DigitalOcean Q2 2025 Earnings Call Transcript

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Provided by Quartr
August 5, 2025

Key Takeaways

  • Positive Sentiment: DigitalOcean reported Q2 revenue of $219 M, up 14% YoY, with AI/ML revenue growing over 100% and Scalar Plus customer revenue up 35%, leading to a raised full-year guidance of $888 M–$892 M.
  • Positive Sentiment: The company achieved $32 M in incremental ARR, its highest level since 2022 and the strongest organic ARR in over three years, reflecting robust new customer adoption.
  • Positive Sentiment: Adjusted free cash flow reached $57 M (26% of revenue) in Q2, prompting an increase in full-year free cash flow margin guidance to 17%–19% while still funding growth investments.
  • Positive Sentiment: DigitalOcean expanded its AI stack with GA of the Gradient AI platform, eight GPU droplet types and new AI agents, driving over 14,000 agents and 6,000 customers, plus key partnerships like AMD Developer Cloud.
  • Neutral Sentiment: The company is on track to refinance its 2026 convertible debt by year-end and may release up to $109 M of tax valuation allowance in H2, improving GAAP net income without affecting non-GAAP metrics.
AI Generated. May Contain Errors.
Earnings Conference Call
DigitalOcean Q2 2025
00:00 / 00:00

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Operator

Ladies and gentlemen, thank you for standing by. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to DigitalOcean Second Quarter twenty twenty five 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

Thank you. And I would now like to turn the conference over to Melanie Strait, Head of Investor Relations. Melanie, you may begin.

Melanie Strate
Melanie Strate
Head - IR at DigitalOcean

Thank you, and good morning. Thank you all for joining us today to review DigitalOcean's second quarter twenty twenty five financial results. Joining me on the call today are Patti Srinivasan, our Chief Executive Officer and Matt Steinfort, our Chief Financial Officer. Before we begin, let me remind you that certain statements made on the call today may be considered forward looking statements, which reflect management's best judgment based on currently available information. Our actual results may differ materially from those projected in these forward looking statements, including our financial outlook.

Melanie Strate
Melanie Strate
Head - IR at DigitalOcean

I direct your attention to the risk factors contained in our filings with the SEC as well as those referenced in today's press release that is posted on our website. DigitalOcean expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward looking statements made today. Additionally, non GAAP financial measures will be discussed on this conference call and reconciliations to the most directly comparable GAAP financial measures can be found in today's earnings press release as well as in our investor presentation that outlines the financial discussion on today's call. A webcast of today's call is also available in the IR section of our website. And with that, I will turn the call over to Patti.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Thank you, Melanie. Good morning, everyone, and thank you for joining us today as we review our second quarter twenty twenty five results. We continue to make meaningful progress on the strategy we laid out at our Investor Day back in April. This is evidenced by our strong second quarter results and supported by the fact that we are raising our full year guidance on both revenue and profitability metrics. My comments today will include a recap of our q two financial results and an update on both our progress in product innovation and our enhanced go to market strategy across both core cloud and AI, which are enabling over a 174,000 digital native enterprise customers to scale on our platform.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Let me start with the second quarter financial results highlighted on slide 10 of our earnings deck. The growth momentum from q one continued into the second quarter with revenue of $219,000,000 growing 14% year over year. We saw excellent strength in our AIML business with revenue growing north of 100% year over year. Revenue from our Scalar Plus customers, our customers who were at $100,000 plus annual run rate during the quarter, continued to see strong growth during the quarter at 35% year over year and increased to 24% of total revenue. Finally, we achieved incremental ARR in the second quarter of $32,000,000 our highest incremental ARR since 2022 and the highest organic incremental ARR in over three years.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Given our strong top line performance in the first half of the year and our confidence in the second half outlook, we are raising our full year revenue guidance range to $888,000,000 to $892,000,000. We are also excited about the traction we are getting with larger customers and increase in committed contracts. I spoke last quarter about a multiyear $20,000,000 plus committed deal, and this was a contributor to the material growth in our remaining performance obligation balance as we continue to seek and secure large multiyear deals with our higher spend customers and key strategic partners. Not only did our momentum carry over to the second quarter, but also the growth to come with the growth continued to come with healthy profitability, including adjusted free cash flow of $57,000,000, which is 26% of revenue. As a result of this performance, we are raising our full year free cash flow guide to 17% to 19% of revenue, demonstrating our ability to accelerate revenue while maintaining attractive free cash flow margins.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Turning to the balance sheet, we continue to make progress on our capital allocation priorities and remain on track to address the outstanding 2026 convertible debt prior to the end of this calendar year. Matt will go into further details on this front in his prepared remarks. Now let me give you some updates on the product innovation that we continue to deliver for our digital native enterprise customers, which you can see highlighted on slides eleven and twelve in the earnings presentation. During the quarter, we released more than 60 new products and features addressing the needs of our higher spend customers, which includes builders, scalers, and scaler plus customers who now drive 89% of our revenue. Notably, 64 of our top 100 customers have adopted a product or a feature released within the last year, and 26 of the top 100 customers have adopted a new capability released within the last quarter.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Both clear proof points of the impact product innovation is having on our digital native enterprise customers. Let me now provide a few product highlights from the quarter starting with core cloud. This past quarter, we officially announced our Atlanta data center, and its resources are now available to all the customers. As a reminder, this is our newest and largest data center, and it is purpose built to deliver high density GPU infrastructure optimized for AI inferencing, which requires a lot more than just GPUs. This data center has our core cloud stack, including compute, storage, and other cloud features that are critical to enabling AI native customers to run full stack applications powered by AI and not just the training or inference part of their software.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

This agentic cloud data center infrastructure is a key differentiating factor for us over other neo clouds as it provides a complete stack for running sophisticated AI applications that have comprehensive needs beyond GPUs. More on that a little later. During the quarter, we continued to build capabilities for larger digital native enterprises. These customers typically require high quality storage, especially for AI workloads. To support that requirement, we enable NFS or network file systems for GPUs so that customers can run the most demanding GPU applications with access to higher performance object storage to meet the demands of enterprise workloads such as video streaming and data lakes.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

We also introduced two advanced networking features in public preview, bring your own IP address or BYO IP and network address translation gateways or NAT gateways. These are critical capabilities that will enable more and larger digital native enterprise workloads to migrate to digital ocean. BYO IP allows customers to use their existing publicly routable IP addresses on DO rather than having to acquire new distillation specific IP addresses. This makes it easy for customers to lift and shift their workloads to our platform without requiring extensive changes to their applications, while NAT gateway allows the customers resources to securely access the Internet from within their virtual private cloud on the DO platform. These innovations on the core cloud platform are enabling us to scale and win more workloads from our digital native enterprise customer base.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

