities are below the line and getting the organization focused and fired up around that is the principal priority for me right now.

Alright, great. Thank you.

Your next question comes from the line of Mark Bachner with Stifel.

Hi, This is mark on for Brad.

I have a quick question on the.

Function that you guys are putting in for the contribution of Russia, Belarus, and Ukraine in Q3 yesterday, it's about two 4%.

In Q2, so just wondering if you are.

Anything you attribute it to that and if so what that does thank.

Thank you.

Well, our expectation was when we did forecast for Q2.

That we would be seeing a material reduction in our Russian related revenues, which we have seen fit.

<unk> been a little bit slower than we thought but our expectations for the balance of the years is that we will still be under pressure, which again is one of the macro headwinds we're looking at what we consider overall consolidated forecast.

Great. Thank you.

Your next question comes from the line of Gabriela Borges with Goldman Sachs.

Good afternoon. Thank you I wanted to ask a question on visibility because I recall that it's something that you've been doing work on.

Yeah.

Just kind of some metrics and early indicators that you look at Tim on the health of the customer base in any given quarter before you see consumption flying and then my follow up is your philosophy on pricing, there's a structural tailwind to your business from introducing high value products and the mix shift becoming more positive over time on the app.

Spoke to apples pricing increases to what extent do you think does.

Those pricing could become part of your annual toolkit.

We'll consistently that Paul as you think about long term breath.

Do you want to take the visibility and then sure sure.

Terms of the visibility Gabriele there's several things that we look at one is looking at our customers greater than $50 and above.

We see.

The majority of our revenues as you know they now represent 85% of our overall revenues and spend.

So we look obviously at the metrics that we see for them, we look at the components for each so we watch very closely.

Their expansion could tranche, a contraction and most importantly churn rates.

Any individual month.

For us to see what the expectations would be for them going forward and we're continuing to Orient. The work that we do internally across this group <unk> heard mentioned several times sales sale in some respect for US is around enablement, it's around working much closer with our greater than $50 spend customers.

And finding ways for them to increase their contribution.

The feedback that we're getting from an increased outreach speaking more directly to thousands and thousands of our customers is helping inform us.

Directionally, where theyre going not only in terms of current trends, but also in terms of some of the things they want to two things.

Things like.

Functions, which is one of the most requested item. So we're leaning more and more information around those customers and that's a primary factor that we look at on a month to month basis, yes.

As it relates to philosophy I love the question because it speaks to a couple of areas. One we're getting pricing leverage in the business because of our $50 enough customers and I put pricing in quotes.

We get because our $50 enough customers, which are now 85% of our total revenue that's up meaningfully from just a couple of years ago as we've added more managed services.

Like manage databases manage kubernetes service, it's extending the wallet share we can capture from our customer then we could three to five years ago. When we were just basic compute basic network.

Bandwidth and basic storage.

So that has the effect that's what drives our a big contributor to ARPA growth that has the effect of driving pricing leverages in the aggregate economics of our revenue mix is product mix going from 100% infrastructure as a service three years to five years ago for example.

82% today.

So we're going to continue to invest in products that are valuable to our customers.

As they grow and the early stage from the builders to the scalar stages of Smbs we.

We're going to continue I mentioned earlier there are other areas that as their workflow evolves. We can be helpful to them. While also maintaining simplicity, so that'll be a tailwind out at ARPA growth as it relates to a price increase explicitly for for example, mostly our eyes here.

I think that Rick.

The first price increase or price changes really material price changes in 10 year history of the company I think that reflects we have made a substantial amount of investment in community over 40000 tutorials free of charge.

And the other documents our support model.

Embraces our customers all customers regardless of price point.

Our simplicity as we add more products and more capability to platform, we continue to ensure that simplicity.

And then a key aspect of simplicity by the way it is consumption model.

People are scrambling to calling CIO.

Beating people up for breaking contracts and try to renegotiate and it works at a plus sign in works into minus in the near term, but that's part of simplicity, it's part of removing friction and barriers that many of our competitors and the cloud have more complexity as it relates to that and so we feel that that is a value proposition.

To our customers and the actions we took in Q2 that went effective in July reflect the value we want to have a great conversation with a customer about the value proposition and the differentiation of our value proposition to help them do the jobs that they need to do help them with their workflows they grow in scale.

And we're going to continue to add product make the product better at security and reliability, which are incredibly valuable to our customers.

Our $50 and up as they ramp their customers on the platform. So we'll continue to invest in our platform will continue to do product extensions to get that RP tailwind from product mix and then I.

I don't necessarily think this will be a annual.

Coal off increase if you will because of because of the calendar flips I do think will be won't be 10 years before you can take the next action and I think the context for any future actions will be like what we employed here, which is as we have learned more about the value that we can deliver for customers we learn more.

Or about their workflow evolution, how best to package, how best to serve that and innovate against that and then what's the right price to <unk>.

Maintain differentiation.

But to be a compelling value.

To our customers and as a reminder, we're roughly 50% for example at the Hyperscale or it should have a highly highly performing platform for people to build and scale a business and that's our approach.

Broach in philosophy going forward.

I appreciate the detail. Thank you.

Your next question.

Comes from the law.

Line of Josh Baer with Morgan Stanley .

Yeah.

Great. Thank you for the question.

I appreciate all the commentary around pricing increases so far and certainly the uncertainty looking ahead.

Wondering looking back what was the impact from pricing in the month of July .

Okay.

You know, what we said as I mentioned earlier expansion was higher in July .

And so we're seeing a positive benefit in Q3.

Net of price pricing on net that's reflected in our outlook. Our outlook is also highly tempered by uncertainty.

Okay.

Okay got it.

Is it like a mid to high single digit annualized benefit from pricing a reasonable range for investors to take away Tonight.

Yeah.

Our guidance stands for itself.

Got it okay. Thank you very much.

There are no further questions I will now turn the call over to Yancey spruill for any closing remarks.

Well, thank you very much for joining us.

We really appreciate the time the continued support that you all have.

For our company and we believe given the uncertainty in the market.

We want to be.

Available and transparent and so we expect to speak with many of you over the coming weeks.

And obviously years ahead.

And we want to get through this tough time, as we're doing with our customers and our team internally.

With you all together.

My conviction has never been stronger about the limitless potential of this business.

Potential that will be realized by enabling.

However, more developers and entrepreneurs to test their ideas build their businesses and realize their dreams.

Have a great rest of the day.

[laughter].

Thank you for participating you may disconnect at this time.