Okta, Inc. Q2 FY2023 Earnings Call

Hi, everybody. Welcome to Okta's Second Quarter Fiscal Year 2023 Earnings Webcast. I'm Dave Gennarelli, Senior Vice President of Investor Relations at Okta. With me in today's meeting, we have Todd McKinnon, our Chief Executive Officer and Co-Founder; Brett Tighe, our Chief Financial Officer; and Frederic Kerrest, our Executive Vice Chairman, Chief Operating Officer and Co-Founder. Today's meeting will include forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements regarding our financial outlook and market positioning. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Forward-looking statements represent our management's beliefs and assumptions only as of the date made. Information on factors that could affect the company's financial results is included in our filings with the SEC from time to time, including the section titled Risk Factors in our previously filed Form 10-Q. In addition, during today's meeting, we will discuss non-GAAP financial measures. These non-GAAP financial measures are in addition to and not as a substitute for or superior to measures of financial performance prepared in accordance with GAAP. A reconciliation between GAAP and non-GAAP financial measures and a discussion of the limitations of using non-GAAP measures versus their closest GAAP equivalents is available in our earnings release. You can also find more detailed information in our supplemental financial materials, which include trended financial statements and key metrics posted on our Investor Relations website. In today's meeting, we will quote a number of numeric or growth changes as we discuss our financial performance. And unless otherwise noted, each such reference represents a year-over-year comparison. And now I'd like to turn the meeting over to Todd McKinnon. Todd?

