Datadog Inc (DDOG) Q4 2022 Earnings Call Transcript

Datadog Inc (NASDAQ: DDOG) Q4 2022 earnings call dated Feb. 16, 2023

Corporate Participants:

Yuka Broderick — Head of Investor Relations

Olivier Pomel — Co-Founder and Chief Executive Officer

David Obstler — Chief Financial Officer

Analysts:

Mark Murphy — JPMorgan Chase and Company — Analyst

Sanjit Singh — Morgan Stanley — Analyst

Brad Reback — Stifel — Analyst

Fred Lee — Credit Suisse — Analyst

Andrew Nowinski — Wells Fargo — Analyst

Koji Ikeda — Bank of America Merrill Lynch — Analyst

Matt Hedberg — RBC Capital Markets — Analyst

Fred Havemeyer — Macquarie — Analyst

Kamil Mielczarek — William Blair and Company — Analyst

Sterling Auty — SVB MoffettNathanson — Analyst

Alex Zukin — Wolfe Research — Analyst

Presentation:

Operator

Good day and thank you for standing by. Welcome to the Fourth Quarter Datadog Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today’s conference is being recorded.

I would now like to hand the conference over to your speaker today, Yuka Broderick, Vice-President of Investor Relations. Please go ahead.

Yuka Broderick — Head of Investor Relations

Thank you, Catherine. Good morning, and thank you for joining us to review Datadog’s Fourth Quarter and Fiscal Year 2022 financial results, which we announced in our press release issued this morning. Joining me on the call today are Olivier Pomel, Datadog’s co-founder and CEO and David Obstler, Datadog’s, CFO.

During this call, we will make forward-looking statements including statements related to our future financial performance, our outlook for the first quarter and fiscal year 2023 and related notes and assumptions, our gross margins and operating margins, our strategy, our product capabilities and our ability to capitalize on market opportunities. The words anticipate, believe, continue, estimate, expect, intend, will and similar expressions are intended to identify forward-looking statements or similar indications of future expectations. These statements reflect our views only as of today and are subject to a variety of risks and uncertainties that could cause actual results to differ materially. For a discussion of the material risks and other important factors that could affect our actual results, please refer to our Form 10-Q for the quarter ended September 30, 2022. Additional information will be made available in our upcoming Form 10-K for the fiscal year ended December 31st, 2022 and other filings with the SEC. This information is also available on the Investor Relations section of our website along with a replay of this call. We will also discuss non-GAAP financial measures which are reconciled to their most directly-comparable GAAP financial measures in the tables in our earnings release which is available at investors.datadoghq.com.

With that, I’d like to turn the call over to Olivier.

Olivier Pomel — Co-Founder and Chief Executive Officer

Thanks Yuka, and thank you all for joining us this morning. We had a solid Q4 to end a strong fiscal year 2022. We delivered significant new innovation for our customers; we saw increasing adoption of our products and we attracted thousands of new customers to our platform. Meanwhile, we delivered strong revenue growth, margins, non-GAAP operating profit, and we generated more than $350 million in free-cash flow.

Let me start with a review of our Q4 financial performance. In Q4, revenue was $469 million, an increase of 44% year-over-year, 8% quarter-over quarter and above the high end of our guidance range. We had about 23,200 customers, that’s from about 18,800 last year. We ended the quarter with about 2,780 customers with ARR of $100,000 or more, up from about 2,010 last year. These customers generated about 85% of our ARR, and we had 317 customers with ARR of $1 million or more compared to the 2,016 we had at the end of last year.

We generated free-cash flow of $96 million, with a free-cash flow margin of 21%. And our dollar-based net retention rate continues to be over 130% as customers increased their usage and adopted more products.

Our platform strategy continues to resonate in the market. As of the end of Q4, 81% of customers were using two or more products, up from 78% a year ago. 42% of customers were using four or more products from 33% a year ago, and 18% of our customers were using six or more products, up from 10% last year.

Now moving on to this quarter’s business drivers. Overall, we observed slower usage growth with existing customers, while continuing to scale our new logo acquisition and new product cross-sales. Starting with usage, usage growth of existing customers in Q4 was overall slightly lower than what we observed in Q2 and Q3, which we attribute first to a continuation of cloud cost optimization by our larger spending customers. And second, to a seasonal annual slowdown in the second-half of December that was more pronounced than in previous years.

As in Q2 and Q3, we continue to see more optimization from customers as a larger cloud footprint, while our smaller spending customers are exhibiting higher growth.

From a product perspective, we didn’t see meaningful differences among our major product as they all experienced solid growth, albeit, decelerating on a year-over-year basis. In contrast to this deceleration in usage growth among the customers, we continue to execute on new logo lands and multiproduct adoption, and we also continue to see stable, very strong gross retention trends.

First, we had our strongest new logo quarter-to-date with a record level of new logo ARR bookings. Second, our sales pipeline remains healthy as our pattern of new logo and cross-sales is scaling above the levels of the past years, and we see demand growing along with our investments in go-to-market.

I’d also like to point out that although we have made steady progress, we still see significant opportunities to grow our penetration and total spend amounts with larger customers. As a data point, as of January 2023, 37% of the Fortune 500 are Datadog customers, up from 30% last year. For these customers, the median Datadog ARR is in the hundreds of thousands of dollars. This leaves a very large opportunity for us to go with these customers as they continue to move towards the cloud and modern DevOps.

We are also pleased with the initial take-up of some of our newest products, including cloud cost management, for which we already added a mid six-figure commitment last month from a global fast-food chain.

