DigitalOcean Holdings, Inc. (DOCN) Q1 2022 Earnings Report, Transcript and Summary

Hello. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the DigitalOcean First Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session. [Operator Instructions]. Thank you. Rob Bradley, Vice President of Investor Relations. You may begin your conference.

Thank you, and welcome, everyone, to DigitalOcean's First Quarter 2022 Earnings Call. Joining me today is Yancey Spruill, our Chief Executive Officer; and Bill Sorenson, our Chief Financial Officer. Before we begin, I want to cover our safe harbor statement. During this conference call, we will be making forward-looking statements, including our financial outlook for the second quarter and full year as well as statements about goals and business outlook, industry trends, market opportunities and expectations for future financial performance and similar items. All of these statements are subject to risks, uncertainties and assumptions. You can review more information about these in the Risk Factors section of our filings with the SEC. We remind everyone that our actual results may differ, and we undertake no obligation to revise or update any forward-looking statements. Finally, we will be discussing non-GAAP financial measures on our call. Reconciliations between our GAAP and non-GAAP financial results can be found in our earnings press release, which was issued earlier this afternoon and in the investor presentation on our IR website. With that, let me turn the call over to our CEO, Yancey Spruill. Yancey?

Thanks, Rob. Apologize for the slight delay, kicking this off. Good afternoon, everyone, and thanks for joining us. I'm pleased to share the details of another strong quarter for DigitalOcean. Q1 demonstrates that we are building a highly efficient business that combines strong revenue growth with significant free cash flow generation. Despite an increasingly uncertain macro environment, we are proving the strength of the DigitalOcean business model quarter-after-quarter and beating our top line guidance once again. We are maintaining our previous revenue outlook for the full year 2022. While there is some near-term global economic uncertainty, especially in Eastern Europe, we have a number of initiatives that give us confidence that we will manage through near-term macro challenges and have another strong year of growth and free cash flow. Bill will walk you through those details in a few minutes. But first, I want to address some of the key developments from the quarter. We're pleased with our Q1 performance as we continue to see exciting developments in product. We released the beta version of serverless function in customers' hands and are on track to make a generally available release to all customers very soon. We saw a dramatic increase in the unique visitors to our website with visits up over 70% year-over-year in the first quarter, that's before the recent acquisition of CSS-Tricks, which will significantly boost monthly visitors as we move through this year. As I will share in the customer story shortly, bringing developers and businesses on to DigitalOcean early in their journey is a vital component to our strategy to drive sustainable growth and website visits are a strong proxy for the health of that part of our customer acquisition strategy. Customers that come through this channel is presenting us with modest near-term revenue but a highly valuable option on their eventual uplift. And in the meantime, we nurture them on their journey. Finally, we continue to make progress building an inbound and outbound sales capability, which contributed 3 percentage points of revenue in Q1, up more than 200 basis points from Q1 of last year. This area is a complement to our self-service revenue motion because these customers start substantially larger, roughly $5,000 to $6,000 per month in revenue relative to our self-serve customers at $15 to $20 per month day one. This sales sourced ARPU is also up 180% year-over-year, a strong demonstration of the potential for this route to market. Revenue in the first quarter was $127.3 million, up 36% year-over-year and a 700 basis point improvement compared to Q1 of last year when we grew 29%. We ended the quarter with $524 million in ARR, which is up 35% year-over-year, a 500 basis point improvement from Q1 of last year. Net dollar retention and revenue per customer were both significant contributors to our top line growth. Once again, NDR improved and was 117% in the quarter, a 1,000 basis point increase from Q1 of last year. Importantly, the churn portion of NDR has been stable at roughly 10% for consecutive quarters now. We continue to invest to improve the entire customer experience in order to help our customers develop, build, grow and scale on our platform. This investment in the customer experience along with targeted product and infrastructure investments that ensure a relevant and growing set of capabilities will continue to be essential to sustaining NDR at current levels or better. ARPU was up 28% in Q1, driven by our customers' own organic growth, and we accelerate their spend by providing them other offerings beyond core infrastructure that they consume as they scale, including managed databases in Kubernetes, serverless in our marketplace. Operating margin