Thanks, Dave, and thank you, everyone, for joining us this afternoon. While the identity market opportunity remains healthy, our Q2 financial results were mixed. We produced better than expected profitability, but our top line metrics were not where we wanted them to be due to challenges related to the integration of the Auth0 and Okta sales organizations, as well as modest macro headwinds. I'll start today's call by going into more detail on our Q2 performance and then talk about the specific actions we're taking to improve our performance. I'll then finish with some other notable items from the quarter. As we evaluated our Q2 results, there were three primary areas we dug into more closely. The first area was to search for any potential latent impact from the security incident earlier this year. We believe the security incident did not have a quantifiable impact on our business in Q2, which is consistent with last quarter. We spend less time discussing the details of the incident with customers and prospects with each passing month. In fact, many customers have expressed their increased confidence in Okta, after we implemented a series of additional security measures as part of our security action plan, which is available on okta.com/transparency. The second area was any discernible impact from the evolving macro environment. We are starting to notice some tightening of IT budgets and lengthening sales cycles relative to last quarter. This leads us to believe that the weakening economy is having some impact on our business. And the third area we examined was impact from the integration of the Okta and Auth0 sales teams, which occurred at the beginning of this fiscal year. When talking about Auth0, it's important to revisit the strategic rationale of why we acquired Auth0. Individually, Okta and Auth0 were leading identity providers. Together, we offer the most comprehensive identity platform in the market that is unmatched competitively and creates powerful long-term network effects for us and for our customers. Organizations around the globe are looking for scalable and secure ways to digitally interact with their customers. Together with Auth0, we win the customer identity market faster and accelerate our vision of establishing Okta as a primary cloud. Integrations are always difficult and touch every part of an organization. While we are making progress, we've experienced heightened attrition within the go-to-market organization as well as some confusion in the field, both of which have impacted our business momentum. In order to improve our performance going forward, we've implemented a number of action items. For starters, we're committed to stemming attrition within our go-to-market team. This is a top priority for me and my staff, and we're in lockstep on actions to take. This includes making changes to our organizational structure to better align on our strategy, increased sales training and enablement and also improving the comp structure for the go-to-market team to ensure they feel set up for success. The second action we've taken is to improve our go-to-market effectiveness. Earlier this month, we unified the pricing, quoting and opportunity management system. This is a big deal because the sales team is now working from a single integrated CRM system, which wasn't the case previously. And third, as of the beginning of this month, we've simplified our approach to our markets, and we are excited to share this high-level plan with all of you today. As part of our plan to achieve that, we're moving forward with a more clearly defined approach with the unveiling of the Customer Identity Cloud and Workforce Identity Cloud. Auth0 will power the Customer Identity Cloud. Okta SIEM, which is often deployed for what we call extended workforce use cases, will move into the Workforce Identity Cloud. This alignment plays to the strengths of both products, the type of users they best serve and the distinct buying centers of customer identity and workforce identity. And this simplification will greatly benefit the go-to-market team immediately by removing confusion about which product to lead with. To be clear, this change refines how our sales reps go to market and does not change the product or service we deliver to our customers. Recall that Okta's traditional strength is selling identity to the Chief Information Officer and Chief Security Officer. In order to elevate the strategic importance of customer identity, we need to improve our relationship with the other members in the C-suite, including the Chief Digital Officer, Chief Technology Officer and Chief Product Officer, who are more heavily influenced by developers in their organization. Reaching developers and selling to this audience is Auth0's strength. The more buyers we can effectively reach, the more identity use cases Okta can help them solve. Becoming the vendor of choice for more identity use cases across the C-suite results in Okta becoming a strategic vendor for the CEO and entire organization. These changes stem from our learnings over the past two quarters. Ultimately, this allows us to deliver more customer value and is a big step toward our vision of Okta as a primary cloud. We are in the process of communicating more of the specific details directly with our customers now and over the coming weeks. Based on early feedback from some of our largest customers, they are excited about how this plan fits into their long-term technology strategies. Turning back to our Q2 results. We added 600 new customers in the quarter, bringing our total customer base to 16,400, representing growth of 26%. We continue to see growth with large customers for both workforce and customer identity. And we are proud to work with some of the most important brands in the world, such as NTT DATA, Siemens and NASDAQ. In Q2, we added 220 customers with $100,000-plus ACV, which is our second highest new quarterly adds for this cohort. Our total base of $100,000-plus ACV customers now stands at over 3,500 and grew 35%. Cohorts for even larger customers that have an ACV of $250,000, $500,000 and $1 million-plus all grew north of 40%. In fact, we had a record quarter for new $1 million ACV customers in Q2. This base of large customers represents roughly 80% of total ACV. Here are just a few notable examples of customer wins in Q2 which come from a wide range of industries. Elevance Health, formerly known as Anthem, a Fortune 50 health insurance provider, was a substantial workforce and customer identity win. Next, the state of Maryland was an outstanding new workforce win. Maryland is focused on building resilience and decreasing risk as threat actors increase attacks on state and local governments. The state's legacy identity management tool was burdensome and lacked the functionality to support the evolving needs of the state. This initial deployment will enhance security and provide the foundation for a statewide identity strategy. Okta Lifecycle Management and Workflows will also enable the state to be more productive by automating onboarding and offboarding of users. A great upsell in the quarter was with the US Department of Homeland Security. The DHS expanded its use of Okta Workforce to support the department's modernization and mission initiatives. Okta will be used to build a modern identity solution for the department and help standardize authentication against all shared applications and services. Additionally, Okta Adaptive MFA will be used to build the department's cyber posture and support its Zero Trust architecture. I'm sure you noticed that a couple of the customer callouts were government organizations; they were just two of many government wins and upsells we had in the quarter. One of our primary focus areas this year is to increase our presence in the federal vertical. To-date, we've experienced significant growth rates in the federal vertical, as well as state and local. We've built solid momentum going into what is typically the biggest quarter of the year for our federal business. Two important upcoming federal business milestones to note are FedRAMP High Authorization and the launch of the Okta Military cloud, both of which we anticipate achieving by the end of this year. We're also very excited about the recent North American launch of Okta Identity Governance. This is a significant step forward as we deliver a unified and comprehensive identity platform and further Okta's position as a strategic identity partner for businesses across the globe. Our approach to this was to rethink the way governance was traditionally done and build a product on Okta principles of cloud-native technology that is easy to use. This means delivering a product that drives better security and compliance outcomes, is easy to deploy and maintain for IT teams and is simple for employees to use. This resulted in a modern unified IAM Governance Solution focused on improving an organization's security posture. Okta Identity Governance is already off to a great start with dozens of customers. A great early win was with Kyndryl, the managed services business spun out of IBM. Kyndryl expanded with Okta Identity Governance this quarter to secure access to their applications to mitigate modern security risks and improve IT resource efficiency. It was just a couple of quarters ago that Kyndryl became a workforce and customer identity customer. We're now looking forward to the global launch later this year. We’ll talk more about our products and product roadmap at Oktane22, which we're hosting in person in San Francisco this coming November. This is Oktane’s 10th anniversary and it will be better than ever. We’ll also host Investor Day as a hybrid event in conjunction with Oktane. So, we hope to see you there in person or virtually. And finally, I want to acknowledge a few updates to our Executive leadership team and Board. First, after 13-plus intense years building Okta together, my Co-Founder and partner, Freddie Kerrest, is going to be taking a much deserved 12-month operating sabbatical, beginning November 1st to spend time with his family, recharge his batteries and think about what's next for Okta. Freddie will be staying close to the company as Executive Vice Chairman and Board member during his sabbatical. I also want to thank Diya Jolly, our Chief Product Officer for her contributions to Okta over the last four years. Diya is an exceptional product leader and I couldn't be more excited to see her pursue her passion as an entrepreneur and builder. We appreciate her staying on as an adviser through early next year as we simplify and align our product teams with the new go-to-market strategy. Going forward, we're splitting the role, so Eugenio Pace will lead product development for the Customer Identity Cloud, and Sagnik Nandy, our CTO, will be the interim lead for Workforce Identity Cloud products. And lastly, I'd like to welcome Emilie Choi, Coinbase’s President and COO, who recently joined our Board of Directors. Over the last decade, Emilie helped scale Coinbase and LinkedIn into two highly influential technology companies. She brings a wealth of experience working with technology entrepreneurs, and we look forward to bringing her perspective to Okta's Board. We have incredibly strong teams and leaders across the company who continue to deliver for customers, and I am committed to investing in their strength and productivity for our long-term success. To wrap things up, I want to thank the entire Okta team for their hard work. The sales integration challenges we've encountered lay squarely on my shoulders and I recognize we have more work to do to regain our momentum. We've taken some decisive actions that we believe will get us back on track. I'm more energized than ever and confident that the steps we are taking will yield improved results. Identity is a critical component of every company's Zero Trust security, digital transformation and adoption of cloud. These three mega trends continue to support our view that identity is a strategic priority for organizations of all sizes. We remain focused on the massive $80 billion market opportunity in front of us. Okta is critical infrastructure for over 16,000 organizations around the globe. Every organization needs identity. And Okta is the recognized market leader that is best positioned to capture this opportunity. Now here's Brett to walk you through more of the Q2 financial details and outlook for the rest of FY 2023.

