Q1 2023 DigitalOcean Holdings Inc Earnings Call
Okay.
Thank you for standing by and welcome to the digital Asia in first quarter 'twenty three earnings conference call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question. During this time simply press star followed by the number one on your telephone keypad.
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Operator assistance press Star Zero, and finally, I would like to advise all participants that this call is being recorded.
Now I'd like to welcome Rob Bradley Vice President Investor Relations to begin the conference Rob over to you.
Thanks, Paul and thank you and welcome everybody to digital Oceans first quarter 2023 earnings call. Joining me today is Yancey Spruill, Chief Executive Officer, and my time for our Chief Financial Officer before we begin I want to cover our Safe Harbor statement. During this conference call, we will be making forward looking statements.
Including our financial outlook for the second quarter and full year as well as statements about goals and business outlook industry trade market opportunities and expectations for future financial performance and similar items.
All of these statements are.
Subject to risks uncertainties and assumptions.
You can review more information about these and the risk factors section of our filings with the SEC.
We remind everyone that our actual results may differ and we undertake no obligation to revise or update any forward looking statements.
Finally, we will be discussing non-GAAP financial measures on our call today.
Reconciliations between our GAAP and non-GAAP financial results can be found in our earnings press release, which was issued earlier this morning.
And in the Investor presentation on our IR website.
With that let me turn the call over to our CEO , Yes, it's true.
Thanks, Rob.
Morning, and thank you for joining us today.
Please to share the results of another strong quarter for digital Ocean.
We made solid progress on our key priorities of adding valuable services for customers on our platform and.
And reshaping our cost structure to accelerate our long term free cash flow margin objectives.
And despite the challenging macro environment.
Or exceeded all of our financial targets.
Our first quarter financial results were strong across the board, we delivered year over year revenue growth of 30%.
As projected our quarter over quarter revenue growth was more muted given the near term macroeconomic headwinds we are experiencing.
These headwinds have resulted in modest net expansion from our customer cohorts as their businesses have seen their own growth deceleration.
They have continued to focus on managing their spend in the midst of the ongoing economic uncertainty.
While it is unclear how long these macroeconomic headwinds will persist.
We remain committed to achieving our financial targets this year.
Matt will provide more detail on our Q1 results and Q2 and full year outlook later on the call.
Stepping back for a second from the current market conditions at.
I have reflected that we just recently crossed the two year anniversary of our IPO.
Over the course of these two years, we have become a much stronger and durable company.
We added significantly to our platforms capabilities and have enabled our customers to grow their businesses.
We dramatically improved our financial profile more than doubling revenue from 2020, the full year prior to our IPO to this year.
An improved adjusted free cash flow to negative 18% in 2020% to 21% plus this year.
We've added a number of valuable offerings for our customers like service functions premium droplets tiered support.
Significant additions to our <unk> content.
Additional database searches to name a few in.
And expanded our total addressable market addressable market through our cloud ways acquisition last year.
That brings us managed hosting capability.
Collectively the improvements we've made to our offerings and our go to market.
We have improved our approved by more than 70%.
We've also returned significant value to our shareholders. Since Q2 2021 repurchasing two 6 million shares for a total of one 3 billion.
While we are proud of these accomplishments we will continue to remain focused on delivering new offerings significant operational improvements in the business.
Allocating capital to accelerate growth, both organically and through M&A.
And delivering capital back to shareholders through a regular buyback program.
We remain bullish on our incredible market opportunity and we know we are still early with plenty of room for significant growth in the years ahead.
Shifting back to our near term plan I'd like to reiterate our key priorities for 2023, which.
Which we believe will enable us to deliver our 2020 targets and will position us for accelerated growth when the macro environment improves.
As shared at our last earnings call, we have prioritized three growth initiatives that underpin our 2023 revenue target.
These initiatives are focused on sales and go to market product monetization.
And delivering the synergies from our cloud ways acquisition.
Each of the initiatives will build on the $660 million annual recurring revenue Foundation, we had entering 2023.
First we will continue to strengthen our go to market capabilities over the course of the companies more than 11 year history, our highly efficient self service go to market motion has been the primary source of new customers.
We'll leverage our platform and become paying customers because of the simplicity and ease of use of our cloud tools the documentation and support we provide our customers the openness of our platform in the attractive price to value that we offer for our services.
