Datadog, Inc. Q4 FY2022 Earnings Call

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. 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.

Thank you, Katherine. 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 31, 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.

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 innovations 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, up 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 216 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 continued to be over 130% as customers increase their usage and adopt 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, up 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-sells. 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 with larger cloud footprints, while our smaller spending customers are exhibiting higher growth. From a product perspective, we didn't see meaningful differences among our major products as they all experienced solid growth, albeit decelerating on a year-over-year basis. In contrast to this deceleration in usage growth for existing customers, we continue to execute on new logo lands and multiproduct adoption, and we also continue to see stable, very strong growth 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-sell 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 in 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 more of them develop. 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 product to general availability, Universal Service Monitoring, which detects all microservices across an organization environment and provides instant visibility into their health and dependencies, or without changes. Universal Service Monitoring bridges our existing monitoring and application performance monitoring capabilities and it involves 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 pushed forward in making each product best of breed. Meanwhile, we have made meaningful progress but remain in early days in the new 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 logs and detection to help customers separate signal from noise in data and Watchdog good cause analysis to identify the root cause of issues and quantify their impact for customers. We launched Cloud Cost Management to help 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 at petabyte scale. We launched Audit Trail to help customers achieve their compliance and governance goals. We extended 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 Cloud Security Management, our rich context-aware CNAP platform. We launched Application Security Management, building on our acquisition of Sqreen in 2021, and we announced the beta of native protection to block malicious actions directly within the data 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 intelligence 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 Sqreen for collaboration, incident response, programming and debugging less than a year after the acquisition, and we continue to expand on the HIPAA and PCI compliance of our products. 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 beta products from 2022 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, Sqreen, HD, Secret and Cloud Craft into the Datadog platform, and we are excited for their potential. In summary, we're 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 teams continue 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 our metric tracking log, 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 our 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 mean time to resolution. This deal will start with infrastructure monitoring and replace three different 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 sprawl 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 displace 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 to 15 Datadog products in order to support its ambitious growth plan. And last for today, we signed a multimillion-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 it's achieved roughly 115% ROI all within a year while reducing average mean time to resolution from 1.5 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 is 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 their applications with their business needs is one of the key benefits of cloud 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 their cloud 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, but 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 our continual 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 achieve them. With that, I will turn the call over to our CFO for a review of our financial performance and guidance.

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 vertical, 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-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 is a better indication of our business trends than 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-market. 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 a 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 a free cash flow margin of 21%. Now for our outlook for the first quarter and the fiscal year 2023. In forming our guidance, we continue 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 $1.09 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 headcount in fiscal year 2023 in the mid-20s percent range year-over-year. This compares to fiscal 2022 headcount 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.

Our first question comes from Mark Murphy with JPMorgan. Your line is open.

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 hyperscale’s, Azure, Google, et cetera, gaining any share of that mix during this year? And then I have a quick follow-up.

Yes. We receive data from our customers who use cloud providers, and we also pay attention to what the cloud providers say about their growth. There isn't a direct correlation between the revenue of these cloud providers and what we observe on the infrastructure side. However, we are noticing similar trends, particularly that their growth has slowed down in Q4. We take into account their forecasts regarding future growth, which helps shape our own guidance. Regarding the shift in mix, we haven't seen anything different from the trends of the past year. The key takeaway is that they are experiencing optimization from some of their largest customers, and we anticipate this optimization to continue throughout the year, which is factored into our guidance.

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?

Yes. In Q4, and I think going forward, we continue to see greenfield and new projects, new workloads being the majority of the driver, but we 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 to create efficiencies, et cetera. They have increasingly been consolidating on Datadog and we see continued opportunities for that. Yes. And I'll add to that. We see demand scaling basically. Like we're still early in cloud migration and digital transformation, and we see no slowdown from companies going from legacy IT to this new world. That's why we get more and more renewals 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 that have large workloads trying to optimize because that's where they can meaningfully set cost.

Thank you very much.

We have a question from Sanjit Singh from Morgan Stanley. Your line is open.

Hi. Thank you for allowing me to ask a question. I wanted to discuss product innovation. Over the past couple of years, you have consistently released products that have greatly benefited your customers. However, considering the current environment, do you think that customers perceive Datadog as a premium observability solution, similar to a Lamborghini? Are there concerns that customers may not require all the features included in a 17-product portfolio? I would like to hear your thoughts on whether Datadog might be seen as overly complex given customers' spending inclinations in the current market.