Thanks, Todd, and thank you, everyone, for joining us today. I'll start with some of the results for the second quarter and then provide our business outlook. Keep in mind that we are now past the one-year anniversary of the Auth0 acquisition and quarterly year-over-year comparisons are now on a like-for-like basis. Let's take a closer look at our Q2 results, and then I'll go over the outlook for the second half of the fiscal year. Total revenue growth for the second quarter was 43%, driven by a 44% increase in subscription revenue. Subscription revenue represented 96% of our total revenue. International revenue grew 52% and represents 22% of total revenue. With this level of international exposure, we had minor FX headwinds, but it's an area we are closely monitoring. Looking at the ACV split between workforce identity and customer identity. Workforce ACV grew 36% and represented 63% of total ACV. Customer identity ACV grew 47% and represented 37% of total ACV. We're pleased with the durable growth of the workforce business, especially at its current scale. While the customer identity business continues to outpace the overall business, the growth was impacted by the sales integration challenges that Todd outlined. RPO or backlog, which for us is contracted subscription revenue both billed and unbilled that has not yet been recognized, grew 25% to $2.79 billion. Impacting total RPO growth is the general shortening of term lengths of recently signed contracts in addition to our increase in public sector contracts, which generally have a one-year term length. Our average term length remains just under three years. Current RPO, which represents subscription revenue we expect to recognize over the next 12 months, grew 36% to $1.5 billion. The growth in current RPO was driven by strength across new and existing customers. We view current RPO as the better metric to assess our quarterly performance relative to calculated billings, which as we've noted, can be noisy due to fluctuation in invoice timing and duration. Calculated billings and current calculated billings grew 36%. Turning to retention. Our dollar-based net retention rate for the trailing 12-month period remains strong at 122%. This was driven by the strong upsell motion we are seeing with our existing customers as they expand on both products and users. As always, the net retention rate may fluctuate from quarter-to-quarter as the mix of new business, renewals and upsells fluctuates. Consistent with prior quarters, gross retention rates remained very healthy and reflect the value of our products to our customers. Before turning to expense items and profitability, I'll point out that I'll be discussing non-GAAP results going forward. Looking at operating expenses. Total operating expenses for the quarter were lower than expected, primarily related to lower-than-anticipated headcount additions. Operating loss was $15 million and much better than we expected, primarily due to the combination of revenue overperformance and lower-than-expected operating expenses. Total headcount increased 38% and is nearly 5,800. Moving to cash flow. Free cash flow was negative $24 million. We anticipate Q2 free cash flow being the seasonal low point for free cash flow this year. We ended the second quarter with a strong balance sheet anchored by nearly $2.5 billion in cash, cash equivalents and short-term investments. Now let's get into our outlook. We're factoring in our Q2 performance, sales integration challenges, heightened sales attrition in an evolving economic environment. To help contextualize this, over half of the outlook headwind relates to our sales integration challenges. A secondary portion of the reduction relates to the heightened attrition, which resulted in a lower-than-expected capacity build as we move through the year. And finally, a smaller portion is additional conservatism related to the macro environment. We are also improving our profitability outlook for the second half of the year. The spend reductions will be achieved by reducing our hiring plans, rationalizing our facilities footprint and applying greater overall financial discipline. We believe these steps will improve our operating margins and ability to attain our free cash flow targets for the year. For the third quarter of FY 2023, we expect total revenue of $463 million to $465 million, representing growth of 32% to 33%. We expect current RPO of $1.54 billion to $1.55 billion, representing growth of 30% to 31%; non-GAAP operating loss of $37 million to $36 million and non-GAAP net loss per share of $0.25 to $0.24, assuming weighted average shares outstanding of approximately $158 million. For FY 2023, we are raising our revenue outlook by approximately $5 million at the high end to $1.812 billion to $1.820 billion, representing growth of 39% to 40%. We are raising our profitability outlook by approximately $57 million. We now expect non-GAAP operating loss of $110 million to $105 million and non-GAAP net loss per share of $0.73 to $0.70, assuming weighted average shares outstanding of approximately $157 million. Lastly, I want to provide a few comments to help with modeling Okta. As I've mentioned in past quarters, we look at growth and profitability through the Rule of 40 lens. Despite the downward pressures on the top line, we are making adjustments to our original spend assumptions and are committed to staying Rule of 40 for the fiscal year. This includes a free cash flow margin in the low single-digits for FY 2023. We expect to return to positive free cash flow in the third quarter and expect Q4 to be our seasonally strongest quarter for free cash flow. Next to help with your transition to modeling on current RPO, we will continue providing a full year billings outlook for FY '23 before discontinuing any reference to billings in FY '24. We are lowering our calculated billings outlook for the year by approximately $140 million due to the outlook headwinds outlined earlier. We now expect calculated billings for FY '23 to be approximately $2.04 billion to $2.05 billion, representing growth of 27% when viewed on a like-for-like basis or 19% on an as-reported basis. Given our near-term outlook coupled with the uncertainties of the evolving macro environment we are reevaluating our FY '26 targets at this time. Having said that, we will continue to balance growth and profitability and we look forward to updating you on our long-term outlook on the Q3 earnings call. To wrap things up, we're confident we have the right action plans in place to build on our progress and expand on our market leadership position. I'll turn it back to Dave for Q&A. Dave?

