Okta, Inc. Q4 FY2023 Earnings Call

Hi, everybody. Welcome to Okta’s Fourth 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; and Brett Tighe, our Chief Financial Officer. 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. Though we may not state it explicitly during the meeting, all references to profitability are non-GAAP. These non-GAAP financial measures are in addition to and not 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 growth changes as we discuss our financial performance. And unless otherwise noted, each such reference represents a year-on-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. We’re pleased with our Q4 results and the significant improvement in our profitability and record cash flow. It was a strong close to FY23 with continued improvement in our go-to-market business performance, giving us confidence going into the new fiscal year. We’ve positioned Okta for continued success with our customers and improved profitability and increased cash flow as an organization to navigate the evolving macroeconomic environment. The three mega trends that have driven Okta’s business over the past several years: the deployment of cloud and hybrid IT; digital transformation projects; and the adoption of Zero Trust security, remain top priorities for organizations around the world. These trends are more relevant than ever, and the role of identity has only grown in importance in helping organizations do more with less. Organizations that can address at least one, if not all three, of these trends will fare better over the long term. All organizations need to enable a more efficient workforce and invest in security and innovation around revenue-generating initiatives, whether during a recession or emerging from one, and all of these initiatives are powered by identity. Remember that Okta was founded during a downturn. Over the past several months, how many companies have you heard talk about increasing efficiency? Okta has always enabled organizations to do more with less. And in this new environment, where business leaders are striving for increased efficiency, Okta is well positioned to advance our leadership position in a market that continues to move toward us. I’ll dive into a deeper review of the quarter and finish with some comments to wrap up FY23. The two Cloud, one Platform approach that we introduced to the market mid last year, the Workforce Identity Cloud and the Customer Identity Cloud has really hit the mark and continues to be well received by our customers and partners. Our go-to-market team has enthusiastically embraced the structure, and we continue to see an upward trend line in the number of sales reps that have closed Customer Identity Cloud deals over the past four quarters. Just last week, we had our annual sales kickoff summit. The energy at the event was fantastic and the team is highly motivated to keep the momentum going. Turning to our Q4 results. We added 550 new customers in the quarter, bringing our total customer base to 17,600, representing growth of 17%. New customer growth is an area where we believe the macroeconomic environment is affecting our business. Conversely, Brett will cover the continued strength we’re experiencing with our upsell, cross-sell business with existing customers. 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 Sonos, Hewlett Packard Enterprise, and MassMutual. In Q4, we added 190 customers with $100,000-plus ACV. Our total base of $100,000-plus ACV customers now stands at 3,930 and grew 27%. Here are just a few notable examples of customer wins and upsells in Q4, which come from a wide range of industries. OpenAI, the company powering ChatGPT was a great Customer Identity Cloud win this quarter. With the increasing popularity of its cutting-edge AI technology, the Company looked to Okta’s Customer Identity Cloud to support authentication for the rapid influx of people interested in using the tool. Having utilized Customer Identity Cloud for authentication as a self-service customer, OpenAI’s developers were able to bolster its Customer Identity needs, thanks to Okta’s ease-of-use, reliability and security. A global 2,000 agriculture and home improvement supply chain company was a great Workforce Identity Cloud win this quarter. The company selected Okta for its breadth of integrations, partnerships and technology roadmap alignment. Okta will provide secure access for its 40,000 employees while providing the company with increased automation to reduce administrative overhead. A Fortune 100 insurance company was an exciting Workforce Identity Cloud upsell this quarter. The company selected Okta’s Customer Identity solution last year to reduce complexity associated with its homegrown identity solution and free up developers’ time to focus on business differentiating projects. With this upsell, the company expanded its investment with Okta to replace its incumbent on-prem workforce technology and eliminate the friction in the end-user experience. We continue to see strong demand for Okta Identity Governance or OIG, as our customers are tapping into the power of Okta’s unified platform to improve their overall security posture and remove identity silos. This helps our customers gain better visibility across their identity stacks and implement a governance solution with faster time to value and cost reductions. It’s still very early days with OIG as it just became globally available in early December. We are seeing a lot of interest across various business segments and verticals from organizations like Notion, the upstart productivity company, to NOV, a Fortune 1000 energy manufacturing company. NOV was a great OIG upsell this quarter. They had been leveraging Okta Workforce Identity Cloud products since 2020 and were looking for a product that would satisfy their regulatory reporting obligations. Since they had already implemented Okta Workflows, OIG was a natural step for them. Reflecting back on FY23, we accomplished a tremendous amount. For example, revenue increased by 43%. RPO hit $3 billion. We added 2,600 customers. We added over 800 customers with an ACV of $100,000 or more. We expanded our portfolio of products, including Okta Identity Governance. And we made tremendous progress on the ESG front, including setting validated science-based targets for Scope 1, 2 and 3 emissions reductions. FY23 was a year of challenges, learnings, action and change. Our vision, purpose, opportunity and everything we do is grounded in what we make possible for customers. Identity isn’t just part of an organization’s infrastructure, it’s a strategic component. And Okta isn’t just a technology vendor, we’re a strategic partner. We’re a stronger company going into FY24 with deeper relationships with our customers and an expanding product portfolio. As we go forward into FY24, organizational leaders around the world are looking for ways to become more efficient in today’s environment, and we’ve never been so confident in our ability to help our customers create more efficiencies for both their workforce and their Customer Identity solutions. Okta too has taken several actions to create more efficiencies within our own organization as we position the Company for our next phase of profitable growth. I also thought it would be helpful to share a few of Okta’s top strategic priorities for FY24. These are shared across the entire organization to align our execution with our broader company strategy. Keep in mind, these are multiyear horizons. The first priority is winning the Customer Identity market. We’ve made tremendous progress in CIAM, but in many respects, we are still just getting started on what we believe is a $30 billion market opportunity. Second, take Workforce Identity to the next level. We’ve done well to establish our clear market leadership over the past 14 years with the broadest independent and neutral identity platform. Consistent with our core value of continuous innovation, we’re pushing to advance our leadership position in the $50 billion workforce market. And third, scale Okta to support durable growth. This includes increasing automation throughout the organization and expanding our international presence in lower-cost geographies, both of which have margin benefits. Scaling for durable growth also includes hardening our own security infrastructure. Of course, underpinning our strategy continues to be our vision to free everyone to safely use any technology. To wrap things up, we’re pleased with our finish to FY23 and believe we’re positioned for profitable growth going into FY24 and beyond. I want to thank the entire Okta team for their tireless work and a special thank you to our customers and partners who place their trust in us every day. Before I turn it over to Brett, I want to give a special thank you to our outgoing General Counsel, Jon Runyan. Jon has been a key adviser since Freddy and I founded the Company, an executive team member over the past eight-plus years and will continue to serve as an adviser through mid-September. I’m very excited that Larissa Schwartz, our Deputy General Counsel, who has been a member of the Okta legal team for the past seven-plus years, is being promoted to Chief Legal Officer. Now here’s Brett to walk you through more of the Q4 financial details and our outlook for meaningfully improved profitability this year.