and free cash flow improvement were also reflected in our Q1 performance. Our non-GAAP operating margin was 11% in Q1, in line over the prior year. Our operating margins are typically lowest in Q1, given certain typical front-loaded costs, such as benefits and related taxes. And we will deliver ramping margins progressively through this year as revenue grows sequentially throughout the balance of 2022. We are committed to generating positive and ramping free cash flow in Q1, despite seasonal challenges, was no different. We believe that a defining differentiator of DigitalOcean investment thesis is our ability to grow fast while generating free cash flow. In the past, we have referred to the company becoming a free cash flow machine and are confident that we are on track to delivering on our 20% or more targeted revenue in the next couple of years as we approach and exceed our first $1 billion of revenue. In Q1, we generated free cash flow of 4% of revenue or $5 million. This was a strong performance as our team is managing our capital spending very well, both in terms of generating operational efficiencies and better management. Similar to our operating margin profile, we expect free cash flow to ramp through the year and margins to increase significantly by year-end. Finally, customer additions were also a key contributor to our Q1 growth. We report -- we had 14,000 total customers and more than 3,000 of those were our customers that are spending more than $50 per month. This higher spending cohort now numbering 102,000 in total, grew 20% year-over-year, and their revenue represented 84% of total company revenue. Even better, their revenue grew 43% year-over-year, much faster than overall company growth We believe there are many more customers that fit this high customer spend profile that we can attract and cultivate this year and in the years ahead. We break down customer size because it's a more relevant indicator in terms of what is fueling our revenue base since we simply don't have an average customer. Most of our customers start at $15 to $20 a month and over time and at their own pace, they grow to greater than $50 per month, which is a point where we typically see lift off. This unique focus on supporting our customers through a journey is a defining differentiator for DigitalOcean in the marketplace. As you can see, the business is on firm footing, and we are well positioned to continue to grow into this immense market opportunity. I'd like to turn your attention to some specific steps we are taking in product development and marketing to continue to execute against our ambitious growth objectives. One of the many growth levers that we have is expanding our product set to better serve our customers' changing needs as they experience their own organic growth. A key ask from our customers is a serverless offering and that is why we acquired Nimbella last year. In Q1, we introduced the beta version of our serverless offering, and it will become generally available in a few weeks Serverless is a rapidly growing adjacent market opportunity that extends and complements our infrastructure and platform offerings and is foundational to our Functions as a Service strategy. Our serverless product is cloud native and allows builders to create and manage applications without having to allocate time and resources to server selection, geography and performance. Instead, builders and developers can elect for DigitalOcean provision servers to meet their needs based on consumption and other factors while they can focus on coding and development. This has been one of our top product launches for 2022, and serverless should help propel customer acquisition, ARPU growth and NDR while also laying the groundwork for future product expansion plans. Efficient customer acquisition has always been one of the hallmarks of our business as best evidenced by low sales and marketing costs. Few companies in software are growing their top line 36% with sales and marketing expenses as well as ours. In Q1, non-GAAP sales and marketing spend was only 12% of revenue. And yet, our largest customers grew 20% and their revenue grew 43%. Expanding our community content is an important element of our customer acquisition strategy, we use this content to drive millions of people to our website each month. In Q1, we made an acquisition that significantly increased our content library. We also launched a refresh of our brand to be more balanced in our positioning to who we serve across developers through SMBs. In March, we acquired CSS-Tricks, a learning site with 6,500 articles, videos, guides and other content focused on front-end development. This nicely complements our existing library of content, furthering our reach with both front end and full stack developers. We now have over 7,000 tutorials to complement the 32,000 other documents on our site, which all contribute to the rapidly growing website visits and will allow us to sustain an efficient customer acquisition motion as we continue to scale the business. When we went public a little more than a year ago, we were averaging roughly 5 million unique visitors to our website each month. Thanks to leveraging -- thanks to leverage we are realizing from significant changes in our self-serve marketing motions and the addition of CSS-Tricks