DigitalOcean Holdings (DOCN 0.95%) stock moved slightly higher in Tuesday trading after it announced earnings for the first quarter of 2023. The company's revenue growth remains solid, and it continues to report a positive adjusted net income.
However, a look at the income statement for the cloud services provider shows something surprising -- operating losses. That could leave investors questioning whether those losses are a reason to avoid the company.
DigitalOcean's revenue and operating expenses
Even with the operating loss, DigitalOcean continues to post respectable growth numbers. In Q1, revenue came in at $165 million, a 30% increase, compared with the year-ago quarter.
Also, revenue-related metrics show the revenue surge came about because of both old and new customers. The company's net dollar retention rate was 107%, so long-term customers increased spending on the platform by an average of 7%. And speaking of averages, the average revenue per user (ARPU) for Q1 2023 was $88.35, growing 16% in one year, pointing to the rising popularity of the company's cloud service offerings.
Unfortunately for DigitalOcean, the 34% increase in operating expenses produced an operating loss of $33 million, leading to a GAAP net loss of $35 million. But despite the GAAP losses, the stock price changed little over the last year. That indicates a possible stabilization after the 75% drop from the company's all-time high. Additionally, its price-to-sales (P/S) ratio of around 6 is near historic lows, making it arguably a bargain growth stock.
Delving into the operating losses
But despite the improvements the company made in its financials, investors need to look at its expenses with a more discerning eye. One can tell this by looking at the non-GAAP income. On a non-GAAP basis, DigitalOcean earned a net income of $29 million, rising 202% in one year.
The GAAP to non-GAAP reconciliation explains what happened. For one, DigitalOcean paid a restructuring charge of just under $21 million. This charge is in conjunction with a plan to adjust its cost structure and achieve adjusted free-cash-flow margins greater than 20%, changes that should improve its profitability longer term.
The other charges of concern are the nearly $32 million in stock-based compensation expenses incurred during the quarter, $28 million of which appear in the GAAP to non-GAAP reconciliation. Admittedly, it's fair to question DigitalOcean on such high levels of stock-based compensation since it undermines GAAP profitability.
Still, the company distributed the stock-based compensation expense across several cost and expense categories. This likely overstates the actual cost of many of its expenses, indicating that revenue can probably cover the true operations-related expenses. Moreover, the company holds $623 million in liquidity, leaving it able to absorb the aforementioned $35 million quarterly GAAP loss.
| Breakdown of Stock-Based Compensation Within the Income Statement | ||
|---|---|---|
| Category | Q1 2023 | Q1 2022 |
| Cost of revenue | $392 | $432 |
| Research and development | $9,590 | $9,720 |
| Sales and marketing | $3,332 | $3,346 |
| General and administrative | $14,280 | $12,483 |
| Restructuring and other charges | $3,937 | - |
| Total stock-based compensation | $31,531 | $25,981 |
Source: DigitalOcean Q1 2023 earnings report.
How investors should react
Given the nature of DigitalOcean's financials, its operating losses shouldn't reflect poorly on the stock. Indeed, investors don't like to see operating expenses exceeding revenue, especially in the current environment. Additionally, the amount of stock-based compensation may seem excessive, given the company's size.
The good news for investors is that DigitalOcean distributed the expense across cost and expense categories. That serves as a strong indication that the cloud stock's revenue can cover its true costs and expenses, a factor that could help send DigitalOcean's stock higher over time.
