# DigitalOcean Holdings, Inc. (DOCN) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from DigitalOcean Holdings, Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1582961/000158296123000009/docn-20221231.htm
Accession: 0001582961-23-000009
Filing date: 2023-02-22
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/DOCN/
All MD&A years: /company/DOCN/mda/
Previous year: /company/DOCN/mda/fy2021/ (FY 2021)
Next year: /company/DOCN/mda/fy2023/ (FY 2023)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes and other financial information included in Item 8 of this Annual Report on Form 10-K. This discussion, particularly information with respect to our outlook, key trends and uncertainties, our plans and strategy for our business, and our performance and future success, includes forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report, particularly in the section entitled “Special Note Regarding Forward-Looking Statements” and Part I, Item 1A, “Risk Factors.” In addition, for more information regarding key factors affecting our performance, see “Key Factors Affecting Our Performance” below.

Overview

DigitalOcean is a leading cloud computing platform offering on-demand infrastructure and platform tools for startups and small and medium-sized businesses (SMBs). We were founded with the guiding principle that the transformative benefits of the cloud should be easy to leverage, broadly accessible, reliable and affordable. Our platform simplifies cloud computing, enabling our customers to rapidly accelerate innovation and increase their productivity and agility. As of December 31, 2022, we had approximately 677,000 customers using our platform to build, deploy and scale applications, including approximately 129,000 customers paying between $50 and $500 per month (which we refer to as builders) and approximately 15,000 customers paying more than $500 per month (which we refer to as scalers). Our users include software engineers, researchers, data scientists, system administrators, students and hobbyists. Our customers use our platform across numerous industry verticals and for a wide range of use cases, such as web and mobile applications,

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website hosting, e-commerce, media and gaming, personal web projects, and managed services, among many others. We believe that our focus on simplicity, community, open source and customer support are the four key differentiators of our business, driving a broad range of customers around the world to build their applications on our platform.

We offer mission-critical solutions across Infrastructure-as-a-Service (IaaS), including our Droplet virtual machines, storage and networking offerings; Platform-as-a-Service (PaaS), including our Managed Database and Managed Kubernetes offerings; and Software-as-a-Service (SaaS), including our Managed Hosting and Marketplace offerings. Improving the developer experience and increasing productivity are core to our mission. Our cloud platform was designed with simplicity in mind to ensure that startups and SMBs can spend less time managing their infrastructure and more time building innovative applications that drive business growth. Simplicity guides how we design and enhance our easy-to-use-interface, the core capabilities we offer our customers and our approach to predictable and transparent pricing for our solutions. In just minutes, developers can set up thousands of virtual machines, secure their projects, enable performance monitoring and scale up and down as needed.

We generate revenue from the usage of our cloud computing platform by our customers, including but not limited to compute, storage and networking services. We recognize revenue based on the customer utilization of these resources. Our pricing is consumption-based and billed monthly in arrears, making it easy for our customers to track usage on an ongoing basis and optimize their deployments.

We have historically generated almost all of our revenue from our efficient self-service customer acquisition model, which we complement with a targeted sales force focused on inside sales, outside sales and partnership opportunities to drive revenue growth. Our model enables customers to get started on our platform very quickly and without the need for assistance. We focus heavily on enabling a self-service, low-friction model that makes it easy for users to try, adopt and use our products. For the years ended December 31, 2022, 2021 and 2020 our sales and marketing expense was approximately 14%, 12% and 11% of our revenue, respectively. The efficiency of our go-to-market model and our focus on the needs of the SMB market has enabled us to drive organic growth and establish a truly global customer base across a broad range of industries.

Our customers are spread across over 190 countries and around two-thirds of our revenue has historically come from customers located outside the United States. For the year ended December 31, 2022, 38% of our revenue was generated from North America, 30% from Europe, 22% from Asia and 10% from the rest of the world.

Our average revenue per customer, or ARPU, has increased significantly from $47.78 in 2020 to $59.96 in 2021 to $75.19 in 2022. We had no material customer concentration as our top 25 customers made up approximately 10%, 10% and 9% of our revenue in the years ended December 31, 2022, 2021 and 2020, respectively. We have experienced strong and predictable growth in recent periods. Our annual run-rate revenue, or ARR, as of December 31, 2022 was $659 million, up from $490 million as of December 31, 2021 and $357 million as of December 31, 2020. ARR as of the end of each month represents total revenue for that month multiplied by 12.

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Growing our builders and scalers (which we collectively refer to as our higher spend customers) is a critical focus for us, and we have successfully increased the number of these higher spend customers and their percentage of our total revenue. We had approximately 15,000 scalers as of December 31, 2022, up from approximately 11,000 as of December 31, 2021 and approximately 8,000 as of December 31, 2020. We had approximately 129,000 builders as of December 31, 2022, up from approximately 89,000 as of December 31, 2021 and approximately 73,000 as of December 31, 2020. Revenue from builders and scalers increased 30% and 45%, respectively, for the year ended December 31, 2022, compared to the year ended December 31, 2021. Revenue from higher spend customers as a percentage of total revenue was 85% in 2022, 83% in 2021 and 79% in 2020. Our average revenue per customer (which we refer to as ARPU) has increased significantly, from $47.78 in 2020 to $59.96 in 2021 to $75.19 in 2022.

Macroeconomic Conditions

Unfavorable conditions in the economy both in the United States and abroad, including conditions resulting from changes in gross domestic product growth, labor shortages, supply chain disruptions, inflationary pressures, rising interest rates, financial and credit market fluctuations, international trade relations, political turmoil, natural catastrophes, outbreaks of contagious diseases, warfare and terrorist attacks on the United States, Europe or elsewhere, including military actions

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affecting Russia, Ukraine or elsewhere, could cause a decrease in business investments on information technology and negatively affect the growth of our business and our results of operations.