in Q1, we delivered an average of over 9 million unique visitors in the quarter, which represents over 70% year-over-year growth. We will continue to look for high-quality content sites that can expand the top of the funnel to increase the base of potential customers and enhance the deal brand around the world. With respect to enhancing our strong brand, which supports increasing organic traffic, we launched a new campaign in Q1, targeting the customers that can build their businesses on deal, leverage the product portfolio we offer and increase their spend as they scale. We want to be the cloud platform of choice for innovative digital SMBs anywhere in the world, and our branding will help promote to that growing audience. Next, I'd like to highlight one of our 102,000 high-spend customers who drive 84% of our revenue, which provides yet another demonstration of the organic tailwinds driving our business. Customers' mission is focused on engaging experience for people to meet online. They do this via a video chat platform that makes virtual introductions, interactions more human. The company started only two years ago and has experienced exponential growth and now has more than 10 million people using their platform The online platform caters to individuals, teams and companies. More than 10,000 teams have adopted their platform for virtual office space, and they have hosted over 20,000 professional events, including job fairs, academic events, conferences and media releases. Company was started by a group of friends after they graduated from college. They were aware of DigitalOcean due to our vast library of technical tutorials and select a deal for our simplicity and pricing. As a start-up, they needed an easy way to build and test ideas quickly and with minimal overhead. Our low-cost outbound data transfer is incredibly valuable for network-intensive loads, which rely heavily on streaming video to large numbers of users. They started on DigitalOcean in May 2020 as part of a startup -- our start-up accelerator, we call Hatch. They received infrastructure credits and dedicated technical support to build their business. Once they completed the Hatch program, they decided to continue to build their business on DigitalOcean. When they started on DigitalOcean, their monthly recurring revenue was just under $300. As of March of this year, their monthly spend has jumped to more than $190,000 or over $2 million of ARR. As we have seen time and time again, this dramatic growth in spend has been paired with the adoption of additional products in our portfolio. They started with droplets and have now added our managed Kubernetes, our managed databases, our platform, our spaces and volume bought storage, our load balancers and our container registry projects across five of our global data centers to deliver great experiences to their customers. This customer offers another example of the journey that businesses take on DigitalOcean, demonstrates how and why we cultivate a large use of developers and early-stage businesses, even if at lower dollar values initially and reap the benefits as many of them get lift off and experience rapid growth while using the increasing mix of our products and services. Last, but certainly not least, I want to share an exciting recent development that highlights our mission to grow together with our customers and the broader developer community. When we went public last year, we planned to contribute 1% of our evaluation at the time of the IPO or $50 million to charitable initiatives over the ensuing decade. Last month, we announced the cornerstone of that initiative, DO impact, a global social impact program aimed at empowering technology innovators through the donation of DigitalOcean infrastructure, philanthropic grants and employee volunteering. We are supporting organizations that we believe are having interesting important impacts such as facilitating technology literacy to communities who haven't historically been part of the broader tech ecosystem, efforts that help tech-enabled non-profits better use technology to support their missions and many other specific use cases. Supporting innovation like this is core in our mission to simplify cloud computing, so builders can create software that changes the world. I'm very proud of this effort because it expands access to cloud computing technology. It creates more opportunities for people around the world and will be a feeder for DigitalOcean's business over the long term. We look forward to expanding our DO impact program in the coming years. We truly believe that our community is bigger than just us. DO impact runs how we live our values and will be an important element of our company as we continue to grow and achieve our first $1 billion of revenue in 2024. In summary, we're off to a good start despite the global challenges we all find in 2022. I'm proud of our team for their accomplishments. I would like to thank each of them for their efforts on behalf of our customers. We are well positioned for continued and durable growth along with ramping free cash flow generation across the balance of this year. I'd now like to turn the call over to Bill Sorenson, our Chief Financial Officer, who will provide details on our financial results in Q1 and our updated outlook for this year.