Thanks, Todd. And thank you, everyone, for joining us today. We’re pleased with the progress we’ve made over the past two quarters. We’ve taken action to significantly reduce our cost structure while maintaining key investments to fuel our future growth, and we’re confident that we have set the path for many years of profitable growth. I’ll review our fourth quarter results and our outlook for FY24. But first, I’ll start with some commentary on the macro environment and the restructuring we announced last month. With regards to the macro environment, similar to last quarter, we have not experienced a meaningful change in sales cycles or close rates. However, customers are requesting shorter-term contract lengths as they become more conservative with their long-term commitments. Additionally, our overall business was more weighted towards upsells versus new business across both SMB and enterprise. New pipeline generation was also more weighted towards upsells. And finally, we continue to experience minor FX headwinds on our top line metrics, which are incorporated into our reported numbers and outlook. With regards to the restructuring that we announced in early February, we’ve taken a GAAP charge of approximately $15 million in Q4. There were many functions in the organization that were affected with the biggest reductions within the go-to-market and G&A teams. The vast majority were located in the United States. Turning to our Q4 results. Total revenue growth for the fourth quarter was 33%, driven by a 34% increase in subscription revenue. Subscription revenue represented 97% of our total revenue. International revenue grew 32% and represented 21% of our total revenue. Looking at the ACV split between Workforce Identity and Customer Identity. Workforce ACV grew 30% and represented 61% of total ACV. Customer Identity ACV grew 35% and represented 39% of total ACV. Over the long term, we expect the mix to trend towards 50-50 with healthy growth in both businesses. RPO, or backlog, grew 12% and hit the $3 billion mark. Impacting total RPO growth is the general shortening of term lengths of recently signed contracts. Our average term length is just over 2.5 years. Current RPO, which represents subscription revenue we expect to recognize over the next 12 months, grew 25% to $1.68 billion. We view current RPO as a better metric to assess our quarterly performance relative to calculated billings, which as we’ve noted, can be noisy due to fluctuations in invoice timing and duration. Calculated billings grew 18% and current calculated billings grew 19%. As we’ve noted previously, this is the final time we’ll be referencing billings performance in our formal commentary. Turning to retention. Our dollar-based net retention rate for the trailing 12-month period remains strong at 120%. The sequential downtick in the net retention rate was driven primarily by a decrease in the upsell rate with our SMB customers. 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 remain very healthy in the mid-90% range. 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. The better-than-expected profitability is primarily due to the combination of revenue overperformance and better-than-expected outcomes from spend efficiency measures. Total headcount at the end of Q4 was just over 6,000, which is flat quarter-over-quarter. That number does not reflect the restructuring action, which will be incorporated in next quarter’s headcount total. We will continue to hire in critical areas and backfill open positions. Moving to cash flow. Q4 free cash flow was seasonally strong, producing a record $72 million. We ended the year with a strong balance sheet anchored by nearly $2.58 billion in cash, cash equivalents and short-term investments. Overall, we’re pleased with our Q4 results. Now, let’s turn to our business outlook for Q1 and FY24. While we’ve been pleased with improved execution over the past two quarters, our projections continue to factor in the uncertainties of the macroeconomic environment. We’re also factoring in the go-to-market leadership transition and the challenges we faced in the first half of last year. We’re taking several actions to reduce our cost structure and increase our efficiency as an organization, including reducing headcount by 5%, rationalizing our facilities’ footprint, narrowing our R&D scope to focus on core product development, eliminating redundant software tools, increasing systems and process automation, and we’re focusing on building operations in lower-cost regions in Europe and Asia Pacific that have fantastic talent bases. With that as a backdrop, for the first quarter of FY24, we expect total revenue of $509 million to $511 million, representing growth of 23%; current RPO of $1.67 billion to $1.685 billion, representing growth of 19%; non-GAAP operating income of $18 million to $20 million; and non-GAAP diluted net income per share of $0.11 to $0.12, assuming diluted weighted average shares outstanding of approximately 178 million. For FY24, we are raising our revenue outlook by approximately $25 million at the high end. We now expect revenue of $2.155 billion to $2.170 billion, representing growth of 16% to 17%. With our continued expense control we plan to achieve non-GAAP profitability for the full year. We expect non-GAAP operating income of $136 million to $145 million, which yields a non-GAAP operating margin of approximately 6% to 7%. Non-GAAP net income per share of $0.74 to $0.79, assuming diluted weighted average shares outstanding of approximately 180 million. We expect free cash flow margin for FY24 to improve to approximately 10%. This includes a cash impact of approximately $15 million related to the organizational restructuring, which will be paid out in Q1. Lastly, I want to provide a few comments to help with modeling Okta. Keep in mind that when viewing our Q1 projections versus our Q4 results, Q1 has three fewer days, which impacts revenue and gross margins. We expect non-GAAP operating margin to build as we progress through the fiscal year. Similar to years past, Q2 is expected to be the seasonal low for cash flow. We are applying a static 26% non-GAAP effective tax rate, now that we expect to be non-GAAP profitable for the foreseeable future. Partially offsetting the higher effective tax rate is a significant increase in interest income related to higher interest rates we expect on our cash and investments. We are also continuing to reduce our stock-based compensation. SBC as a percentage of revenue decreased by 7 percentage points in FY23, but remains elevated largely due to the Auth0 acquisition. We expect SBC to be in the low 30% range of revenue in FY24. The improvement is being driven by slower hiring, decreased grant sizes and as the SBC impacts from the Auth0 acquisition begins to roll off. We remain committed to further reducing SBC and dilution over the long term. To wrap things up, I’ll reiterate that we’re pleased with the progress we’ve made over the past two quarters. Our business performance has improved, but we recognize there’s still more work to do. We’ve significantly reduced our cost structure while maintaining key investments to fuel our future growth, and we’re confident that we’ve positioned the company for many years of profitable growth. With that, I’ll turn it back to Dave for Q&A. Dave?