2023 Restructuring

On January 27, 2023, our Board of Directors approved a restructuring plan to adjust our cost structure and accelerate our timeline to achieve our desired free cash flow margins. The restructuring plan includes both the elimination of positions across the company as well as the shifting of additional positions across a broader geographical footprint over the next several months. See Note 16. Subsequent Events to our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information regarding these commitments.

Key Factors Affecting Our Performance

Increasing Importance of Cloud Computing and Developers

Our future success depends in large part on the continuing adoption of cloud computing, proliferation of cloud-native start-ups and SMBs and the increasing importance of developers, all of which are driving the adoption of our developer cloud platform. We believe our market opportunity is large and that these factors will continue to drive our growth.

Increasing Usage by Our Existing Customers

Our customer base of approximately 677,000 customers as of December 31, 2022 represents a significant opportunity for further consumption of our services. We are highly focused on gaining a better understanding of the needs and growth plans of our existing customers. This deeper relationship with our customers will help us identify opportunities to educate our customer base on ways to utilize the platform more effectively for their individual use cases, as well as provide a feedback loop to inform our product roadmap. We expect to continue to increase our revenue from existing customers through the introduction of new products and features tailored to our customer base in addition to expanded customer outreach, focused on larger customers and specific use cases.

Growing Our Base of Higher Spend Customers

We believe there is a substantial opportunity to further expand our customer base to attract more businesses that can scale on our platform. We are investing in strategies that we believe will attract higher spend customers, including expansion of our sales team, and new marketing initiatives that further optimize our self-service revenue funnel to help customers expand their usage. In addition, our recent Cloudways acquisition added a significant number of higher spend customers to our platform due to the higher price point of its Managed Hosting offering.

Enhancing Our Platform and Product Offerings

We believe the market opportunity for serving startups and SMBs is very large and goes far beyond providing the core IaaS services of compute, storage and networking. We have a history of, and will continue to invest significantly in, developing and delivering innovative products, features and functionality targeted at our core customer base. In addition, we may pursue both strategic partnerships and acquisitions that we believe will be complementary to our business, accelerate customer acquisition, increase usage of our platform and/or expand our product offerings in our core markets. Our results of operations may fluctuate as we make these investments to drive usage and take advantage of our expansive market opportunity.

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Key Business Metrics

We utilize the key metrics set forth below to help us evaluate our business and growth, identify trends, formulate financial projections and make strategic decisions. We are not aware of any uniform standards for calculating these key metrics, and other companies may not calculate similarly titled metrics in a consistent manner, which may hinder comparability. The table below includes the impact of our Cloudways acquisition with respect to the metrics disclosed for the year ended December 31, 2022.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","2021","","2020"],["Learners","468,065","","","445,756","","","426,739"],["Builders","129,150","","","88,787","","","72,627"],["Scalers","15,032","","","10,568","","","7,624"],["ARPU","$","75.19","","","$","59.96","","","$","47.78"],["ARR (in millions)","$","659","","","$","490","","","$","357"],["Net dollar retention rate","115","%","","113","%","","103","%"]]
[[/GREPCENT_TABLE]]

Customers

The number and growth of our higher spend customers is of particular importance to us as these customers represent a significant majority of our revenue and revenue growth, and they are representative of the SMB customers that grow on our platform and use multiple products.

Learners

We define learners as customers having generated an invoice of less than $50 for the month end period and that have been on DigitalOcean’s platform for more than three months.

Builders

We define builders as customers having generated an invoice between $50 and $500 (inclusive) for the month end period.

Scalers

We define scalers as customers having generated an invoice of greater than $500 for the month end period.

ARPU

We believe that our average revenue per customer, which we refer to as ARPU, is a strong indication of our ability to land new customers with higher spending levels and expand usage of our platform by our existing customers. We calculate ARPU on a monthly basis as our total revenue in that period divided by the number of customers determined as of the last day of that period. For a quarterly or annual period, ARPU is determined as the weighted average monthly ARPU over such three or 12-month period.

ARR

Given the renewable nature of our business, we view annual run-rate revenue as an important indicator of our current progress towards meeting our revenue targets and projected growth rate going forward. We calculate ARR at a point in time by multiplying the latest monthly period’s revenue by 12.

Net Dollar Retention Rate

Our ability to maintain long-term revenue growth and achieve profitability is dependent on our ability to retain and grow revenue from our existing customers. We have a history of retaining customers for multiple years and in many cases increasing their spend with us over time. To help us measure our performance in this area, we monitor our net dollar retention rate. We calculate net dollar retention rate monthly by starting with the revenue from the cohort of all customers during the corresponding month 12 months prior, or the Prior Period Revenue. We then calculate the revenue from these same customers as of the current month, or the Current Period Revenue, including any expansion and net of any contraction or attrition from these customers over the last 12 months. The calculation also includes revenue from customers that generated revenue before, but not in, the corresponding month 12 months prior, but subsequently generated revenue in

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the current month and are therefore reflected in the Current Period Revenue. We include this group of re-engaged customers in this calculation because our customers frequently use our platform for projects that stop and start over time. We then divide the total Current Period Revenue by the total Prior Period Revenue to arrive at the net dollar retention rate for the relevant month. For a quarterly or annual period, the net dollar retention rate is determined as the average monthly net dollar retention rates over such three or 12-month period.

