DigitalOcean (DOCN) Q3 2026 earnings review
DigitalOcean raises its 2027 sales target, but server costs rise
DigitalOcean, a cloud computing provider shifting from individual developers to artificial intelligence workloads, grew faster while its profit margins shrank. Third-quarter revenue rose 40% to $321 million, and chief executive Paddy Srinivasan raised the 2027 sales growth target above 60%. However, the cost of running new data centers pushed gross margin down almost 10 percentage points to 50%.
| Revenue | $321M +40% from a year ago |
|---|---|
| New annual run-rate revenue added | $160M +266% from a year ago |
| Gross margin | 50.1% down 9.5 percentage points from a year ago |
| 2027 revenue growth outlook | Raised to 60%+ up from 50%+ previously |
⚖️ Verdict: 🟢 Bullish
The story got better because the company opened its Memphis data center ahead of schedule and proved that AI demand is filling its new servers faster than planned. One caution: the expansion relies heavily on leased equipment, which pushed lease debt up by $793 million this year by our math and left profit per share excluding one-offs down 17%.
The question now is whether the 10-point gross margin drop and falling profit per share are temporary start-up costs or the permanent economics of AI cloud hosting. Either profits rebound as the new data centers fill up in 2027, or lease payments and server depreciation keep eating the revenue gains. Gross margin in the first half of 2027 will settle it.
🐂 Bull Case
AI Demand Pushes 2027 Growth Target Above 60%
DigitalOcean rents cloud computing power and software tools that run artificial intelligence models, a task called inference. "Revenue growth accelerated year-over-year to 40%, our fifth consecutive quarter of acceleration, and we added a record $160 million of ARR," chief executive Paddy Srinivasan said. Annual run-rate revenue (ARR) is the latest quarter's sales multiplied by four.
- Total ARR: $1.285 billion, up 40% from a year ago
- AI Customer ARR: $376 million, up 288% from a year ago
- New AI Customer ARR added since last quarter: $142 million by our math, or 89% of the company's total $160 million addition
- 2027 revenue growth target: raised to 60% or higher, up from a prior estimate above 50%
This matters because the cloud provider has raised its growth targets in four straight quarters. Usage on its Inference Engine rose roughly tenfold from last quarter, and it launched Managed Agents to help software programs work on their own. By our math, ARR from customers not using AI tools grew 11% from a year ago, so AI workloads carry almost all the expansion.
What to watch: new ARR in the fourth quarter, where the revenue outlook points to $113 million at the middle of the range by our math. Another beat above that implied pace would show that recent product launches are bringing in new workloads ahead of the 2027 plan.
Million-Dollar Customers Drive Nearly a Third of Sales
DigitalOcean started as a cloud service for individual software developers, but large AI businesses now drive its growth. Srinivasan said customers spending over $100,000 a year make up 41% of revenue, and "they are not renting capacity; they are adopting the platform." The group shipped 49 product updates and added 21 AI models to its catalog during the quarter.
- Customers spending $1 million or more a year: count up 96%, revenue up 273% to 30% of total sales
- Customers spending $500,000 or more a year: count up 47%, revenue up 214% to 33% of total sales
- Customers spending $100,000 or more a year: count up 11%, revenue up 133% to 41% of total sales
Because revenue in each tier is growing more than twice as fast as the number of customers in that tier, existing buyers are expanding their spending. What to watch: the share of AI revenue coming from inference software rather than raw server rental in the quarterly filing. A high share would confirm customers are buying the full software platform.
Memphis Opened Early and Capacity Reached 180 Megawatts
A standing concern was whether industry supply delays would slow DigitalOcean's data center build-out, especially its third 2026 site in Memphis. This quarter the cloud provider opened Memphis ahead of schedule, "delivering all three 2026 data centers on time or early". It also secured another 20 megawatts of data center power for 2028, lifting total committed capacity to about 180 megawatts.
Finishing the 2026 sites early removes the execution risk for this year's capacity ramp and allowed Srinivasan to raise both the fourth-quarter and 2027 revenue forecasts. What to watch: the delivery schedule for the 60 megawatts of capacity planned across four sites in 2027. Keeping those sites on schedule is necessary to hit the 60% growth target next year.
🐻 Bear Case
Data Center Costs Cut Gross Margin by Ten Points
Srinivasan described the business as delivering durable and profitable growth, and the company beat its quarterly profit per share forecast by 55%. Under the headline beat, however, the cost of running its servers is growing much faster than sales, and profit per share is falling compared with last year.
- Gross margin: 50.1%, down 9.5 percentage points from 59.6% a year ago by our math
- Depreciation and amortization (the expense of wearing out servers): $75.1 million, more than double last year's $35.1 million
- Operating margin excluding one-offs: 23%, down 7 percentage points from 30% a year ago
- Profit per share excluding one-offs: $0.45, down 17% from $0.54 a year ago on a 17% higher share count
Because data center leases and server depreciation start hitting the income statement as soon as facilities open, margins shrink while new sites fill up. The fourth-quarter outlook calls for $0.30 to $0.32 in profit per share excluding one-offs, down about 30% from a year ago at the middle of the range.
What to watch: first-quarter gross margin once the new Memphis facility is fully utilised. Another drop below 50% would show that AI servers carry structurally lower margins than the older developer cloud.
Equipment Leases Add Debt That Cash Flow Leaves Out
DigitalOcean reported $130 million in free cash flow excluding one-offs, or 41% of revenue, and raised its full-year cash flow margin outlook to 20%–22%. As the release notes, however, that measure leaves out equipment bought through finance leases and financing arrangements.