Thanks, Brett. I see that there's quite a few hands raised already and I will take them in that order. Operator provided instructions. So with that I will start with Erik Heath at KeyBanc. Erik?

Thanks Dave and thanks for taking the question. So, Todd, Freddie, I appreciate the detail on how you're reorienting the product portfolio. But wanted to drill in on how you're changing the kind of sales organization and Freddie is going to take some time off? And then also just any additional color you could provide on maybe how you're reorienting some of the sales comp structures going forward?

Yes, for sure. Thanks for the question. I'll start with the sales organization. The big change there happened at the beginning of this fiscal year, on February 1. We took the Auth0 sales team, which had been selling independently through the first three quarters after the acquisition, and combined them with the Okta sales team. The idea is that hundreds of Okta reps now sell the whole portfolio, Okta plus Auth0, and the Auth0 reps also sell both portfolios. That was a significant step in integration. I want to clarify that Freddie does not manage the sales team that reports to Susan St. Ledger and Steve Rowland, our CRO. Freddie is very involved in customer conversations, which we can discuss separately. Organizationally, the sales integration was the combination of the teams earlier this year. The challenge is how to take those hundreds of reps and make them productive selling both Customer Identity Cloud and Workforce Identity Cloud. One issue is that we need to reach a new set of buyers. Okta traditionally sold to CIOs and CSOs, but to succeed in customer identity we have to reach VPs of technology, CTOs, chief marketing officers, chief digital officers, and other C-suite executives who are more influenced by developers. That is the strategic rationale for the acquisition. By combining the sales teams and focusing on those buyers, we are very bullish on the long-term implications of offering a unified identity platform across these use cases. At the same time, we are iterating on tactics, learning from mistakes, and course-correcting. One concrete step is simplifying how we enable sellers and the product portfolio they present to customers. We are streamlining to two clear platforms: Customer Identity Cloud, which is Auth0, and Workforce Identity Cloud, which covers employees and the extended workforce such as partners and suppliers. That simpler set of platforms makes it much easier to train the hundreds of sellers and bring this vision and product portfolio to market.

Thanks Todd.

Next, let's go to Alex Henderson from Needham.

Great. Thank you very much. I've been focused on understanding the recent news flow that's come out in October since the hack that was announced and particularly the Scatter Swine and the Oktapus program…

Don't you love the names, Alex.

Excuse me

Don't you love the names?

Yes, they're awesome, right? And then there's an additional one that came out recently talking about the SMS cloning mechanics and the opportunity for people to use those to penetrate better permissions into the cloud and upgrade their permissions. That obviously happened after the end of the quarter when it apparently attacked 140-plus Okta customers. Can you please address that piece of the puzzle because it's a little transparent to us when we see all of that? I had a conversation with a VAR this morning and he's already seen some pushback from customers as a result of that in terms of closing deals as we speak.