To leverage that traction, we are complementing our industry leading product led growth motion with a small dedicated migrations team to support customers moving existing workloads from hyperscalers and other clouds to DigitalOcean's platform, and we facilitated 76 of these migrations during the quarter. One example of this is a company called Exetium, a next generation cybersecurity provider delivering innovative, no cost incident response as part of its fully managed security operation center or SOC offering. Designed for businesses and managed service providers or MSPs, Exciteum's managed SOC provides real time threat detection, threat hunting, and incident response, all without the high cost typically associated with legacy solutions. Exciteum signed an eighteen month contract with DigitalOcean selecting the platform to migrate from other cloud providers due to our compelling total cost of ownership, performance, and ease of use, enabling Excitium to deliver its cutting edge cybersecurity solutions more efficiently and at scale. Serveb dot host, a Scalar Plus customer that offers managed hosting specifically tailored for the craft content management system, has already adopted our newly released network address translation gateway, enabling their customers to securely act access the Internet within their digital ocean virtual private cloud.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

We're also very excited about the progress we're making on our AIML platform, which we now call the digital ocean gradient AI agentic cloud, which complements our full stack general purpose cloud. Slide eight in the earnings presentation shows the power of having these two platforms side by side, enabling our customers to take full advantage of the integrated stack that is required to build and run AI powered applications in the future. The Gradient AI agent cloud has three components, Gradient AI infrastructure, Gradient AI platform, and Gradient AI agents. Let me start with the Gradient AI infrastructure where we expanded our GPU droplets lineup significantly to now include eight major types, including the h, l, and RTX series GPUs from NVIDIA, and the latest Instinct series GPUs from AMD. Another major update that makes Gradient AI infrastructure great for inferencing is a new inference optimized GPU droplet, which simplifies the setup and deployment of LLMs by leveraging Docker.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

And this new GPU droplet comes preconfigured with VLLM and includes built in optimizations like multi GPU parallelism, smart batching, faster and higher token generation, built in support for hugging face model downloads, speculative decoding, prompt caching, and multimodal concurrency so that customers can go from deployment to serving tokens in minutes on any GPU droplet without having to do all these steps manually. We recently announced a collaboration with AMD that provides DO customers with access to AMD Instinct MI three twenty five x GPU droplet in addition to MI 300 x droplets. These GPUs deliver high level performance at lower TCO and are ideal for large scale AI inferencing workloads. Another example of this growing collaboration between the two companies is the gradient AI infrastructure powering the recently announced AMD Developer Cloud, which enables developers and open source contributors to test drive AMD Instinct GPUs instantly in a fully managed environment, managed by our gradient AI infrastructure. This enables developers to start AI development with zero hardware investment and accelerate the time to value in tasks like benchmarking and inference scaling.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

This further advances our mission of democratizing access to AI while maintaining the quality, performance, and flexibility our customers have come to expect from DIO. Let's look at how customers are taking advantage of our gradient AI infrastructure. Featherless dot ai is a serverless AI inference platform offering API access to an expansive and growing catalog of open rate models, primarily hugging face models like LAMA, MistFrog, QUEN, DeepSea, RWKB, and more. Federalist AI leverages DigitalOcean for its simplicity and price performance, and they were an early adopter of our AMD m I 300 x GPU droplets, which offer industry leading price performance and ease of use for inference workloads. Another GPU droplet customer is Cryb AI, a native a digital native enterprise specializing in AI generated documentation, which is used by 94% of the Fortune 500 companies.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Cryb AI migrated their AIML training workloads to DigitalOcean from competitive cloud providers, and it's now leveraging Dio's GPU droplets to build and train their process documentation and knowledge sharing platform. Moving on to the next layer of our Gradient AI agentic cloud, we recently announced the general availability of DigitalOcean Gradient AI platform, which provides the industry's easiest and most cost effective platform for developing production grade AI agents with automated safety and security guardrails. The Gradient AI platform, as shown on the right side of slide eight of the earnings deck, is a one of a kind platform that caters to the end to end agent development life cycle or ADLC for short, enabling AI native, SaaS, and any software application customer to build, test, deploy, monitor, operate agentic AI software. Customers can use a rich set of proprietary and open source foundation models, including OpenAI, Anthropic, Mistral, DeepSea, and LAMA as high performance serverless endpoints. These serverless endpoints automatically scale to meet real time application demands, thus freeing customers from having to manage compute resources on their own.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

The Gradient AI platform provides built in god rays that verify AI behavior, a new best in class agent evaluation framework to drive high accuracy and relevance of AI results, and a robust experimentation capability to deliver optimal AI performance. Over 14,000 agents have been created since announcing this platform, which is almost double the number of agents last quarter. More than 6,000 customers have leveraged this platform since January, with 30% of these customers being new to DigitalOcean. One of the customers leveraging our new Gradient AI platform is quickest with a q, a leading AI powered collaborative workspace product that helps product, marketing, and sales teams generate strategy documents, campaigns, and playbooks using shared AI personas. Quickest leverages the Gradient AI platform to create persona generating agents, enabling model comparisons and orchestrating tasks on the Gradient AI platform to fetch and summarize the markdown content.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Quickest chose DigitalOcean because they needed a flexible and scalable infrastructure to support complex AI workflows, and they valued the simplicity of deploying agents and integrating them to the quickest product line with very low little coding involved. Moving on to the gradient AI agents layer, our first commercial AI agent is the cloud based copilot, which continuously monitors critical server components like the web stack, disk space, inodes, and post help to detect issues in real time, diagnose root causes, and deliver actionable recommendations faster than traditional alerting systems. An example of a customer leveraging this product is Mint Media, a full service media and marketing company specializing in video production and digital marketing. Mint Media uses our cloud based Copilot GenAI agents to automatically detect and remediate web posting issues. Mint Media manages over a 180 websites and saw significant time savings by leveraging cloud based Copilot and the associated AI power insights and automated issue resolution.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

What previously required hours of manual debugging is now handled in minutes through the agent's detailed actionable recommendations. In addition to the product innovations we delivered, we also made material progress on the go to market front during this quarter. From a new customer acquisition perspective, we saw meaningful progress in the top of the funnel from our product led growth enhancements with revenue from core cloud customers in their first twelve months significantly outpacing growth of prior years, which is a great leading indicator of future growth potential. Our direct sales motion and the strong ecosystem partnerships are driving more AI native customers with large scale inferencing requirements than we have ever seen in the past. Our growing success with these marquee customers is evident in the increased RPO that I mentioned earlier in my comments, and we anticipate this trend to continue as we scale out our AI capabilities.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

In closing, I'm pleased both by the results of the second quarter and by the progress we are making on the strategy that we articulated at our Investor Day back in April. We maintained our top line growth momentum from q one to q two while maintaining healthy profitability metrics, enabling us to raise our guidance across both revenue and profitability metrics for the fiscal year 2025. We delivered continued product innovation and both drove improved performance in our industry leading product led growth engine and continue to get traction with our direct sales go to market motion, especially for AI. We recently launched the gradient AI platform into full general availability, a significant step in our offering to our customers, a twin stack of cloud capabilities as outlined in slide eight of the earnings slide deck. In a single unified stack, we provide a mature, complete general purpose cloud and on the other stack, a modern agentic AI cloud.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

