DigitalOcean Holdings, Inc. (DOCN) Q2 2025 Earnings Call Transcript

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Overview

The earnings call presents a positive outlook with strong AI ARR growth, record incremental ARR, and balanced growth between AI and core cloud. Despite mixed impacts on NDR, the company raised guidance and achieved high ARR. Encouraging AI business margins and strategic investments further bolster the positive sentiment. The market strategy and shareholder return plan show a focus on growth and stability, with a slight reduction in share repurchases to address outstanding convert. Overall, the positive elements outweigh the concerns, suggesting a positive stock price movement.

Key Financial Performance

Revenue $219 million, growing 14% year-over-year. Reasons for change: Growth momentum from Q1 continued, excellent strength in AI/ML business with revenue growing north of 100% year-over-year, and strong growth from Scalers+ customers at 35% year-over-year.

Incremental ARR $32 million, the highest incremental ARR since Q4 of 2022 and the highest organic incremental ARR in over 3 years. Reasons for change: Strong top-line performance and increased traction with larger customers and committed contracts.

Adjusted Free Cash Flow $57 million, which is 26% of revenue. Reasons for change: Healthy profitability and ability to accelerate revenue while maintaining attractive free cash flow margins.

Gross Margin 60%, which was 100 basis points higher than the prior year. Reasons for change: Improvements in customer acquisition and strong customer adoption of AI/ML products.

Adjusted EBITDA $89 million, an increase of 10% year-over-year. Adjusted EBITDA margin was 41%, approximately 100 basis points lower than the prior year. Reasons for change: Durable revenue growth and ongoing cost discipline.

Non-GAAP Diluted Net Income Per Share $0.59, a 23% increase year-over-year. Reasons for change: Expanding per share profitability by driving durable revenue growth while exercising ongoing cost discipline.

GAAP Diluted Net Income Per Share $0.39, a 95% increase year-over-year. Reasons for change: Revenue growth, operating leverage, and prudent management of stock-based compensation.

Net Dollar Retention 99%, up from 97% in the same quarter last year. Reasons for change: Improvements in customer acquisition and strong customer adoption of AI/ML products.

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Operating Highlights

AI/ML Business Growth: Revenue grew over 100% year-over-year, driven by strong demand for inference workloads.

Gradient AI Agentic Cloud: Launched Gradient AI Platform for developing AI agents, with over 14,000 agents created since launch.

New Products and Features: Released over 60 new products and features, with 64 of the top 100 customers adopting new capabilities.

GPU Droplets: Expanded GPU lineup with NVIDIA and AMD GPUs, including new inference-optimized GPU Droplets.

Atlanta Data Center: Opened a new data center optimized for AI inferencing, offering a complete stack for AI applications.

Customer Migration: Facilitated 76 migrations from other cloud providers, highlighting competitive pricing and performance.

AI Partnerships: Collaborated with AMD to provide access to AMD Instinct GPUs, powering AMD Developer Cloud.

Revenue Growth: Q2 revenue reached $219 million, a 14% year-over-year increase.

Scalers+ Customers: Revenue from customers with $100,000+ annual run rate grew 35% year-over-year.

Free Cash Flow: Adjusted free cash flow was $57 million, 26% of revenue.

AI/ML Focus: Positioned as a leader in AI/ML with a twin stack of general-purpose and AI-specific cloud platforms.

Go-to-Market Strategy: Enhanced direct sales and ecosystem partnerships to attract AI-native customers.

Long-term Financing: Plans to address 2026 convertible debt by year-end with multiple financing options.

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Risk or Challenges

Market Conditions: The company faces competitive pressures in the AI/ML space, with a need to differentiate its offerings from other cloud providers. Additionally, the demand environment for AI/ML workloads is robust, but maintaining this momentum could be challenging.

Regulatory Hurdles: No explicit mention of regulatory challenges was made in the transcript.

Supply Chain Disruptions: No explicit mention of supply chain disruptions was made in the transcript.

Economic Uncertainties: The company is exposed to broader economic uncertainties that could impact customer spending and adoption of its services, particularly in the AI/ML and cloud computing sectors.

Strategic Execution Risks: The company is heavily investing in AI/ML and cloud innovations, which require successful execution to maintain growth. There is also a reliance on large-scale customer migrations and multiyear deals, which could pose risks if not executed effectively.

Financial Risks: The company has outstanding convertible debt due in 2026, which it plans to address by the end of the calendar year. This could pose financial risks if market conditions or financing options change unfavorably.

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Guidance & Outlook

Full Year Revenue Guidance: DigitalOcean has raised its full year revenue guidance to a range of $888 million to $892 million, representing approximately 14% year-over-year growth at the midpoint.

Full Year Free Cash Flow Guidance: The company has increased its full year free cash flow guidance to 17% to 19% of revenue, demonstrating confidence in maintaining attractive free cash flow margins while accelerating revenue growth.

Third Quarter Revenue Guidance: Revenue for Q3 2025 is expected to be in the range of $226 million to $227 million, representing approximately 14.1% year-over-year growth at the midpoint.

Third Quarter Adjusted EBITDA Margin: Adjusted EBITDA margins for Q3 2025 are expected to be in the range of 39% to 40%.

Full Year Adjusted EBITDA Margin: The company has raised its full year adjusted EBITDA margin guidance to the range of 39% to 40%.

Non-GAAP Diluted Earnings Per Share (EPS) Guidance: For Q3 2025, non-GAAP diluted EPS is expected to be $0.45 to $0.50. For the full year 2025, non-GAAP diluted EPS is expected to be $2.05 to $2.10.