And finally, churn has remained low with gross revenue retention steady in the mid-to-high 90s. We believe this high retention number is indicative of the business criticality of Datadog for our customers.

Now, let’s move on to R&D. During the quarter, we released our latest products to general availability, Universal Service Monitoring, which detects all micro-services across an organization’s environment and provide instant visibility into their health and dependencies, all without any code changes. Universal Service Monitoring bridges our existing infrastructure monitoring and application performance monitoring capabilities, and with end-to-end observability with minimal deployment friction.

Now let’s take a moment to review the R&D team’s accomplishments in 2022. We ended the year with 17 generally available products, up from 13 at the end of 2021. And we greatly expanded the capabilities of our existing products. Overall, in 2022 we have meaningfully broadened our observability capabilities and push forward in making each product better. Meanwhile, we have made meaningful progress, but remain in early days in the newer areas of cloud security and developer experience.

In observability, we continue to expand our end-to-end unified platform. We now have more than 600 integrations, including all the latest products on AWS, GCP and Azure. We launched new AI capabilities such as Watchdog Log Anomaly Detection, to have customers separate signal from noise in the data, and Watchdog Root Cause Analysis, to identify the root cause of issues and quantify the impact on customers.

We launched cloud cost management to have customers take control of their infrastructure costs. We announced service catalog to manage service ownership at scale. We made observability pipelines generally available, enabling customers to collect and transform data from any source to any destination all at petabyte scale. We launched Audit Trail to help customers achieve their compliance and governance goals. We expanded sensitive data scanner Beyond Logs to inspect, APM and RAM data flows. And we now collect data from SNMP traps to provide greater visibility into physical network equipment.

In cloud security, we kept building out our platform. We launched a cloud security management or reach context-aware CNAP platform. We launched Application Security Management, building on our acquisition of CoScreen in 2021, and we announced the beta of native protection to block malicious activity directly within the Datadog platform.

In developer experience, we are expanding on our CI visibility product. We introduced continuous testing to bring efficient and reliable testing within CI/CD pipelines. And we launched a beta of intelligent test runners, which significantly reduces the time and cost of running tests.

And last but not least, we delivered a number of platform wide initiatives. We achieved FedRAMP Moderate Authorization and have since landed a number of government agencies as customers. Our customers today can also use CoScreen for collaboration, incident response, pair programing and debugging less than a year after the acquisitions. And we continue to expand on the HIPAA and PCI compliance of our product.

As you can tell, we’ve been busy, and I want to thank the R&D team for a very productive year. Looking ahead to 2023, our teams are continuing to push forward as a better products from 2022 to include data streams monitoring, workflow automation, event correlation, heat maps, dynamic instrumentation, workload security profiling, resource catalog and native protection among others.

We also continue to integrate our 2022 acquisitions, CoScreen, HD, Seekret and Cloudcraft into the Datadog platform, and we are excited for their potential. In summary, we are looking forward to delivering many more capabilities to help our customers in 2023.

Now, let’s move on to sales and marketing. Our go-to-market team continued to execute very well into the end of 2022, in particular on new logo lands. So, let’s go over a few of our wins this quarter. First, we signed a seven-figure land with a Fortune 500 industrial group. This company was using multiple open-source and built-in cloud monitoring tools, which led to release delays and consumer-facing outages. In addition to metrics tracing and logs, this company will rely on our ability to integrate open telemetry data sources to deliver immediate value. This customer’s initial deal includes 13 products across observability, security, and developer experience categories.

Next, we signed a seven-figure land with a Fortune 500 financial services company. This customer is moving hundreds of applications from on-prem to the cloud and multiple legacy tools were creating gaps in visibility and post PCI compliance problems. This customer today is looking at savings of roughly $1 million in the first year of using Datadog, and a meaningful reduction in meantime to resolution. This deal will start with infrastructure monitoring and replace the three disparate tools with plans to expand to other Datadog products in the future.

Next, we signed a seven-figure land deal with a major federal government agency. This agency was looking to reduce tools pro and aimed at a rapid rollout to hundreds of different programs, while saving money on engineering and issue resolution. This agency is among a number of new government customers in 2022 following our FedRAMP Moderate Authorization. And this deal is expected to be split at least eight commercial legacy monitoring tools.

Next, we signed a seven-figure land deal with a leading Japanese system integrator. This company has been a very successful hardware system integrator, and is looking to grow its digital and cloud transformation business. This customer plans to add-up 15 Datadog products in order to support its ambitious growth plans.

And last for today, we signed a multi-million-dollar expansion with one of the world’s leading insurance companies. Prior to using Datadog, this company was using more than 30 tools across nine business units. By consolidating onto Datadog, the customer estimates reduction of roughly 115% ROI all within a year, while reducing average meantime to resolution from one and half hours to 15 minutes. With this renewal, this company is adding database monitoring, cloud security management and application security management, and is now using 12 Datadog products.

That’s it for this quarter’s customer highlights. And again, I’d like to thank our go-to-market teams for their great execution in Q4 and throughout 2022.

Now, let me speak to our longer-term outlook and my thoughts on 2023. Although we are seeing customers be more cautious with their cloud usage expansion in the near-term, we see no change to the long-term trends towards digital transformation and cloud migration. We think it’s healthy for customers to optimize, and we believe that the ability to correct course and continually align the nature and scale of the applications with their business needs is one of the key benefits of transformation. At Datadog, we have always organized our products and our business around helping customers gain agility and reduce costs, and we do it by enabling stronger business performance and efficient use of their engineering and infrastructure spend.