These integrated stacks enable AI native customers to run-inferencing at scale while taking advantage of the core core cloud modules and digital native customers to build AI directly into their software applications without having to do the heavy lifting of dealing with AI infrastructure. With this unique twin cloud and AI stack, we are getting increasing momentum with AI native companies with larger scale inferencing workloads, and our we are expanding our partnerships with key ecosystem players in the AI domain. We're also making good progress on our balance sheet and refinancing priorities positioning us for a strong 2026. Thank you, and I'll now turn it over to Matt.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Thanks, Patty. Good morning, everyone, and thanks for joining us today. As Patty discussed, we are very pleased with our Q2 twenty twenty five performance, and we are confident in our ability to sustain and build on this momentum in the latter half of the year. In my comments, I'll walk through our Q2 results in detail, provide an update on our balance sheet and capital allocation strategy and share our third quarter and full year 2025 financial outlook. Starting with the top line, revenue in the first quarter was $219,000,000 up 14% year over year.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Our annual run rate revenue or ARR was $875,000,000 which was $32,000,000 above Q1. This incremental ARR of $32,000,000 was the highest incremental ARR since 2022 and the highest organic incremental ARR achieved in over three years. We continue to build and strengthen our relationships with our higher spend customers and key strategic partners. This is evidenced by the material increase in our remaining performance obligation balance as we continue to secure large multiyear deals with our digital native enterprise customers, which is an early but promising new go to market motion for the company. Our product innovation and go to market enhancements are resonating with this target customer base.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

In Q2, revenue from our Scalars Plus customers or customers whose annualized run rate revenue in the quarter was greater than $100,000 and who represent 24% of overall revenue grew 35% year over year with a 23% increase in customer count. This is clear evidence of the increasing traction that we are getting with our largest customers as they expand their use of our core cloud products and adopt our new AI offering. Q2 revenue growth was primarily driven by improvements in customer acquisition across both core cloud and AI as well as strong customer adoption of our AIML products. As Patti mentioned, revenue from core cloud customers in their first twelve months significantly outpaced growth in prior years, which is a great leading indicator of future growth as these stronger recent cohorts not only drive up revenue from customer acquisition, but also they should positively contribute to net dollar retention when they reach their thirteenth month and become part of our NDR cohort. Our Q2 net dollar retention was 99%, up from 97% in the same quarter last year and within the expected range that we communicated on the prior quarter's call.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

We also delivered strong AIML revenue growth in Q2 as we continue to see a robust demand environment, particularly for inference workloads with AI revenue growing north of 100% year over year. Turning to the P and L, we delivered strong performance on all of our key profitability metrics. Gross margin for the second quarter was 60%, which is 100 basis points higher than the prior year. Adjusted EBITDA was $89,000,000 an increase of 10% year over year. Adjusted EBITDA margin was 41% in the second quarter, approximately 100 basis points lower than the prior year.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Non GAAP diluted net income per share was $0.59 a 23 percent increase year over year. This increase is a direct result of expanding per share profitability by driving durable revenue growth while exercising ongoing cost discipline. GAAP diluted net income per share was $0.39 a 95% increase year over year as we continue to grow revenue, drive operating leverage and prudently manage stock based compensation. Q2 adjusted free cash flow was $57,000,000 or 26% of revenue, up significantly from our front loaded Q1, which included a large portion of the upfront investment required to bring the Atlanta data center online. As I'll detail later in my comments, we remain confident in our ability to deliver attractive adjusted free cash flow margins for the full year.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Although the timing of capital investment payments will continue to create quarter to quarter variations in adjusted free cash flow margins, Hence our highlighting of the trailing twelve month adjusted free cash flow margins on slide 15. Our balance sheet continues to be strong as we continue to maintain material cash and cash equivalents and ended the quarter with $388,000,000 in cash. We also continued to execute our share repurchase program in the quarter with $20,000,000 of repurchases in Q2, back approximately 691,000 shares. This brings our cumulative share repurchases since IPO to $1,600,000,000 and 34,800,000.0 shares through 06/30/2025. At the end of Q2, we had $3,400,000 remaining on our current share repurchase authorization.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

On the debt front, we continue to actively evaluate the market and our financing alternatives and remain committed to fully addressing the 2026 convert over the balance of this calendar year. We have multiple attractive financing options available to us, including convertible debt, bank debt and bonds, we plan to tap into these markets as needed to optimize our long term cost of capital. Before we move on to guidance, I'll highlight one non cash item related to both the balance sheet and the P and L. We continue to evaluate the necessity of our valuation allowance on certain existing tax deferred tax assets each quarter in accordance with U. S.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

GAAP. While the valuation allowance is still necessary for Q2, in the latter half of fiscal twenty twenty five, we may release all or a portion of our valuation allowance of $109,000,000 which was discussed in our most recent 10 ks as well as in our most recent 10 Q. When released, we estimate this would have the financial impact of decreasing our non cash tax expense by the amount of the release, resulting in a corresponding increase in net income. When this occurs, it will be a positive non cash event and will have no impact on non GAAP financial metrics. Moving on to guidance.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

For the 2025, we expect revenue to be in the range of $226,000,000 to $227,000,000 representing approximately 14.1% year over year growth at the midpoint. For the full year 2025, we are raising our annual revenue guidance to the range of $888,000,000 to $892,000,000 representing approximately 14% year over year growth at the midpoint. Given our strong Q2 performance, visibility into our customers' usage trends and the strength of the AIML demand environment, we are able to raise our full year guide with Compton. For the 2025, we expect our adjusted EBITDA margins to be in the range of 39% to 40%. For the full year, we raised our adjusted EBITDA margin guide to the range of 39% to 40%.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

For the 2025, we expect non GAAP diluted earnings per share to be $0.45 to $0.50 based on approximately $102,000,000 to $103,000,000 in weighted average fully diluted shares outstanding. For the full year 2025, we expect non GAAP diluted earnings per share to be $2.05 to $2.1 based on approximately $103,000,000 to $104,000,000 in weighted average fully diluted shares outstanding. Turning to adjusted free cash flow, we raised our guided adjusted free cash flow margins for the full year to 17% to 19%, increasing our projected cash flow margins at the same time we are accelerating our revenue growth outlook, which speaks to the confidence we have in our ability to maintain attractive free cash flow margins while we accelerate our top line growth. Consistent with our historical guidance practice, we are not providing adjusted free cash flow guidance on a quarter by quarter basis given it is heavily influenced by working capital timing as you saw in our year to date results. That concludes our prepared remarks.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

I will now open the call to Q and A.

Operator

Thank you. We will now begin the question and answer session. Your first question comes from Patrick Walravens with Citi Citizens. Please go ahead.