Rather than paying cash upfront for AI servers, the US cloud group is financing them. Balance-sheet debt for finance leases and equipment financing jumped to $924 million in September from $131 million at the end of 2025, an increase of $793 million by our math. In the third quarter, the company also signed a new $785 million equipment lease facility "to fund the expansion of capacity to meet growing customer demand".
This matters because lease principal and interest must still be paid in cash over the life of the servers. Cash interest payments already rose to $25.2 million in the first nine months of 2026 from $2.7 million a year earlier. What to watch: the schedule of future lease payments in the quarterly filing, which will show the yearly cash bill coming due in 2027.
Contract Backlog Dipped After Last Quarter's Jump
Remaining performance obligation (RPO) measures the total value of signed customer contracts not yet booked as revenue. DigitalOcean highlighted that RPO reached $800 million, up from $61 million a year ago, with $345 million due to become revenue over the next 12 months.
Compared with last quarter, however, the backlog shrank. At the end of June, RPO stood at $894 million, with $366 million due within a year, so total backlog fell by $94 million by our math. That means the company worked through its existing multi-year contracts faster than it signed new ones during the summer, while month-to-month usage carried revenue growth.
What to watch: fourth-quarter RPO additions. A second straight drop would show that the nine-figure contracts signed in the spring were one-off deals rather than a steady shift toward long-term commitments.
Risks This Quarter Didn't Answer
Four standing concerns from prior quarters received no new figures in the earnings release and remain open until the quarterly filing or conference call.
- AI revenue reclassification: AI Customer ARR counts all spending by any customer who uses an AI tool, and the release does not split new AI usage from existing cloud spending that moved into the category.
- Server rental pricing: no disclosure on whether short-term AI contracts are renewing at lower prices as industry chip supply improves.
- Startup customer concentration: no update on what share of revenue comes from the top 25 customers as million-dollar accounts reach 30% of sales.
- Rival cloud platforms: no retention rate disclosed since Net Dollar Retention was retired last quarter, leaving no direct measure of customer churn against larger cloud rivals.
👓 Other Themes
One-Time Debt and Tax Items Swung Reported Net Income
DigitalOcean reported a GAAP net loss of $43 million, down from $158 million of net income a year ago, because both periods carried large one-off items. This quarter included a $57 million charge to retire $472 million of its 2030 convertible debt using a stock offering "with minimal cash usage and minimal dilution, with issued shares mostly offset by the retired notes". A year ago, net income included roughly $118 million from a one-time tax benefit and a debt repurchase gain.
💲 Other KPIs
Combined cash ($666.1 million) and marketable securities ($178.6 million) more than tripled from $254.5 million at the end of 2025, helped by an $888 million stock offering earlier this year. The balance comfortably covers the remaining $312.1 million of current debt maturing in December 2026.
Money owed by customers for services already delivered rose 53.8% from $90.9 million at the end of 2025, outpacing the 30.5% nine-month revenue growth rate. As DigitalOcean shifts from small developers paying by credit card to million-dollar enterprise contracts, more sales sit in unpaid invoices at quarter-end, using $62.0 million of operating cash flow over the nine months.
Deferred revenue — cash customers have paid upfront for cloud services not yet delivered — held steady against last quarter's $53.0 million and remained nearly nine times the $5.9 million balance at the end of 2025. The higher level reflects upfront prepayments from large AI customer commitments signed this year.
🔮 Guidance
Raised. The plan now calls for 44% to 45% revenue growth from a year ago, up from an earlier target of 35% or more. It is the third consecutive quarter management has raised its fourth-quarter exit target, up from 25%+ at the start of the year.
New. The forecast sits about 2.4 percentage points below the third quarter's 44.9% margin as full-quarter operating expenses from the new Memphis data center take effect.
New. The middle of the range is down 31% from the third quarter's $0.45 and down 30% from $0.44 a year ago. Higher server depreciation, lease interest, and a 4% sequential rise in the share count drive the step-down, though DigitalOcean beat its last three quarterly EPS targets by more than 50%.
New. The share count steps up from 123.4 million in the third quarter and 111.5 million a year ago, reflecting the full-quarter impact of July's stock offering and employee stock grants.
Raised. The middle of the range moved up $34.5 million by our math, pointing to 34% full-year growth. It is the third raise this year following earlier increases of $47.5 million and $37.5 million.
Raised. Management lifted the full-year margin target by 2.5 percentage points after third-quarter revenue grew faster than operating expenses.
Raised. The full-year target jumped 9 percentage points because DigitalOcean financed more of its new equipment through leases rather than direct cash capital spending. By our math, the outlook implies a 17.5% margin in the fourth quarter, down from 40.5% in the third quarter.
Raised. The full-year target rose by $0.235 at the middle of the range after the third-quarter beat, but still sits 24% below the $2.12 earned in 2025.
Unchanged. The full-year average share count stays roughly 16% above 2025's 105.3 million shares.
Raised. Srinivasan lifted next year's revenue growth floor by 10 percentage points after opening all three 2026 data centers on or ahead of schedule.
❓ Key Questions
What is free cash flow after paying equipment lease principal?
Finance lease and equipment debt grew by $793 million in nine months, and the company signed a new $785 million lease facility, but reported free cash flow leaves those principal payments out.
How much of AI ARR is reclassified cloud spending?
AI Customer ARR includes all spending from any customer using an AI product. Investors need to know how much of the $142 million quarterly jump came from existing customers adopting a small AI tool.
Why did total contract backlog fall by $94 million?
Remaining performance obligations dropped from $894 million in June to $800 million in September. Did customers pause signing multi-year deals, or did DigitalOcean simply work through spring contracts without replacing them?
Where will gross margin settle once new data centers fill?
Gross margin dropped nearly 10 percentage points from a year ago to 50.1%. Management has not said whether that drop is temporary start-up cost or the permanent margin of AI server workloads.