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DigitalOcean's (NYSE:DOCN) Q1 Earnings Results: Revenue In Line With Expectations But Stock Drops


Full Report / May 04, 2022
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Cloud computing provider DigitalOcean (NYSE: DOCN) reported results in line with analyst expectations in Q1 FY2022 quarter, with revenue up 35.9% year on year to $127.3 million. Guidance for the full year also exceeded estimates, however the guidance for the next quarter was less impressive, coming in at $134 million, 1.17% below analyst estimates. DigitalOcean made a GAAP loss of $18.1 million, down on its loss of $3.33 million, in the same quarter last year.

DigitalOcean (DOCN) Q1 FY2022 Highlights:

  • Revenue: $127.3 million vs analyst estimates of $126.2 million (0.87% beat)
  • EPS (non-GAAP): $0.07 vs analyst expectations of $0.12 (40% miss)
  • Revenue guidance for Q2 2022 is $134 million at the midpoint, below analyst estimates of $135.5 million
  • The company reconfirmed revenue guidance for the full year, at $566 million at the midpoint
  • Free cash flow of $5.03 million, up from $52 thousand in previous quarter
  • Net Revenue Retention Rate: 117%, in line with previous quarter
  • Customers: 623,000, up from 609,000 in previous quarter
  • Gross Margin (GAAP): 63.2%, up from 57.7% same quarter last year

Started by brothers Ben and Moisey Uretsky, DigitalOcean (NYSE: DOCN) provides a simple, low-cost platform that allows developers and small and medium sized businesses to host applications and data in the cloud.

DigitalOcean offers a range of cloud computing options for developers and small businesses. Hyperscalers Amazon Web Services, Microsoft Azure, and Google Cloud Platform are the dominant providers of the cloud infrastructure that has become the standard for companies today.

For individual developers and small and medium businesses, the large cloud platforms present some hurdles to adoption: the actual onboarding and implementation processes can be difficult, pricing models can be complex and at times unpredictable, and there is a relatively low level of support for SMBs, as the cloud giants are focused on serving enterprise customers.

DigitalOcean focuses mainly on less application and website hosting use cases and differentiates itself from the hyperscale platforms through the intuitive simplicity of its user interface, which allows customers to spin up “Droplets” (their term for a virtual machine) in under a minute. The company offers a high level of live-person customer support regardless of spend levels, and utilizes open source software to keep costs low. For context, DigitalOcean’s bandwidth prices are a fraction of its hyperscale rivals.

Data is the lifeblood of the internet and software in general, and the amount of data created is growing at an accelerating pace. Likewise, the importance of storing the data in scalable and efficient formats continues to rise, especially as the diversity of the data and associated use cases expand from analyzing simple, structured data to high-scale processing of unstructured data, images, audio and video.

Digital Ocean’s main competitors are the hyperscale cloud providers: Amazon (NASDAQ:AMZN), Microsoft (NASDAQ: MSFT), and Alphabet’s Google Cloud Platform (NASDAQ: GOOGL). IBM (NYSE:IBM) and Oracle (NYSE:ORCL) round out the larger players. A second set of rivals are niche cloud providers that target certain verticals or geographies such as OVH, Vultr, Linode, and Heroku, which is owned by Salesforce.com (NYSE:CRM).

Sales Growth

As you can see below, DigitalOcean's revenue growth has been very strong over the last year, growing from quarterly revenue of $93.6 million, to $127.3 million.

DigitalOcean Total Revenue

And unsurprisingly, this was another great quarter for DigitalOcean with revenue up 35.9% year on year. Quarter on quarter the revenue increased by $7.66 million in Q1, which was in line with Q4 2021. This steady quarter-on-quarter growth shows the company is able to maintain a strong growth trajectory.

Guidance for the next quarter indicates DigitalOcean is expecting revenue to grow 29% year on year to $134 million, slowing down from the 34.9% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 30.8% over the next twelve months.

Customer Growth

You can see below that DigitalOcean reported 623,000 customers at the end of the quarter, an increase of 14,000 on last quarter. That is a little better customer growth than last quarter and quite a bit above the typical customer growth we have seen lately, demonstrating that the business itself has good sales momentum. We've no doubt shareholders will take this as an indication that the company's go-to-market strategy is working very well.

DigitalOcean Customers

Product Success

One of the best things about software as a service businesses (and a reason why they trade at such high multiples) is that customers tend to spend more with the company over time.

DigitalOcean Net Revenue Retention Rate

DigitalOcean's net revenue retention rate, an important measure of how much customers from a year ago were spending at the end of the quarter, was at 117% in Q1. That means even if they didn't win any new customers, DigitalOcean would have grown its revenue 17% year on year. Trending up over the last year, this is a good retention rate and a proof that DigitalOcean's customers are satisfied with their software and are getting more value from it over time. That is good to see.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. DigitalOcean's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 63.2% in Q1.

DigitalOcean Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.63 left to spend on developing new products, marketing & sales and the general administrative overhead. Despite it trending up over the last year this would still be considered low gross margin for a SaaS company and we have no doubt shareholders would like to see the improvements continue.

Cash Is King

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. DigitalOcean's free cash flow came in at $5.03 million in Q1, turning positive year on year.

DigitalOcean Free Cash Flow

DigitalOcean has generated $37.2 million in free cash flow over the last twelve months, a decent 8.06% of revenues. This FCF margin is a result of DigitalOcean asset lite business model, and provides it with optionality and decent amount of cash to invest in the business.

Key Takeaways from DigitalOcean's Q1 Results

With a market capitalization of $4.36 billion DigitalOcean is among smaller companies, but its more than $1.55 billion in cash and positive free cash flow over the last twelve months give us confidence that DigitalOcean has the resources it needs to pursue a high growth business strategy.

We enjoyed seeing DigitalOcean’s impressive revenue growth this quarter. And we were also glad to see the acceleration in customer growth. On the other hand, revenue guidance for the next quarter missed analysts' expectations. Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. But investors might have been expecting more and the company is down 5.51% on the results and currently trades at $41.1 per share.

Is Now The Time?

When considering DigitalOcean, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think DigitalOcean is a solid business. Its revenue growth has been strong. And while its gross margins show its business model is much less lucrative than the best software businesses, the good news is its very efficient customer acquisition hints at the potential for strong profitability, and its customers are increasing their spending quite quickly, suggesting that they love the product.

DigitalOcean's price to sales ratio based on the next twelve months is 7.7x, suggesting that the market is expecting more steady growth, relative to the hottest tech stocks. There are definitely things to like about DigitalOcean and looking at the tech landscape right now, it seems that it doesn't trade at an unreasonable price point.

The Wall St analysts covering the company had a one year price target of $113 per share right before these results, implying that they saw upside in buying DigitalOcean even in the short term.

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