Patrick Walravens
Equity Research Analyst at Citizens JMP Securities, LLC

Great. Thank you very much and congratulations. Patty, could you talk a little bit more about the AIML revenue and, you know, the over 100% increase there and maybe walk us through a little bit the history of this offering and and why the current version is is really starting to kick in.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Yeah. Thank thank you, Patrick. Good morning. Good way to get started. So the AIML revenue, as I mentioned in the call, grew more than 100% year over year.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

So if you remember, last q two is when we we brought a lot of h 100 NVIDIA gear online. So more than doubling that this quarter was a significant step for us. And what is different is, as I explained, we have a three layer AI stack. On the foundational level is our gradient AI infrastructure stack, which is a network of GPUs both from AMD as well as NVIDIA. And then in the middle layer is our gradient AI platform that we just took from private and public preview all the way to general availability.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

And then on the topmost layer is agents. So the type of customers that use these three layers are slightly different at this point. So AI infrastructure is consumed typically by AI native companies that have their own model or have taken a open source model and and are doing some tweaks to it and hosting those models and scaling them, especially in the inferencing mode, are typically consuming the AI infrastructure. And a majority of our revenue comes from the gradient AI infrastructure stack. And that's not very dissimilar from the the rest of the industry.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

The Gradient AI platform that we recently pushed out to GA is where any software application, like a SaaS provider, for example, can start consuming AI into their own applications without having to do the heavy lifting of building and managing their own GPU infrastructure. So we have serverless endpoints for these LLMs, for example, and we have a bunch of other tools and modules that are critical building blocks for consuming AI into your own application. So it becomes very, very easy to to build AI into your existing application. And that's what is powering the growth of our AI revenue is predominantly on the infrastructure side, but we are driving a lot of adoption and mind share with developers with the AI platform. And on the agentic layer, the first commercial application of that is the cloud based Copilot.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

That's typically adopted by end customers as a way to automate some of the manual tasks that they are seeing in managing and operating cloud cloud based applications.

Patrick Walravens
Equity Research Analyst at Citizens JMP Securities, LLC

That's very helpful. Thank you.

Operator

Your next question comes from the line of Mike Cikos with Needham and Company. Please go ahead.

Mike Cikos
Senior Analyst at Needham & Company

Hey guys, thanks for taking the questions here. Just to further the conversation on the AIML, good to see the north of 100% revenue growth reflecting some of the more recent trends you guys have seen on the ARR front. We just wanted to see I know historically you guys have given us more color on the underlying components for that net new ARR. I think last quarter you guys had cited north of 160% year year. Maybe I missed the data point, just wanted to see how that net new is growing on the AIML front in the June.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Mike, it's Matt. I think what we said is that our ARR was growing. AI ARR was growing, north of a 160% in prior quarters. Didn't that wasn't referring to the incremental ARR, at least the the actual ARR. And the the north of a 100 reflects still, you know, very strong growth.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

In fact, if you look at the incremental ARR for this, this quarter at 32, you know, it was a good balance across both AI and and and core cloud, But it was our highest incremental ARR in the company's history. And the reason that it dropped, if this is where you're you were going with the question around from a 160 to north of a 100, is just as Patty had said, we lapped the q two when we launched all of our, you know, our AI capabilities, and we had a bunch of pent up demand. So the q two growth, in the AI business in particular, from last year was was high, so it's just a difficult comp. But if you look at the, incremental ARR that we're adding for the, you know, in that business on a go forward basis, we're accelerating. It's a it's an accelerating business.

Mike Cikos
Senior Analyst at Needham & Company

Got it. And for the the NDR, I know that the the 99 here is in keeping with that commentary you guys have provided last quarter. Can you just explain, what what actually acted against that? Because I would have thought there would have been at least some benefit from you guys lapping that Cloudways price increase in April.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Yeah. I think that, when we look at the, at the NDR, and and this is the reason that we we signaled it'll it'll likely bounce around the the kind of current range, you know, into this quarter and and probably going for the next couple quarters, is that, you know, with with the in the market, we haven't seen a degradation market. We haven't really seen any change in the market since, you know, the April time frame. But as we we look at our some of our larger customers in the in the long tail, there's a I'd say there's a mixed impact on customers. It's very individual.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

So some customers we see that that are, maybe on edge and they're they're optimizing or they're a little bit hesitant to, to expand their business. But in the same industry or in the same size of customer, we also see a number of customers that are accelerating the business. They're doing really well, and they're expanding their business with us, and they're growing their workloads. And you see that in the growth of the, you know, the the the customers, the scalars plus at 35%. We're seeing really strong growth in, you know, in parts of our customers, but we're also seeing others that that that are being cautious and and, and aren't scaling as as as fast.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

And so, you know, we're we we think that we're likely to to stay kind of in this level. I'd say what what the good news is, you know, despite the fact that the MDR, which is a hair lower at 99, we were able to raise our guidance. We're we're delivering the best incremental ARR that we've delivered in in a very long time. And so we're very encouraged by the trends. I think that NDR is still it's such a laggy metric.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

It's gonna be a little stubborn to to improve, but that's not gonna slow us down from a a revenue growth standpoint. We're we're doing enough with the new product acquisition on the core cloud, which is doing really, really well, getting really good cohorts, and they're coming in. We've got the migration motion, which is a relatively new motion. It doesn't always impact, MDR. And then we've got the growth and acceleration in the AI business.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

So we're very bullish on the growth prospects and that was what enabled us to raise the guidance for the year.

Mike Cikos
Senior Analyst at Needham & Company

Great. Thank you, guys.

Operator

Your next question comes from the line of Gabriela Borges with Goldman Sachs. Please go ahead.

Gabriela Borges
Gabriela Borges
MD - Software Research at Goldman Sachs

Hey, good morning. Thank you. I wanted to touch on the unit economics of the AI business. Matt, I know in the past, you've talked about the three year payback period, but we'll have both been very consistent in saying as you move from bare metal GPUs to more differentiated services exactly as you've illustrated illustrated in the the graphic in the slides, you should be able to command more gross margin, essentially. So maybe give us an update on how those efforts are tracking.