Collectively we are focused on building at our customers' ecosystem of learners builders and scalar.
We are investing attract more learners, providing an environment to nurture and launch an idea into a business.
We're extending our product capabilities to enable the long term successful growth of the builders and scalar on our platform.
I'd like to think of our self service model is one of the world's most efficiently generation engines, where customers pay small amounts to learn and test at our platform.
And they represent a ripe opportunity to foster their development such that over time, they become a rapidly growing businesses on our platform.
Importantly, the cost to acquire these customers is very low.
Our ability to attract learners, who have high intention to become builders and scalar has been an important evolution of our self service go to market strategy.
We are evolving our tools and upfront content to attract higher spending customers and we're also changing our onboarding process to better serve these high intent customers early in their digital Ocean journey to reduce the time, they spend as a learner and become higher spending customers sooner.
Additionally, we have invested significantly in enhancing our ability to engage with a higher percentage of the 146000.
Builders and scalar is on our platform.
We are seeing good traction for luxury leveraging data analytics.
Our sales teams better target candidates for upgrades or additional product adoption.
Including moving their multi cloud workloads to digital ocean from other providers.
This expanded customer engagement effort is bearing fruit as our legacy cohorts of builders and scalar has continued to increase spending at robust rates and we continue to add to these cohorts at strong rates of growth.
Our second key initiative is to continue to deploy new capabilities or new bundles that both increase the value we provide to customers and drive up our <unk> and our share of wallet.
These product modernization efforts are focused primarily on our fast growing builder and scalar customer segments as we listen closely to their feedback and extend our capabilities in response to help them continuing to scale their own businesses.
As an example of a recent monetization initiative, we launched a premium dedicated drop late in Q1.
Which targets bandwidth intensive applications, such as video streaming and AD Tech businesses we've.
We've seen strong adoption of this product extension as it improves the ability of our customers to scale efficiently.
In other words, it enables cloud optimization for our customers.
The premium dedicated dropped as an example of our packaging our existing capabilities to better serve the needs of a specific customer applications provide.
Providing additional value for which our customers are willing to pay.
We were already an attractive destination for bandwidth intensive use cases, given our capabilities and value pricing.
However, our bandwidth intensive customers had to customize our base service to additional software to configure to their specific use case, which added time complexity and costs to their use of our platform.
Based on their feedback we launched this new tailored solution, which speeds up their deployment and reduces their cost to maintain and grow their business, which offers them a more efficient path for growth.
This new product SKU as an example of us creating higher ARPA opportunities for customers through packaging, our services versus an outright increase in price.
We believe we have an opportunity to enhance the customer experience on our platform with other examples like this on an ongoing basis.
Another example of extending our platform to meet the needs of our larger customers was the expansion of our backup storage capabilities.
In this case, we augmented our platform Inorganically acquire complementary early stage product company Snapshooter in Q1.
To add backup and snapshot storage features this acquisition as a part of a broader initiative to augment our overall storage capabilities, where we expect to continue enhancing the functionality across our service portfolio over the next several quarters into 2024.
Looking ahead at the product roadmap over the rest of 2023, we will continue to invest to enable enhance our storage offerings to meet the needs of our builder and scalar customers.
By addressing a broader set of storage use cases at larger scale, we will make it attractive for existing customers to put more of their cloud workloads on digital ocean and make it attractive for builders and scalar as on other cloud platforms to bring their workloads to digital ocean.
We are also evaluating other strategic platform extensions such as the introduction of GPU and AI ml offerings, which would be a strong complement to our existing capabilities and expand our total addressable market.
Although we are refactoring, our cost structure in 2023 to deliver significantly better margins and free cash flow.
We don't want this year to be solely about efficiency.
We are positioning ourselves for faster growth in the future and the opportunity to enhance our offerings with GPU and AI ml services as a focus.
The ongoing organic and inorganic investment in our platform through product expansion and modernization efforts is key to driving long term growth.
We're leveraging the numerous customer conversations were having during this challenging market environment, both to educate customers on how they can leverage our existing products and services differently to help them optimize their spend and to understand how to prioritize our product development roadmap.
Our focus on the large SMB customer segment that traditionally has been underserved by more enterprise focused technology companies as a direct contributor to the stable churn we've seen over the last year.
Even as our growth has decelerated.
Our commitment to simplicity higher touch support.
Extensive relevant.