Components of Results of Operations

Revenue

We offer mission-critical solutions across Infrastructure-as-a-Service (IaaS), including our Droplet virtual machines, storage and networking offerings; Platform-as-a-Service (PaaS), including our Managed Database and Managed Kubernetes offerings; and Software-as-a-Service (SaaS), including our Managed Hosting and Marketplace offerings. We recognize revenue based on the customer utilization of these resources. Customer contracts are primarily month-to-month and do not include any minimum guaranteed quantities or fees. Fees are billed monthly, and payment is typically due upon invoicing. Revenue is recognized net of allowances for credits and any taxes collected from customers, which are subsequently remitted to governmental authorities.

We may offer sales incentives in the form of promotional and referral credits and grant credits to encourage customers to use our services. These types of promotional and referral credits typically expire in two months or less if not used. For credits earned with a purchase, they are recorded as contract liabilities when earned and recognized at the earlier of redemption or expiration. The majority of credits are redeemed in the month they are earned.

Cost of Revenue

Cost of revenue consists primarily of fees related to operating in third-party co-location facilities, personnel expenses for those directly supporting our data centers and non-personnel costs, including amortization of capitalized internal-use software development costs and depreciation of our data center equipment. Third-party co-location facility costs include data center rental fees, power costs, maintenance fees, network and bandwidth. Personnel expenses include salaries, bonuses, benefits, and stock-based compensation.

We intend to continue to invest additional resources in our infrastructure to support our product portfolio and scalability of our customer base. The level, timing and relative investment in our infrastructure could affect our cost of revenue in the future.

Operating Expenses

Research and Development Expenses

Research and development expenses consist primarily of personnel costs including salaries, bonuses, benefits and stock-based compensation. Research and development expenses also include amortization of capitalized internal-use software development costs for research and development activities, which are amortized over three years, and professional services, as well as costs related to our efforts to add new features to our existing offerings, develop new offerings, and ensure the security, performance, and reliability of our global cloud platform. We expect research and development expenses to increase in absolute dollars as we continue to invest in our platform and product offerings.

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of personnel costs of our sales, marketing and customer support employees including salaries, bonuses, benefits and stock-based compensation. Sales and marketing expenses also include costs for marketing programs, advertising and professional service fees. We expect sales and marketing expenses to continue to increase in absolute dollars as we enhance our product offerings and implement new marketing strategies.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel costs of our human resources, legal, finance, and other administrative functions including salaries, bonuses, benefits, and stock-based compensation. General and administrative expenses also include provision for expected credit losses, software, payment processing fees, business insurance, depreciation and amortization expenses, rent and facilities costs, loss on sublease, and other administrative costs. We expect to incur significant additional legal, accounting and other expenses to support our operations as a public company, including costs associated with our compliance with the Sarbanes-Oxley Act. We also expect general and administrative expenses to increase in absolute dollars as we continue to grow our business.

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Other (Income) Expense

Other (income) expense consists primarily of interest expense on our convertible notes and existing credit facility, loss on extinguishment of debt, accretion/amortization of premium/discounts and interest income from our available-for-sale investments, and gains or losses on foreign currency exchange.

Income Tax (Benefit) Expense

Income tax (benefit) expense consists primarily of income taxes in certain foreign and state jurisdictions in which we conduct business. We maintain a valuation allowance on our U.S. federal and state deferred tax assets as we have concluded that it is more likely than not that the deferred assets will not be realized.

Results of Operations

The following table sets forth our results of operations for the periods presented:

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

___________________

(1)Includes stock-based compensation as follows:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","2021","","2020"],["","(in thousands)"],["Cost of revenue","$","1,820","","","$","1,147","","","$","545"],["Research and development","39,354","","","23,315","","","7,765"],["Sales and marketing","14,909","","","8,471","","","1,924"],["General and administrative","49,746","","","28,644","","","19,222"],["Total","$","105,829","","","$","61,577","","","$","29,456"]]
[[/GREPCENT_TABLE]]

Stock-based compensation for the year ended December 31, 2020 included compensation of $18.3 million related to secondary sales of common stock by certain current and former employees, which is primarily included in General and administrative. There were no such expenses recorded for the years ended December 31, 2022 or 2021.

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The following table sets forth our results of operations as a percentage of revenue for the periods presented:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","2021","","2020"],["Revenue","100","%","","100","%","","100","%"],["Cost of revenue","37","","","40","","","46"],["Gross profit","63","","","60","","","54"],["Operating expenses:"],["Research and development","25","","","27","","","24"],["Sales and marketing","14","","","12","","","11"],["General and administrative","29","","","24","","","25"],["Total operating expenses","68","","","63","","","60"],["Loss from operations","(5)","","","(3)","","","(6)"],["Other (income) expense","\u2014","","","2","","","8"],["Loss before income taxes","(5)","","","(5)","","","(14)"],["Income tax (benefit) expense","*","","*","","*"],["Net loss attributable to common stockholders","(5)","%","","(5)","%","","(14)","%"]]
[[/GREPCENT_TABLE]]

___________________

* Less than 1% of revenue

A discussion regarding our financial condition and results of operations for the year ended December 31, 2022 compared to the year ended December 31, 2021 is presented below. A discussion regarding our financial condition and results of operations for the year ended December 31, 2021 compared to the year ended December 31, 2020 can be found under Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 25, 2022, which is available on the SEC’s website at www.sec.gov.

Comparison of the Years Ended December 31, 2022 and 2021

Revenue

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2022","","2021","","$ Change","","% Change"],["","(in thousands)"],["Revenue","$","576,322","","","$","428,561","","","$","147,761","","","34","%"]]
[[/GREPCENT_TABLE]]

Revenue increased $147.8 million, or 34%, for the year ended December 31, 2022 compared to the year ended December 31, 2021. This increase is primarily due to a 25% increase in ARPU to $75.19 from $59.96, with our higher spend customers contributing 6% of that growth, as well as a $16.7 million revenue contribution from Cloudways. The increase in ARPU was primarily driven by continued adoption of our products by our customers leading to higher average usage on our platform.

