DigitalOcean Holdings Inc

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DigitalOcean (NYSE:DOCN): One on One with the CEO Q3 2021





Date Published:

Lede
We spoke with the CEO DigitalOcean (NYSE:DOCN) following our earnings review from 11-4-2021.

As a reminder, all of our CEO and CFO interviews for all companies are available on the Interviews Tab.

 

Preface

We discussed several topics with CEO Yancey Spruill, from clarity on the quarter just reported to the future beyond 2025.

Some highlights of our conversation are included below.

I started out addressing DOCN’s take on ‘exiting’ customers that were bad actors and said:

It’s one thing to say that you sell trust, but it’s another to actually be trustworthy and have integrity; even if it impacts a metric that many people follow and you did it in the name of good governance.

So, I thank you.

And you are clearly a company that leads with integrity.

I might be the one person left on the planet that cares about integrity, but I care about it, even when I’m criticized for addressing it.

With that as a tone setter for the conversation, we then turned to the rather high net dollar retention rate for a technology company that serves SMBs and that turned the conversation to churn.

It naturally struck a company culture tone.

Yancey noted:

 

Companies that accept churn, I just think culturally it’s a problem.

I think for me, that’s a big deal because it sets the foundation for our ability to grow in the future.

That feeds right into the 116[%] dollar retention.

We see still opportunity to improve from here, but that’s a huge headline.

 

It’s easy to hear the confidence that Yancey has in DOCN’s business and future and we addressed that too.

He said:

 

Everybody keeps asking, how are you confident?

We’re confident because we talk to our customers, we know what makes them happy, what makes them stay.

 

It’s with that beginning to the talk that reinforced to us how focused the company is on customer satisfaction and long-term processes to enable that.

One of the most remarkable aspects of DOCN’s business is its customer growth with very low sales and marketing expense.

That customer growth is the basis for business growth moving forward due to the high net dollar retention and this growing number of customers that move from small businesses to medium sized businesses on DigitalOcean’s platform.

Yancey said:

 

Yeah, I’m liking to use the word graduate because well, at the IPO it said that customers are graduating off of DO.

In fact, what really happened is they graduate on our platform and start to ramp at the business.

We started a customer off, tens of thousands of customers each month through the self-serve motion. And over time they grow.

And so, every month we’re unleashing new customers that are launching businesses and they become part of that ecosystem of customers that are scaling on the platform.

 

The conversation then turned to the acquisition of serverless provider Nimbella. With regard to the acquisition, Yancey revealed:

 

We got new people with different DNA, different perspective on cloud and that just makes us all better. Because it broadens our perspective.

So quite a few of our customers are running AWS [serverless]. Because we didn’t have a functions and they were asking us, please launch a serverless so we can have all of our apps integrated.

So, this is being really responsive to the customer dynamic.

 

We then turned to the efficacy of the new advertising campaign and how the company was finding success so early with the new plan.

The CEO said:

 

I would say that as we improved management of the funnel that starts with 5 million visitors to the website.

And operationalize each material step in the customer journey, until the year after they put the credit card down and they’ve been on the platform.

We really rearchitected that whole workflow, customer flow. And we’ve done it in a way where it’s very repeatable. We understand the levers, we continue to improve that experience.

That’s really was a prerequisite for us to start to bring high intent customers to our platform.

 

While on the subject of newly effective sales and marketing expense and still a very low overall spend relative to revenue, I asked about increasing that spend, and if the company, already growing revenue at 37%, could spend more to grow faster.

Yancey replied:

 

We’re happy to spend faster than 37% to support a faster growth rate than 37% and a durable growth rate faster than 37%.

We’ll do that all day every day.

We want to go create a multi-billion-dollar business here over the next several years. And we’re happy to spend to do that.

 

Finally, I turned to growth after 2024, beyond the guided to its first $1 billion in revenue for that year and then looking even further forward to 2025 and beyond.

Yancey reiterated his prior view from our conversation just one quarter ago.

 

I think we’re going to run through a billion and our goal is durability of growth. This is a massive opportunity.

We think adding and being consistent on product innovation, support the journey from customer from two-person development team, to people who are running small, medium sized businesses on the platform.

Thinking long-term is going to enable us to run through a billion and absolutely start to focus on what the next billion looks like.

 

We spoke in greater depth about other subjects as well.

Please enjoy the full transcription of our one-on-one conversation with the CEO below.

 

One on One with the CEO of DigitalOcean

 

Ophir Gottlieb:

I want to take a moment to tell you how impressed I am with your decision to tighten the rules on exiting customers.