Thanks, Yancey. Good afternoon, everyone, and thanks for joining us today to discuss another quarter of strong results that produce revenue and free cash flow that exceeded expectations. Yancey captured much of the positive momentum we are seeing across the business, so I'll keep my remarks fairly brief. I'm going to focus on some top line numbers, customer dynamics, free cash flow and CapEx, along with our financial outlook before turning it over to the operator to take your questions. For the first quarter, revenue grew 36%, which represents our fourth consecutive quarter of revenue growth greater than 35%. This was driven by 117% net dollar retention, the highest we have ever reported as a public company. Revenue per customer improved 28% and 20% growth in the number of high spend customers with total customer growth of 6%. We also had healthy cash from operations of $30 million and free cash flow that was 4% of revenue. Once again, our results demonstrate DigitalOcean's superb product market fit. DigitalOcean's combination of customer growth, ARPU growth and high-teens NDR are proving to be a valuable mix and continues to be the foundation for durable 30% plus revenue growth. Providing some more context on our customers, we see ongoing success in attracting and onboarding high-spend customers or those who spend more than $50 per month with DigitalOcean. This cohort is now more than 102,000 strong and grew by 20% year-over-year, up from 85,000 in Q1 2021. In many regards, these customers, which typically use multiple products and services have been critical to the improvement in NDR that we've experienced over the last two years. In Q1, revenue from these customers grew 43% and now represent 84% of our total revenue, up from 80% last year. The increasing percentage of revenue indicates their value to our financial performance as their revenue is growing faster than the company overall. We are pleased to add 3,000 of these customers in Q1, and we're very focused on deliberate strategies to increase these customers but by nurturing our very large base of smaller customers as they themselves scale their businesses and by bringing in higher spend customers at the outset. Efforts include targeting potential customers in specific verticals and use cases that are good fits with our platform offerings and pricing model, including video, streaming, media, managed service providers and web agencies. Additionally, we are working to increase our top of funnel. As you heard from Yancey, our unique visitors have grown by over 70% year-over-year. At the same time, we are continually improving our funnel dynamics to activate and convert the potential higher spend customers more rapidly. Lastly, we also have sophisticated data analytics triggers to help us facilitate these customers being offered and purchasing additional products from us as they scale. Our goal is very straightforward. We want to significantly increase the number of high spend customers, drive their NDR higher through customer success best practices and grow their revenue faster than the company average. We think in our massive and growing market opportunity, there are many more high-spend customers that we can attract, convert, grow and retain. Our continued focus on customer support, targeted sales outreach and our product efforts in areas such as serverless will help us accelerate the growth in these customers. Q1 is the first quarter where we report solely on non-GAAP operating income as a measure of profitability versus adjusted EBITDA, which we had used historically. For the quarter, this metric was $13.6 million, reflecting 11% of revenue, which fell short of our guidance target previously provided of 12% to 13%. The primary driver of this variance were payroll taxes related to stock-based compensation, that were previously forecasted over the course of the year, but that had a greater impact in Q1. Without that impact, we would have met guidance as we continue our focus on operating efficiency while at the same time, increasing spend in marketing and customer success. We remain solidly on track to improve profitability over the course of 2022, driven in part by continued improvements in gross margin and overall spend efficiency and are confident in our full year guidance, which I will address shortly in my remarks. Next, I want to share some exciting news on our expanding global footprint, which we believe will help us accelerate our growth in an important geography for us. We are on track to open a new data center in Australia in Q4 of this year. As we have shared previously, we plan and manage our capital expenditures with a six to eight quarter horizon. The launch of this new data center was planned within our continually improving capital expenditure targets. As a result, even with this investment, we expect to deliver a further reduction in CapEx as a percentage of revenues this year. We still project that CapEx will be approximately 22% of revenue for calendar year 2022 and remain confident that we can lower that further into the teens over time. This CapEx improvement over the past few years is one of the changes we are very proud of as it is a improvement from Q1 2020 when CapEx was 44% of revenue and even last year's Q1 CapEx of 25% of the revenue, which allows us to drive growth in free cash flow. Free cash flow is the beneficiary when you prioritize efficient growth and manage capital expenditures. And we very pleased to deliver $5 million of free cash flow in Q1 or 4% of revenue, especially considering that Q1 is usually our most modest in terms of free cash flow as we have a number of significant cash outlays at the start of the year, the largest being the bonus payments to our employees. We expect to build our free cash flow as we progress through the year, and we are maintaining our outlook for 8% to 10% of revenue for 2022. As you know, back in February, our Board approved a $300 million share repurchase program. During Q1, we used $150 million of that approval to repurchase 2.6 million shares. As Yancey shared on our previous call, we view this buyback as a commitment to our investors that they will not experience dilution from any equity we may use over the next few years to attract and retain our best-in-class employees. We expect to repurchase the remaining $150 million in Q2. Now I'd like to provide our Q2 and full year outlook. The war had minimal impact on our Q1 results. And while we do not have employees or operations in Russia or Ukraine, we do have customers who do business in these countries. Historically, revenue from Russia and Ukraine combined have been approximately 3.5% of our total revenue, but we have seen a marked decline in our Russia source revenues over the last three months which is not surprising given the financial sanctions that hinder payment processing. And while sanctions are not impacting payment processing in Ukraine, hardships and disruption from the war may affect some of our customers there. While we are maintaining and are confident in our full year revenue guidance, we also need to be prudent with our Q2 outlook to take into account the potential for disruption to revenue that is directly exposed as a result of this conflict. For the second quarter, we expect revenue to be in the range of $133 million to $135 million, which reflects the potential loss of approximately $3 million of revenues from Russia and Ukrainian customers. We expect Q2 non-GAAP operating margin to be in the range of 10% to 11% as we complete the bulk of our 2022 hiring by the end of Q2. For the full year, we are maintaining our revenue guidance to be in the range of $564 million to $568 million, which at the midpoint is 32% growth. Please keep in mind that the time we issued that guidance, we had not factored in the impact of the war. However, even with the potential loss of between $8 million and $10 million of revenues related to Russia and Ukraine, we are still confident in achieving that revenue growth due to the number of efforts underway that will offset the potential war-related losses. The continued outperformance of our outbound sales efforts further improvements in the funnel to drive self-serve revenue ahead of plan and the launch of our new serverless product in a few weeks. And lastly, we see opportunities around the way we package and price our product portfolio, which we have discussed with all of you before. With all of these efforts, we are very confident in our full year revenue outlook, despite the near-term macro uncertainty and also believe these efforts will provide a material carryover benefit into 2023. We expect full year non-GAAP operating margins to be in the range of 13% to 15%, which is also consistent with our previous guidance. Lower margins were anticipated early in the year as we have made a number of investments, particularly in people that will impact profitability in the first half of the year. Margins will improve over the second half of the year, as revenue growth will outpace spend. As I mentioned a moment ago, in 2022, we expect free cash flow as a percentage of revenue to the range of 8% to 10%. The combination of continued revenue growth and increasing cash flow generation put us on track for the continued achievement of the Rule of 40. That concludes my remarks. Now let's turn it over to Q&A.