Cost of Revenue

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2022","","2021","","$ Change","","% Change"],["","(in thousands)"],["Cost of revenue","$","211,927","","","$","170,595","","","$","41,332","","","24","%"]]
[[/GREPCENT_TABLE]]

Cost of revenue increased $41.3 million, or 24%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to the impact of adopting the new lease standard (see our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information) and depreciation of our network equipment to support the growth in our business, as well as costs associated with our revenue share programs. Gross profit increased to 63% for the year ended December 31, 2022 from 60% for the year ended December 31, 2021, primarily due to a decline in depreciation as a percentage of revenue and lower colocation.

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Operating Expenses

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2022","","2021","","$ Change","","% Change"],["","(in thousands)"],["Research and development","$","143,885","","","$","115,684","","","$","28,201","","","24","%"],["Sales and marketing","81,544","","","50,878","","","30,666","","","60","%"],["General and administrative","165,185","","","102,590","","","62,595","","","61","%"],["Total operating expenses","$","390,614","","","$","269,152","","","$","121,462","","","45","%"]]
[[/GREPCENT_TABLE]]

Research and development expenses increased $28.2 million, or 24%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to higher personnel costs and stock-based compensation.

Sales and marketing expenses increased $30.7 million, or 60%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to higher personnel costs and stock-based compensation, and increases in advertising costs and amortization of our acquired intangibles.

General and administrative expenses increased $62.6 million, or 61%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to higher personnel costs and stock-based compensation, and increases in the provision for expected credit losses, acquisition related compensation, insurance and software licensing fees, acquisition and integration related costs, foreign indirect taxes and audit fees.

Other (Income) Expense

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2022","","2021","","$ Change","","% Change"],["","(in thousands)"],["Other (income) expense","$","(1,812)","","","$","7,015","","","$","(8,827)","","","(126)","%"]]
[[/GREPCENT_TABLE]]

Other (income) expense decreased $8.8 million, or 126%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to lower interest expense due to the payoff of the debt under our credit facility and notes payable in the first quarter of 2021, interest income from our marketable securities for the current period, and a loss on extinguishment of debt in the prior period, partially offset by amortization expense from our convertible notes.

Income Tax (Benefit) Expense

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2022","","2021","","$ Change","","% Change"],["","(in thousands)"],["Income tax (benefit) expense","$","(124)","","","$","1,302","","","$","(1,426)","","","(110)","%"]]
[[/GREPCENT_TABLE]]

Income tax (benefit) expense decreased $1.4 million, or 110%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to income taxes related to international jurisdictions in which we conduct business.

Liquidity and Capital Resources

We have funded our operations since inception primarily with cash flow generated by operations, private offerings of our equity and debt securities, borrowings under our existing credit facility and capital expenditure financings. Cash provided from these sources is used primarily for operating expenses, such as personnel costs, and capital expenditures. From time to time, we may also use excess cash for share repurchases.

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In February 2022, our Board of Directors approved the repurchase of up to an aggregate of $300.0 million of our common stock throughout fiscal year 2022 (“First Program”). As of May 16, 2022, we repurchased the shares representing the entire amount available under the First Program. On May 23, 2022, our Board of Directors approved a new stock repurchase program authorizing the repurchase of up to an additional $300.0 million of our common stock throughout fiscal year 2022 (the “Second Program”). As of August 19, 2022, we repurchased the shares representing the entire amount available under the Second Program. As of December 31, 2022, we repurchased and retired 13.6 million shares of common stock at an average price of $44.03 per share for an aggregate purchase price of $600.0 million, representing the entire amount available under the First Program and the Second Program.

As of December 31, 2022, we had $140.8 million in cash and cash equivalents and $723.5 million in marketable securities. Our cash and cash equivalents primarily consist of money market funds and commercial paper. Our marketable securities consist of U.S. treasury securities, commercial debt securities, and commercial paper.

We believe our existing cash and cash equivalents, cash flow from operations and availability under our Credit Facility (as defined below) and Convertible Notes (as defined below) will be sufficient to support working capital and capital expenditure requirements and our outstanding contractual commitments for at least the next 12 months and in the long term.

In February and March 2020, we entered into and subsequently amended a second amended and restated credit agreement with KeyBank National Association as administrative agent. In November 2021, we further amended such credit agreement to revise certain covenants that restricted the incurrence of indebtedness to permit the issuance of the convertible notes discussed below. In March 2022, we entered into a third amended and restated credit facility (as amended, the “Credit Facility”) to increase our borrowing capacity from $150.0 million to $250.0 million. Our Credit Facility will mature on the earlier of (a) March 29, 2027 and (b) 90 days before the maturity date applicable to any outstanding convertible notes issued by the Company in an aggregate principal amount equal to or greater than $100,000.

Our Credit Facility is secured by a first-priority security interest in substantially all of our assets. Our Credit Facility contains certain financial and operational covenants, including a maximum senior secured net leverage ratio financial covenant of 3.50x. Consolidated total debt and consolidated EBITDA, which are non-GAAP measures used for this covenant, are calculated in accordance with the definitions set forth in the Credit Facility. In this context, these measures are used solely to provide information on the extent to which we are in compliance with these financial covenants and may not be comparable to consolidated total debt and consolidated EBITDA used by other companies or any other non-GAAP measures we present elsewhere in this prospectus. We were in compliance with all covenants under our Credit Facility as of December 31, 2022.