 

It's one thing to say that you sell trust, but it's another to actually be trustworthy and have integrity; even if it impacts a metric that many people follow and you did it in the name of good governance.

 

So, I thank you. I'm going to move on to the questions. It's not a question, but just, I don't know if anyone else has noticed or anyone else has said anything, but it makes a really big difference to me.

 

And you are clearly a company that leads with integrity and I might be the one person left on the planet that cares about that, but I care about it.

 

Yancey Spruill:

Well, thank you for that. We did have one of our other investors say that. Thank you. It's very important.

 

Ophir Gottlieb:

I'm glad someone else said it. Okay. All right.

 

Having said all that, let's get into some Q&A.

 

Before I go into some depth, I want to give you an opportunity to talk about what was most important to you.

 

I see obviously, DigitalOcean beats, the consensus for revenue, ARR, ARPU, net retention, gross profit, gross profit margin, EBITDA, full year revenue guidance all while guiding to 31% for 2022.

 

Tell investors how this is all happening, because even still, DigitalOcean is surprising them, no matter how many times I write that it is not surprising.

 

Yancey Spruill:

I think when I step back and look at two years ago, as we were coming in and kind of map out what it's going to take to get this business on track, to reach its potential. The one thing I looked at was net dollar retention below 100% was such a huge headwind.

 

And so, we began talking about, hey, we needed to fix expansion, but first, churn. For a couple reasons, one, culture.

 

Companies that accept churn, I just think culturally it's a problem.

 

So, we kind of mapped out a roadmap to figure out what was addressable. And, as we got into the Q4 of last year, started looking at a low double-digit [churn] target.

 

And to me, I think it's notable that we got there. Within 12 months of really changing a lot of our processes, and really starting to act against that.

 

I think for me, that's a big deal because it sets the foundation for our ability to grow in the future on a couple reasons.

 

One, we're not losing as many customers.

 

But as we talked about today, this bifurcated customer base where we bring in a lot of small customers, incubate them and then a percentage of them, launch businesses that grow and become a meaningful part of the actual revenue stream.

 

The more customers we keep raises the option value on that unleashing those entrepreneurs.

 

So, it's very important part of the ecosystem that we keep churn down.

 

And it also, from a different aspect of the business, it's forced us to make the customer experience better from when they hit the website to their first 90, 120 days, their first year, the most churn occurs.

 

And, we've gotten better all across the company in order to achieve that.

 

So, for me, I think that's a headline because we set that out and to get there.

 

And I, the other thing that's really important is for us to be a business focused on SMBs that have essentially 90% gross retention. Is very, very strong. And, so I think that's a real headline.

 

That feeds right into the 116[%] dollar retention.

 

We see still opportunity to improve from here, but that's a huge headline.

 

Obviously the ARPU growth of 28% when we continue... Again, as those customers stay longer, they grow and they buy more of our different products. So it's validation of our product strategy of our support model and our engagement model.

 

And so, I think those are important because they're delivering accelerating revenue growth now. But we can manage those metrics.

 

And, so it gives us confidence. Everybody keeps asking, how are you confident?

 

We're confident because we talk to our customers, we know what makes them happy, what makes them stay.

 

And we're going to manage the business to drive those metrics, keep them at least where they are and that supports a really fast growth rate. So I think those are really important. Obviously, getting CapEx; this is our third quarter declining or managing it per expectations.

 

I think we're building the confidence in investors that the CapEx numbers that they were seeing when they looked to invest one, were in the past, we're managing this business in the future.

 

And then I think the free cash flow, you look at our free cash flow margin. You look at our revenue growth and you add those two together and we're building what should be considered an elite software business technology business that has really rapid growth and is efficient in delivering cashflow to investors today. Not years into the future.

 

Ophir Gottlieb:

Well said.

 

There was some interesting conversation on the conference call this morning surrounding customer count growth for this group of about 90,000 customers. So about 15% of customers that make up something like 85% of total revenue.

 

This cohort in particular is growing several-fold the overall 7% number.

 

Is that new customer additions in this realm or is that smaller customers that are growing into this category?

 

Yancey Spruill:

Yeah, I'm liking to use the word graduate because well, at the IPO it said that customers are graduating off of DO.

 

In fact, what really happened is they graduate on our platform and start to ramp at the business.

 

And so, the count is growing because of that.

 

We started a customer off, tens of thousands of customers each month through the self-serve motion. And over time they grow.

 

And so, every month we're unleashing new customers that are launching businesses and they become part of that ecosystem of customers that are scaling on the platform.

 

So that's fueling the growth. And that's why customer growth is important, not for this quarter, but not for next quarter.

 

But it's important for the long-term health of the business because we're incubating tens of thousands of new customers a month.