AI/ML Revenue Growth: Revenue from AI/ML is growing north of 100% year-over-year, driven by strong demand for inference workloads.

Customer Acquisition and Growth: Revenue from core cloud customers in their first 12 months is significantly outpacing growth of prior years, indicating strong future growth potential.

Scalers+ Customer Growth: Revenue from Scalers+ customers (those with $100,000+ annual run rate) grew 35% year-over-year, with a 23% increase in customer count.

Gradient AI Platform Adoption: Over 14,000 AI agents have been created on the Gradient AI Platform, with more than 6,000 customers leveraging the platform since January 2025. 30% of these customers are new to DigitalOcean.

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Shareholder Return Plan

Share Repurchase Program: The company executed a share repurchase program in Q2 2025, buying back approximately 691,000 shares for $20 million. Cumulatively, since its IPO, the company has repurchased $1.6 billion worth of shares, totaling 34.8 million shares. At the end of Q2, $3.4 million remained on the current share repurchase authorization.

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Key Q&A

Q:Could you talk a little bit more about the AI/ML revenue and the over 100% increase there? And maybe walk us through a little bit the history of this offering and why the current version is really starting to kick in?

A:AI/ML revenue grew more than 100% year-over-year, driven by the Gradient AI infrastructure stack, which is a network of GPUs from AMD and NVIDIA. The Gradient AI platform, recently made generally available, allows software applications to integrate AI without heavy GPU infrastructure. The Agent layer, such as Cloudways Copilot, automates tasks for cloud-based applications. Growth is predominantly from the infrastructure side, with increasing adoption of the AI platform.

Q:I know historically, you guys have given us more color on the underlying components for that net new ARR. How is the net new growing on the AI/ML front in the June quarter?

A:AI ARR was growing north of 160% in prior quarters, but now reflects over 100% growth due to lapping Q2 when AI capabilities were launched. Incremental ARR for the quarter was 32%, the highest in the company's history, with a balance across AI and core cloud. The drop from 160% to 100% is due to a difficult comparison from last year.

Q:Can you explain what acted against the NDR, given the Cloudways price increase in April?

A:NDR remained at 99%, with mixed impacts from customers. Some customers optimized or hesitated to expand, while others accelerated and grew workloads. Despite a slight NDR decrease, the company raised guidance and achieved its best incremental ARR in a long time. New product acquisitions and AI growth are driving revenue growth.

Q:How are the unit economics of the AI business tracking, particularly gross margin and LTV CAC relative to the core business?

A:The AI business has encouraging margins, with higher layers of the AI stack offering better margins than pure infrastructure. Inferencing customers pull other cloud services, increasing long-term value. Investments in Gradient AI Agent Cloud and infrastructure optimization aim to scale inferencing workloads, which have long tails and drag other cloud primitives along.

Q:Can we think of the highest incremental ARR and organic ARR in over 3 years as a new high watermark?

A:The high incremental ARR is due to product-led growth in core cloud customers, migration motion bringing digital native enterprise customers, and scaled inferencing customers. The growth is secular and durable, not driven by one big contract or GPU capacity spike. ARR reflects actual customer revenue and utilization, providing a steady predictor of growth.

Q:Where is the industry at the moment in terms of capacity constraints for AI, and how are you differentiating?

A:Capacity constraints are a challenge, but the company differentiates with its twin stack cloud, offering both AI infrastructure and general-purpose cloud services. Customers leverage AI infrastructure and higher stack services, as well as sophisticated storage and compute requirements. The company is scaling customers and building forward momentum.

Q:What is the breakdown of the business between AI and non-AI, and how is the core cloud business performing?

A:AI is a small but growing portion of the business, estimated at 5-10% of revenue. Core cloud continues to grow at low double digits, with new customer revenue exceeding expectations. Incremental ARR shows a balance between core cloud and AI growth.

Q:Are you seeing higher volatility or churn in AI customers, and how do you categorize their journey?

A:AI customers are not categorized as testers, learners, builders, or scalers. Many are inferencing customers with product-market fit and scaling needs. The shift to inferencing has reduced test-and-leave behavior, with customers staying, expanding, and leveraging different parts of the stack.

Q:What are the pricing dynamics for GPUs, and how are you managing utilization?

A:GPU utilization is robust, with inferencing customers prioritizing price performance over raw throughput. This allows flexibility in allocating GPU families. Pricing dynamics differ between training and inferencing workloads, with inferencing customers scaling globally and dragging other cloud primitives along.

Q:How are you incorporating large deals into guidance, given their lumpiness and newness?

A:Large deals are a new motion, with a focus on making customers successful and articulating technology differentiation. Inferencing deals take time to scale, and guidance remains conservative, reflecting only predictable revenue from large deals.

Q:What is the trajectory for gross margin in the back half of the year and into next year?

A:Gross margins are expected to remain consistent through the year, with modest headwinds next year as AI becomes a larger portion of the business. Core cloud efficiencies, such as bandwidth and data center optimization, will help maintain healthy margins.

Q:What is the capital allocation strategy, and how are share repurchases being managed?

A:The focus is on organic growth and addressing the outstanding convert. Share repurchases have been reduced to prioritize these objectives. Once the convert is addressed, repurchases will target offsetting dilution.

Q:Review of Unclear Management Responses

A:Management avoided directly answering questions about the specific breakdown of AI revenue as a percentage of total revenue, stating only that it is a small but growing portion. Additionally, they did not provide clear details on the exact impact of AI on NDR or the specific characteristics of large deals in terms of size and duration.

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Earnings Word Cloud

The most frequently occurring keywords in this quarter's earning call

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