Regardless of near-term macro pressure, we believe it is still early days, and we expect that companies worldwide will continue to grow the next gen IT footprint to deliver value to their customers.

Given the large opportunities we see in front of us, we plan to keep building and innovating. We have already made progress in observability, so we still have much to do to deliver more value and solve more problems for our customers. And we are excited about our opportunities in cloud security, developer experience as well as our early efforts in areas around ITSM and real-time business intelligence.

As we have since we founded Datadog, we are also balancing long-term investments against maintaining the discipline to ensure a continued financial performance. We recognize that the macro-environment remains uncertain. So, while we continue to focus on scaling and investing, we are growing those investments in a disciplined fashion in 2023, and David will discuss this in more detail.

We remain confident in our long-term opportunities, and we are continuing to invest in our strategic priorities to catch-up them.

With that, I will turn the call over to our CFO for a review of our financial performance and guidance. David?

David Obstler — Chief Financial Officer

Thanks, Olivier. In Q4, we continued to execute well and delivered value to our customers. Revenue was $469 million, up 44% year-over-year and up 8% quarter-over quarter. To dive into some of the drivers of our Q4 performance, first, we saw existing customer usage growth in October and November at a similar level to what we saw in Q2 and Q3. In the month of December, we saw a slower growth dynamic as the typical slowdown we see at the end of December was more pronounced than in previous years. As a result, the growth rate in usage by existing customers was lower in Q4 than in Q2 and Q3.

Next, similar to Q2 and Q3, we saw larger spending customers grow slower than smaller spending customers. As with Q2 and Q3, we saw relatively more deceleration in the consumer discretionary verticals, particularly in e-commerce and food delivery.

Geographically, we saw solid and relatively similar growth across all regions. As Olivier discussed, we experienced strong new logo ARR growth and low churn again in this quarter. We had a record level of new logo bookings in the quarter across customer sizes. Our dollar net-based net retention remained at strong levels, above 130% for the 22nd consecutive quarter. And gross revenue retention has remained unchanged over the last several quarters and remained steady in the mid to-high 90s. We believe this high and steady gross retention points to the mission-critical nature of the Datadog platform for our customers.

Now moving on to our financial results. Billings in the quarter were $536 million, up 31% year-over-year. Billings duration was slightly lower year-over-year. Remaining performance obligations or RPO was $1.06 billion, up 30% year-over-year. And RPO duration declined on a year-over-year basis. And we note that current RPO growth was in the high 30s year-over-year. We continue to believe revenue was a better indication of our business trends and billings and RPO as those can fluctuate relative to revenue based on the timing of invoicing and the duration of customer contracts.

Now, let’s review some of the key income statement results. Unless otherwise noted, all metrics are non-GAAP. We have provided a reconciliation of GAAP to non-GAAP financials in our earnings release. Gross profit in the quarter was $378 million, representing a gross margin of 81%. This compares to a gross margin of 80% last quarter and also 80% in the year-ago quarter. We continue to experience efficiencies in cloud costs reflected in our cost of goods sold in this quarter. In the mid to-long-term, we continue to expect gross margin to be in the high 70s range.

Our Q4 non-GAAP opex grew 54% year-over-year as we continue to grow our headcount in R&D and go-to-markets. Q4 operating income was $83 million or an 18% operating margin, compared to an operating income of $71 million or a 22% operating margin in the year-ago quarter. As a reminder, the year-ago operating margin benefited from lack of in-person office, travel and event costs due to our COVID policies during the pandemic.

Turning to the balance sheet and cash-flow statements, we ended the quarter with $1.9 billion in cash, cash equivalents, restricted cash and marketable securities. Cash flow from operations was $114 million in the quarter, and after taking into consideration capital expenditures and capitalized software, free-cash flow was $96 million for free-cash flow margin of 21%.

Now for our outlook for the first quarter and the fiscal year 2023. In forming our guidance, we continued to use conservative assumptions as to the organic growth of our customers compared to historical periods. And as usual, we are basing our near-term guidance on recent activity we see with our customers. We are incorporating an expectation for seasonally weaker growth in the first quarter due to the subdued growth in the month of December, that creates a lower growth trajectory to start the first quarter. While our customers are continuing to expand with us, we are assuming in our guidance that cloud optimization continues to affect our expansion rate in 2023.

For the first quarter, we expect revenue to be in the range of $466 million to $470 million, which represents a 28% to 29% year-over-year growth. Non-GAAP operating income is expected to be in the range of $68 million to $72 million, or an operating margin of 15%.

Non-GAAP net income per share is expected to be in the range of $0.22 to $0.24 per share, based on approximately 348 million weighted-average diluted shares outstanding. For the full-fiscal year 2023, we expect revenue to be in the range of $2.07 billion to $2.09 billion, which represents a 24% to 25% year-over-year growth.

Non-GAAP operating income is expected to be in the range of $300 million to $320 million for a margin of 15% at the midpoint. Non-GAAP net income per share is expected to be in the range of $1.02 to $1.9 per share, based on approximately 351 million weighted-average diluted shares outstanding.

Now, some additional notes on the guidance. First, regarding our fiscal year 2023 investments, we continue to balance near-term financial strength with investment in our large, long-term opportunities. Our non-GAAP operating income guidance reflects this discipline. We will continue to grow our R&D and go-to-market teams as we broaden our platform in service of our customer needs, albeit at a slower pace than in previous years. As a result, we are planning to grow our operating expenses including COGS in the fiscal year 2023 in the low 30s percent range year-over-year. We plan to grow our head count in fiscal year 2023 in the mid 20% range year-over-year. This compares to fiscal 2022 head count growth of approximately 50% year-over-year.