Yeah, Alex, I want to make sure I understand. You said Oktapus, is that what you meant? Okay. The issue you're referring to is a recent instance of something that happens all the time: phishing attacks are constantly occurring. Threat actors try to exploit the most commonly used identity systems, and because so many customers use Okta, they often target us. They create fake Okta sites to trick users into entering credentials, then use those credentials to break in. We have entire teams whose job is to monitor the dark web and infrastructure providers to take down these fake sites and notify customers. The incident involved groups known as Oktapus and Scatter Swine. It's the same threat actor and the same basic issue. What was different this time is that the attack succeeded against a small number of customers. The attackers used an innovative technique: they phished not only passwords but also one-time codes and weaker tokens such as SMS. That approach usually fails, but because it was novel it worked on a few customers. The takeaway is that we need to move toward a passwordless future so authentication is not phishable. Our platform supports that, but it is highly configurable. Customers can choose different configurations depending on the resource they are protecting and their risk tolerance. Options range from just a password, which is very phishable, to an impossible-to-phish setup with no login page, no password, and cryptographic verification that requires being on a managed work device. Some customers had sensitive resources protected by configurations that were less secure than required. Our responsibilities are transparency and education. We are being very proactive in communicating what happened, including a detailed blog post we share with customers. We also need to do a better job helping customers understand their product configuration and the associated risks relative to the sensitivity of the resources they protect. We want to help the industry and our customers move toward an unphishable configuration, meaning no passwords and no login pages.

So is there no impact in your results in August as a result of that high-visibility event?

Well, first of all, the event you described occurred after Q2. So there's clearly no impact on Q2. In the current quarter, all of our conversations with customers have been very confident in our ability to protect them and configure the product in a way that's effective. We're being a good partner to them to understand how to defend these things en masse because this is happening all the time to customers. They know that their infrastructure is being attacked and having partners that can help them ratchet up their defenses all the way towards this unphishable configuration is something they're very comfortable with.

Great. Thank you very much for the clarity.

Let's go to Gregg Moskowitz at Mizuho.

Okay. Thank you very much for taking the question. So without a doubt, Auth0, Todd, is a very strong solution for developers. But this refined go-to-market, as you noted, is a different design than what was initially articulated following the announcement of the acquisition about 18 months ago. And so some may wonder, is this a first step towards deemphasizing Okta's core workforce solution? So can you tell us why that is not the case? And then secondly, given the big convergence that's happening in identity access across workforce and CIAM, will this have any bearing in your opinion on your ability to sell joint Workforce and CIAM deals going forward?

Yes, I think it's a super insightful question. And I think I would describe this as a clarification and a simplification. If you think about the market, it's a spectrum. On one end of the spectrum is your pure new app, B2C, where a development team drives revenue and needs flexibility and extensibility — that's Auth0’s bread and butter. The other end of the spectrum is very similar to workforce: you're giving access to partners or a mix of partners and customers to your instance of e-mail or to your instance of Salesforce or to your off-the-shelf SaaS app — that's where Okta SIEM historically was, and it behaves much like workforce. There wasn't a bright line in that spectrum where on the left side it was all Auth0 and on the right side it was all Okta; they were blended. So what we're doing now is making it clearer: the majority of the Okta SIEM use cases that were really extended workforce-focused are going to be clearly in the Workforce Identity Cloud. The Customer Identity Cloud will be Auth0. There will be some overlap in the middle, but this is really a clarification in terms of product positioning so our hundreds and hundreds of reps can more effectively go to market. We're not deemphasizing workforce. Workforce remains a core strength and a critical, durable part of our business.

And if I can just add to that a couple of examples might help. First of all, you got to remember the historical context here. Historically, Okta started as a workforce-focused business. We added Customer Identity and Access Management and you see a lot of those examples of people using Okta Customer Identity and Access Management as that extended workforce that Todd was just talking about. For example, Flex, the giant contact manufacturer, uses Okta Customer Identity and Access Management to manage the distributors in their supply chains. It's a limited number. They know exactly who they are. It works a lot more like an extended workforce. What we're trying to do here with the Customer Identity Cloud and the Workforce Identity Cloud is simplification. It's about making it easier for customers to understand where they should go, who they should talk to, as well as for our salesforce to communicate that. Finally, we have good examples so far of Okta and Auth0 working very well together over the last couple of quarters. We've talked about some of them on this earnings call: Fifth Third Bancorp, Eventbrite, DICK'S Sporting Goods, News Corp — plenty of organizations that see the value of Okta Workforce and Auth0 together. And this quarter we had Vialto Partners, which bought both Workforce and Auth0 to support their modernization efforts and secure access across the entire organization.

Thanks, guys. Appreciate the explanation.

Okay. Let's go to Andy Nowinski at Wells Fargo.