Great. Thanks, Brett. I see that there’s quite a few hands raised already, so I’ll take them in order. And in the interest of time, please limit yourself to one question, so that we can get to everyone. And then, you’re welcome to queue back up with additional questions. So, with that, let’s take the first question from Rob Owens at Piper. Rob?

Thanks, Dave, and good afternoon, guys. Curious how you’re thinking about DBNRR as we move throughout the year. You’ve seen some pressure there, obviously, and I think you addressed it in the script. But especially as we contemplate OIG ramping some of the cross-sell activity that you’re seeing on the CIAM front, can you put some guardrails around where this could be as we move throughout the year? Thanks.

Hey Rob, thanks for the question. It’s nice to see everyone. We’re pleased with the results. And I think one of the themes to the results are the foundation of the business are very solid. And the core of that solidity is the customer success. And in that net retention rate, the foundation is the gross retention rate, which remains healthy and consistent in the mid-90% range. I think the change you’ve seen in the rate sequentially and projecting forward, the change will largely be because of just the amount of upsells. And as there are headwinds on the business and the amount of upsells change, that’s going to be the changing factor. We have the macroeconomic impact in the business overall that we’re trying to account for going forward. But we also have a lot of positives, like you mentioned. We have really record performance in terms of cross-sells in the quarter we just finished. And we expect with our improved execution on the Customer Identity side that will continue. And then we have this product, OIG, which is early, and it’s only been generally available since December, but it’s got all the markings of a hit. It’s exceeded our expectations, and we’re going to get one full year in market with that in FY24. So, we’re super excited about that.

Yes. I would just add to that. Rob, thanks for that question. I think to put a finer point on what Todd was saying, I totally agree with everything he’s saying around gross retentions. We think it’s going to travel in that mid-90% range that we’ve seen be very stable for a while now. I think we are going to see a little bit in that net upsell rate you were describing. I think we will see a little bit of headwind for the reasons you were saying around macro. And then I think the other one is around we didn’t close as many new customers in FY23 as we would have liked, which means there is less customers to upsell into in FY24. So I do think we see a little bit of a headwind on that net retention rate as we travel through FY24.

Let’s go to Gray Powell with BTIG.

Okay, great. Thank you for taking the questions. And really good results here. I was happy to see the guidance. One thing I want to make sure that I understood correctly. Just looking at the Q1 revenue guidance, it implies that revenue is flat from Q4. I understand the commentary around three less calendar days, seasonality around the macro, but it just seems really conservative. Anything else that we should be thinking of that’s going on in Q1? And then, just your confidence level in the ramp needed to hit the full year guide in terms of sequential growth.

Yes. Gray, it’s a good question. Yes, it really has more to do with that 89 days versus 92 days. Just as a reminder for everybody, we recognize revenue on a daily basis. So, at these dollar levels and these growth rates it does become material for us. In terms of the top line guide for the full fiscal year, we’re confident. Obviously, we’re taking a prudent approach given we’re still very early in the year. We’ve talked about the macro headwinds. And we’ve talked about, obviously, go-to-market leadership transition and then also some of the challenges we had last year. We’re not saying job done. Despite the fact that we’ve had two good quarters in a row for both attrition in the field and also participation of the field in Customer Identity deals, we’re excited about the momentum, but I also want to be thoughtful given how early we are in the fiscal year.