Next, as interest rates have risen, our interest income has increased and become more meaningful. We expect net interest and other income for the fiscal year 2023 to be approximately $75 million. We expect tax expense in fiscal year 2023 to be $11 million to $13 million. And finally, we expect capital expenditures and capitalized software together to be in the range of 4% to 5% of revenues in fiscal year 2023.

To reiterate Olivier’s comments, we see no change to our long-term opportunities as our customers embark and expand on their cloud migration and digital transformation plans. We remain strongly positioned to help our existing and prospective customers with these journeys.

I want to thank Datadog’s worldwide for their efforts in 2022, and I’m excited about our plans for the next year. With that, we will open the call for questions. Operator, let’s begin the Q&A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Mark Murphy with J.P. Morgan. Your line is open.

Mark Murphy — JPMorgan Chase and Company — Analyst

Well, thank you very much. Olivier, I was wondering if you can comment on the AWS infrastructure monitoring portion of the business specifically. Do you see that trending above or below the 25% rate of the total business this year. And I’m wondering if you perhaps see some of the other hyperscalers, Azure, Google etc., gaining any share of that mix during this year, then I will have a quick follow-up.

Olivier Pomel — Co-Founder and Chief Executive Officer

Yeah, so look, we obviously we see — we get data from our customers using those slot providers and we also listen to the commentary that cloud providers provide on the — in terms of their own growth. There is not a one-to-one mapping between what happens on the revenue side for the cloud providers and what we see on the infrastructure side on our end. But we are seeing some of the same trend where the growth slows down through our Q4, and we’ve been listening to their comments when they give guidance for what their growth might look like in the near future, which also informed all in guidance.

In terms of the mix-shift, we don’t see anything that differs from the trends we saw throughout the last year. I think the story there is they are also seeing optimization from some of their customers, these are largest customers, and on our end, we expect that optimization to continue throughout the year. That’s what we’ve built into our guidance.

Mark Murphy — JPMorgan Chase and Company — Analyst

Okay, understood, and then, David, I believe you mentioned record new logo ARR bookings in the quarter. Great to hear. I think we’re wondering what you attribute that to just given the environment is so challenging, and there was mention of several of these companies landing with eight or 10 or 15 Datadog products and replacing legacy tools or replacing open-source. Do you see an increase in those kinds of consolidation opportunities, and maybe just a broadening where this landscape is viewing Datadog as the converged observability leader and wanting to consolidate in that direction.

David Obstler — Chief Financial Officer

Yeah, in Q4, and I think going forward, we continue to see greenfield and new projects, new workloads being the majority of the driver, but have seen over the quarters, and we talked about some of them in our prepared remarks consolidation opportunities, when a client is already in their cloud journey and has workloads and is looking to get a platform, create efficiencies, etc., they have increasingly been consolidating on Datadog, and we see continued opportunities for that.

Olivier Pomel — Co-Founder and Chief Executive Officer

Yeah, add to that, we see demand scaling basically like we are still early in cloud migration and digital transformation, and we see no slowdown from companies going from legacy IT to these new world. That’s why we get more and more new logos and more and more volume there. The part of the business we see going slower is the larger customers that are further along in this cloud transformation to have large workloads, trying to optimize because that’s where they can meaningfully save cost.

Mark Murphy — JPMorgan Chase and Company — Analyst

Thank you very much.

Operator

Thank you. One moment for our next question. We have a question from Sanjit Singh from Morgan Stanley. Your line is open.

Sanjit Singh — Morgan Stanley — Analyst

Yeah, thank you for taking the question. I wanted to ask about the product innovation, and in some sense, you guys have had a pretty impeccable track record of leasing a lot of product, that’s sort of benefited your customers over the last couple of years, but given sort of the environment that exists today, do you feel that in some sense Datadog gets viewed by customers as sort of a Lamborghini type observability solution, meaning that, are you in terms of customers may not need all of the bells and whistles that a 17 product portfolio can provide. Any thoughts there and whether Datadog maybe potentially over-engineered for in terms of customers’ willingness to spend in the current environment.

Olivier Pomel — Co-Founder and Chief Executive Officer

Yeah, so, so, I definitely don’t think we position ourselves as the Lamborghini. We’re not — the Lamborghini doesn’t have a glove box and needs to go to the shop every two weeks, that’s definitely not us. We have been investing heavily in product innovation, we have a lot of products today, that thanks for this acceleration of product innovation over the past few years are early in their lifecycle. What we see in the current environment is that it is actually helping us get to these consolidation deals that were mentioned a little bit earlier, because we can cover more of what our customers need to do and drive more efficiencies. Again, it’s still early in that because many of the products are early in their lifecycle, so they might not be applicable to every single type of customer and every single type of situation. But I think this is validating our destination there, and it shows we need to do more of that, not less.

At a time where larger customers are very, very careful about their spend, it might be more difficult for some of those products to gain a lot of adoption with any particular customer at a very-high level of spend. So, we are focusing today on getting the maximum number of those customers to adopt those products and plant the seed of future growth as they further consolidate and move to the cloud.

Sanjit Singh — Morgan Stanley — Analyst

Understood. And just a follow-up on those larger customers who are seeing their usage trends slow more than smaller customers. Relative to the commitment, how are you guys sort of handling that? Are you in a situation where you’re rolling over credits? Or are you sort of enforcing sort of the take-or-pay aspect of the contract? Any color there on how you are working with those larger customers in terms of where they stand relative to their commitment?