In March 2021, we consummated our initial public offering (“IPO”) of 16.5 million shares of our common stock at an offering price of $47.00 per share resulting in aggregate net proceeds to us of $723.0 million after deducting the underwriting discounts and commissions and offering expenses payable by us.

In November 2021, we issued $1.50 billion aggregate principal amount of 0% Convertible Senior Notes due December 1, 2026 (the “Convertible Notes”), in a private offering, for net proceeds of $1.46 billion, after deducting underwriting fees, expenses and commissions. The Convertible Notes are senior unsecured obligations and do not bear regular interest, and the principal amount of the Convertible Notes does not accrete. The Convertible Notes will mature on December 1, 2026 unless earlier converted, redeemed, or repurchased.

We may from time to time seek to retire or purchase our outstanding equity or debt, including the repurchase of our common stock or the Convertible Notes, through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions, and other factors. The amounts involved in any such transactions, individually or in the aggregate, may be material. Further, any such purchases or exchanges may result in us acquiring and retiring a substantial amount of such indebtedness, which could impact the trading liquidity of such indebtedness.

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The following table summarizes our cash flows for the periods presented:

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(In thousands)","2022","","2021","","2020"],["Net cash provided by operating activities","$","195,152","","","$","133,109","","","$","58,458"],["Net cash used in investing activities","(1,148,158)","","","(113,605)","","","(115,633)"],["Net cash (used in) provided by financing activities","(610,363)","","","1,593,379","","","124,026"],["(Decrease) increase in cash, cash equivalents and restricted cash","(1,563,618)","","","1,612,888","","","66,651"]]
[[/GREPCENT_TABLE]]

Operating Activities

Our largest source of operating cash is cash collections from sales to our customers. Our primary uses of cash from operating activities are for personnel costs, data center co-location expenses, marketing expenses, payment processing fees, bandwidth and connectivity, server maintenance and software licensing fees.

Net cash provided by operating activities was $195.2 million, $133.1 million and $58.5 million for the years ended December 31, 2022, 2021 and 2020, respectively, for which the increases in each year were primarily driven by an increase in cash collections from higher revenues, partially offset by an increase in cash expenses for personnel related costs.

Investing Activities

Net cash used in investing activities was $1.1 billion for the year ended December 31, 2022 compared to $113.6 million for the year ended December 31, 2021. The increase was driven by our investment in available-for-sale marketable securities of $1.7 billion, the acquisition of Cloudways of $305.2 million and purchase of property and equipment of $9.3 million, partially offset by maturities of available-for-sale marketable securities of $956.8 million.

Net cash used in investing activities was $113.6 million for the year ended December 31, 2021 compared to $115.5 million for the year ended December 31, 2020. The decrease was driven by decreases in capitalization of internal-use software development costs and capital expenditures for property and equipment, partially offset by cash paid for acquisition of businesses, net of cash acquired.

Financing Activities

Net cash used in financing activities of $610.4 million for the year ended December 31, 2022 was primarily due to the repurchase and retirement of our common stock for $600.0 million.

Net cash provided by financing activities of $1.6 billion for the year ended December 31, 2021 was primarily due to net proceeds from our Convertible Notes issuance of $1.5 billion and IPO of $723.0 million (including $1.4 million paid in fiscal year 2020), partially offset by repayments on the Credit Facility and notes payable of $263.2 million and repurchase of our common stock of $350 million.

Net cash provided by financing activities of $124.0 million for the year ended December 31, 2020 was primarily due to $75.2 million in net proceeds from. borrowings under the Credit Facility, the proceeds of which were used to repay the previous credit facility, $49.8 million from our Series C preferred stock offering, and $14.0 million of proceeds from the issuance of common stock under our stock plan, partially offset by $17.9 million in repayment of notes payable and capital leases associated with financed equipment purchases.

Contractual Obligations and Commitments

We have various contractual obligations and commitments, such as long-term leases, purchase commitments and long-term debt, that are disclosed in the footnotes to the consolidated financial statements. See Note 7. Debt, Note 8. Operating Leases, and Note 9. Commitments and Contingencies to our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information regarding these commitments.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

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We believe that the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of our operations.

Revenue Recognition

We recognize revenue in accordance with Accounting Standards Codification (or ASC), Topic 606, Revenue from Contracts with Customers, or ASC 606. We account for revenue using the following steps:

1. Identify the contract with a customer

We consider the terms and conditions of the contract and our customary business practices in identifying our contracts under ASC 606. We determine we have a contract with a customer when the customer agrees to the terms of service, we can identify each party’s rights regarding the services to be transferred, we can identify the payment terms for the services, we have determined the customer has the ability and intent to pay and the contract has commercial substance. We apply judgment in determining the customer’s ability and intent to pay, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, we apply security checks and validate their payment method.

2. Identify the performance obligations in the contract

Our performance obligation is to provide our cloud-based infrastructure for customers to use at the customers’ election. The availability of services is free of charge, and therefore we have no performance obligation until the customer elects to use the services.

3. Determine the transaction price

The transaction price is calculated based on the customer’s usage for the month at an hourly rate that is published on the Company’s website. None of our contracts contain a significant financing component.

4. Allocate the transaction price to performance obligations in the contract

The transaction price is calculated based on actual monthly usage and pricing that is published on the Company’s website. This is considered a single performance obligation, and thus the entire transaction price is allocated to the single performance obligation.