[Operator Instructions] Your first question comes from Michael Turits with KeyBanc Capital Markets. Your line is open.

Hi, this is Billy [ph] on for Michael. Good to see customer ads get back to the mid-teens level. I guess, how should we think about the sustainability of that mid-teens level to drive customers' growth to your goal of 10%? Thanks.

Well, our longer-term target remains 10% for year-over-year net logo adds, customer adds. And we're making very good progress. We talked about the growth in our website visits. Our conversion rates have been good, where the net new customers we're adding has been very strong as has the dollar per revenue out of the box as we've talked about. And then we're complementing that with our sales efforts. So we feel very good about where we are today in terms of customer additions. We're going to continue to invest in that. And as we -- as Bill noted, we are outperforming our initial plans this year in this area, and we're going to continue to have this be a principal area of focus. So 10% is our longer-term goal. We should start to edge up to that over time, and we're very pleased with the performance in the first quarter and our current outlook for this part of our customer acquisition motion.

Great. Thanks.

Your next question comes from Mark Murphy with JPMorgan.

Yes. Thank you very much. So Yancey, Europe is a big question on everyone's mind, and we know you factored it into your guidance. I'm curious outside of your -- any kind of direct exposure into Russia and Ukraine, how would you characterize the activity kind of elsewhere in Europe, just in terms of business confidence, usage trends and retention rates? When you do see impact, how is that kind of manifesting for you? And I have a quick follow-up.

Yes. So our -- as we talked about in the outlook and sort of the impacts we're seeing in this 60, 70 days, since this unfortunate situation to put it mildly has started, clearly we're seeing some impacts in the areas we talked about. I think there is broader uncertainty. But in terms of our business trajectory, I would say we're largely per expectation to this point. obviously, things could change. But there's no doubt that -- and what we saw a couple of years ago when we went into a pandemic and a severe recession was our customers hung in there. And we were able to execute, acquire customers, lower churn, et cetera. So the SMB marketplace is very resilient and so that’s been demonstrated time and time again through financial crisis, disruptions, et cetera. Also, I'd point folks to -- Forrester issued a report in the first quarter citing 200% IRRs returns that customers get when they use DigitalOcean. So the reality is we're a very cost-efficient solution for people and where we show up in the income statement of our customers is cost of sales. And we're a vital aspect to them turning on their service. And so it's one of the last areas for them to turn it off. And when you look at the value proposition centers of the relative cost, we tend to be 2-ish, 2.5% of COGS for our customers, the spend that they have with us. We're just an incredibly and highly performing capability. So we feel like we've demonstrated resiliency during the pandemic or at least the first two years of this pandemic. And so feel good about the value proposition. We feel good about the additions we're making to the platform to provide even more value for customers. For example, our serverless functions coming online here in a couple of weeks. But in terms of what we're seeing is about what we expected and we'll see how things progress as we move through the year.