Yes. And I think that if you — when we first gave that top line guide three months ago, from that point until now, our confidence in the ability to execute this year has, I would say, increased. So, I think we’re turning in the right direction along with some of the positives in the business we’ve talked about.

That’s perfect. Nice work. Thank you very much.

Thanks. Nice to speak with you.

Next, we’ll go to Hamza Fodderwala at Morgan Stanley.

Todd, congrats on the OpenAI win.

Thanks, Hamza.

I wanted to ask, I mean you’ve been running effectively the sales force now for about a quarter. I was wondering if you could give us any finer points around what the sales execution is looking like from an attrition standpoint, in particular. I looked at the Customer Identity growth at 35%, it’s slowed down a bit, obviously, given the execution. So, I imagine you can’t be satisfied with that just given the opportunity ahead of you in Customer Identity. So, I’m curious, when that sort of starts to stabilize?

In general, I’m the type of person that’s not satisfied with a lot of things. So yes, I think we can — across the business, I think we can always improve. In terms of the go-to-market organization, it’s obviously a very important part of Okta. There have been a bunch of changes there. So, let me just level set the group. First of all, Susan, our outgoing President of go-to-market, was here through the end of February. So her and Steve Rowland, who’s also leaving, cranked it out. And obviously, you can see the numbers. They did a good job and their teams did a good job delivering in Q4. Now, with them leaving, we have interim leaders on the Chief Revenue Officer side stepping up. Jon Addison has been at Okta a couple of years now, has been running Europe, and he is in the interim CRO role. Now, we’re looking — and I’m spending a ton of time looking for the next great go-to-market President over all of it. So until we find that person, I’ll obviously be more involved working with Jon. But we’ve also collapsed and focused the organization so that marketing, customer success, services and everything is under one leader, Okta veteran, Eric Kelleher. So, we have two go-to-market leaders running go-to-market with me, the leader over them. Then as part of that change, we’re also moving marketing under Eric, that’s led to another change, which is our Chief Marketing Officer is going to be leaving Okta. So, that’s a change as well. But we have this consolidated team under Jon and under Eric that has a deep bench. There’s a lot of people that are psyched up. They’ve delivered Q4 and Q3. The trends are getting better in terms of number of reps doing CIC deals, which is very positive. The attrition, which is a key metric we’ve talked about for the last couple of quarters, is we’ve had really two positive quarters in terms of low rep attrition, which is great. We just got back from Las Vegas, where we had an amazing sales kickoff and reiterated the product positioning and the messaging and got everyone trained for the year. So, there’s a lot of very positive things happening there. And I’m very confident in this team to go out and have a great FY24.

Next, we have Jonathan Ho at William Blair.

Congratulations on the strong quarter and the operating margin guide. I just want to drive a little bit deeper into the operating margin and guidance and sort of take a look at the $15 million cost restructuring actions. How is that going to translate into cost savings for 2024? And how do we think about sort of that balance going forward between showing reacceleration in growth as well as the operating leverage? Thank you.

Yes. I would say if you look at the non-GAAP operating margin for FY24 or the free cash flow margin for FY24, there are about a seven-point increase relative to what we just produced in FY23. And it’s not really just a single action that’s producing that. You brought up the restructuring action. It’s really a tale of multiple actions that we’ve been taking over the last few quarters. If you remember, the last couple of quarters, I’ve talked about slowing down hiring. I’ve talked about real estate rationalization, cost efficiency measures like software rationalization. And you see the results in Q3 and Q4, you see pretty large beats on our expectations for both non-GAAP operating margin in both of those quarters. So, it really was — it’s been a plan that we’ve been working for a while now to set ourselves up to have that cost envelope as we enter into FY24. But we don’t think we’re going to be done in FY24. We’re not going to be okay, 6% to 7%, we’re all set and done and we’re going to go on our merry way. It’s all about continuing to scale this business to be able to profitably grow this business. And that’s why you heard about one of our three strategic initiatives that Todd talked about a few minutes ago was around scaling and automating the business. So, we want to be able to profitably grow this business, not just in ‘24, but also ‘25 and beyond. So, that’s one thing to keep in mind, Jonathan. But also just that balancing of growth and profitability. One of the things that we did in this year’s budget is really focus our investments for those three strategic initiatives that we talked about around solidifying our leadership in Workforce Identity, capturing more of the market in Customer Identity, and then obviously, the scale and automation I just talked about. Those are about how can we focus our investments, make us grow as fast as possible, but doing it in a responsible way from a profitability perspective. And so, we’re going to continue to balance growth and margin just like we’ve done for years now, and we’re going to continue to do it as we move forward.

Next up, we have Ittai Kidron from Oppenheimer.

Thanks, Dave. And congrats, guys Great quarter. I guess a couple of small ones for me. One on comp, starting the New Year, are there any changes to the comp plan if you can go into that? And then, Todd, a little bit more to you. I want to dig into OIG, maybe you could give us a little bit more color on that. Clearly, you’re off to a solid start there. But maybe you can give us a little bit of a flavor. If I’m a $100,000 customer, what is the percent uptake in deal sizes that could come if I adopt OIG on a broad basis? Number one. Number two, are deployments mostly greenfield? Do you find that you’re just entering into open white space or they’re displacement-driven? Any color you can give on the traction there would be great.