Olivier Pomel — Co-Founder and Chief Executive Officer

Yeah, we are — so we always want to partner with customers and build a long-term relationship with them. We’ve had some customers that have run into very significant business headwinds where their own businesses have contracted quite a bit, and in those situations, we always work with them to structure the contracts and make sure we get to a better outcome. We’ve done that with one of our major customers over the past quarter, and we’ve had similar conditions with some other customers as well. So that’s part of — customers are also part of the guidance we’re giving for the year.

David Obstler — Chief Financial Officer

And I just want to add that because we tend, as you know, to go land and expand and our customers tend to under-commit relative to what they eventually get to, we haven’t seen across the customer base a very meaningful increase of sort of unused commitments. And so that’s something about our go-to-market that creates flexibility with clients to commit as they see usage.

Sanjit Singh — Morgan Stanley — Analyst

I appreciate it, and [Indecipherable]

Operator

Thank you, and one moment. Our next question comes from Brad Reback from Stifel. Your line is open.

Brad Reback — Stifel — Analyst

Great. Thanks very much. Just one real quick one. David, I know billings isn’t necessarily the best metric to sort of focus on, but 1Q is a really monstrous comp. So maybe any color you can provide as we should think about billings, especially with changes in duration in calendar ’23 and maybe lower commits upfront from customers on renewal?

David Obstler — Chief Financial Officer

Yeah, I think — again, I think it is really driven by the ARR and linearity of that. So, I don’t think we plan for billings, etc. We essentially have had billings, as you know, go above and below the revenue based on the billings in that period. And so, we don’t see really any change in that type of pattern. But again, bring everyone back to ARR and revenues as the major economic driver.

Brad Reback — Stifel — Analyst

That’s great. And then, Oli, real quickly, if you look back at your business historically, there’s been a fairly tight linkage between your growth rate and the hyperscalers with a multiple on it. As we sort of look forward, what types of things need to happen to expand that multiplier? Thanks.

Olivier Pomel — Co-Founder and Chief Executive Officer

Well, I mean, look, we’re covering more and more of the — we’re solving a bigger and bigger problem for our customers, which means we’re expanding our TAM, and so we can have a larger and larger multiplier over time. That’s why we’re investing in new categories, that’s why we keep building up observability, and that’s why we’re doing all these investments. So that’s where we’re going. I think you’re right, though, that the underlying wave that is — has been a tailwind throughout the history of the company with cloud migration and digital transformation. I think that there might be a bit more of a headwind over the next few quarters. But we strongly believe that it will become a tailwind again in the future. We just can’t tell you when exactly. We’ve listened to the calls of the hyperscalers, they can’t tell you when either. We’re in the same boat there. So, what we’re doing today is we’re focusing on the drivers of future success which are covering more of the customer landscape, sort of getting into more new logos, more geographies, more segments and also developing our products and getting those products adopted by more of these customers, which is how we’re going to have accelerating growth in the future.

Brad Reback — Stifel — Analyst

Prefect. Thanks very much.

Operator

Thank you. Our next question comes from Fred Li with Credit Suisse. Your line is open.

Fred Lee — Credit Suisse — Analyst

Hey, good morning, and thank you for taking my question. I’m curious about product expansion and what will help Datadog gain share as a percent of hyperscaler spend, a little bit related to Brad’s question — the second question a minute ago. I was wondering if we could get an update on which products you’re gaining the most traction and have the greatest potential in 2023?

Olivier Pomel — Co-Founder and Chief Executive Officer

Well, so we have a lot of products that are early in their lifecycle. Some of them are large categories where we are seeing larger and larger revenue, and we have very ambitious plans, such as security. Some others are newer but might be a bit more topical in 2023, such as Cloud Cost Management. So, I think it’s really going to be a mix. We see some interesting early signs of Cloud Cost Management, which is still only billed to a handful of customers at this point, but already seeing very large commitments from some of these customers. We called that out on the call. So, we think it might be — if you think of anything that might have more of an impact in the short-term, that might be one of those. But really, the way we think about all those products is how do we turn them all into major products in two, three, four years out, how do we win these additional categories, and how do we become the platform of choice for consolidation in the long term, that’s what we’re driving towards.

Fred Lee — Credit Suisse — Analyst

And just a quick follow-up on the security portion. So, with regard to the uptake of your security solutions, how would that compare? How does that compare to the adoption patterns of infra and APM?

Olivier Pomel — Co-Founder and Chief Executive Officer

Well, it’s a bit difficult to compare to infra because it was the very first thing we did in the early days of the company. We — it’s actually pretty comparable to what we’ve seen with APM, where it’s a domain with a lot of investment required. We also have a very ambitious and very differentiated approach to it, which requires quite a bit of a build-out and quite a few things to figure out with customers. But we’re also seeing continuous adoption and growth, thousands of customers using the platform. We see it being adopted at a very large scale by very large customers, which — some of which we also mentioned on the call today. So, we’re not completely there yet. There’s still a lot of work to do, but we think it’s tracking well to — with respect to what we can expect in our plan.

Fred Lee — Credit Suisse — Analyst

Great, thank you very much.

Operator

One moment. Our next question comes from Andrew Nowinski with Wells Fargo. Your line is open.

Andrew Nowinski — Wells Fargo — Analyst

Great. Good morning, everyone. So, thank you for taking the questions. I wanted to ask you about the usage patterns of large customers versus small customers. I know you said you’re — the smaller customers were not seeing as much of a slowdown in usage. But what gives you confidence that those smaller customers just haven’t reached or reacted to the slowing macro yet? And we may see maybe a slowdown in that segment going forward.