 

And a percentage of them are going to be unleashed into a business and become much more meaningful part of the revenue picture over time. So that's why customer count is important.

 

It's a longer-term indicator of the health of the business. And we believe that at 10% [compounded annual growth] or better, we think it's still achievable and still a target for us.

 

We're adding a lot of people to the ecosystem and that's going to give us that option value on future growth.

 

And then, focusing on retention and expansion of net dollar retention and ARPU growth, multiproduct adoption. That's what's fueling growth.

 

Ophir Gottlieb:

There's no doubt that 10% CAGR in customer additions for the foreseeable future that is just massive, massive optionality.

 

And now we have really good evidence that the optionality has value through this growth in this sort of top 15% of customers.

 

Two quarters ago we spoke about net dollar retention and how quickly it was rising. And here again, as we were saying, it spiked to 116 [per cent].

 

In the long run, we see at least a part of net dollar retention coming from the platform side of the business.

 

In that realm, let's talk about the full blown acquisition of Nimbella rather than a partnership.

 

So, what is it that you saw that made the opportunity from Nimbella compelling enough to acquire them rather than partner with them?

 

Yancey Spruill:

Well, I think in my experience partnering with a very small company is difficult logistically. They don't have the process, et cetera. They're just figuring things out.

 

So even though they have the IP, we just think it's a better outcome to acquire.

 

Although we might have started with a conversation of a partnership that very quickly pivoted to an acquisition. We're excited to have them in here.

 

There's a number of reasons to do acquisitions of this size and scale. Even though it's a dozen or so employees we acquired with the business.

 

With a product that, they had made generally available and we will have generally available in the first half of next year. We got new people with different DNA, different perspective on cloud and that just makes us all better. Because it broadens our perspective.

 

And so, I think it's really important to do M&A if for that, I was just talking to our chief product officer a little while ago about that very concept of, you know it's optionality on talent and innovation to bring new people into our ecosystem so that we can get better.

 

So, we're already seeing that with them and so we're excited.

 

We think Serverless is going to be a pillar, like a database, managed databases, managed Kubernetes, our marketplace. We're excited to get that in the hands of customer as we get in the next year.

 

Ophir Gottlieb:

On the side of the platform,  were you were seeing a reason to, or demand for basically FaaS, this sort of making APIs easier to work with in microservices?

 

That was something that your top 15% were clamoring for, I guess?

 

Yancey Spruill:

Well, the top five request in general for new products, as Mongo [MongoDB] was also one of the top requested features for customers.

 

So quite a few of our customers are running AWS [serverless]. Because we didn't have a functions and they were asking us, please launch a Serverless so we can have all of our apps integrated.

 

So, this is being really responsive to the customer dynamic.

 

And we see it as, we're at 10% of revenue today across our platform and service software as a service capability. That was up from zero a little over two years ago.

 

And we expect to drive that to about 20% on arrival of our first billion dollars in revenue in a few years.

 

And Serverless going to be a big aspect of how we get from 10 to 20%.

 

Ophir Gottlieb:

Okay. It seems to me that with the move to Serverless, well I'll just see if you can comment, on the move to Serverless, people, there's this sort of narrative as, obviously like DigitalOcean's best customers will go to AWS.

 

And I actually view it differently.

 

I think if you're adding serverless, then it seems like there are companies that are with the hyperscalers in particularly AWS that will now have the capability of leaving AWS fully and coming onto DigitalOcean.

 

So, it seems like this is not just growing the software side and adding functionality that's requested fine.

 

It seems like this is a rather competitive move and that's why I was asking you about the acquisition.

 

Yancey Spruill:

Yeah. When you package simplicity, community, our support model, our open-source commitment with competitive price products and you start to add more capabilities, it's enabling these entrepreneurs who three to five years ago looked at DO and say, I'll come and test at DO.

 

But I want to build a hundred-million-dollar business and I'm going to need all these other capabilities.

 

Should I do that day one, when I know I'm going to have to go multicloud with all these other applications or should I just go to these other places?

 

And so, we became a destination for infrastructure as a service.

 

But people knew they had to go multi-cloud, now they know they can build a really big business with the core functionality that we're offering on the platform.

 

I think this makes us a very compelling alternative.

 

And, there's quite a few people who go to AWS, launch a business. They get to 1 million, 2 million, 5 million revenue. And they launch different products, different geographies, and they need help to DevOps.

 

They still don't have a DevOps team.  They still are a relatively small organization, and yet they don't spend enough money to matter [o the hyperscalers].

 

A lot of customers on those hyperscalers, we are actually documenting to help them manage their infrastructure on the hyperscalers.