Okay. Thank you. I guess, I just had a quick clarification first. Did you say you're reevaluating those fiscal 2026 targets, so taking that $4 billion revenue target off the table for now until you reevaluate it? And then my question was, we're getting a lot of questions from investors as to what actually triggered the need for these go-to-market refinements since over the last, call it, 12 months whether it was the elevated attrition that perhaps made you make these changes or the recent macro changes that we're seeing with the extended deal cycles? Just curious as to — if you can point your finger to why now? Thanks.

It's a great question. On the first part of your question, the $4 billion FY 2026 target — if we're going to achieve that, we have to have a successful Customer Identity Cloud. As we reevaluate in the short term how to keep that momentum going, I think it's prudent to re-evaluate that target given the short-term changes that we're optimizing for the Customer Identity Cloud. We're committed to coming back on the next earnings call with a very detailed refined version of those commitments and that target. On the second thing, the sequence of events is important. The sales teams were integrated this year. So it's really six months of information and learnings that we have to iterate on. Last year, Auth0 ran as a separate sales team and had a great year. So we know there's market fit and we know we can grow this business. It's just about the integration of the sales teams and what that drove in terms of attrition and some of the things we've talked about in terms of optimizing how we get that back on track to achieve this strategic imperative, which is we have to be the winner in the large customer identity market.

Thanks, Todd.

Let's go to Adam Tindle at Raymond James.

Okay. Thank you. I just wanted to maybe start, Todd, if we could revisit some of the industrial logic for the Auth0 acquisition. The idea was some synergies, the business is better together, but now we're refining them. I guess the question would be, what would you have done differently in that assessment, because I know future M&A you talked about being a potential catalyst for the company. So what have you learned? And secondly, what will Eugenio do in his new role to reenergize the more standalone Auth0 business? Thanks.

So I don't think we're separating the businesses. First of all, the high-level idea for the acquisition was that Customer Identity is a massive opportunity. Every digital interaction with every person and every company will be digital. Customer identity is at the core of all of that. If you want to be a primary cloud for identity, you have to cover all the use cases. There's no scenario where I go talk to the CIO or the CEO of a major healthcare chain and say, I'm the workforce vendor for your workforce. It has to be for your workforce and your customers and your extended workforce and everything in between. So that was the strategic rationale. Fast forward: in the first nine months after the deal closed, the product team and sales team largely ran independently and had a great year. This year we took the next step of combining the hundreds of Okta sellers and adding Auth0 to their toolkit. As we've gone through that process in the first six months, we've learned a lot. One of the big things we learned is that there was too much complexity in trying to parse apart the different use cases, and we needed to simplify that complexity. We say if you're building a consumer app or a B2B SaaS app, it's in the Customer Identity Cloud and Auth0 leads. If it's a workforce app and the buyer is the CSO or CIO, that's Workforce Identity Cloud. Very clean, very simple. We have a combined sales team, clear product messaging and we're iterating to make this work at scale.

Next, let's go to Ittai Kidron at Oppenheimer.

Thanks, Dave. Todd, maybe just to follow up on that. It seems like you're going to have to maintain two parallel sales motions at the same time. So I guess I'm trying to figure out your priorities. As you think about the next two to three years, it looks like the synergies that you are hoping to get by bringing these two organizations together cannot be fully realized, given that you're going to have to create this duality at least from a sales motion standpoint. How do I think about the trade-offs as you look at them from a growth or a profitability standpoint? You're going to have to sacrifice profitability to maintain these two organizations running at the same time to a certain degree; does that mean you're taking away from workforce in order to enable more of the Auth0 side of the business in order to drive profitability to where you want to be or is it longer to get to that profitability breakeven?

It's a really good question. One thing I want to correct is that we have one salesforce, not two. A big part of the synergy is one salesforce. Reaching the massive markets for Customer Identity and Workforce Identity, we believe the sales motion is to cover all use cases and all buyers and sell at a higher level. We're not splitting the salesforce. The strategy and synergy are predicated on making this one sales team successful. That said, your point about profitability trade-offs is valid. We're always balancing how we grow efficiently to attack this market while ensuring we're generating cash and operating at an efficient level. That's why you see us reference the Rule of 40. We're not going to burn cash at all costs; we're going to balance growth and margins. On R&D, there is some duplication today between the two teams but over time you'll see that rationalized and common services pulled together. That's multiple years out. The immediate focus is on go-to-market scale and making sure that integration is effective.

And I'd add that you can see us already balancing growth and margin. Our growth expectations for the year have moderated a little bit, and we've improved operating loss by about $57 million this year. In the long-range framework, we expect to expand margins over the coming years.

Maybe just following up on that, can you tell us from an attrition standpoint, where was it more pronounced on the Okta side or the Auth0 side?