I don't believe we see ourselves as the Lamborghini of observability solutions. Unlike a Lamborghini, which requires frequent maintenance, we're focused on product innovation. We've invested in developing a range of products that are just beginning their life cycle. In the current environment, this is actually advantageous for us, as it allows us to secure consolidation deals by meeting a broader range of customer needs and enhancing efficiencies. However, since many of our products are early in their life cycle, they may not suit every customer or situation right away. This approach is confirming our direction and indicates that we need to continue on this path. Given that larger customers are cautious with their spending, it may be challenging for some of these products to achieve widespread adoption at high spending levels. Our current emphasis is on encouraging as many customers as possible to adopt these products to lay the groundwork for future growth as they consolidate and transition to the cloud.

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're working with those larger customers in terms of where they stand relative to their commitment?

Yes. 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 the guidance we're giving for the year.

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

Our next question comes from Brad Reback from Stifel. Your line is open.

Great. Thank you 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?

Yes, I believe this is primarily influenced by the ARR and its linearity. We do not specifically plan around billings. As you know, our billings have fluctuated above and below the revenue in different periods. Therefore, we do not anticipate any significant changes in this trend. However, it's important to emphasize that ARR and revenues are the key economic indicators.

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 hyperscale’s with a multiple on it. As we sort of look forward, what types of things need to happen to expand that multiplier? Thanks.

We are addressing increasingly significant challenges for our customers, which allows us to enhance our APM capabilities. This expansion will lead to a greater multiplier over time. Our investments in new categories and the ongoing development of observability reflect this direction. While cloud migration and digital transformation have served as strong tailwinds for us historically, we anticipate they may pose challenges in the near term. However, we firmly believe these factors will turn favorable again in the future, though we cannot specify when exactly. Our focus is on driving future success by engaging more customers, entering new markets and segments, and enhancing our product offerings, all of which will contribute to accelerated growth moving forward.

Our next question comes from Fred Lee with Credit Suisse. Your line is open.

Good morning. 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 a second 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.

We have many products that are still in the early stages of their life cycle. Some fall within larger categories where we are experiencing increasing revenue and have ambitious goals, like security. Others, such as Cloud Cost Management, are newer and could be particularly relevant in 2023. We're starting to see promising initial signs from Cloud Cost Management, which is currently only utilized by a small number of customers, but we're already seeing significant commitments from some of them. We noted this during the call. If you're considering any product that could have a more immediate impact, this might be one of them. Overall, our focus is on how to develop these products into major offerings over the next few years, how to capture additional categories, and how to establish ourselves as the preferred platform for consolidation in the long run. That's our goal.

And just a quick follow-up on the security portion. So, concerning the uptake of your security solutions, how would that compare to the adoption patterns of infrastructure and application performance management?

It's a bit challenging to compare to infrastructure since it was our very first initiative. It's quite similar to what we've experienced with application performance management, as it's a sector that requires substantial investment. We have a highly ambitious and unique strategy that demands significant development and several aspects to work out with customers. Nonetheless, we're witnessing ongoing adoption and growth, with thousands of customers utilizing the platform. It's being embraced on a large scale by major clients, some of whom we highlighted in today's call. While we’re not completely there yet and recognize that there’s still a lot to accomplish, we believe it's progressing well in line with our expectations in our plan.

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

Great. Good morning everyone. Thank you for taking my question. I wanted to ask about the usage patterns of large customers versus small customers. I know you said 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.

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 others are larger than their observability bills. And then we're 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 to 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 macro environment. 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.

Okay. That's great. 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.

We collaborate with our large customers to ensure they receive what they need. We are working on optimizing gross margin through our engineering efforts. Even a 1% change in gross margin can significantly impact their business, allowing us to reinvest in future growth. Adjusting prices by 1% has minimal effect on customers. The best way to address their concerns as they expand and generate more data is to provide them with more options to process that data, enabling them to match their spending with the value they receive. We have been developing this on the product side, so this isn't solely a pricing issue; it relates more to product and structure. Regarding our costs, I want to clarify that while we discussed gross margin trends and future expectations, the operating expense guidance for 2023 in the low 30s range does not include COGS, which we mentioned separately.

Helpful. Thank you, guys.

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

Great. Hi, Olivier. Hi, David. Thanks for taking my question. 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 guidance today versus when you first gave guidance last year for 2022.

Yes. 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 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 is up actuals ended up larger. But the intent and the strategy of providing this guidance on conservative assumptions relative to that has not changed.

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

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.

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 is to grow in the mid-20s but continuing to go-to-market teams at a slower pace. So just is that mid-20s is the right way to think about sales capacity hiring this year, too?

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.

In the end, the reason 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.

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.

Got it. Thank you guys. thanks for taking my question.

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

Great. Thanks guys. Olivier, 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 rough magnitude of those? And are they still in hyper growth?