Content and direct engagement with their customers is a key differentiator for digital Ocean.
And it has created a very loyal customer base.
Remaining close to our customers while their own businesses see a slowdown in growth is going to position us well to capture more than our fair share of the revenue opportunity as growth rates normalize and reaccelerate over time.
The third growth initiative is the continued investments in our recently acquired cloud waste managed hosting capabilities.
Cloud based business continues to perform well managing its growth despite the weaker macro.
And as an accelerant to our overall growth expectations for the balance of this year.
We are pleased with the progress we've made on integration in our first six months post acquisition.
We have seen a 46% increase in new cloud waist customers Q1, 2023 over last year's Q1.
And some of that increase results from the way we have leveraged our well established self served funnel to drive customer leads to cloud where.
We are encouraged by the early results of the recent addition to the product capabilities and pricing changes, we announced that cloud brings.
A strong ratification of their value proposition and brand.
We continue to be very optimistic about the long term potential for cloud ways as the driver of value for our customers and investors.
Before I conclude I wanted to take a moment to address changes that we've made to our leadership team.
Just as we have been focused on aligning our operating model cost structure and investment priorities and achieving our long term growth and free cash flow ambitions.
We've also been working to build a leadership team that can scale and help us deliver on these objectives.
And we've made a number of changes and additions this year to augment our team.
First we've created an important new role as senior Vice President of communications to bring additional focus and expertise to our efforts to connect with our customers and support them along their journey.
Nancy Coleman, a seasoned executive with experience in technology businesses at similar stages of size and scale is.
Taken this role to drive communications to our stakeholders as we increase awareness of the company's capabilities.
And elevate our storytelling across our customers employees and investors.
The addition of this role is another important step in the effort to upgrade our go to market capabilities that started with the integration of our sales customer success and marketing efforts under Chief revenue officer at the beginning of 2023.
We have also taken steps to better align our product development investments and drove priorities with the Q1 departure of our Chief product Officer, we took the opportunity to consolidate product development under our COO.
Combining our infrastructure and new product development teams to drive better coordination and synergies and to move product strategy under our chief strategy officer to ensure that our product level strategy efforts are tightly aligned with our overall corporate strategy.
And long range plan.
Yes.
Okay.
This creates a simpler more efficient organizational structure.
And we will drive improved development execution and tighter alignment across our broad set of strategic priorities.
To further augment our go to market capabilities. We also announced the addition of Chris Merit to our board of Directors. Chris is an accomplished sales executive and has a broad history across multiple business models and technology <unk>.
Including both self serve and direct sales motions.
He most recently spent 10 years as the Chief revenue Officer, a cloud player and help them scale their business from $1 million to $1 billion.
And <unk> during his tenure.
We look forward to adding Chris's perspective to our board and executive leadership team.
Collectively these recent changes support our strategy to become the preeminent cloud infrastructure provider to small and medium sized businesses. In summary, we're very pleased with both our progress early in 2023 delivering against our revenue growth and free cash flow targets and our ability to maintain the 2023 target set on our last earnings call.
Despite the ongoing macroeconomic challenges, we continue to invest across an array of product infrastructure and go to market areas, while refractory our cost structure to position the company for durable profitable growth in the growing $98 billion annual market for developer in SMB cloud infrastructure.
I will now turn the call over to Matt to provide details on our financial results and our outlook for the balance of the year.
Thanks, Jessie good morning, everyone and thanks for joining us today to discuss another quarter of strong results with revenue margins earnings and free cash flow to continue to demonstrate the resilience and growth potential of our business model.
I will focus my remarks today on our first quarter results on our progress on several key initiatives and our updated financial outlook.
We delivered revenue of $165 1 million in the first quarter, which was 30% growth year over year, and 1% growth sequentially from the fourth quarter of 2022.
We saw resilience in our cohort performance. Despite the ongoing headwind of continued cloud optimizations by customers with an <unk> of 107% for the quarter.
Churn continues to hold steady, which is a great accomplishment in this lower growth environment with topline pressure coming instead from lower expansion and elevated contraction that continued through the quarter.
In the current environment holding churn at historical levels is a testament to both the value of our platform and the loyalty of our customer base, even if they focus on optimizing their spend and retaining our customers will position us for success when they themselves returned to growth.
Our resilient customer graduation model continues to be a source of strength and durability in the face of the challenging macroeconomic environment.
