DigitalOcean Holdings, Inc. Q3 FY2024 earnings

DigitalOcean reported third quarter fiscal 2024 revenue of $198 million, up 12.1% year over year. Gross profit was $119 million, up 11.9%. Operating income was $24.6 million, down 30.6%. Net income was $32.9 million, up 71.8%, and diluted EPS was $0.33, up 65.0%. Gross margin was 60.2%, down 0.1 percentage points, while operating margin was 12.4%, down 7.6 percentage points. On a non-GAAP basis, adjusted EBITDA was $87 million, up 14% year over year, at a 44% margin, and non-GAAP diluted net income per share was $0.52. The tension in the quarter is that revenue and net income grew while operating income fell. The filing ties the operating expense swing partly to a prior-year stock-based compensation reversal and to continued investment in AI/ML offerings and infrastructure.

Cash generation stayed solid, but it came with much heavier spending. Net cash provided by operating activities was $73 million, up 35.7% year over year. Capital expenditures were $57.35 million, up 183.5%. Adjusted free cash flow was $26 million compared with $56 million in the third quarter 2023. Deferred revenue was $5.58 million, up 9.4%. The capex increase reflects continued investment in AI/ML offerings and infrastructure, which the MD&A also links to higher cost of revenue. Gross margin held near the prior-year level even as those investments increased.

For the nine months ended September 30, 2024, revenue was $575.69 million, up 12.4% from the prior-year period, and gross profit was $348.86 million, up 15.3%. Operating income was $58.47 million, up from the prior-year period, and net income was $66.23 million, also up from the prior-year period. Diluted EPS was $0.70, up from the prior-year period. Gross margin was 60.6%, up 1.5 percentage points, and operating margin was 10.2%, up 10.0 percentage points. Net cash provided by operating activities was $211.39 million, up 36.9%, and capital expenditures were $132.89 million, up 98.1%.

Operational metrics pointed to progress with larger customers. Builders and Scalers, customers spending more than $50 per month, increased 6% from the third quarter 2023, and their revenue grew 15% year over year. Revenue from Builders and Scalers was 88% of total revenue, up from 86%. The company had about 638,000 Learners, Builders and Scalers at September 30, 2024, including about 18,000 Scalers and about 145,000 Builders. Scalers rose from about 16,000 and Builders from about 138,000 in the prior-year period. Net dollar retention rate remained stable at 97% compared with the prior quarter. DigitalOcean released 42 new product features during the quarter, made GPU Droplets accelerated by NVIDIA H100 Tensor Core GPUs available to all customers as of October 1, 2024, and launched early availability of the GenAI Platform. Other releases included Global Load Balancers and Kubernetes Log Forwarding. The company repurchased 297,827 shares during the quarter. Top 25 customers made up approximately 9% of revenue, compared with approximately 7% in the prior-year period.

Guidance gives a mixed near-term picture. For the fourth quarter, DigitalOcean initiated guidance with adjusted EBITDA margin of 34% to 38%, non-GAAP diluted net income per share of $0.27 to $0.32, and fully diluted weighted average shares outstanding of approximately 103 to 104 million shares. For the full year 2024, the company raised its revenue guidance and set adjusted EBITDA margin of 40% to 41%, adjusted free cash flow margin of 15% to 17% of revenue, non-GAAP diluted net income per share of $1.70 to $1.75, and fully diluted weighted average shares outstanding of approximately 103 to 104 million shares. The main risks include a material weakness in internal control over financial reporting, a history of operating losses, the ability to attract and retain customers, competition, macroeconomic conditions, integration of acquired businesses including Paperspace, reputational or liability risks from AI/ML development, security breaches, and customers' continued access to the platform. The sharp rise in capital expenditures and the lower adjusted free cash flow are also worth watching, especially if the AI infrastructure buildout continues at this pace.