No. We observe a similar trend in growth for our major products like APM, logs, and infrastructure monitoring in Q4. This is partly due to customer optimization occurring upstream at the provider level. Consequently, we anticipate slightly slower growth in the number of hosts monitored on cloud providers and APM, as well as a decline in logs. Some optimizations occur directly at the observability level, particularly with logs and certain transaction-based aspects of APM, where customers are focused on maximizing value and reducing noise. Overall, we see consistent trends across the products, which is why we didn’t highlight any specific differences. In the future, we will provide more details on their relative sizes, but the growth rates were not significantly different in Q4, so there wasn't anything noteworthy to mention.

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. Presumably that dips below 130%. Any sort of commentary on how that might progress through the year?

Yes, I think you're correct. Implicit in that guidance is a figure below 130%. We will inform everyone once we have more information. We have noticed a slowdown, particularly in relation to the change in the organic growth rate that we've discussed since the middle of Q2 last year. It will depend on how this affects net retention positively or negatively, considering that net retention is compared to the year-on-year customer count.

Got it. Thanks.

Our next question comes from Fred Havemeyer with Macquarie. Your line is open.

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 seats have been directly impacted which is because of general disruption to DevOps and engineering teams?

No. We believe it's primarily because customers can reduce their cloud expenses. One of the advantages of the cloud is that it's an ongoing cost. You can modify it over time and change how you manage applications. There are various strategies you can use to optimize costs, which are not available if everything is on-premises since those costs are already fixed and limit future spending. We do notice some variability and unpredictability with certain clients due to their reassessments, which means conversations might involve different stakeholders and some reorganization. However, the main focus remains on optimizing cloud infrastructure and expenses, particularly for those with significant spending. Most of our products are based on infrastructure usage or data volume rather than per user, so we are not significantly affected by layoffs.

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 just help customers better understand both where they're spending, how they're spending and what sort of ROI they're seeing?

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 cost 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 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.

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

Good morning. Thank you 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?

Yes, I believe there are two distinct paths to consider. As we previously stated, we had a strong performance in acquiring new clients this quarter. Our pipeline remains robust, indicating continued solid demand for new projects and workloads. Regarding organic growth, as is common in many years, when employees take vacations and reduce their workload, we typically see a recovery in January. We did experience some of that this year. However, due to current market volatility, we prefer to remain cautious about interpreting those trends too optimistically. We will keep everyone informed on how this develops.

Mathematically, Q4 had more front-loaded recognized revenue, which is why we entered at a lower level and that's reflected in the sequential numbers being a bit lower. Regarding trends, I agree with David that seasonality was higher than in previous years, which can be explained in various ways. Essentially, when customers look to save money, they are more careful about turning off lights when they go on vacation. So far in early 2023, what we are seeing aligns with what we experienced in Q4 and the second half of 2022 overall. It's still too early to make definitive judgments, but this consideration plays a role in our guidance; we don't believe the optimization efforts have ceased and assume they will continue. We are uncertain when they will stop, but we are not anticipating that in our guidance for this year.

Yes, 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 likely to address most of these TAM?

So, I mean, I can't give you specific numbers there. I know we're seeing wins and 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 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.

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

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 to quarters? Any sense would be helpful.

It's somewhat difficult to provide a one-size-fits-all answer because our customers have different structures and are at various stages with their businesses and the economy. Some customers have gone through multiple rounds of layoffs or made several adjustments to their operations. Generally, we find that the quickest way for them to enhance their capabilities is by changing the data they log or use in application performance management. Following that, they often make more significant changes at the cloud provider level, which can lead to higher savings but requires more time for reorganizing workloads and engineering efforts. We've observed this trend with several customers, and those that have adapted have begun to see growth again. However, it's too early to make a definitive statement about the rest of our customer base, as their experiences vary widely.

Understood. Thank you.

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

Thanks for taking my 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 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?

Currently, our guidance assumes that the growth trends of increasing customer numbers will continue throughout the year. We are not predicting any major changes, but rather a continuation of the trends we observed last year. We anticipate some level of contribution based on those figures. We also believe there will be a period of reacceleration as our optimization efforts take effect. However, due to the high level of macroeconomic uncertainty, it's challenging to pinpoint when that might occur. We have noted that cloud providers are also unsure about timing, which is why we are being cautious in our guidance.

We've always indicated that our free cash flow has generally exceeded our EBIT margin. Historically, it's been slightly above in some quarters and slightly below in others. We have not observed any significant changes in payment terms or cash flows. Therefore, we have no current reasons to adjust our outlook on cash flow conversion for the company.

Okay. Thank you, guys.

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.

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, Datadogs 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.

This concludes today's conference call. Thank you for participating. You may now disconnect.