Fed by our extensive pool of learners that spend less than $50 per month, we saw a net sequential increase after both graduation and churn of close to 2000, new builders, who spend between 505, sorry $50 million 500 per month and more than 350, new scalar who spend more than $500 per day.
Builders and scalar has continued to be the drivers of our growth representing 86% of revenue and growing.
At 41% and 24%, respectively, despite together being only 24% of our customer base.
Our go to market and product monetization initiatives remain largely focused on meeting the needs of these growing customers.
We exceeded our outlook on both adjusted EBITDA and free cash flow margins in the first quarter through the continued disciplined management of our expenditures and the Swift execution of our previously announced cost reduction initiatives.
Adjusted EBITDA was 34% of revenue, which compared favorably to 29% in Q1 of 2022.
The improved margin was driven by a 22% year over year decrease in sales and marketing expense and a 2% year over year decrease in R&D expense as we reshaped the cost structure to align with the lower market growth expectations and accelerated our timeline to reach our long term free cash flow margin target.
Adjusted free cash flow margin was 16% of revenue up 4%.
From Q1 of 2022.
This strong result was due to both the higher adjusted EBITDA margins and the timing of several capital projects that we expect will occur later in 2023.
Q1, 2023 will be the low point in 2023 for margins. The first quarter of each year includes the cash flow impact of annual bonuses as well as higher payroll taxes and other seasonal cash impacts <unk>.
Additionally, our cost savings actions occurred in the middle of the first quarter, which resulted in savings being only partially realized in the period.
As we progress through 2023, we expect to steadily improve profitability and to exit the year with adjusted EBITDA margins in the low forties and with adjusted free cash flow margins approaching 30%.
Our strong adjusted EBITDA and free cash flow margins results came despite the anticipated near term pressure on gross margin, which on a GAAP basis came in at 56% in the first quarter compared to 63% in Q1 of 2022.
The year over year decline in gross margin as the expected result of the previously discussed increase in coli co location expenses. Following the expansion of several facilities, including the new Sydney datacenter in the short term impacts of higher power costs in Europe .
Datacenter expansion is a key element of our growth strategy as we increase our footprint to meet growing customer demand.
While margins are initially impacted with these expansions, we will grow into the new capacity over the coming quarters, improving their utilization and margin profile.
We also expect to see a declining flat to declining power costs in Europe over the course of 2023, which will also provide additional margin improvement.
Despite the gross margin pressure, we effectively managed our overall operating expenses to exceed our profit outlook for the first quarter and we are on track to achieve our margin goals for the full year.
Our non-GAAP earnings per share of <unk> 28 was within our guidance range, but was impacted by a onetime international tax expense from the <unk> acquisition in 2022 that reduced our non-GAAP earnings per share by <unk> <unk>.
As we shared on our last call. We identified a total of $60 million of annualized cost savings $25 million of which was related to head count and $35 million of which were related were non head count related.
That would enable us to accelerate our long term cash flow margin targets into 2023.
We have made good progress on these savings and optimization initiatives with our February reduction in force and with rationalization of expenses and direct marketing software licenses travel entertainment and other third party spend.
We are pleased with our progress so far this year and we are confident that we will be able to achieve the full targeted 2023 savings.
In addition to our strong margin performance. We also made meaningful progress on our ongoing share buyback program.
As we have discussed we are highly focused on driving outsized growth in both earnings and free cash flow per share as the long term drivers of shareholder value creation through continuous improvement in operating margins, coupled with our commitment to return capital to shareholders.
During Q1 of 2023, we've made meaningful progress on the share repurchase front repurchasing seven 8 million shares for a total of $266 million at an average share price of $34 27.
As of the end of last week, we had approximately $175 million remaining of our $500 million approved repurchase program and we expect to deploy the full remaining balance of the authorized repurchases over the course of 2023.
The company's strong balance sheet and significant free cash flow generation enabled us to invest in growth initiatives continue to make acquisitions and repurchase shares on an ongoing basis. We expect to continue our repurchase program up to 125% of free cash flow in 2024 and beyond.
Given our progress to date on the buyback and our anticipated utilization of the remaining balance over the course of 2023, we expect to end the year with approximately $103 million to $105 million and weighted average fully diluted shares outstanding for the full year 2023.
It is important to note that our fully diluted shares outstanding includes $8 4 million shares associated with our convertible debt, which has a conversion price of $178 51.
