DigitalOcean Holdings, Inc. Q1 FY2023 earnings

DigitalOcean's first quarter ended March 31, 2023 delivered double-digit revenue growth but wider losses. Revenue rose 29.7% year over year to $165.1 million. Gross profit rose 16.4% to $93.3 million. Gross margin fell to 56.5%, and operating margin fell to -19.7%. The company reported an operating loss of $32.5 million and a net loss of $34.9 million. Diluted loss per share was $(0.37), down from the prior-year quarter. The GAAP loss widened as co-location, depreciation, and restructuring costs weighed on results. The company also recorded a restructuring charge in the period, which management tied to a cost structure reset.

On a non-GAAP basis, adjusted EBITDA was $56.2 million, or 34% of revenue. Non-GAAP diluted net income per share was $0.28. Operating cash flow was $36.2 million, up 19.1%. Capital expenditures were $23.3 million, up 1.2%. Adjusted free cash flow was $25.7 million. Deferred revenue was $5.0 million, down 4.4%. The wide gap between GAAP and non-GAAP results came from stock-based compensation, restructuring and related salary continuation charges, acquisition related compensation, amortization of acquired intangibles, and acquisition and integration costs. The company also repurchased 7,759,973 shares for $266 million during the quarter, which reduced the share count but used cash.

Operationally, ARR ended the quarter at $669.1 million, up 28% year over year. ARPU rose 16% to $88.35. Net dollar retention rate was 107%, compared with 117% in the first quarter of 2022. Customers spending more than $50 per month, which DigitalOcean calls Builders and Scalers, increased 43% from the first quarter of 2022. The company ended the quarter with approximately 15,000 Scalers and approximately 131,000 Builders. It served approximately 614,000 Learners, Builders and Scalers as of March 31, 2023. Higher spend customers represented 86% of revenue. Management pointed to the Cloudways acquisition as a contributor to higher spend customers, but the lower net dollar retention rate shows that expansion from the existing customer base has cooled.

Guidance for the second quarter of 2023 includes an adjusted EBITDA margin of 37% to 38% and non-GAAP diluted net income per share of $0.40 to $0.41. Fully diluted weighted average shares outstanding are expected to be approximately 103 million for the quarter. For the full year 2023, DigitalOcean guides to an adjusted EBITDA margin of 38% to 39%, adjusted free cash flow margin in the range of 21% to 22%, and non-GAAP diluted net income per share of $1.70 to $1.73. Full-year fully diluted weighted average shares outstanding are expected to be approximately 103 million to 105 million. A revenue outlook was issued alongside those measures, but the company does not provide a reconciliation of forward-looking non-GAAP figures to GAAP, citing the variability of stock-based compensation and other items. That gap leaves the GAAP path for the year uncertain.

The quarter carried clear risks. Gross margin declined as co-location and depreciation costs rose. Net dollar retention at 107% means less expansion from the installed base, and the macroeconomic backdrop remains weak. The restructuring plan, approved on January 27, 2023, is expected to be substantially complete by the end of the third quarter of 2023. It aims to adjust the cost structure and accelerate the timeline to reach adjusted free cash flow margins greater than 20%. DigitalOcean also lists a history of operating losses, limited operating history, competition, security breaches, privacy and data security laws, managing growth, and integration of Cloudways among its risk factors. Recent growth may not be indicative of future growth. The balance sheet remains leveraged, and the buyback drew down cash while debt stayed in place.