On the comp, the comp plans and the comp changes, the one thing that is very positive for the go-to-market team and for Okta’s plan for this year going into FY24 is that relative to last year, there are far, far fewer changes in terms of product mix that the sales rep have to be able to sell, territory changes, org structures. It’s nothing like last year. Last year, there was a lot of change, which I think was, in retrospect, pretty hard to navigate through. We’ve kept things much more consistent this year, whether it’s structure of the comp plans, whether it’s territory changes, whether it’s organizational changes. There obviously are some, but we’ve kept things largely the same and focused, and so that’s really good for continuity there. We’ve also tried to keep it simple. I think a lot of companies try to overly make comp plans complex, and sometimes it’s better to keep it simple. Customer Identity, Workforce Identity, make customers successful and so forth. So I think that’s part of why we’re confident in the year. It’s a big contributor in terms of continuity there. On OIG specifically, the way to think about it is it’s a natural adjacency for us. If you think about access management and what it does is it gives you profiles and roles and gives you access to resources, and it does that in real time and checks it as you log in and gives you single sign-on, etc. So, it’s a natural extension to have the system that reports on who can go where, and it does exception reporting and compliance reporting on who can go where and make sure the right people are going to the right place. It’s tightly coupled to that system. So it’s a natural adjacency. It’s a natural upsell. I think in the history of identity, the reason that governance grew up independently of access management is basically because there was no Okta. There was no independent and neutral leader of access management, so companies had to create these governance solutions in an unnatural way, which is off to the side. I think it’s a natural thing to bring them together. The success of the product has actually been pretty interesting. The IGA solutions out there tend to be sold to larger enterprises and be more complex implementations. And so, we thought that our product would start more at the smaller companies and be bottoms up. And we’ve seen a much more balanced enterprise success and mid-market success than we expected. And to your question about $100,000, the simple way to think about it is if it’s a $100,000 customer, it might be a $30,000 to $50,000 upsell for the governance solution. And that I think will increase as the product gets more mature and our selling motion gets more mature. In the examples I gave on the call, Notion is a relatively small company, a great innovative company, relatively small. NOV is a large Fortune 1000 energy company. It’s this combination of Okta access management and Okta Identity Governance that is very impactful. The last thing is whether it’s greenfield versus replacement: the majority is greenfield. But replacements have exceeded our expectations. We have seen some of those, not many, but some. And then the RFP wins have exceeded our expectations. We have a lot of work to do, but it’s off to a really good start.

That’s great. Good luck.

Next, let’s go to Adam Tindle at Raymond James.

Todd, I wanted to acknowledge you’ve seen obviously significant improvement in profitability of the business, proving a lot of what the business can do. At the same time in the slides, you talk about how you’re so early in this opportunity based on this $80 billion market. So, I guess, more of a philosophical question at the end of the fiscal year to ask why is focusing on profit right now the right strategy, given we are seeing moderation or deceleration in the growth metrics concurrent with this. And if you’re trading off a little bit of growth for profit, what do you do with the $2.5 billion of cash on the balance sheet and more coming in? Thank you.

I think about it broadly in two buckets. One is the growth rate and the spend in sales and marketing, those things are very related. The more we spend in sales and marketing, the more we grow. That’s one bucket. So when you think about how we’re balancing growth rate with sales and marketing expense, there’s two factors. There’s the macroeconomic environment. We don’t — there’s a limit in terms of the growth rate with the macro economy. Going forward, we’re being prudent about that limit. So that gates our investment in sales and marketing and our growth rate. The second factor is some of the execution challenges we had last year. We had a bunch of attrition, which brought down growth. It takes time to ramp back up, whether it’s hiring people and having them ramp, which translates into growth. So there are some factors there that we’re accounting for. The second bucket is efficiency and discipline in running the business. Like many companies, we lived through many years of low interest rates and an environment favoring growth at all costs. We need—and it’s healthy—to be more efficient and make sure we’re investing in the highest ROI initiatives. We’re not spreading ourselves too thinly, both from the go-to-market side and the R&D side, and other areas of G&A. That’s part of why we reduced headcount about a month ago. It’s also part of the third pillar of our strategy: scale Okta for durable growth and build efficiency now that will be impactful as we scale to much larger revenue levels. Regarding cash on the balance sheet, part of it was raised as a margin of safety. Now that we’re turning toward profitability and generating cash, the balance gives us optionality for M&A at the right point to expand the portfolio in strategic, synergistic ways, typically smaller tuck-ins. It’s a good option to have, and we’re always looking at managing the balance sheet overall.

Yes. I would just add, Adam, the additional cash flow that we’re going to generate this year gives us even more optionality as we think about capital allocation for remaining converts and what to do with them. It’s a win-win for us to become a more efficient company while balancing growth.

A lot of this goes back to execution and the fundamentals of the product. We had a meeting with a CIO of a large global media company and they told me identity is one of their top three priorities this year. Despite macroeconomic and structural industry issues, they’re prioritizing identity. That is invaluable when you’re building a company. That customer focus and mindshare gives a foundation to work through short-term issues for long-term success.

Okay. Let’s go to Gabriela Borges at Goldman.

I wanted to follow up on the comments on the growth and profitability. And I can appreciate it’s a little bit too early for normalized long-term targets. I’d love to get a little bit of a preliminary view — how are you thinking about what does the normalized growth profile of this business look like minus the macro of what’s happening right now? Thank you.