Gabriela Borges
Gabriela Borges
MD - Software Research at Goldman Sachs

How do you feel about the gross margin and the LTV to CAC of the AI business relative to the core business.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Yeah. We're, we're very so, you know, we are very encouraged and, comfortable with the, margins that we're getting in the AI business, as you said, Gabrielle, of the the, the higher layers of the stack, the three layer stack that Patty describes, have better margins than, you know, pure infrastructure. But even at the pure infrastructure level, we're we're very comfortable with the, you know, the returns, particularly given the long term value that we believe. And you talked about the LTV, the long term value that we believe we will generate, from those customers. As as Patty, has talked about multiple times, inferencing customers, which is what we're seeing, you know, more and more of even at the infrastructure layer as we're kinda going through this.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

They will pull other, cloud services through. They need databases. They need storage. They need bandwidth. They need standard, compute CPU.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

And so, you know, this this is a bit of, you know, we're still investing ahead in terms of okay. If there's a bunch of infrastructure, the margins on that are the are are, you know, lower than the margins at the higher stacks, but you need that baseline, infrastructure capability to get the higher layer services. And so we we think it's a a very good investment, very good use of our capital, and, we're we're very encouraged by the the returns that we're getting and and the promise of of higher returns as that business matures and and then we get more pull through revenue and and we get more of this the revenue shifting to the higher layers of of the AI stack.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

And just to add to it, Gabrielle, this is Patty. Just just to add to what Matt just said, that's why we're also, forward investing in making our gradient AI agentic cloud very, very optimized for inferencing. So I talked about our inference optimized droplet. If you look at that right side of the slide eight, you will also see that we are investing in model optimization. We are investing in infrastructure optimization at the infrastructure level.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Everything is aimed to scale inferencing workloads on our platform, which tend to be which tend to have very long tails. And as Matt mentioned, they also drag through some of the other cloud primitives. So they drag the left side along with them as the inferencing workload scale globally. So we feel very good about where we are and some of the early success we are seeing with very marquee customers that are starting to scale up their inferencing footprint on us.

Gabriela Borges
Gabriela Borges
MD - Software Research at Goldman Sachs

Yeah. That that makes sense. Thank you. And, Patty and Matt, the follow-up I have here, just on these comments on highest incremental ARR, highest organic ARR in over three years in terms of the net new that you're adding, can we think of this as the new high watermark? I'm looking at what's being implied in guidance.

Gabriela Borges
Gabriela Borges
MD - Software Research at Goldman Sachs

Talk to us about your ability to consistently deliver growth off that metric and whether there's any unevenness, whether because of seasonality or company specific factors like the timing of new AI capacity coming online that we should be aware of as we think about the fourth model.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Yeah. I can start, Matt, and and you can

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Go ahead.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Fill in. So we did not have anything on natural natural this last quarter. Like, we didn't bring a bunch of capacity online or there was no seasonality associated with it. I think we are just as we mentioned in our prepared remarks, we are honing our product led growth motion for our core cloud customers, and that is starting to really produce results on one hand. Our migration motion is bringing in a new type of customers that are typically digital native enterprise customers, and we are starting to grow them.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

And on the AI side, we're just starting to see some scaled up inferencing customers. So it's a combination of all of those. It's just not one big contract or one spike in capacity of GPUs or anything like that. It's a very secular and durable type of momentum that we are seeing on the new customer acquisition side. Matt?

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

I I agree with all that, Patty. I think that, again, the reminder on ARR is it's not based on a booking. It's not based on a sale. It's based on actual customer revenue and customer utilization. And so, you know, it's it's, it's I think that that, you know, we hope that that's a, a steady predictor and going forward of the exit trajectory, you know, that we're on and a and a good indicator.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

So it's certainly a critical metric for us. And as Patty said, we're we're encouraged by our ability to to increase that. Certainly, you know, it'll like, any metric will will vary quarter to quarter. Know that it'll always be, up into the right, but, we have enough motions going that, that we're very confident in our ability to improve that metric.

Gabriela Borges
Gabriela Borges
MD - Software Research at Goldman Sachs

Really nice progress. Thank you for the detail.

Operator

Your next question comes from the line of Raimo Lenschow with Barclays. Please go ahead.

Raimo Lenschow
Raimo Lenschow
Managing Director at Barclays

Perfect. Thank you. Staying on that AI notion and inferencing, like what if you think about like the, Patty, you talked about like your how you try to differentiate there, etcetera. Where is the industry at the moment in terms of also capacity constraints? Like is that still a factor for you that it's helping, or is it really now about all differentiation?

Raimo Lenschow
Raimo Lenschow
Managing Director at Barclays

Thank you. And then I have one follow-up from Ed.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Thank you, Raimo. Capacity constraints are way of life in AI as we are scaling like everyone else. So we are trying to stay ahead of it a little bit, but it's there are just so many factors there in terms of the the real estate footprint and the power and the cooling and the actual gear. So there's just a lot of variable factors here. But but I think for us, it all boils down to why some of these marquee AI native customers are starting to choose us over the other alternatives that they have.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

And it is really the the twin stack cloud that we have laid out in slide eight. So I don't think there are too many cloud providers that can claim to have both sides of of that equation. And we certainly feel like we we are driving home that point in terms of not not only offering a world class AI infrastructure, but increasingly, those same customers are also starting to leverage some of the the guardrails and the agent evaluation framework and the agent observability and things like that going up stack on the right side on of the agentic cloud. But, also, as Matt mentioned, they also have very sophisticated storage, data processing, and CPU compute requirements as well. Because at the end of the day, these are very sophisticated applications that require the the might of a full stack general purpose cloud.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

So I think that is the differentiation differentiator that we are leaning on, and we feel really confident. I've been talking about this for about four quarters. And finally, we have the the the twin stacks that we have described on slide eight of the earnings deck, and we feel really good. We're just getting started. And some of the the RPO and the large contracts that we have been talking about, they have not even started hitting their full stride as we are scaling those customers.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

So we feel really good about the forward momentum that we are building.

Raimo Lenschow
Raimo Lenschow
Managing Director at Barclays

And that kind of leads into my next question for Matt. Like, if I think about second half, got a good few questions already of people saying, actually, you're kind of raising probably raising a little the full year by more than you actually beat in Q1, Q2. So there's obviously a lot of confidence in the second half. Should we think about more RPO gives you more visibility, which drives some of that guidance because we know you as a conservative person normally? Thank you.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Thanks, everyone. But I I wish that it was all the RPO that was giving us, full confidence. If you look at the the RPO, while we're really encouraged by the the increase, it's still a very, very small portion of our business. So that that that's certainly encouraging, but I'd say, when we look at the performance that we had in the first in the first half, we look at the, visibility that we have into the customer usage patterns. We look at the migrations that, that we're seeing in that motion kind of coming.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

We looked at the traction we're getting with, with AI and with with some of the through some of the, direct sales and partnerships and and some of the conversations that have articulated we're having with with large, AI native companies. We we we just we we have enough irons in the fire, that we're confident, you know, increasing, the revenue guide. And and what to me is is, most encouraging, because you do, you know, know I am a relatively conservative guy, is that we're able to increase our free cash flow margin at the same time. And so to me that that, you know, we can demonstrate that we can grow revenue, we can accelerate revenue while maintaining attractive free cash flow margins. And and to me, that's incredibly, encouraging as we think about the, what's in front of us in the second half and how that sets us up for 2026.

Raimo Lenschow
Raimo Lenschow
Managing Director at Barclays

Yes. Okay, perfect. Thank you. Congrats.

Operator

Your next question comes from the line of Jason Ader with William Blair. Please go ahead.