5. Recognize revenue when or as we satisfy a performance obligation

We offer mission-critical solutions across Infrastructure-as-a-Service (IaaS), including our Droplet virtual machines, storage and networking offerings; Platform-as-a-Service (PaaS), including our Managed Database and Managed Kubernetes offerings; and Software-as-a-Service (SaaS), including our Managed Hosting and Marketplace offerings. We recognize revenue based on the customer utilization of these resources. Customer contracts are primarily month-to-month and do not include any minimum guaranteed quantities or fees. Fees are billed monthly, and payment is typically due upon invoicing. Revenue is recognized net of allowances for credits and any taxes collected from customers, which are subsequently remitted to governmental authorities.

Our global cloud platform is supported by various third parties. We considered the principal versus agent guidance in ASC 606 and concluded that we are the principal for all services provided to its customers.

We may offer sales incentives in the form of promotional and referral credits and grant credits to encourage customers to use our services. These types of promotional and referral credits typically expire in two months or less if not used. For credits earned with a purchase, they are recorded as contract liabilities when earned and recognized at the earlier of redemption or expiration. The majority of credits are redeemed in the month they are earned.

Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing. Any payments received in advance of billing are a contract liability, which is recorded as Deferred revenue within Total current liabilities on the Consolidated Balance Sheets.

Accounts Receivable Net of Allowance for Expected Credit Losses

Accounts receivable primarily represents revenue recognized that was not invoiced at the balance sheet date and is primarily billed and collected in the following month. Trade accounts receivable are carried at the original invoiced amount less an estimated allowance for expected credit losses based on the probability of future collection. We determine the adequacy of the allowance based on historical loss patterns, the number of days that customer invoices are past due,

57

reasonable and supportable forecasts of future economic conditions to inform adjustments over historical loss data, and an evaluation of the potential risk of loss associated with specific accounts. When we become aware of circumstances that may further decrease the likelihood of collection, we record a specific allowance against amounts due, which reduces the receivable to the amount that we reasonably believe will be collected. We record changes in the estimate to the allowance for expected credit losses through provision for expected credit losses and reverses the allowance after the potential for recovery is considered remote. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past.

Business Combinations

We apply the provisions of ASC 805, Business Combinations (“ASC 805”), in accounting for our acquisitions. ASC 805 requires that we evaluate whether a transaction pertains to an acquisition of assets or to an acquisition of a business. A business is defined as an integrated set of assets and activities that is capable of being conducted and managed for the purpose of providing a return to investors. Asset acquisitions are accounted for by allocating the cost of the acquisition to the individual assets and liabilities assumed on a relative fair value basis; whereas the acquisition of a business requires us to recognize separately from goodwill the assets acquired and the liabilities assumed at the acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date as well as any contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the business acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of a business acquisition’s measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations.

Accounting for business combinations requires us to make significant estimates and assumptions, especially at the acquisition date, to determine the fair value of assets acquired and liabilities assumed, including the selection of valuation methodologies, estimates of future revenue and cash flows and discount rates in determining the fair value of intangible assets. Although we believe that the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results.

In addition, uncertain tax positions and tax related valuation allowances assumed in a business combination are initially estimated as of the acquisition date. We reevaluate these items quarterly based upon facts and circumstances that existed as of the acquisition date with any adjustments to our preliminary estimates being recorded to goodwill if identified within the measurement period. Subsequent to the measurement period or our final determination of the tax allowance’s or contingency’s estimated value, whichever comes first, changes to these uncertain tax positions and tax related valuation allowances will affect our provision for income taxes in our consolidated statement of operations and could have a material impact on our results of operations and financial position.

Internal-Use Software Costs

We capitalize costs to develop software for internal use when both the preliminary project stage is complete and management has authorized further funding for the project based on a determination that it is both probable that the project will be completed and used to perform the function intended. Costs related to preliminary project activities and post implementation activities are expensed as incurred. Capitalized costs include external consulting fees, payroll and payroll-related costs, and stock-based compensation for employees in our development teams who are directly associated with, and who devote time to, our internal-use software projects during the application development stage. Once an application has reached the development stage, qualifying internal and external costs are capitalized until the application is substantially complete and ready for its intended use. Capitalized qualifying costs are amortized on a straight-line basis when the software is ready for its intended use over an estimated useful life, which is generally three years. We evaluate the useful lives of these assets on an annual basis and test for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets.

We exercise judgment in determining the point at which various projects may be capitalized, in assessing the ongoing value of the capitalized costs and in determining the estimated useful lives over which the costs are amortized.

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Recently Adopted Accounting Pronouncements

See Note 2, Summary of Significant Accounting Policies, in our Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for a discussion of recent accounting pronouncements.

Non‑GAAP Financial Measures

To supplement our consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles in the United States, or GAAP, we provide investors with non-GAAP financial measures including: (i) adjusted gross profit and adjusted gross margin; (ii) non-GAAP income from operations and non-GAAP operating margin; (iii) adjusted EBITDA and adjusted EBITDA Margin; (iv) non-GAAP net income and non-GAAP diluted net income per share; and (v) free cash flow and free cash flow margin. These measures are presented for supplemental informational purposes only, have limitations as analytical tools and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. In particular, free cash flow is not a substitute for cash used in operating activities. Additionally, the utility of free cash flow as a measure of our financial performance and liquidity is further limited as it does not represent the total increase or decrease in our cash balance for a given period. Our calculations of each of these measures may differ from the calculations of measures with the same or similar titles by other companies and therefore comparability may be limited. Because of these limitations, when evaluating our performance, you should consider each of these non-GAAP financial measures alongside other financial performance measures, including the most directly comparable financial measure calculated in accordance with GAAP and our other GAAP results. A reconciliation of each of our non-GAAP financial measures to the most directly comparable financial measure calculated in accordance with GAAP is set forth below.