We anticipate that the combination of our ongoing buyback program and the eventual resolution of our convertible debt will more than offset any dilution from stock based compensation and will result in a 15% to 20% decrease in our share count over the coming years.
Turning towards our financial guidance for Q2, 2023, we expect revenue to be in the range of $169 $5 million to $175 million.
For the second quarter, we expect adjusted EBITDA margins to be in the range of 37% to 38% and non-GAAP earnings per share to be 40% to 41.
Based on approximately $103 million and weighted average fully diluted shares outstanding.
For the full year, while we continue to see headwinds from customer optimizations, and we're still early in our go to market and product monetization efforts. We are comfortable with our previously provided guidance and expect revenue to be in the range of $700 million to $720 million.
With our strong margin performance in Q1, 2023, providing room for incremental growth investment. We continue to expect adjusted EBITDA margins to be in the range of 38% to 39% for the full year.
Having better visibility into the impact of our share repurchase program. We now expect non-GAAP earnings per share to be in the range of $1 70 to $1 73.
For the full year 2023 free cash flow will increase as a result of our improved profit margin and lower capital expenditures driving 21% to 22% free cash flow margin, excluding the onetime costs associated with our workforce reduction and transaction costs.
Like adjusted EBITDA free cash flow will ramp throughout the year, and we expect free cash flow margin to approach, 30% by the fourth quarter.
That concludes our prepared remarks, and we will now open the call up to Q&A.
Thank you that will speak as a net this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad in their respective time and to allow us many opportunities for our coal is today, we do request that you keep it to one question per person.
Your first question comes from the line of <unk> demand from Bank of America. Your line is open.
Yes. Thank you so much.
E&C the larger Hyperscale orders are all loading deceleration so at OE H in Europe and Dr. Decelerated in one kilo IRR grew at the slowest pace sequentially clearly there are all these macro headwinds.
You're still maintaining your revenue guide for the year.
Can you talk about maybe what is giving you the confidence in your fiscal year guide and how the weaker macro is changing customer behavior that you're seeing.
And our quick second part of your thought on that.
AI comments, we did run a survey of digital Ocean users that reflected a lot of the positive elements of differentiation that you called out.
Also noticed AIG became a top tier Phil floor workload case at <unk> and builders.
Any color on that.
They are all interesting use cases and are these the customers that are asking for the GPO clusters, you referenced and how that might impact your capex profile. Thank you so much.
Just first on the AI Dai.
Dynamics, we have businesses running AI based models and businesses on our platform today and they've been doing it for many years, we've always from the founding invested in really high performance computing and so although gpus offer some differentiation.
And enhancing of our compute we still offer very high performance compute strong bandwidth capability. So.
We're looking at as a product extension and.
And yes, GPU tends to be capital intensive, but we obviously no capital intensity very well and expect.
Our foray into this area over time.
Be well within our.
Previously made comments about long term free cash flow margins capital.
Capex as a percentage of revenue, but we do think it will enhance our addressable market with some of the new order of business models that are emerging and give us some of our existing customers more options.
Beyond just for example, our premium dedicated drop of droplet product is very compelling for bandwidth intensive.
And computational intensive use cases that could be AI.
But we will create broader offerings and have more to say about it.
As we go into the near term.
On the first comment.
I think what we're seeing in the broader environment is first off we're very excited about the fact that our churn.
Has.
It's been very stable over this past year, it ticked up a little bit, but we know we've noted gale with the some of the blockchain and the dynamics in Russia, mainly causing that but we did see churn even improved.
The decline as we move through Q1 and into Q2, so that's a very strong thing.
Being that we focused on because weakening environment you want to keep your customers and I think our team is doing a very good job of that.
What we're seeing is that our customers are.
We have a consumption based model and what's driving the lower end Dr. Our growth is the fact that their expansion.
It has slow pretty meaningfully over the last year. That's the main driver for an MTR has contracted and why our growth is growth rate is contracted.
And we talk with them anecdotally with our sales our customer success teams. We did we've done formal surveys and sentiment continues to be that.
The dynamics with our customers is that their demand environments weakening they really appreciate.
Shaped a consumption based model because it allows us to adjust accordingly.
And but we continue to focus on them and we've made really good progress.
In certain instances, even with our customers that have multi cloud workloads on digital ocean and others.