Olivier Pomel — Co-Founder and Chief Executive Officer

Well, it’s hard to tell what’s going to happen in the future, right? So, we don’t really have a crystal ball there. What we see, though, is that customers save money where it matters, which tends to be the very large line items, which for customers that are fairly far along into the cloud, is going to be, first, their cloud provider deals that are, again, one or two orders of magnitude larger than their observability bills. And then we are going to be affected by that, and maybe with some optimization more specific to observability as well. So that’s what we see there. That’s why we see most of the large customers do that.

On the smaller side, I’ll point out that many of our smaller customers are actually very large companies that just are fairly new into the cloud and are still growing to the cloud. So, they are seeing exactly the same thing as their peers who are spending a lot more on us. It’s just the part of their business that is where the spend is growing as opposed to where the spend is today and needs to be controlled.

The last thing I will say is on the very low end of our customer base, we do see impact of the macroenvironment. We have a little bit more churn at the very, very low end, which is what you see our customer count not going up as much despite us having very strong notable quarters. That’s more focused at the very, very low end of the customer base, and it’s not moving the numbers at all in terms of gross retention, which remains very high.

Andrew Nowinski — Wells Fargo — Analyst

Okay. That’s great. Thank you for the color there. I was also wondering, your gross margin was surprisingly strong in the quarter. I’m wondering if there’s anything you can do on pricing given these large customers focus on cost optimization.

Olivier Pomel — Co-Founder and Chief Executive Officer

Well, we work with the large customers, obviously, to make sure that they get what they need. We’re optimizing gross margin, obviously. We’re doing quite a bit on our end to, on the engineering side, to do that. At all levels, 1% of gross margin is making a very large difference for their business, and we can reinvest that in future growth. Changing prices by 1% based on that doesn’t make a big difference for customers. I think when they — the real way to address their concerns as they keep scaling and generating much more data and sending more observability data to us is to give them more options to process that data so that they can align with what they pay to us with the value they get. And we’ve been also building that on the product side. So, it’s not really a pricing question, it’s more of a product and structure question.

David Obstler — Chief Financial Officer

And I just wonder now that we’re on cost, I just want to add a little clarification. I think we talked about the trends of gross margin and what we expect for the future, and we gave some guidance as to operating expenses in 2023. I believe I might have misspoken. The operating expense guidance in 2023 in the low 30s range excludes COGS. We gave the COGS guide separately as far as our comments on that, just to clarify.

Andrew Nowinski — Wells Fargo — Analyst

Super, thank you guys.

Operator

Our next question comes from Koji Ikeda with Bank of America. Your line is open.

Koji Ikeda — Bank of America Merrill Lynch — Analyst

Great. Hey, Olivier. Hey, David, thanks for taking the questions. I wanted to ask you a question on the guidance, and maybe a compare and contrast here. So I was wondering if you could talk about maybe how to think about the levels of conservatism embedded in the full year 2023 ratified today versus when you first gave guidance last year for 2022.

David Obstler — Chief Financial Officer

Yeah, I think we’ve continued to use the same approach which is to look at the history and discount the major assumptions, which are the organic growth or the expansion of existing customers and new logos. I think the difference in the actual results were in the periods of times where we saw more than pro rata or more than historical adoption and growth of existing customers, the ratio between that discount and where it ends it up in actuals ended up larger, but the intent and the strategy of providing this guidance on conservative assumptions relative to that has not changed.

Koji Ikeda — Bank of America Merrill Lynch — Analyst

Got it. And just one quick follow-up there.

Olivier Pomel — Co-Founder and Chief Executive Officer

To be clear, our guidance doesn’t assume that the optimization stops. What we’ve seen over the past few quarters, basically in the second half of 2022, we assume it’s going to continue. We know it’s going to end at some point, but we don’t know when exactly, so we’re not building that into our guidance.

Koji Ikeda — Bank of America Merrill Lynch — Analyst

Got it, got it. That’s helpful. Thank you, and just one follow-up here, a question on sales capacity. Just thinking about hiring plans there. You mentioned in the prepared remarks, overall headcount to grow in the mid-20s but continuing to grow the go-to-market teams at a slower pace. So just is that mid-20s the right way to think about sales capacity hiring this year, too?

David Obstler — Chief Financial Officer

Yes, yes. I think that’s right. We are growing our investments in go-to-market and sales capacity approximately plus or minus at the guidance we gave in headcount growth.

Olivier Pomel — Co-Founder and Chief Executive Officer

In the end, the two reasons for that is we still have ground to cover. We still have segment and geographies to cover. And also, as we mentioned earlier, we’re having actually great success when it comes to landing new logos and new products with customers. So, our sales interactions are productive. Our return on investment is there, so we need to keep doing that. Again, these are the seeds of future success we are planting, and we don’t intend to stop.

David Obstler — Chief Financial Officer

I would clarify that because of the ramping nature of salespeople, the growth rate that we had, which was in excess of that 25% in 2022 means that the coming online of that ramp capacity is at a rate higher than that in 2023 as we begin to harvest the investment from that.

Koji Ikeda — Bank of America Merrill Lynch — Analyst

Got it, got it. Thanks guys, thanks for taking the questions.

Operator

Thank you. Our next question comes from Matt Hedberg with RBC. Your line is open.

Matt Hedberg — RBC Capital Markets — Analyst

Great, thanks guys. Oli, for you. Any data points around product splits? I know in the past, you’ve talked about APM and logs. I think it’s been a couple of quarters since we had an update on the size of those businesses. But any sort of like rough magnitude of those? And are they still in hyper growth?