Adjusted Gross Profit and Adjusted Gross Margin

We believe adjusted gross profit and adjusted gross margin, when taken together with our GAAP financial results, provides a meaningful assessment of our performance, and is useful for the preparation of our annual operating budget and quarterly forecasts.

We define adjusted gross profit as gross profit exclusive of stock-based compensation, amortization of capitalized internal-use software development costs, amortization of intangible assets, and depreciation of our data center equipment included within Cost of revenue. We exclude stock-based compensation, which is a non-cash item, because we do not consider it indicative of our core operating performance. We exclude depreciation and amortization, which primarily relates to our investments in our data center servers that are long lived assets with an economic life of five years, because it may not reflect our current or future cash spending levels to support our business. While we intend to spend a significant amount on capital expenditures on an absolute basis in the coming years, our capital expenditures as a percentage of revenue has declined significantly and will continue to decline. We define adjusted gross margin as a percentage of adjusted gross profit to revenue.

The following table presents a reconciliation of Gross profit, the most directly comparable financial measure stated in accordance with GAAP, to adjusted gross profit for each of the periods presented:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(In thousands)","2022","","2021","","2020"],["Gross profit","$","364,395","","","$","257,966","","","$","172,848"],["Adjustments:"],["Depreciation and amortization","$","93,381","","","$","81,937","","","$","69,547"],["Stock-based compensation","1,820","","","1,147","","","545"],["Adjusted Gross profit","$","459,596","","","$","341,050","","","$","242,940"],["Gross margin","63","%","","60","%","","54","%"],["Adjusted Gross margin","80","%","","80","%","","76","%"]]
[[/GREPCENT_TABLE]]

Non-GAAP Income from Operations and Non-GAAP Operating Margin

We define non-GAAP income from operations as (Loss) income from operations, excluding stock-based compensation, acquisition related compensation, amortization of acquired intangibles, acquisition and integration related costs, impairment of long-lived assets, restructuring and severance, and other unusual or non-recurring transactions as they occur. We define non-GAAP operating margin as non-GAAP income from operations as a percentage of revenue. We use

59

non-GAAP income from operations to understand and evaluate our core operating performance and trends and to develop short-term and long-term operating plans. We believe that non-GAAP income from operations facilitates comparison of our operating performance on a consistent basis between periods, and when viewed in combination with our results prepared in accordance with GAAP, helps provide a broader picture of factors and trends affecting our results of operations.

The following table presents a reconciliation of Loss from operations, the most directly comparable financial measure stated in accordance with GAAP, to Non-GAAP income from operations for each of the periods presented:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(In thousands)","2022","","2021","","2020"],["Loss from operations","$","(26,219)","","","$","(11,186)","","","$","(15,791)"],["Adjustments:"],["Stock-based compensation","$","105,829","","","$","61,577","","","$","29,456"],["Acquisition related compensation","9,443","","","\u2014","","","\u2014"],["Amortization of acquired intangibles","6,301","","","671","","","304"],["Acquisition and integration related costs","5,439","","","469","","","\u2014"],["Impairment of long-lived assets","1,635","","","285","","","1,222"],["Restructuring and severance","\u2014","","","\u2014","","","4,213"],["Non-GAAP income from operations","$","102,428","","","$","51,816","","","$","19,404"],["Operating margin","(5)","%","","(3)","%","","(5)","%"],["Non-GAAP Operating margin","18","%","","12","%","","6","%"]]
[[/GREPCENT_TABLE]]

Adjusted EBITDA and Adjusted EBITDA Margin

We define adjusted EBITDA as net loss attributable to common stockholders, adjusted to exclude depreciation and amortization, stock-based compensation, interest expense, acquisition related compensation, acquisition and integration related costs, income tax (benefit) expense, loss on extinguishment of debt, restructuring and severance, impairment of long-lived assets, revaluation of warrants, release of a VAT reserve, and other charges. We believe that adjusted EBITDA, when taken together with our GAAP financial results, provides meaningful supplemental information regarding our operating performance and facilitates internal comparisons of our historical operating performance on a more consistent basis by excluding certain items that may not be indicative of our business, results of operations or outlook. In particular, we believe that the use of adjusted EBITDA is helpful to our investors as it is a measure used by management in assessing the health of our business, determining incentive compensation, evaluating our operating performance, and for internal planning and forecasting purposes.

Our calculation of adjusted EBITDA and adjusted EBITDA margin may differ from the calculations of adjusted EBITDA and adjusted EBITDA margin by other companies and therefore comparability may be limited. Because of these limitations, when evaluating our performance, you should consider adjusted EBITDA and adjusted EBITDA margin alongside other financial performance measures, including our net loss attributable to common stockholders and other GAAP results.

60

The following table presents a reconciliation of Net loss attributable to common stockholders, the most directly comparable financial measure stated in accordance with GAAP, to adjusted EBITDA for each of the periods presented:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(In thousands)","2022","","2021","","2020"],["Net loss attributable to common stockholders","$","(24,283)","","$","(19,503)","","$","(43,568)"],["Adjustments:"],["Depreciation and amortization","$","102,232","","$","88,371","","$","75,574"],["Stock-based compensation","105,828","","61,577","","29,456"],["Interest expense","8,396","","3,744","","13,610"],["Acquisition related compensation","9,443","","\u2014","","\u2014"],["Acquisition and integration related costs","5,439","","469","","\u2014"],["Income tax (benefit) expense","(124)","","1,302","","912"],["Loss on extinguishment of debt","407","","3,435","","259"],["Restructuring and severance","\u2014","","\u2014","","4,213"],["Impairment of long-lived assets","1,635","","285","","1,222"],["Revaluation of warrants","\u2014","","(556)","","12,825"],["Release of VAT reserve","\u2014","","(3,188)","","\u2014"],["Other(1)","(10,615)","","707","","1,564"],["Adjusted EBITDA","$","198,358","","$","136,643","","$","96,067"],["Adjusted EBITDA margin","34%","","32%","","30%"]]
[[/GREPCENT_TABLE]]

___________________

(1)For the year ended December 31, 2022, amount is Other income (expense), net and consists primarily of interest and accretion income from our marketable securities. For the years ended December 31, 2021 and 2020, amounts are attributable to third-party consulting costs to enhance our finance function.