Jason Ader
Co-Group Head - Technology, Media & Communications at William Blair

Yes. Thank you. Good morning, guys. I just wanted to see if you could give us a little bit of a breakdown of the business right now when we think about the kind of AI side versus the non AI side. I know you've given the growth rates.

Jason Ader
Co-Group Head - Technology, Media & Communications at William Blair

Can you tell us just sort of ballpark, is this like I don't know. I'm kind of I'm in the neighborhood of, like, five to 10% of revenue now from from AI. I don't know if there's any specificity you can give on that, but that would be really helpful.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Okay. So we're not you know, we we don't break this out, and part of it is because of the you know, we we believe that a lot of the AI, capabilities are gonna be pulling through other other capabilities. And so that the impact is is, of the growth is beyond what's representative. You just kinda wrote down the skews, that we consider AI. But you're in the ballpark.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

I'd say it's, you know, it's increasingly, becoming a material chunk of the business. It's still small because it's a it's a a business that we just launched a year ago and and we're accelerating. But but that's a reasonable, ballpark for percentage of revenue, and we expect that to to increase and and, you know, but, you know, it it will become an increasingly meaningful portion of our business in 2026, but it'll still be a small portion. The core cloud is still a very healthy and growing portion of our business, and and the AI business is a great complement to that and and is accelerating our growth and and also opening up different kind of entire channels and and new customers to bring in that kill will drive the core cloud growth up as well.

Jason Ader
Co-Group Head - Technology, Media & Communications at William Blair

Okay. Great. And then just as a quick follow-up. Is it fair to assume that the core core cloud business was, grew at a similar rate in q two versus q one, in that kind of, you know, low double digits? Is that is that accurate?

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Yeah. The the we we still see momentum in the, in the core cloud business. And while the NDR was a little bit lower, in q two than it was in q one, the revenue that we're getting from, from new customers is, is is ahead of, our plan and our expectations. We're we're doing a really good job there. And, again, you gotta remember, NDR is is a little wonky, laggy metric because what happened, like, the change in in revenue from a year ago has as much impact as the change in revenue this year.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

So the the core cloud business is continues to to to accelerate. It's it's in that low double digit growth rate and, is improving.

Jason Ader
Co-Group Head - Technology, Media & Communications at William Blair

So that most of the upside then was from new customers, sounds like?

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Yeah. Correct. Yeah. Because, I mean, it it with NDR coming down a little bit, the the customer acquisition plus the, the growth in AI offset the slight, you know, headwind from the the NDR. But, again, if you look at the incremental ARs, if you look at it on an exit run rate standpoint, there was a very good balance between the core business and AI.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

And so you both saw AI at its highest point, but there was still very good core cloud growth on an incremental ARR as well.

Jason Ader
Co-Group Head - Technology, Media & Communications at William Blair

Okay. Awesome. Thanks, guys. Your

Operator

next question comes from the line of Josh Baer with Morgan Stanley. Please go ahead.

Joshua Baer
Joshua Baer
Executive Director & Software Equity Research Analyst at Morgan Stanley

Great. Thanks for the question. Just wanted to confirm that in the net dollar retention rate, AI and ML revenue is not in that metric. Is that right?

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Yes. Right, Josh. That's still that that is still the case and will likely be the case, you know, for a while. As we've talked about it internally and we've talked about Investor Day, we said it'll eventually, you know, contribute to the to the NDR. And and we still believe it will.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

The the, it'll likely be for more inferencing workloads where they're, you know, steady production workloads. They're not projects where someone comes in, test something for a month, then and kind of scales it back. So if you think about the time lag of, someone being an NDR, they don't the customer doesn't count even, you know, in our core cloud until their thirteenth month. And so if you're turning up inferencing workloads now with, you know, with with, marquee customers, it'll be a year before they, you know, they would even hit MDR. So it it'll be you know, we'll we'll incorporate the, at least, the interesting portion of AI at some point, But it's it's certainly not gonna be in the next couple quarters.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

So it continues to not include ADR continues to not include AM.

Joshua Baer
Joshua Baer
Executive Director & Software Equity Research Analyst at Morgan Stanley

Okay. Got it. Yeah. I would I would think, like, especially now as it's it's scaling, but also you have more than twelve months. You talked about 100% growth off of the q two last year where there was AI revenue, and it's all organic, you know, kind of missing piece to that NDR percentage just around, that expansion from existing customers.

Joshua Baer
Joshua Baer
Executive Director & Software Equity Research Analyst at Morgan Stanley

I did wanna ask you about the large deals. Like, how we should be expecting the potential for large deals in the future? And then also for you, Matt, how you're thinking about it from a guidance perspective, assuming that would be a little bit lumpy or have longer sales cycles or it's just a new motion for you guys? You know, how do you incorporate the potential for large deals and guidance? Thank you.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Do you wanna start and talk just talk about the nature of large deals? And I can talk I can answer Josh's question about the guidance.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Yeah. So the nature of large deals is a very new muscle for us both from a sales, business development, forecasting, all of the above. I think what we are driven by is can we make these customers successful, and do we have enough of a technology edge that can attract and retain and and get these customers to scale? And that's the number one thing that I'm focused on that brought in and Larry are focused on is making sure that we have the ability to articulate our technology differentiation in a durable fashion and have the the right engineering expertise on the ground to make these customers successful. So I feel fairly encouraged by the couple of early successes that we have had, And, we can and we see enough in the pipeline to be quite encouraged with these kinds of deals.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Now with inferencing, it just takes time to to go from winning a customer deal to actually scaling that up with real world traffic. So we are in the process of doing that with with some of our customers. And extrapolating that into the future, we'll we'll see how we can do a a more predictable job in terms of forecasting how these things fall. But it I expect this to be lumpy and spiky in the beginning before it starts normalizing because our customers are also new to this. And they get sudden spikes based on some new updates to their models or new updates to their software.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Some of them are in the consumer AI space. Some of them are in the b two b AI space. So we are learning along with them, and they're learning with us in terms of their business model and how it is scaling out. So I'll let Matt answer how we will start reflecting these things in our financials.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

With with that context, Josh, that you you would expect based on our our our track record and our history, we'll be conservative in in forecasting those. I mean, the good news is, as Patty said, you know, we we we book revenue when when we get that revenue. It's not like we're signing, you know, massive deals that that that just turn on, right away. So we have visibility into the ramps and how those those customers are going. But but given it's such a new motion and and given some of those kind of the newness of it for both us and the customers that I described, we'll be conservative in terms of, of including any any projected revenue from from large deals until we're we're very comfortable that, you know, that that things are on the right track and and we're growing and and we have good visibility into that growth.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

So I I would expect that, that you would continue to see us be conservative as it reflects that relates to any large deals reflected in our forecast.

Joshua Baer
Joshua Baer
Executive Director & Software Equity Research Analyst at Morgan Stanley

Great. Thank you.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Your

Operator

next question comes from the line of James Fish with Piper Sandler. Please go ahead.