Okay. I think I’ll leave it there. Thank you very much for taking my question.

Your next question comes from Raimo Lenschow with Barclays. Your line is now open

Hey, thank you. Could I ask on the -- if you -- just to remind us, new products like serverless, you had MongoDB as an extra service that you launched, like what are the price points there? And how big do you think those extra products that are kind of slightly higher value-add than your normal droplet could be over time as part of the whole organization? Thank you.

Yes. So those are modest uplifts in terms of depending upon the volumetric and the types of use cases the customers have. They tend to be uplifts in terms of ARPU adds to existing customers. And what I would say is when we launch a product, our expectation is that three-plus years out, we're going to be at least 300 basis points contribution to growth to give you a sense of size and scale. It takes a while for those customers given the nature of our revenue model, our subscription to offer the number of customers to build on the platform. We're now seeing Mongo getting into that critical mass that will be a material contributor at really high growth rates. We'll expect serveless to build during the course of this year, contribute to revenue growth and be an outsized driver of pushing revenue supporting our 30%R plus growth targets overtime. And but we're targeting new products contributing 300 basis points two-, three-plus years out as a criteria for when and how we decide to launch what products.

Okay. Perfect. Congrats, thank you.

Your next question comes from Tim Horan with Oppenheimer & Company. Your line is open.

Thanks, guys. Just 2 follow-ups. On the new products, can you maybe just talk about how many major new products you think you can launch a year at this point? And just maybe some color on what areas make the most sense. And then just following up on your comments on maybe further thinking on what a recession might mean for you guys? And can you give any metrics what happened two years ago when we had a slowdown? I know it was a different world, but did you see much impact to trends at all at that time. Thanks.

Well, our sort of -- recent cadence is sort of one major new product a year plus a number of feature enhancements on existing capabilities. We've obviously made some significant changes in our product and technology innovation capability over the last six months. We're starting to execute on change in the first half of this year which I’m really excited about. And the designation of that change is to give us greater velocity. So we'd like the capacity to do more than one major new product a year and more than a handful or a couple of handful of feature enhancements. So we're in the motion here while expecting in the second half of this year and certainly next year to significantly improve our velocity, quality, transparency of our execution because what we've seen in the last two to three years is the launch of managed databases, Kubernetes, our first foray app platform in services, obviously, service functions coming this month, Our marketplace is we've substantially added to the revenue growth because per the customer journey in the case we just shared, as customers build out their capabilities in their businesses, they consume more PaaS offerings or SaaS offerings. And to the extent we give them relevant SaaS offerings, that's going to be a strong contributor to growth. So I'm excited about the changes we've made, the investments we're making in product and innovation is a huge fuel of our growth and of our reputation and relationship with our customers. And so very excited about increasing velocity here as we get into the back half, second half of the year and into 2023. In terms of the first question about a recession two years ago, well, I hope we all never see a more severe recession that we saw two years ago this time as we got into this pandemic. I'll say this. Churn was approaching 20% when we went into the pandemic. As you said earlier, it's cut in half. Obviously, net dollar retention was just around maybe just under. It's in the mid- to upper teens today. Customer acquisition was relatively flat. It's upper single digits today. Growth was in the low 20s, mid-20s in the mid- to high 30s today. So I think we were able to endure through a significant revamp and focus on our support going back, doubling down on simplicity, doubling down on our support model. We've made significant investments in the tutorials and our digital content. I think we went into the pandemic with 2.5 million, 3 million website visitors a month. Obviously, we've tripled that. So we doubled down on the customer experience in the last -- I should say it last year as we entered the pandemic recession. We're going to continue to double down on the customer experience. We've demonstrated that getting closer to our customers, more intimate understanding our customers, serving this journey, nurturing customers on this journey is a key differentiator for us. And we think that's what's going to enable us to sustain 30% or better growth during a time of uncertainty that we're all sort of seem to be in right now.

Thank you.

Your next question comes from Jim Fish with Piper Sandler. Your line is open.