Talking with them about moving there and actually moving their workloads from other cloud providers. So it's a difficult environment.
<unk>.
In terms of things that we can control. However, I think our engagement with our customers are focused on support our customer success and our compelling differentiated packaging of our products.
As we're working through this with our customers and so we reiterated the range because when we if you go back to how we talked about our guidance in the beginning of the year.
Low end of the range contemplated.
No real change no real contribution from incremental initiatives and even a slight weakening in the macro we didn't necessarily see a slight weakening in the macro as you recall, our Q1 guidance contemplated.
Our relatively flat sequential from Q4, so it was well within our expectations.
In Q2, and what we're seeing now with the initiatives that we have launched Volta the go to market.
Some of the products that we have already in market, we have others coming online are seeing ramping and again to get to that high end of the range calls for the success of those those products. So we're comfortable with the range given the downside on the low end, reflecting what we think is probably slightly better than what we said.
That several months ago, and these initiatives coming online during the year. So clearly seeing traction as customers are looking for ways to get more value. So that explains the holding tight on our guidance for for this year.
Thanks Nancy.
Your next question comes from the line of Michael <unk> from Keybanc. Your line is open.
Hey, guys. Congratulations on the stability and then certainly on the margin inefficiency expansion.
I wonder if fees that are not in yet as well I guess could you just talked about.
Your thoughts on gross margins and Capex for the year, obviously, you've done a great job on the Opex side, a little bit of pressure on gross margins and then youre benefiting it seems from some timing, but also some efficiency on capex.
Yes, I'll start in reverse on that with the Capex Capex came in at 15% of revenue for the quarter and that's generally consistent with what we expect for the full year, So I've mentioned timing.
We don't expect that for the Capex as a percent of revenue is going to increase in any material way.
From the from the first quarter on the gross margin front, that's something that we had none is coming right. We signaled that rated.
We have made investments in our data center footprint, we've added the Sydney datacenter, we've expanded some capacity in certain markets.
And that causes a near term kind of increase in.
And the cost structure.
It was about 350 basis points impact around Colocation year over year. We also invested in some upgrades around bandwidth to improve some performance.
Our network that was about 125 basis points.
And then there was another 125 basis point impact from the <unk>.
European utility costs, which we don't think.
Persist much longer.
And then 2023.
But the important thing is that despite the increase in that and the cost on the gross cost side, we were able to effectively manage and exceed the EBITDA margins and the free cash flow margins and by the end of the year, we expect to be north of 60% on the gross margin front.
It's just a really a temporary.
The challenge on the gross margins.
Thanks for that detail and color and congrats on the stability and efficiency.
Your next question comes from the line of Ryan Lynch Chow from Barclays. Your line is open.
Thank you Ed.
My question was more on on the optimization of the end demand sequence your CMC.
Obviously like if you think about like the big enterprises enabled renegotiate their clouds right in their renewals in Q3 Q4, and then you kind of done what you're dealing with how do you see the peak cheering are playing out for you is that kind of an ongoing rolling kind of optimization.
That is going on there.
What are the sequence that you are looking for to see if theres a change or are you just kind of basically lately.
But the cyclical Hugo Thank you very much.
So we've now been about 12 months into this lower growth dynamic as our businesses our customers have.
<unk> been expanding slower again with a consumption based model. It corrects immediately so we've been living with this again for a year.
I think a key signal.
Importantly, as I pointed out the churn has been stable is actually improving right now.
Those are two really important that's a really important side versus the second is.
For the turn.
We'll be looking at for expansion to begin.
The fact that our customers actually consuming more cloud because their businesses begin to expand again that'll be a key signal for us it's relatively stable, but slower than it was certainly a year or two ago and that explains the lower ADR.
Overall, our growth rate.
As it relates to optimization I would say the consumption based model kind of builds in optimization because as their bills business slows.
They pay for what they use so as their customers are consuming.
Consuming less they consume less bandwidth et cetera, they just spend less or bill correct immediately. So we have a built in optimization. If you will into our model, which is why we saw this earlier than some of the people with one of our longer year contracts, what I would say about the conversations we've been having with our.
Customers is as their businesses have slowed and typically are small businesses tend to have really rapid growth rates, they're taking a pause and theyre looking at architecture Theyre looking at longer term or intermediate term dynamics around how they run cloud and they have led to some great.