James Fish
James Fish
MD & Senior Research Analyst at Piper Sandler Companies

Hey, guys. Know, you keep using the word conservative here, but on on the guide side, we haven't seen this level of second half step up in some time, really going back to the pandemic. And and you guys deserve credit here doing 32,000,000 of met or direct organic. But can you just walk us through the linearity you are seeing, what you're expecting from some of the newer solutions in the second half to to raise guide by this much? And any of the other moving parts that helps you bridge the this kind of larger than normal step up here?

James Fish
James Fish
MD & Senior Research Analyst at Piper Sandler Companies

Because if if I look at this and and say you book similar kind of just slightly better net ARR in the sort of $3,035,000,000, range over the next few quarters, it really doesn't leave much wiggle room based on on how you guys are are defining ARR versus revenue now.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

I think, Jim, it's a good good question. The recall in the last, quarter, we didn't raise guidance. Like, we we beat q one. We didn't raise the guide for q two, and and we did that intentionally because the market, you know, has changed pretty pretty dramatically. And we just didn't didn't know what was gonna happen from a macro standpoint.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

We've we've now got a a full quarter under our belt on that front. We feel good about the visibility we have with the the core customers. We've got a bit of the beat from the first quarter and the beat in the second quarter to pass through. But as I said, we we have enough levers at the moment that that we're confident in. We've got the the revenue from new customers, you know, the month one to month 12 that's doing very well.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

And it's that's a, you know, a relatively stable and predictable. Like, it's a you you know, we're we're seeing increased volume. We're seeing increased conversion. We're seeing better customers in that cohort, and that's a fairly, durable kind of improvements that we've made. And so we're we're really confident in that.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

We've got the migration motion that we've turned up that, you know, as Patty talked about, 70 something, migrations during the, the quarter. That's a a very new motion for us, but we've got clearly a pipeline of those because those aren't things that you just, like, somebody comes in one day and and you you turn on a migration. You have to you're talking to the customer for a period of time. So we're we're managing a pipeline around that. We also have very good visibility into our AI pipeline and, are getting increasing traction there.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

So we we've we've got enough things that are going that, that give us confidence to, to be able to deliver on that. And and as I said in, you know, in the prior, question or the in the answer, we we haven't fully reflected a large deal potential in the, in the guide that we have. And and that certainly gives us, you know, the upside potential, beyond what we've we've even, you know, we're talking about. So we we feel good that we're confident in the base, confident enough to raise the the guide, and that that there's still, you know, other things we can be doing and and and progress we could be making over the balance of this year to to give us further room.

James Fish
James Fish
MD & Senior Research Analyst at Piper Sandler Companies

Got it. And then, Patty, maybe for you, can you talk about what you're seeing on on sort of the GPU pricing dynamic? Is does it seem like across the space pricing came down a little bit and how you're thinking about, you know, the ability to repurpose any GPUs that kind of migrate from customer to customer or, you know, what you're seeing in terms of utilization at this point across the the GPU side? Thanks, guys.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

K. Thank you, Jim. The the utilization is very robust. We are running very lean on on our GPU fleets regardless of the generation of GPUs we are talking about. As we become more and more heavy on the inferencing side, it gives us a lot of degrees of freedom in terms of how we allocate the machines.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

And, typically, what we're seeing with our inferencing customers is, yes, they do care about the generation of GPUs, but they care more about the price performance rather than just the the raw throughput of any given generation of technology. So let's say you have a you have a 100 units of GPU on the current generation. And if we can deliver the same price performance with 90 units of GPU in the next generation, the customer really doesn't care as long as it's in the same family of of GPUs, and they don't have to reengineer or do anything. So they're so we are getting to a point where it's more about the price performance rather than the price alone or the performance alone. So that gives us a lot of degrees of freedom in terms of how we allocate which family of GPUs across our inference workload customers.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

And I think this is going to get even more important as we start scaling up many of our customers across geographies and and start doing this in multiple data centers. So a lot of lot of new things to be figured out there, but the the pricing dynamics and training workloads are quite a bit different from the ones that we are experiencing in a stack that is predominantly driving inferencing.

Operator

We have time for one more question. And that question comes from the line of Brad Reback with Stifel. Please go ahead.

Brad Reback
Brad Reback
Managing Director at Stifel Financial

Great. Thanks very much. Matt, as we think about gross margin for the back half of the year as the revenue mix maybe shifts a little bit and you continue to invest in the CapEx, how should we think about the trajectory? And then heading into next year as you lap the change in useful life, what type of impact should we expect then? Thanks.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Thanks, Fred. The gross margins are we we expect to be relatively consistent at current levels over the balance of this year with, again, as you said, the the AI business is, it's growing fast, but it's still a small part of the business. So it's not it's not gonna have a material impact on on gross margins. If you if you roll that out to next year, clearly, we're not at a point ready to give guidance, but we would expect it to have, you know, kind of a modest, headwind to gross margins, but it's you know, it's still gonna be and the the vast majority of our business is gonna be at the the same high margins that we have. And we continue to drive efficiencies in, in the core business, bandwidth optimization, you know, the the, the longer term data center optimization strategy that we have.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

And so we're we're confident that we can maintain kind of healthy gross margins in the, in in the in the realm that we have right now. And if if AI becomes a, a much, much bigger portion of our business, you'll clearly have visibility into that, know, as we do. And at that point, you would see a little bit of margin pressure. But at this point, the gross margin, we expect to stay right around where it is to balance the year.

Brad Reback
Brad Reback
Managing Director at Stifel Financial

That's great. Thanks very much.

Operator

Your next question comes from the line of Mark Zhang with Citi. Please go ahead.

Mark Zhang
Mark Zhang
AVP - Equity Research at Citigroup

Hey, great. Good morning, guys. Thanks for squeezing me in. Maybe just want to dig a little bit more into the RPO performance, very nice to see. But but can you give us a sense of, you know, maybe the your characteristics here?

Mark Zhang
Mark Zhang
AVP - Equity Research at Citigroup

What are the average deal sizes, contract duration? I just wanted to confirm that AI was the leading contributor here, or you saw, you know, good contribution from CoreCloud as well? Thanks.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

That was with surely go go ahead, man.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

I was saying from they're starting to reverse. So it was the increase in RPO was from both core cloud and AI, so it wasn't wasn't just, it wasn't just AI. Clearly, there's some AI deals, that that are in there. The the and you can see that I think the the average, duration, and I might be quoting q one, so I apologize if it's slightly off, but it's, like, nineteen months. So you can get the average, kind of length of the the the deal.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

It's, you know, the two two say, call it two years on the outside and sometimes one one year, somewhere between one and two years is, is the the typical for us. Because this is a relatively new motion, for us. And it's great that we're getting customers that are used to and value the the ability to just do straight consumption with us to make the commitments to, you know, for a minimum level of of revenue over some period of time. So that's that's something that's very encouraging and and speaks to the product innovation and the the improvements we've made in the core cloud and and customers' confidence in our ability to continue to to meet their needs. Don't Patty, if you wanted to add something to that.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

No. I think you you nailed it, Matt. Yeah. It is definitely a combination of both both our core cloud as well as AI. So there's not this is not just reflective of just one giant huge deal or anything like that.