This is Quinton on for Jim Fish. Thanks for taking my question. Maybe first, just a quick one net large customers added in the quarter, did see a slight downtick compared to prior levels, is there higher churn here, or anything to call out that was kind of one-time in nature, or was this kind of 3,000 level, the way to think about it as a little bit more sustainable moving forward? And then we do have a quick follow-up. .

I think the way to think about it is revenue growth was basically in line with where it was last to prior quarter. So yes, customer growth and adds each quarter can oscillate a little bit, but still very strong. I think what's important to note is we expect it to be materially higher than the overall company growth rate because like the customer example we just shared with you thousands of those people every month, they're going into the higher dollar category as they get lift off on their business. And so that's a key aspect of this. And then we'll also see more of those new customers as we continue to ramp and see strong performance in our inbound and outbound and partner channel efforts -- sales efforts. So without -- I wouldn't necessarily focus on the 400 basis point change quarter-over-quarter. I focus on the revenue growth and the percentage of revenue contribution also ticked up and that's a trend. Those three things, customer growth will be higher in this $50 an up. Revenue growth will be higher than the overall company and percentage of revenue mix will continue to expand. I think those are the three things to focus on. And then the quarter-to-quarter variability in some of those metrics, but the metrics will hold consistent in the near-term as we see it.

Got it. Yes, that makes a ton of sense. And then maybe touching more on the launch for the serverless. Can you talk about your strategy here? Is the goal kind of in Q2 and Q3 to drive adoption first and then monetization kind of in the back half of the year, or is it kind of monetization along with adoption? Maybe any sense of motion is going to move would be helpful? Thank you.

Well, we want awareness and adoption, and that's going to lead to -- as those customers ramp, we want monetization. We launched the product because it's interesting for customers, and it will be interesting to support top line revenue growth goals of 30% or better. So that's how we see it. But it builds, right. The nature of adding our customer you get 1/ 12 of an annual revenue each month. And so we'll be driving customer growth. We focused on month-over-month trends in terms of customers' ads, how they're using the product. Are they testing Sirius or what have you, and we expect to see super high growth rates in the near term on customer adds and revenue and that will be a meaning. As those dollars become material, they obviously start to materially impact overall growth, and that will be the case here for the next several years on our way to 300 basis point contribution to overall revenue mix in the next two to three years for serverless.

Your next question comes from Wamsi Mohan with Bank of America. Your line is open

Yes, thank you. My question is on the revenue trajectory. You're coming in slightly below 30% of the midpoint on 2Q. But your comps really start to get tougher again and -- I mean they are tough in 2Q, but they're also tougher in 3Q and 4Q. Can you help us think through what are the incremental things that can get you back about 30% growth in 3Q? Do you get back, first of all, about 30% growth in 3Q based on your full year guide, you should be tracking there either or a big acceleration in 4Q. So how should we think about sort of the trajectory based on your new product introductions and new initiatives as we think through that ramp? And I have a question on operating margin after that.

Well, I'll let Bill address the operating margin. I think it's quite simple. We -- our jobs to set expectations that we meet and beat. And I know there's a lot of gamesmanship on the beats in the game, what the guide, all this. We've just set expectations we intend to be. I think that's the point. As we said, there is some near-term, and we're taking the sort of the near-term impact from Russia, Ukraine, et cetera, this quarter. So we're taking a little dip this quarter as we pull our revenue out of the outlook. We'll start to normalize against that because of the outperformance we're seeing in our go-to-market motions on sales and self-serve, which we talked about, the launch of serverless and some packaging and pricing monetization initiatives that we're taking a very hard look at right now. So that's how we lap that. But you're right, we were accelerating through last year, and that creates 'tougher comps.' At the same time, we have other initiatives this year to help us offset the impact of that to continue to support 30% or better growth rate. And we also set expectations that we intend to be -- so I think that's how to think about our approach to how we set expectations, the guidance we just discussed and our plans for where we see opportunities to continue to deliver strong growth in the business.

Okay. Thanks, Yancey. And Bill, maybe on the operating margin and free cash flow commentary, I think you guys said Q1 is typically the bottom and then you sort of build from there, both for operating margin and free cash flow. But I think you called out some hiring initiatives in Q2 that's going to pressure operating margin sequentially here into Q2. So as we think about that free cash flow profile as well, how should we think about the cadence of that? And then you guys actually did have a slight miss on your operating income that you called out in the quarter as well. So the ramp to sort of the second half profitability, is that all just revenue leverage coming on higher revenues, or is there anything else happening on the cost line as well? Thank you.