Obviously, we’re going to balance growth and profitability as we go forward. Something we’ve done for years. Our goal is to profitably grow the business. If there are investments that stoke growth and are efficient, we’ll make them. We want to ensure investments are high probability of payoff and high ROI. I can’t give you an exact normalized growth number right now, but we will continue to balance growth and margin over time and expand margins beyond ‘24 while growing responsibly.

Gabriela, thanks for the question. One way I think about it is our strategy to be the one-stop shop for identity. There is significant value to customers in having an independent, neutral partner that gives them choice and avoids lock-in. To do that we need balance across Workforce Identity and Customer Identity and get to more of a 50-50 mix with healthy growth in both. When you add the TAMs together and we execute well, it can be a healthy grower and profitable for a long time.

Next up is Rudy Kessinger at D.A. Davidson.

I guess I’m curious maybe kind of related to Gabriela’s question. The restructuring, the cuts you made in S&M, I’m curious how that impacts your capacity to grow? And I guess maybe the question is, if your execution improves, maybe the macro impacts on is severe and maybe you get better traction with IGA, what kind of growth do you have the capacity to deliver if things go right? Is 20% to 25% completely out of the question, or is something like that doable?

Okay. I can’t give you an exact number, Rudy. But when we thought about the plan, we were careful not to sacrifice capacity build for FY25. The capacity we have for FY24 is the capacity we’re going to have. We could hire some folks in the first half and have a small amount of capacity built for the second half. In reality, we’re making sure we have capacity for FY24 and also set up for FY25. We’ve been thoughtful about how we’re thinking about capacity build for both fiscal years so we’re not getting over our skis in one period versus the other.

More specifically, the headcount growth in the second half of the year drives the capacity for the following year. People you onboard by the end of Q4 will drive growth next year.

Let’s go to Matt Hedberg at RBC.

I’ll offer my congrats as well. Todd, maybe a higher-level question. During COVID, we heard a lot of customers that wanted to just stay put on a legacy identity provider. Now, there were a few years removed, a lot of the partners we talked to think there could be a more material replacement opportunity from the legacy side. Can you talk about that as like a long-term catalyst within maybe identity governance and PAM, less so CIAM, obviously, more greenfield opportunity?

It’s a great question. I think the biggest opportunity is the mainstream company deciding to do identity and security from the cloud. That’s still not fully mainstream. Some companies are building their own workforce identity or using legacy vendors. This transition to cloud is a major opportunity for us. The cloud benefits we provide — integration and flexibility — are advantages. Another factor is that buyers are smart and economical: if they can get more functionality from one vendor, whether it’s access plus governance plus privilege, that helps. Microsoft is a competitor, but when they tell customers to use cloud identity, that helps make the market more mainstream, which is beneficial for us. The mainstream migration to cloud for workforce identity is a large long-term opportunity, and we’re well positioned to lead as an independent neutral provider with breadth of integrations and best-of-breed choices.

Okay. Next up is Brian Colley at Stephens.

So last quarter, you talked about the macro impacting the SMB market in the U.S. most acutely. I mean, have you seen any of that macro impact start to bleed in — impact larger companies or customers in other geographies as well, or is it still mostly limited to U.S. SMB?

Yes, Brian. It’s mainly U.S. at this point from our perspective, at least what we can see in the quantitative data. In terms of enterprise, we have seen the new business versus upsell mix change in both SMB and enterprise, more so in SMB. So it is starting to leak a little into enterprise. In international, we haven’t seen it as much quantitatively. Qualitatively, sales leadership across regions has heard about tighter budgets and project delays. So we’ve got both quantitative and qualitative signals indicating the macro has started to hit us in the last couple of quarters.

One interesting dynamic is that large enterprise deals have been doing well. So while there may be some macro headwinds in enterprise, it’s being counterbalanced by big deals closing. We had a large upsell with a well-known insurance company in the quarter, which is an example. So in aggregate, the enterprise business may be balanced by those wins.

Let’s go to Shaul Eyal from TD Cowen.

Congrats on the ongoing notable improvement. Todd or Brett, the business remains on solid fundamentals, as Todd indicated. We’re seeing the macro impacting new logos predominantly. As you think about the fiscal ‘24 guidance, how should we be thinking about the new logos in that context?

I would say that’s probably where the headwind will exist. We want to grow both new business and upsells as fast as possible. If there’s a headwind, it is more likely to happen with new logos in FY24. We’d love for that not to happen, but given the macro, customers are more likely to engage with vendors they trust. Our strong gross retention and upsell performance reflect customer loyalty. We’re actively selling both new business and upsells, but we remain prudent in our expectations.

Great. Next up is Joe Gallo at Jefferies.

I really appreciate the question. And I love that you laid out your top priorities for fiscal ‘24. Todd, can you just double click on what’s needed to win the CIAM market? Is there a technical moat you need to widen, or is it more go-to-market focused?

I’d say the primary factor is go-to-market focus, though it’s broader: product, engineering, product marketing, demand generation — the whole end-to-end needs to mature. CIAM is a big opportunity and is related but distinct from other parts of identity, requiring the Company to align and focus. This includes clarity of product portfolio, enablement, clear messaging, and all the systems to execute. There are gray areas about category boundaries and how CIAM overlaps with customer data or marketing functions. Our platform approach with marketplace integrations for fraud detection, identity verification, and more is a strength. It provides customer value and allows us to help define the market as it matures. We are the leader by a wide margin, and it’s an exciting place to be.

We’ll go to Adam Borg at Stifel.