Non-GAAP Net Income and Non-GAAP Diluted Net Income Per Share

We define non-GAAP net income as Net loss attributable to common stockholders, excluding stock-based compensation, acquisition related compensation, amortization of acquired intangibles, acquisition and integration related costs, release of VAT reserve, loss on extinguishment of debt, impairment of long-lived assets, restructuring and severance expense, revaluation of warrants, and other unusual or non-recurring transactions as they occur. We define non-GAAP diluted net income per share as non-GAAP net income divided by the weighted-average shares including the dilutive effects of our convertible preferred stock, warrants, stock options, RSUs, PRSUs, ESPP and Convertible Notes.

We believe non-GAAP net income per share provides our management and investors consistency and comparability with our past financial performance and facilitates period-to-period comparisons of operations, as this metric generally eliminates the effects of unusual or non-recurring items from period to period for reasons unrelated to overall operating performance.

The following table presents a reconciliation of Net loss attributable to common stockholders, the most directly comparable financial measure stated in accordance with GAAP, to Non-GAAP Net income for each of the periods presented:

61

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(In thousands except per share data)","2022","","2021","","2020"],["GAAP Net loss attributable to common stockholders","$","(24,283)","","","$","(19,503)","","","$","(43,568)"],["Stock-based compensation","105,829","","","61,577","","","29,456"],["Acquisition related compensation","9,443","","","\u2014","","","\u2014"],["Amortization of acquired intangible assets","6,301","","","671","","","304"],["Acquisition and integration related costs","5,439","","","469","","","\u2014"],["Release of VAT reserve","\u2014","","","(3,188)","","","\u2014"],["Loss on extinguishment of debt","407","","","3,435","","","259"],["Impairment of long-lived assets","1,635","","","285","","","1,222"],["Restructuring and severance","\u2014","","","\u2014","","","4,213"],["Revaluation of warrants","\u2014","","","(556)","","","12,825"],["Income tax effects of non-GAAP adjustments(1)","(34)","","","235","","","6"],["Non-GAAP Net income(2)","$","104,737","","","$","43,425","","","$","4,717"],["Non-GAAP Diluted net income per share(2)(3)","$","0.94","","","$","0.37","","","$","0.11"],["Weighted-average shares used to compute Non-GAAP diluted net income per share","118,178","","","118,028","","","41,658"]]
[[/GREPCENT_TABLE]]
___________________

(1)The income tax effects of non-GAAP adjustments are calculated based on the applicable statutory tax rate for the relevant jurisdiction, except for those items which are non-taxable or subject to valuation allowances for which the tax expense (benefit) was calculated at 0%. The tax benefit for amortization is calculated in a similar manner as the tax effects of the non-GAAP adjustments.

(2)Amounts are attributable for both the common and convertible preferred stockholders, treated as one class of stock, for the periods presented for 2021.

(3)Non-GAAP net income has been adjusted for the dilutive impact of deferred financing fees related to the Convertible Notes of $5,910 and $696 for the years ended December 31, 2022 and 2021, respectively.

Free Cash Flow and Free Cash Flow Margin

Free cash flow is a non-GAAP financial measure that we define as Net cash provided by operating activities less purchases of property and equipment, capitalized internal-use software costs, purchase of intangible assets, and excludes acquisition and integration related costs. Free cash flow margin is calculated as free cash flow divided by total revenue. We believe that free cash flow and free cash flow margin are useful indicators of liquidity that provide information to management and investors about the amount of cash generated from our core operations that, after the purchases of property and equipment, can be used for strategic initiatives, including investing in our business and selectively pursuing acquisitions and strategic investments. We further believe that historical and future trends in free cash flow and free cash flow margin, even if negative, provide useful information about the amount of Net cash provided by operating activities that is available (or not available) to be used for strategic initiatives. For example, if free cash flow is negative, we may need to access cash reserves or other sources of capital to invest in strategic initiatives. One limitation of free cash flow and free cash flow margin is that they do not reflect our future contractual commitments. Additionally, free cash flow does not represent the total increase or decrease in our cash balance for a given period.

The following table presents our cash flows for the periods presented and a reconciliation of free cash flow and free cash flow margin to Net cash provided by operating activities the most directly comparable financial measure calculated in

62

accordance with GAAP:

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(In thousands)","2022","","2021","","2020"],["Net cash provided by operating activities","$","195,152","","","$","133,109","","","$","58,458"],["Adjustments:"],["Capital expenditures - property and equipment","$","(106,389)","","","$","(97,072)","","","$","(98,360)"],["Capital expenditures - internal-use software development","(8,913)","","","(6,391)","","","(12,328)"],["Purchase of intangible assets","(4,915)","","","(5,636)","","","(5,118)"],["Acquisition and integration related costs","2,863","","","526","","","\u2014"],["Free cash flow","$","77,798","","","$","24,536","","","$","(57,348)"],["As a percentage of revenue:"],["Net cash provided by operating activities","34","%","","31","%","","18","%"],["Free cash flow margin","13","%","","6","%","","(18)","%"]]
[[/GREPCENT_TABLE]]