Well, it's a variety of things. But first, one other thing on the revenue one, we took $3 million out of Q2. And if you didn't take $3 million out of Q2, you're 32% plus. So what we have is a near-term hit from some macro factors that we're going to outgrow as we move through the year. In terms of the margin, we do see sort of a flat margin in Q2, and that's largely because we're doing the vast bulk of our hiring by June 30. And after that, we don't see any incremental ramp in spend through the year. And as you know, Q3 and Q4 are two largest quarters of the year. So spending growth will basically be substantially slower and you will see our margins up into the mid- to high teens as you move into Q3 and Q4, even with lower profile, even in Q2, where we're around 10%, 11% from a guidance perspective, we're still forecasting positive free cash flow. And as we move through the year and again the profitability margins get bigger, you'll see bigger contributions than the 4% or so that we had in Q1, but we expect to be progressive in terms of our CapEx generated per quarter will continue to grow quarter-on-quarter.

Okay. Thanks so much.

Your next question comes from James Breen with William Blair. Your line is open.

Thanks for taking question. Just can you talk about DBNR 117 and how you think about that moving up as you add products and given the existing growth in your customer base? Thanks.

So as we look at net retention, we're definitely going to have a challenge in Q2. $3 million of revenue coming out of the top line for us as a result of what's going on in Eastern Europe is clearly going to have a near-term impact on NDR. We see, though, as we move forward in the back half of the year, moving back up sort of to the high teens. And the question that we continue to work on is where can we drive it to? Our goal would be to drive it over 120%. We have an enormous customer base, as you know. But part of what we're doing is to focus on those 50% -- $50 and greater, those folks who are demonstrating 117%, 118% NDR. So after a tough comp in Q2, our expectations is that you're going to see NDR move back up towards that 116%, 117% range. And our hope, as we've already seen historically, I mean, last year, in particular, a massive leap in terms of our NDR launched with new products as new products are coming on, customers are buying more products, which in turn is driving incremental usage of the base infrastructure. So we think and serverless launch is another step to us driving greater and greater ARPU and greater and greater NDR from our customers, particularly those bigger than $50 a month.

Great. Thanks.

Your next question comes from Josh Baer with Morgan Stanley. Your line is open.

Thanks for the question. Two quick ones. I know the CS-Tricks content is and will remain free and open, but I was just wondering if there's any advertising or other revenue streams associated with that acquisition?

Nothing that's material, nothing that's meaningful. No.

Okay. Great. And then I was hoping you could talk a little bit more about the brand relaunch. I was just wondering what were some of the changes that were made and why what you are looking to achieve? Thanks..

Well, if you look historically at DigitalOcean, we have this dynamic where 500-plus thousand customers generating 15% of our revenue and 15%, which we put more in the developers or early-stage startups. And we spent a lot of our effort just on the brand there. But 15% of our customers, 100,000, 102,000 last quarter generate nearly 85% of our revenue. And we weren't spending a proportion of effort in communicating and speaking to that constituency. And so I think we're -- it's more balanced, and it's more speaking to the journey and come grow with us. And so I would say that was -- that's the principal focus is to make sure that we're aligning who we serve, how we serve them over what stages that we serve them in our messaging. And that's especially important as we've been not just nurturing the customers like in the case study that we just showed or discussed on this call and previous earnings calls. It's also increasingly important as month-after-month with our outbound selling effort, we're seeing lots of customers come from hyperscalers and the reason that they come to us is because we have a highly performance set of capabilities at half the price. And we wanted to make sure that we broaden our brand to speak to people and resonate with them as they're considering alternatives from being underserved at other platforms. And that's what we're trying to accomplish as a part of repackaging the brand.

Great. Thank you.

There are no further questions at this time. I turn the call over to Yancey for closing remarks.

I want to thank you all for joining us. As you can tell, we're very excited about our Q1 results. And despite the uncertainty that we face, we feel confident in our ability to flow through given the assets, the brand, the team we have here at DigitalOcean. We look forward to continuing our conversation with you, our investors in the weeks, months and obviously, the years ahead, and we're working hard to realize the limitless potential of DigitalOcean. So thank you so much and have a great rest of the day.

Thank you. This concludes today's conference call. You may now disconnect.