<unk> with us putting customers in different packaging that actually gives them a more efficient growth paths similar to the KSA I just cited with the premium dedicated droplets. So this has been a great opportunity for us in a challenging environment, where our customers are nervous.
For us to work with them.
To put them on a more efficient path that they feel better about.
So that they can manage through the current period of time.
And be poised when they do accelerate to have a more efficient growth path that is going to see growth for us, but also more peace of mind for them. So we're taking this opportunity.
To get closer to our customers, which I think in a recession or certainly a super low growth environment, which the tech industry. Our industry is in is the approach that we've decided to take.
Yes, okay perfect. Thank you.
Your next question comes from the line of Mike <unk> from Needham Your line is open.
Hey, guys. Thanks for taking the questions here I wanted to cycle back to.
Matt Matt's prepared remarks, I think to open up you had cited these elevated contraction rates and I just wanted to see if we could get a better sense of the shape of those rates.
How did <unk> play out.
As far as those contractions, we were seeing with April now behind US was there any change there and then the second question was I know that you guys reiterated the calendar 'twenty three guidance.
But at the end of February <unk> had also announced a price increase for cloud ways can you give us a sense of what's embedded in your guidance based on that cloud, we price increase or was that already in some way incorporated in your previous thinking thank you.
Thanks, Mike.
Just to close out on that one.
The cloud based price increase was contemplated in the guide so that was baked into our plan.
He made the decision at the time, we acquired cloud ways with which was right. When we were just recently done the price increase for overall Dio that we would wait until we close that transaction and got a little further in and did some analysis before we.
Just blanket increase the prices of cloud ways, but so we did that it took effect in April .
But it was that we knew that going into the into the planning process and into the guidance.
On the contraction.
<unk> said that if you think of what <unk> is a function of three things its churn it's expansion and its contraction in the net of all of those three gives you.
And Dr.
And so if you look at the decline in the NDA are from first quarter from fourth quarter to first quarter churn didn't contribute to in a negative way to that reduction in churn held flat in fact, as you said, we've seen kind of month over month through the course of.
2023 and improvement in the in the churn rate modest improvement in the churn rate. So the delta that you're seeing as.
As in the MBR is driven almost entirely by the combination of lower expansion in more contraction, which is very consistent with the optimization and kind of a pause. The E&C just described in our in our customer base. So if youre trying to get a map kind of view of it just look at the <unk> and assumed churn.
Flat kind of quarter over quarter and that will that will give you the results for expansion and contraction.
Awesome. Thanks. Thank you for the color did you guys quantify the benefit from the cloud with a price increase for this this guidance we have not.
I am done.
No we did not.
Okay, Alright, Thank you I'll turn it back to my colleagues.
Your next question comes from the line of Brad Reback from Stifel. Your line is open.
Great. Thanks, very much so.
With the current guide sort of pointing towards the mid to upper teens exit growth rate for the year. The capex growing at 15% should we think about that being the long term sustainable organic growth rate for the business.
We are.
Our guidance reflects our outlook for the year and.
We aren't commenting on longer term growth expectations for the business, we continue to invest to drive growth.
That's at a higher than what you just cited but at the same time.
But theres things that we can't control beyond and so we're focusing on what we can control, which is why we made a very strategic decision months ago to accelerate to longer term free cash flow margins today.
And and as snatches sided we'll be approaching those even in this quarter, but certainly as we exit this year.
And what that positions us for US an area of lower growth. This is that this is the growth rate that persists.
Attractive margins and returns on capital.
If growth Reaccelerate in where we are investing in new products as we cited to data to do that.
We'll have more cash.
Current capacity as well as deliver more leverage in the operating model. So.
We're pleased to reiterate the guidance for the year were pleased actually with what were quite a few of the trends that we saw as we moved.
Moved through Q1, and as we're into Q2 here.
And as we get to the back half of this year and certainly in the early next year, we will have more to say about 2024, and perhaps beyond depending upon how the macro shaping up.
Great. Thanks very much.
Your next question comes from the line of can John Baugh from JP Morgan Your line is open.
Yeah, Hey, guys. Thanks for taking the question Enc, maybe could you talk about the cloud means performing especially around the multi cloud adoption that you were talking about I'm.
Im assuming cloud wins will be a beneficiary of that how are you driving that motion and secondly, it seems like the pricing increase in cloud wins proportionally higher for some of the competitive offerings.