 

So, I do think this is a move that will help attract businesses. SMBs, not enterprise, SMBs, to get yet another reason to come over to DO from other alternatives.

 

Ophir Gottlieb:

Yeah. I think it is too. But sort of the, if we're talking about SMBs would be the ‘M’Bs.

 

Yancey Spruill:

Right. Correct.

 

Ophir Gottlieb:

On the [earnings] conference call, you said something really interesting, paid advertising is working to accelerate customer acquisitions.

 

And of course, for anyone that follows DigitalOcean, this is particularly interesting because DigitalOcean spends very little on sales and marketing.

 

And still, even this quarter, showed 37% year over year revenue growth.

 

So, what can you tell us about the new advertising approach and spend both where you see it going long term and with respect to whom you're actually targeting?

 

Are you poaching hyperscaler customers, or who are your ideal targets with this advertising and where is the strategy going?

 

Yancey Spruill:

I would say that as we improved management of the funnel that starts with 5 million visitors to the website.

 

And operationalize each material step in the customer journey, until the year after they put the credit card down and they've been on the platform.

 

We really rearchitected that whole workflow, customer flow. And we've done it in a way where it's very repeatable. We understand the levers, we continue to improve that experience.

 

That's really was a prerequisite for us to start to bring high intent customers to our platform.

 

And so, all pages are bringing high intent versus people who just, are cruising in the internet, reading about various things and open-source software.

 

When you start to target people through pay, they're obviously searching for something very specific.

 

So, we are now in a position given how much progress we've made on self-serve funnel that we can target people and that's very effective for us.

 

And so, our framework for 10% of revenue, the right sales marketing spend number is, we look at LTV to CAC, we looking for churners.

 

And, if we could grow the business faster, i.e. aggregate growth rate, we'll spend more than 10% of revenue. We inherited that number, we've changed the mix of that number. It actually went backwards and now we spend that percent, that means sales and marketing spend growth at current revenue growth rate, 37%.

 

So, we're happy to do that. We're happy to spend faster than 37% to support a faster growth rate than 37% and a durable growth rate faster than 37%.

 

We'll do that all day every day.

 

At 10% of revenue, we have a lot of headroom and opportunity to invest, to grow in a faster growth rate.

 

If we weren't at this growth rate, if we were at last year's revenue growth rate, we could be printing substantially higher EBITDA margins. We don't think that's the right train.

 

We want to go create a multi-billion dollar business here over the next several years. And we're happy to spend to do that.

 

Ophir Gottlieb:

Yeah. I'm glad to hear you say that. I think DigitalOcean is one of the few companies I cover where investors are clamoring for you to spend more on sales and marketing, as opposed to spend less.

 

It's funny. It's really nice to see that.

 

I mean, it's easy to say, spend more on sales and marketing, but it needs to be effective. And it seems like it's becoming effective, which is nice to see.

 

Two quarters ago, we spoke about this vision I have of DigitalOcean that while you've given this sort of formal revenue guidance for at least a billion dollars [in revenue] by 2024, or for, let's say fiscal year 2024; that I per se didn't feel as though 2024 was some magical line in the sand when growth would suddenly slow from there forward.

 

I don't see a billion dollars in revenue as nearing DigitalOcean's asymptote.

 

Nowhere near, maybe at 8 billion, I would say that.

 

You basically noted, two quarters ago that you, you didn't see things changing materially after 2024 per se.

 

I mean, it's a long time in the future, but do you reiterate that view that nothing over the last three months has changed your long-term view of growth prospects for DigitalOcean into 2025 and beyond.

 

Knowing full well that when we're talking three, four years in the future, it's a little ethereal.

 

Yancey Spruill:

We're not going to be sitting around the table hyperventilating on December 31st, 2024 saying we're done. Right?

 

I agree with you. I think we're going to run through a billion and our goal is durability of growth. This is a massive opportunity.

 

And, we think that we can pull a bunch of different levers and focus on the levers that matter to accelerate growth.

 

Obviously, focusing on retention expansion; i.e. Improving net dollar retention was critical to redirecting the growth rate, focusing on ARPU and nurturing customers on the platform. It was vitally important.

 

We think adding and being consistent on product innovation, support the journey from customer from two-person development team, to people who are running small, medium sized businesses on the platform.

 

Thinking long-term is going to enable us to run through a billion and absolutely start to focus on what the next billion looks like.

 

In fact, we just got our plan approved for next year, in last week or two weeks ago. And we're starting to implement on 2022, and we've already gotten ahead of 2022 on a number of things.

 

The outperformance we were looking at an EBITDA. And so that feels good.