Attrition across all of Okta is too high. Historically it was around 15%, it's been a little over 20% recently. We want to bring that back down to the pre-COVID levels around 15%. On the go-to-market side, there was a more pronounced attrition in the former Auth0 team. Some of this was expected: Auth0 was a smaller company pre-acquisition and the change in territory structure and the expectations of selling multiple products led some to look elsewhere. In retrospect, one thing I would have done differently is adopt a more moderated hiring plan coming into this year. We had a very aggressive hiring plan to cover every nook and cranny of the market, which in hindsight was a mistake. We're starting to see trends reverse already. We're hiring a lot of great talent at all levels, but we need to get ramped reps back up to capacity and that takes time. We're focused on team stability, compensation adjustments and enablement to get attrition down and ramp efficiency back up.

And we're not just sitting on our hands. We are addressing the problem, including looking at compensation structure and making some improvements. We're identifying problems and implementing solutions quickly.

We are attracting a lot of really good talent, both reps and managers. One of the big things is making it simpler for them to ramp because the payoff is huge. The simpler the enablement, the greater the leverage of the salesforce.

Keith Bachman at BMO. Keith?

Good afternoon. Thank you for taking the question. Todd, I wanted to come back to you and ask a broad question on — you didn't mention competition as one of the factors perhaps influencing the change in guide. I want to try to understand the broader comments there, and I'll break it into two pieces: A, on the workforce side, we had the opportunity to attend Gartner's Identity conference last week, and there was certainly a lot of discussion from both presenters and attendees that Microsoft is getting much more competitive here, whether it's causing Okta to change prices or actually losing share. So I wanted to get your response to that. And then b, another comment was on the IGA and PAM side, while they're in different stages of development, the feedback was that both Okta's IGA and PAM would be 'light relative to the competition.' I wanted a broader perspective on what role competition played in the guide down, specifically on the workforce side against Microsoft and then an update on IGA and PAM.

Happy to address the competitive environment. It had nothing to do with our guide reduction. The guide reduction was driven by integration and attrition and some macro conservatism. The competitive environment, particularly on workforce, is different than customer identity. Workforce is a large, somewhat fragmented market and the buyer is now choosing cloud. Historically, when Microsoft entered the market it validated the category. We're on the right side as a cloud vendor. Competition from Microsoft is real and they are aggressive, and I understand why. They aim to lock people into their ecosystem. But customers often want neutrality and flexibility across thousands of applications and devices. That's where an independent identity platform like Okta has strong value. We do lose some deals to Microsoft, and we study competition closely, but the broader trend is cloud adoption and the need for neutral identity infrastructure across diverse application ecosystems. Regarding IGA and PAM, we heard similar things historically about Okta being 'light' for certain functionality. When customers say the product is lightweight, that often indicates ease of use and faster adoption. IGA being simpler can actually expand the market because it removes friction that legacy solutions introduced. We're focused on making governance modern, simple and effective.

Okay. All right. I will see the floor. Thanks a ton.

We'll take our next question from Jonathan Ho at William Blair.

Hi, good afternoon. I just wanted a little more detail in terms of the reduction in outlook and how much of it came from each of the three main factors you outlined and also how quickly you think the market motion improvements will have an impact? Thank you.

A little over half was the sales integration issues. The second biggest was the attrition issue we've talked about in the field. And pretty small was the macro piece. In terms of timing to address these, we've implemented plans on the sales integration and attrition issues already, but it's not a one-off fix. Enablement and making sure reps go to the right buyer is something we're focusing on now but it will take several months to fully realize. We will evaluate the results over the next three to six months and continue to adjust as needed. We're confident in the solutions but we'll keep iterating.

I want to emphasize the philosophy here. We're trying to build something massive and enduring. We could have chosen easier paths, avoided the bold acquisition and not stretched ourselves, but we're committed to being bold and long-term oriented. That vision is not changing. On tactics — how we prosecute these things, integrate sales teams, tweak messaging and iterate — we'll be pragmatic and change quickly when something isn't working. The sales integration challenges lay on my shoulders. I wish some things had gone differently, but I'm proud of the bold vision and that we are realistic and aggressive about fixing what isn't working. I'm confident we'll improve and achieve massive long-term success.

Thank you.

We'll go to John DiFucci of Guggenheim.

Sorry, guys, it's been a while. Hey guys. I figured out how to unmute. So listen guys, it's really interesting. In the quarter you had a record number of $1 million deals. You saw a really big uptick in accounts receivable, which makes you sort of think it's back-end loaded. That makes sense because large deals are usually back-end loaded. You're also seeing some macro influence. But this all kind of begs the question and your guidance says a little bit about it, but can you specifically talk about your pipeline in the context of all that?

Pipeline continues to grow and it's an area we continually work on. A lot of the pipeline today reflects how we used to operate — more workforce-oriented or extended workforce-oriented. There's some Customer Identity pipeline, but as we enable the field and clarify messaging, we expect more of those developer-driven Customer Identity deals to scale. That gives us optimism about the future for the coming quarters and years. Developer-led customer identity deals typically start from self-service trials, and over time our broader salesforce will get more effective at converting those into large enterprise deals.