How long do your peers, what are you hearing from customers on that price increase and how do you think that plays out.
Well.
<unk> is performing very well there has been a slight uptick in the growth rate.
Since the close.
Really owing to a lot of the acceleration in new customers is incredibly exciting.
Those customers were.
Who are coming to digital ocean.
Mismatched expectation before the close of the deal that they were expecting a more managed experience many of them churned and we've done a great job and saving those customers in and getting them into cloud waste out of the box and they are going to be long term customers with <unk>.
Increasing value as a result, so that they are really excited to have a bullet first bullet on the synergies of the copper Mary platforms and actually realizing those synergies so early and so significantly.
So we're really excited.
As we continue to look at other areas on the sales and marketing side to better match customers, whether it's our cloud <unk> solution into the right fit either it's day, one our overtime so.
So we feel very good about that in terms of the pricing.
Change.
It's early.
Six weeks after its got effective we feel good about the early returns on that and as Matt cited that had been baked in that was put on pause as we close the acquisition last year. So it was contemplated earlier this year and <unk>.
<unk> has got a previous price increase four or five years ago and it was time.
And feel good about.
The early.
Feedback and.
What we're seeing in terms of demand on the platform.
Since that announcement.
And it has gone into effect.
Got it thank you.
Your next question comes from the line of Gabriele Bush's from Goldman Sachs. Your line is open.
Hi, Good morning, Thank you Nancy.
How you think about the impact of AI on the collateral.
One is the risk that im trying to understanding.
Wanted some collateral helping bridge what may be a technical gap to help get your Kaufman ambition license software and to what extent that Dorian Jeong assumptions.
Starting in late by other AI tool I would love to Hawaii.
Well I think in the bigger picture.
Is it a very compute intensive.
Stores in Texas.
Bandwidth in Texas.
Product set however, the ultimate products are successful product shake out and so I E. An infrastructure as a service incentives. So I think overall AI.
AI tools applications will ultimately be a tailwind for our business.
And as I cited earlier there are already businesses, who are running AI models that our whole premise is artificial intelligence that are serving customers at.
At reasonable size on our platform today and have been for years.
So.
As it relates to sort of the core compute what we would be looking to offer us capabilities that allow our customers to leverage AI tools are built language models.
Or run.
Sure.
Complex compute algorithms.
Beyond what they can do today on our platform, which is why we also acknowledge that we're looking at a GPU. So.
Not.
Sure I understand specifically your question or that's something that we are necessarily concerned about in terms of the infrastructure part of our business because we think infrastructure enables AI applications.
And frankly, we should be a beneficiary over time, we've already been a beneficiary from AI models business is running on our platform.
As of today.
Thank you for the detail.
Your next question comes from the line of Jim Fish from Piper Sandler Your line is open.
Hey, guys. This is <unk> on for Jim fish. Thanks for taking my question with another quarter of learnings behind the team. Following the <unk> deal has there been any changes in the other managed service providers willingness to offer digital Ocean just due to your accelerated investments in cloud ways or have those kind of channel relationships remained relatively unchanged.
Following client base. Thank you.
So the managed hosting managed services business is very large and very fragmented around the world that this was obviously a.
The key diligence concern for us as we were going through the negotiations and the conversations with cloud weighs a year ago and.
No.
The sentiment was that it would not be an issue and the reality is that it is not an issue. We are not seeing other managed service and hosting providers that are have been meaningful customers on digital ocean.
We have not seen them move volumes away in fact, one of the larger ones on our platform that has a multi cloud managed hoster moved cloud.
Services onto our platform as a part of the optimizations in Q1, so the direct answer to your questions. We have not seen it we werent concerned.
Going into the deal after diligence and that's something we've seen.
Two plus quarters that we've owned the company.
Got it helpful. Thank you.
Yeah.
And that concludes our Q&A session for today I would like to turn the call back over to Yancey Spruill for closing remarks.
Thank you all for joining us we truly appreciate the opportunity to update you on our progress in transforming our business into a durable high growth business and a free cash flow machine in both good times and in bad.
We look forward to continuing the conversation in the weeks and months ahead as we work hard to realize this limitless potential of this opportunity we call digital Ocean have a great rest of the day.
This concludes today's conference call enjoy the rest of your day you may now disconnect.
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Yes.
Okay.
Yes.