Olivier Pomel — Co-Founder and Chief Executive Officer

No. I mean, we see a fairly — like when you think of the products that are a major scale today, which are APM, logs and infrastructure monitoring, those are seeing about the same trend in terms of growth in Q4. And I think that’s partly because some of the optimization we see from customers happens across this side, because it happens upstream from us at the provider level. And that’s why we’ll see slightly slower growth of host monitored on the cloud providers or APM and also a bit less log. Some of it happens more directly at the observability level, logs in particular or some aspects of APM that are transaction based, where we see customers optimizing there and making sure they get the best value and cut the noise. But as a result, we see fairly similar trends across the products. So that’s why we didn’t call out anything specific in there. We, in the future, I’m sure we will share more about their relative sizes. But again, the growth rates are not that different in Q4. So, it’s — there was nothing to call out.

Matt Hedberg — RBC Capital Markets — Analyst

Okay. Thanks, and then maybe just, David, on the guide, obviously with kind of a mid-20s revenue guide, you talked in the prepared remarks about having an NRR above 130 for almost two years, and presumably that dips below 130. Any sort of commentary on how that might progress through the year?

David Obstler — Chief Financial Officer

Yeah, I think you’re right, and puts it in that guide is below 130. We’ll report to everybody as we have that. We’ve seen it relate to the decel, I would say, on that, that given the change in the organic growth rate that we’ve been talking about starting in the middle of Q2 last year, it would be — it’s getting past that to the extent that it changes — that changes that net retention plus or minus, given the net retention is comparison against the year-on-year customers. So, you do have headwinds in the compare through the time that we had the change of the organic, which we had said was in the middle of Q2 of last year.

Matt Hedberg — RBC Capital Markets — Analyst

Got it, thanks.

Operator

Okay, one moment. Our next question comes from Fred Havemeyer with Macquarie. Your line is open.

Fred Havemeyer — Macquarie — Analyst

Hey, thank you. I wanted to ask, with respect to the slowdowns that you’ve been seeing within certain customers, have you seen anything to suggest that these could be related to layoffs in tech, either because, say, that up seats have been directly impacted which is because of general disruption to DevOps and engineering teams?

Olivier Pomel — Co-Founder and Chief Executive Officer

No. We think it’s mostly because they can save money on their cloud bills. The — again, one of the great things about the cloud is that the — it’s an ongoing expense, you can adjust it over time, you can restructure the way you’re running applications. So, there are some knobs you can use to optimize, which you can’t if you’re running everything on-prem, as all the costs are sunk already and pretty far into the future. So, we mostly see that — I mean, there’s a little bit more noise and predictability with some customers because they’re having checkups, and so you need to talk to different people and they need to reorganize a little bit. So, it can add a little bit of noise in some of the conversations. But really, the dominant motion is they’re optimizing their cloud infrastructure, their cloud bill and their — that’s especially the case if they’re spending a lot there. The vast majority of our products are infrastructure usage or data volumes, not per seat. So, we’re not directly impacted by layoffs.

Fred Havemeyer — Macquarie — Analyst

Thank you for that, and then just a quick follow-up would be, actually in the prepared remarks, thank you for the context on Cloud Cost Management. Can you perhaps more generally talk about your customers’ interest in FinOps and how Datadog is positioned to be able to help customers better understand both where they’re spending, how they’re spending and what sort of ROI they’re seeing?

Olivier Pomel — Co-Founder and Chief Executive Officer

Yes, our customers are definitely interested in FinOps. The larger they are, the more they are interested, and that directly relates to the work they do in cloud optimization. It’s a very nascent category today. It’s a nascent practice for most of our customers. And we also have a lot of experience internally running ourselves a very large cloud operation across all of the large cloud providers. So that’s why we believe we can build something that is fairly differentiated there. Our product there is having a great reception from customers, even though it’s still early. I mentioned earlier, we signed a six-year deal, annual deal with a large restaurant chain, and we see more of that coming our way. So, we think it’s one way in which we can also help our customers as they need to optimize and be more efficient in the short and midterm.

Operator

Our next question comes from Kamil with William & Blair. Your line is open.

Kamil Mielczarek — William Blair and Company — Analyst

Good morning, thanks for taking my question. I want to clarify one of David’s comments that you’re incorporating seasonally weaker growth in the first quarter due to subdued growth in the month of December. Can you expand on how demand and customer conversations have trended in the first few weeks of ’23 and whether that’s changed since ’22 year-end?

David Obstler — Chief Financial Officer

Yeah, I think you have two different avenues. I think we said in new logos, we had a strong quarter. We continue as we mentioned to have a strong pipeline, meaning that for new projects, new workloads, we continue to see a solid demand environment. In terms of the organic, when you have — and this happens in most years, when you have people going on vacation and sort of reducing the amount of logs or work they’re doing, you tend to see a rebound of that in January. We did see a bit of that, but given the volatility in the market, we want to be cautious in reading too much into that. And we’ll let everybody know how that plays out.

Olivier Pomel — Co-Founder and Chief Executive Officer

Mathematically, we — the Q4 was more front loaded than back loaded in terms of whole recognized revenue. So, we entered Q1 at a lower level than — so that’s why we also have the sequential that is a little bit lower there. In terms of the trends, I’ll just second what David said. We — when that seasonality was higher than we had seen in previous years, and we can explain that in different ways, and basically, if customers are trying to save money, they’re a lot more careful about turning off the lights when they leave for vacation basically. But what we see in early 2023 so far is consistent with what we see in Q4 or in the second half of 2022 and ’23 too [Phonetic] in general. So, it’s too early really to pass judgment, but it really factors into our guidance, which is that we don’t believe that the optimization has stopped. We assume it’s going to continue. We don’t know yet when it is going to stop. We know it’s going to happen at some point, but we’re not planning it for this year in our guidance.