 

And so, our exec team's going to meet very soon talk about 2023 and beyond, because our exit runway for 2023 is going to be squarely in the face of a billion in terms of 2024.

 

So, we want to be out ahead of it and because there is this massive opportunity that we're playing in.

 

Ophir Gottlieb:

The last thing I have for you, you spoke about this on the call, you called it your principles of differentiation.

 

And of all the questions I get from DigitalOcean, this is probably the second most frequent. And you can imagine why, if people don't know the story and don't care to know the story, then I don't know infrastructure is infrastructure, isn't it?

 

So, can you explain for investors essentially those principles of differentiation, or if even prefer, answer the why DigitalOcean questions that we get?

 

Yancey Spruill:

It's interesting; the third infrastructure business I've been a part of DigitalGlobe, SendGrid and now DigitalOcean.

 

When you talk to a customer in this business, or either any of those businesses, they don't view the infrastructure as incidental. It's not a commodity it's central to their life, right?

 

It's central to how they're building applications to serve their customers, to solve their problems.

 

And, that's what I love about these types of companies, because it is tricky.

 

People think, well, it's a bunch of servers and network gear, blah, blah, blah.

 

But the reality is, it's enabling people to serve their customers. It's foundational to what they do.

 

And why our differentiators matter so much because simplicity makes the burden of understanding a lot of around the technology having to have DevOps, if you're a five-person team, just trying to get an app off the ground with a million of revenue, you'd much rather invest that in a software development engineer or a digital marketing person than have to hire an IT person to manage your gear.

 

And to manage the complexity of software hardware interfaces.

 

So, our customers are grateful that they're is finally a technology solution that is simple, easy, intuitive to use that was built for them.

 

The fact that we have documentation, and we don't say you got to be above a certain price point to get access to our tutorials and our documentation.

 

That's a force multiplier for people who, again, they don't count the technical expertise. This, maybe they quit their day job to try to chase the dream.

 

We're helping to fuel that with this well written documentation. The fact that we give people support so that when they get stuck, we help them get unstuck.

 

My first customer meeting was a customer at [Microsoft] Azure and they were trying to launch their second game.

 

And they couldn't get it to work on Azure. And they were too small to matter to Azure, they couldn't talk to anybody. And we got connected to them.

 

We got them up and running on their game and they grew rates of venture capital, they just sold the company.

 

We're talking about entrepreneurs who had a dream and big cap tech is made for enterprise. And enterprises have armies of IT and DevOps people. They can deal with complexity.

 

They don't care as much about that. They don't care about open source software. They're all proprietary.

 

And so, we are a purpose-built solution for early stage businesses to unleash them.

 

When we were going through the IPO process, it was clear that a lot of our investors thought simplicity was a marketing term.

 

But if you talk to our customers, I can guarantee in 10 minutes, they're going to use the word simplicity, and they're going to use the word support. And they're going to use the word love, which is in our values.

 

They're going to say that how they love the support. That people frequently tell us, can we pay for support? We will be happy to pay for it because it's so good and helpful for them.

 

And why that's important is because they can't turn around and look behind them.

 

They can't call IT on the seventh floor. It doesn't exist.

 

So, the product experience for them has to stand on itself and when it doesn't, they need help. And that's why people are so passionate about being customers on DO.

 

Ophir Gottlieb:

Yancey thank you so much. Those are all my questions. Is there anything I didn't ask that I should have asked or anything you wanted to say that you didn't get a chance to say?

 

Yancey Spruill:

No, I we're excited. We have those of us who've been here a couple years since been journey to get to this point and we're just getting started.

 

So, really excited about getting the company energized about serving customers; for our passion about expansion and retention.

 

They're hearing in the [earnings] call now, and they're asking us questions about it.

 

They're helping them prioritize, how to do their jobs better. And, there's nothing more exciting for me to see the organization it's not top down and or, ‘hey, we got to fix these metrics.’

 

People understand how to, what those metrics mean in their jobs.

 

And the good thing is now we've brought in Gabe Monroy to be our chief product officer.

 

And we're now set up to do product innovation really well and sell that into our customers. Because we've learned all those closely.

 

So, it's so early in this opportunity and it's not like we're selling a lot of promise to come, right? It's a high grower; it's generating nice free cash flow in a limitless market opportunity. And we're really excited.

 

Ophir Gottlieb:

Yeah, it's a remarkable opportunity and execution.

 

All right, Yancey, thank you so much. I look forward to speaking with you, I guess it would be February of next year. And have a great rest of your week, rest of your month and have a happy new year.

 

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The author is long DigitalOcean at the time of publication.


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