Maybe just for Todd on the macro. Obviously, we talked a little bit about some of the headcount reduction that you guys made, and we’ll be hearing more broadly about headcount reductions across the industries. Maybe just remind us how correlated Okta’s top line growth is to headcount changes in your installed base overall.

First, our products are licensed on recurring subscriptions, often multi-year. The average term is over 2.5 years, so these aren’t month-to-month that can be rapidly downsized. They’re licensed on a number of employees for workforce or monthly active users for CIAM. So when contracts come up for renewal, fewer employees or users can reduce revenue. However, the contract duration provides some insulation. Additionally, when customers do have fewer users, we often offset that with selling more products — for example, upselling Workflows, Lifecycle Management, or advanced MFA — which can keep or grow the contract value. Those two dimensions — contract duration and product portfolio — help insulate our gross retention and NRR. Of course, these dynamics will influence trends over time, but they provide meaningful resilience.

One other factor is the diversity of our customer base. We don’t only sell to tech companies. If you look at our industry mix, no industry is greater than 10% of our total ACV. While there have been layoffs in tech, other parts of the economy haven’t been as affected. That industry diversity is one reason identity is such a universal problem across sectors and company sizes.

All right. Let’s go to Sterling Auty at MoffettNathanson.

Hey guys. This is Billy Fitzsimmons on for Sterling Auty. I’ll keep it quick for you. You guys talked about how macro compared for from Q4 to Q3. But I’m curious, how did Q4 2023 end of quarter close rates compare to Q4 a year ago, back in 2022?

Close rates have been fairly similar across that time frame. Sales cycles and sales duration haven’t changed either. When we talk about the macro, we’re talking about factors like new business versus upsell mix, contract duration, and qualitative feedback from sales leadership. But close rates themselves haven’t shifted materially.

Okay. Next up is Wolfe Research.

This is Patrick on from Wolfe. Similar vein to the last question. Now that you’re two months into the year and selling into 2023 budgets, what changes have you noticed, if any, in customer budget dynamics, both in general and specifically with regard to the priority of identity security within the budgets? Thanks.

We’re only a month into our fiscal year, so it’s early to get a full read. We haven’t noticed a material change yet. Our fiscal year starts Feb 1. We’re confident in our ability to execute the plan for the year, and from conversations at the sales kickoff, the field is confident and trained for their plans. We may need a few more months to get a more definitive look at customer buying behavior because customers themselves are still sizing things up in the current macro environment.

Great. Let’s go to Eric Heath at KeyBanc.

Great. Thanks, Dave. And good to see the strong results here, Brett and Todd. So, Brett, I guess two questions for you just on the margins. If you look at subscription gross margins, it’s been improving quarter-over-quarter for a handful of quarters now. Just curious, what’s driving that improvement? And how to think about that going forward? That’s one. And then two, if I look back to Okta and the pre-Auth0 era, I saw that your free cash flow margins were typically about 10 points higher than your EBIT margins were, I think your guidance for this year calls for about a 6-point delta there. So just talk about any dynamics that might be happening on that front as well.

In terms of gross margin improvement, it’s driven by becoming more efficient across the board — slowing hiring and cost-efficiency measures. You saw the impact in the second half of the year. We expect subscription gross margins to travel roughly in the same range in FY24 as in FY23. Regarding the delta between free cash flow margin and operating margin, the compression is partly a function of the business growth rate and cash collection timing. If billings grow faster, cash collection accelerates, which can widen that delta. With a slightly slower growth profile, you’ll see a moderate compression between free cash flow and operating margin.

Okay. We’re running up on the hour, but I think we can go a little bit over time here and try to get as many as we can. We’ll go to Peter Weed at Bernstein.

Thank you. And congratulations on the continued momentum in the business. I just want to make sure everyone knows that we would go over even if the results weren’t strong. I think you clarified saying, at the beginning of this year, whether it’s January or February, you’re not seeing any new deterioration relative to what was seen in the second half of last year. In those quarters, we ended up seeing quarter-over-quarter growth rates of about 6% in some periods. Yet, if I look at the guidance for this upcoming year, if I take the quarter four results and annualize that, you’re talking about for an entire year having a 6% growth rate relative to just annualizing the fourth quarter. When you set that type of guide, what are you seeing that could be a credible reason why what has been seen in the second half of last year and what you continue to see in January and February might fall apart and result in such a huge deceleration relative to the quarter-over-quarter path that’s been going on without accelerated problems?

Keep in mind, the second half of the year revenue growth rates reflect prior period performance because of how revenue recognition works. Going forward, we’re being thoughtful with guidance: factoring macro, go-to-market leadership changes, and not being overly aggressive on early expectations. We’re early in the fiscal year with 11 months left, and we want to be prudent about those factors.

Are you seeing specific things that worry you, like further deterioration in new customers relative to what we’re seeing? Sales pipelines look okay and SMBs may be bottoming. So is enterprise the worry? What keeps you up at night the most when you look forward? What should we watch for that would indicate something might be going on?

What keeps me up is the sum of the items we’ve already discussed: macro uncertainty, productivity in the field, and being thoughtful about the right actions to take. We do believe the macro could get worse, so we’re incorporating that prudence into our expectations.

Let’s go to Keith Bachman at BMO.

I’m going to ask a question for Todd. Could you talk about your win rates over the last one to two quarters and how those might have changed, in particular regarding categories you may want to highlight like SMB or large enterprise or CIAM versus Workforce? And, second, just to broaden out the go-to-market question, beyond comp plans are there territory redistributions or other changes in go-to-market strategy?