Kamil Mielczarek — William Blair and Company — Analyst

That’s helpful. Thank you. And just as a quick follow-up. It’s nice to see the large wins on the federal side. I realize it’s still early, but can you update us on how big of a contribution that could be in ’23, and how important are additional authorizations for expanding into that market? Or does FedRAMP Moderate allow their customers these TAM?

Olivier Pomel — Co-Founder and Chief Executive Officer

So, I mean, I can’t give you specific numbers there. I know we’re seeing wins, we’re seeing engagements from the government agencies and the committees that serve them. So, all that is very good. We still have some building to do on the go-to-market teams for that, and we also still have some things to build on the product side, like there’s more levels of certification we want to get to reach more of those customers, so we still will build. What I’d say is we’re getting the proof points that we’re fit and that customers can use us in those environments and that there is a real market for us there.

Kamil Mielczarek — William Blair and Company — Analyst

That’s helpful, thanks again.

Operator

Thank you. Our next question comes from Sterling Auty with SVB MoffettNathanson. Your line is open.

Sterling Auty — SVB MoffettNathanson — Analyst

Yeah, thanks. Hi guys. Oli, I’m curious if you have any sense working and talking with customers as to when they started an optimization project, how long it actually takes them to get to that new level. Obviously, it can change if the economy gets worse, but is this something where they started and it takes them a month, a quarter, two quarters? Any sense would be helpful.

Olivier Pomel — Co-Founder and Chief Executive Officer

Yes. So, it’s a little bit hard to give an answer that fits all types of customers because they’re also all going to — they organize a little bit differently. There are different scales in there and they’re going through different phases with their businesses in the economy. We’ve seen customers having multiple rounds of layoffs, for example, or having to adjust multiple times what they’re doing with their business. But what we see in general is that the fastest thing they can do to have an impact on the abilities to adjust some of the data they send in logs or in APM. And after that, you’ll see them do a little bit more at the cloud provider level, which is higher impact in terms of their own savings, but also takes a little bit more time because we need to reorganize some of their workloads and invest more engineering time in doing that. So, we’ve seen that happen with some of our customers.

For a number of our customers, we saw it happen and we think they’ve done, and that’s — and we see them start growing again. But it’s too early to call it for the rest of the customer base as again, they’re all going through a fairly different things at different scales.

Sterling Auty — SVB MoffettNathanson — Analyst

Understood. Thank you.

Operator

And we have a question from Alex Zukin with Wolfe Research. Your line is open.

Alex Zukin — Wolfe Research — Analyst

Hey guys, thanks for taking the question. I guess, Oli, if you think about the trends that you saw in the second half of last year and what you’re seeing year-to-date. When you think about optimizations versus timeline to spin up new workloads and the effect that, that has on the NRR as it progresses, when you look at the timeline that you think that takes and the anniversary of these headwinds particularly with the larger customers, how does that look from a linearity perspective over the course of the year?

Olivier Pomel — Co-Founder and Chief Executive Officer

So right now, in our guidance, we’re assuming that we’re seeing the same trends of growth of rising customer throughout the year. Like we’re not estimating any inflection. We’re assuming a continuation of that with some level of conservatism compared to the actual result last year. That’s what we are building in. The — again, we believe that there’s going to be some reacceleration at some point as the optimization has on its course. But given the level of macro uncertainty, I think it’s too difficult to — we can’t actually tell you when. Again, we’ve listened to the call of the cloud providers, they also can’t tell you when. And so, we’re being prudent with the guidance there.

Alex Zukin — Wolfe Research — Analyst

Perfect. And then, David, maybe just one for you around cash and cash conversion, free cash flow. As we look at the year, just curious if there’s any kind of different flexibility in payment terms or even just the assumption for the cash conversion from operating income to cash flow for the full guidance for fiscal ’23.

David Obstler — Chief Financial Officer

We’ve always said that our free cash flow has been around slightly higher than our EBIT margin. If you look back, you’ll see that it is in some quarters a little above, in some quarters a little below. We have not seen any changes of — any material changes in payment terms or the flows of cash. So, there’s nothing we’ve seen so far that would cause us to change our views about cash flow conversion for the company.

Alex Zukin — Wolfe Research — Analyst

Okay, thank you guys.

Operator

Thank you. That’s all the time we have for questions. I’d like to turn the call back over to Olivier Pomel for closing remarks.

Olivier Pomel — Co-Founder and Chief Executive Officer

Thank you all. So, I just want to take a minute to first thank our customers for trusting us with their business and partnering with us. I know some of them are going through difficult times last year and also early this year. And so, we’re working with them. Potentially we all come out of it stronger. I also want to thank our employees at Datadog everywhere around the world for actually delivering a fantastic year in 2022 from all of the metrics we control ourselves. We saw some slowdown in consumption with some customers, but we also delivered a lot of value for customers. We scaled our go-to-market teams. We did great in terms of landing new logos, attaching new products, shaping new products that solve more problems for our customers. And we think that this bodes very well for the future. So, I’m very optimistic. I’m looking forward to a fantastic year in 2023 with everyone. And on this, I’ll close the call.

Operator

[Operator Closing Remarks]