Mark Zhang
Mark Zhang
AVP - Equity Research at Citigroup

Got it. Thank you. And then just maybe a quick follow-up. Just on capital allocation, it seems like you guys have been stepping up on share repurchases since, I guess, end of last year. But now working out the authorization is going down to about $3,000,000 What's sort of the thought process around just, yeah, capital allocation going forward? Thanks.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Yeah. Our, our capital allocation so we actually, reduced the amount of, repurchases that we've been doing over the last two years. We we did almost 500,000,000 in in 2023. And then across 2024 and into 2025, it it was only 140,000,000. Our primary objective at the moment, and and we articulated this in in Investor Day, is, it's all about it's all about, organic growth and and investing to drive organic But then secondly, and and, you know, as important is we're committed to, to making sure that we've taken care of the balance sheet and we've addressed the outstanding, convert.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

And we've we've said that we're gonna do that by the end of this year, and we started that process with our $800,000,000 bank facility, you know, 500,000,000 of that is a term loan. And so we're we're dialing back the, the share repurchases just so that we can make sure that we take care of those first two, objectives. And as soon as we take care of those two objectives, the first one will be ongoing, but the the second being taken care of the, of the outstanding convert, then we'll, you know, we'll we'll go back to a, let's say, a reasonable level of share repurchases that are targeted at offsetting dilution. So it's, I think, priority one is organic growth, priority two is take care of the convert, and priority three is use repurchases to offset dilution. And right now priorities one and two are the bigger focus for the next quarter or so.

Operator

Your next question comes from the line of Thomas Blakey with Cantor. Please go ahead.

Thomas Blakey
Managing Director at Cantor Fitzgerald

Hey, guys.

Thomas Blakey
Managing Director at Cantor Fitzgerald

Congratulations on the results and thanks for squeezing me in here. I have a point of clarification first to I think it was Jason Ader's question earlier. Matt, did you say that the core cloud accelerated in 2Q? And then from a question perspective, I know the core AI is organic now, growing over 100%. What kind of derivative impact did it have to NDR, if any, Patty or Matt? Just or you would think there'd be some kind of, like, flow through of these customers buying more services on the platform?

Thomas Blakey
Managing Director at Cantor Fitzgerald

And I and I, you know, that that I would just be curious to see what kind of impact that had on the on that on that metric. Thank you.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

So on on the the second part of your question, the, a lot of the AI customers that are coming, to us are are new customers. Right? So they're in the particularly in the infrastructure, side of AI. So they're they're not yet buying, you know, a ton a tremendous amount of of of products on the core cloud side. And even if they did, they haven't been in the cohort long enough to count towards MDR.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

So they're they're not they're not there's basically not much impact from that. That's the future benefit, which I I think you're you're appropriately, pointing out. And I'm sorry. Could you repeat the first part of your question?

Thomas Blakey
Managing Director at Cantor Fitzgerald

Yeah. I think you said earlier on the call to a question that, core cloud, you know, kind of excluding AIML, accelerated, and I just wanted to make sure I heard that correctly.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Yeah. Yeah. The the year over year growth rates for the in the core cloud continue, continue to improve. So, again, when you look at a metric like NDR, it's, a function of what happened, the change in in in revenue last year compared to the change in revenue this this year. So it's it's got a lot of kind of laggy components to it, on the core cloud in terms of the the incremental ARR, the the the and the kind of the overall ARR growth of the core business that that continues to accelerate.

Thomas Blakey
Managing Director at Cantor Fitzgerald

Thanks, Scott.

Operator

Your next question comes from the line of Wamsi Mohan with Bank of America. Please go ahead.

Wamsi Mohan
Wamsi Mohan
Senior Equity Research Analyst at Bank of America Merrill Lynch

Yes. Thanks for taking my question here. I guess, firstly, on your AI customers, are you seeing higher volatility or churn in that customer base? And just to clarify, is the penetration of these customers, how would you categorize that between maybe learners, builders, scalers in your traditional way of of thinking about the customers? Where where are these in their journey, and any any thoughts around graduation rates on on these customers?

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

Yeah. Great question, Ramsit. It's good to hear from you. The it's a completely different customer acquisition motion, so we don't think of them as testers, learners, builders, scalers, but they typically don't go through that journey on our platform. A lot of these customers are in in the initial stages, there were a lot of very early stage startups.

Paddy Srinivasan
Paddy Srinivasan
CEO & Director at DigitalOcean

But as we are seeing a lot of traction on the inferencing side, these customers, in their own evolution or in their own progression, have crossed some of the chasms in terms of both funding as well as finding product market fit and customer traction. But they're coming to us with inferencing needs that are scaling, which by definition means that they have found product market fit, and now they have a captive audience that is willing to pay for their inferencing need. So we are starting to see there was a lot of the the the test and and leave kind of phenomenon in the fine tuning on the training side last year. But now as we have started flipping more and more towards the inferencing side, these customers come, they stay, they expand, and they start leveraging different parts of our stack described in in my diagram. So it's a very different life cycle that you're seeing on this side.

Wamsi Mohan
Wamsi Mohan
Senior Equity Research Analyst at Bank of America Merrill Lynch

Okay. Great. Thanks, Patty. And if I could follow-up quickly with Matt. On on the growth CapEx side, any incremental thoughts over here?

Wamsi Mohan
Wamsi Mohan
Senior Equity Research Analyst at Bank of America Merrill Lynch

I know you said, you know, organic investments and driving organic growth as sort of highest priority. So relative to your comments that you made last quarter, how should we be thinking about the, growth CapEx profile over the next few quarters or into next year? Thank you so much.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

Yeah. Thanks, Wamsi. Yeah. I think, a couple of things. One, I would I would point to again, we've we've increased the free cash flow margin, guidance and and, we feel good about that, relative to the, to the growth rates that we're articulating.

Matt Steinfort
Matt Steinfort
CFO at DigitalOcean

And and what we said in the last quarter and say again is if we see the opportunity to accelerate growth beyond what we communicated at the at the Investor Day of 18 to 20% by by 2027, we certainly do that. And and we have a lot of tools in our toolkit to to be able to do that in a capital efficient and cash flow efficient way. So we're we're very confident, remain very confident that we can grow revenue, while maintaining attractive free cash flow margins.

Operator

And ladies and gentlemen, that does conclude our question and answer session. And it does conclude today's conference call. Thank you for your participation, and you may now disconnect.

Executives
    • Melanie Strate
      Melanie Strate
      Head - IR
    • Paddy Srinivasan
      Paddy Srinivasan
      CEO & Director
    • Matt Steinfort
      Matt Steinfort
      CFO
Analysts
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