It’s a very insightful question because go-to-market is more than comp plans; it’s the sum of changes the team must adapt to. There aren’t many disruptive changes at the go-to-market strategy level. We ran the SKO recently; Jon Addison as interim CRO and Eric Kelleher emphasized priorities consistent with the company: win CIAM, execute on Workforce. Our win rates remain very healthy across the business, including Customer Identity where the decision often is buy versus build, and Workforce where migration to cloud is driving opportunities. We have technical specialists, but there is one sales team responsible for the customer relationship; they sell across our portfolio. That model has advantages for strategic relationships, though it requires strong training and enablement.

Okay. When you say healthy, have win rates changed much in the last one to two quarters?

No. They’ve been healthy for a long time.

Let’s go to Madeline Brooks at Bank of America.

Just a quick one. I wanted to get a sense of what an ideal split is for Okta between upsell and cross-sell and new business. And then additionally, on the new business side, over the last quarter, did you implement any discounting or further bundling?

In terms of discounting, discounting has been very consistent and hasn’t changed much. Regarding the mix, we want a higher proportion of new business than we currently have. We're too weighted towards upsells, and that’s an area of focus. Some of that mix is due to the macro, but we also need to get better at new business.

Another factor is rep ramp. New reps often sell to existing customers first because those are the easiest opportunities. So you’ll see improvement in new business as reps ramp and get more experience.

Can you remind us of the percentage breakout between them as it stands for the fourth quarter?

We don’t usually disclose that breakdown publicly. We focus on net retention, which was 120% for the trailing 12 months.

We’ll go to Brian Essex at JPMorgan.

If I could take one layer deeper on sales force organization: are you structured as a single sales team selling both Workforce and CIAM, or do you have more specialized teams? Do you envision shifting towards a platform approach? Are you seeing many multiproduct Workforce plus CIAM deals?

There is one sales team: a single rep owns the customer relationship and sells across our products, with technical specialists and presales support. The model is aligned with our strategy to be the strategic partner for identity. The sales rep is expected to engage multiple buying centers and sell the right solutions. There are advantages and challenges: it can be harder to train, but done well it results in larger strategic deals. We are also seeing multiproduct deals and cross-sell success between Customer Identity self-service and broader Okta offerings.

And those responsible for developers — is that separate or under the same team umbrella?

There is a dedicated team focused on the developer self-service motion that drives adoption of Customer Identity self-service. Once a self-service lead converts into a larger deal, it typically moves to the main sales team. The sales team benefits from those self-service leads, so we need to ensure reps are enabled to handle them.

Okay. Let’s go to Tez Koujalgi at Wedbush.

I have a question for Brett. Your guide implies about a 5% growth in OpEx for the quarter and for the year. Is that reflective of the sales capacity increase? Would your sales capacity increase at the same 5% rate?

Our sales capacity is designed to hit the FY24 bookings number and also set us up for FY25. We’re ensuring the right people are in the right segments and geos to go after opportunities this year and next. We’re being thoughtful about hiring and capacity so we have what we need for both fiscal years without overextending in a single period.

One quick follow-up. Your current RPO guide implies cRPO stepping down from Q4 to Q1. That’s unusual. Are you being conservative, or is there something seasonal happening with backlog?

At the top end, it implies roughly flat, but keep in mind Q4 is our seasonally biggest bookings quarter and Q1 is seasonally the smallest for bookings. With a slightly lower growth rate than in prior years, seasonality shows up differently. There’s nothing materially different in booking seasonality beyond that.

We’ll go to Patrick Colville at Scotiabank.

Thanks, guys. Congrats on a very solid set of results. Looking at your ACV disclosure, workforce has held up robustly over the trailing 24 months, whereas the deltas have been in the customer segment. My two-part question: one, some think workforce is maturing — what is the Street missing? And two, what would it take in the customer segment for that growth to start plateauing or increasing?

We’re excited about both businesses. I think the Street underestimates the opportunity in Workforce. There’s a narrative that Workforce is mature; I disagree. Workforce remains a significant opportunity as mainstream companies move to cloud-based identity. Customer Identity should still be growing faster given its smaller base, and we can improve execution there. We’ve been investing in execution and are confident Customer Identity will accelerate. Our strategy is to be the independent, neutral identity partner across both markets, and success in both is critical to our long-term opportunity.

We’ll take the last question from Fatima Boolani at Citi. Apologies to Carson, Fred and Brad. We’ll get to you next time.

Ladies last in 2023. Thanks for taking my question. Brett, I’ll make it quick. Between you and Todd, you quantified the contract duration and some of the dynamics there. But I’m wondering what you’re assuming in your guidance as it relates to contract duration with renewals. And as a related matter, are there any particularly large cohorts of renewals coming up that you’re being more cautious about due to shortened contract durations?

Good question. There’s no major cohort that’s wildly different from the rest. One benefit of longer-duration contracts is they spread renewal timing. We don’t have any particular cohort assumptions materially different in renewals. We expect gross retention to remain stable based on what teams are seeing in the business. Gross retention reflects the day-to-day value we deliver and is a consistent strength for us.

Okay. That’s the time we have today. Before we go, I want to let you know that we’ll be attending a couple of investor conferences this quarter. We’ll be at the Morgan Stanley conference in San Francisco next week on the 6th and the KeyBanc conference in San Francisco on the 7th, and we hope to see you at one of those events. And if you have any other follow-up questions, you can reach us at ir@okta.com. Thanks.