So is it safe to say that the pipeline for the CIAM business is still something you're figuring out?

Yes, especially on the pure B2C developer-influenced side. That integration is still in process. The traditional CIO/CSO customer identity pipeline is progressing as expected; it's the new developer-driven muscle we're building out for the salesforce that will take time.

Pipeline itself continues to grow. The issue is how we prosecute it and make things simple for our salesforce and customers. That's what we're focused on fixing.

Next, Trevor Walsh at JMP.

Thanks. Maybe jump off Brett or Todd. You mentioned longer sales cycles and scrutiny around budgets. Given there are two different buying centers around workforce and CIAM, do you have any way to bifurcate whether this lengthening is more pronounced in the IT/ops/security realm with workforce versus on the CIAM side? Any additional color would be helpful.

I think it's more broad-based, but one datapoint is geographic: EMEA showed some of the earliest signs of macro headwinds.

Next, Rob Owens at Piper.

Hi. Thanks for taking my question.

Hi Rob.

Can you touch a little on public sector? You mentioned some wins there, obviously having the federal fiscal year-end exposure here. What's the thought process and what could Fed mean for you with some of the larger-scale programs they're running?

We have a number of priorities this year: Customer Identity, international growth and federal. The federal market is a big opportunity. We've been investing in sales distribution and infrastructure and we've done a lot to go from FedRAMP moderate up to FedRAMP High and IL-4 for DoD, which enables the Okta Military cloud. That business did very well in Q1 and Q2. September is the end of the federal fiscal year, and we're optimistic about the opportunities there. Government is turning more to cloud and the evolving threat landscape and modernization needs are driving demand for identity solutions.

Second quarter in a row, public sector has been our fastest-growing segment. We've focused on it and are pleased with the progress, though there's more to do.

All right. Thank you, guys.

Next up, Matt Hedberg at RBC.

Hey, guys. Brett, maybe just to put a final point on the headwinds. I appreciate the $140 million headwind to full-year billings. Can you give us any insight into what your internal shortfall was for Q2 versus your internal billings plan? And maybe walk us through how the quarter played out — did this happen mid-quarter or in the last couple of weeks of the quarter? Just a sense of the timeline would help.

The biggest takeaway is linearity: the quarter was more back-end loaded, which is a result of the integration issues, attrition issues and the macro. The macro effects we started to see toward the end of the quarter; budgets began tightening and sales cycles elongated toward quarter-end. That contributes to the AR balance and the feeling of back-end loading.

Next up, Peter Weed at Bernstein.

I appreciate your conversation around churn and the challenges on the go-to-market side. I'd like to turn the light on R&D. Sequentially quarter-over-quarter, spend came down about 7% which could suggest some attrition or efficiencies. Given the tight market for talent, how should we think about that signal? Should we read into this as intentional efficiencies from integration or is it attrition-related? How should we think about product impact going forward?

Good question. Attrition in R&D has actually been one of the stronger areas — it's not an attrition-driven decline. There is some acquisition-related comparison complexity between quarters and some kickoff activities in Q1. We have been doing a lot of hiring in R&D and it remains one of our lower-attrition areas. Both Customer Identity Cloud and Workforce Identity Cloud have a lot of exciting roadmap items: Identity Governance is launching, integrations in the ecosystem, enhanced anti-phishing capabilities and other capabilities that will make the platform more strategic to CEOs and CTOs alike. Over time you'll see more common services and rationalization across teams.

I wouldn't read too much into the quarter-to-quarter R&D variation. Some of it is acquisition accounting and timing of expenses. We continue to hire in R&D and the area has relatively low attrition.

Strategically and tactically, both clouds have important product work coming. We're proud of the R&D progress and will continue to invest in product innovation.

Great. So we shouldn't read into it as a talent attrition issue; more about timing and integration efficiencies.

Okay. Final question from Josh Tilton at Wolfe.

Hey, guys. Thanks for squeezing me in. Given all the challenges that you mentioned, what gives you the confidence that you're not going to have to lower numbers again in the back half of the year?

We've baked in everything we know at this point into the guidance — current RPO, revenue and billings assumptions. We've accounted for sales integration issues, attrition and the macro conservatism we've discussed. We're prudent in our assumptions and believe the guidance reflects what we currently expect.

End of Q&A. Before we go, we want to note that we'll be attending two conferences this quarter: the Citi Tech Global Conference in New York on September 8 and the Goldman Tech Conference in San Francisco on September 12. As Todd mentioned, we're going to be hosting our Investor Day at Oktane Inc '22 on November 9. If you have any follow-up questions, you can e-mail us at investor@okta.com. Thanks.

Thanks, everyone.

Thank you.

Thanks, everyone.