Earnings Call Transcript - OKTA Q3 2023

Dave Gennarelli, Senior Vice President of Investor Relations

Hi, everybody. Welcome to Okta's Third 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. 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 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 numerical 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?

Todd McKinnon, CEO

Thanks, Dave, and thank you, everyone, for joining us this afternoon. We're pleased with our Q3 results, but before reviewing them, I thought I'd provide an update on some of the progress with respect to the execution challenges we faced this year. Our confidence in our ability to further advance our leadership position in a very large market opportunity has not wavered. In fact, with all the great new products and functionality we announced at Okta in '22 earlier this month, we are more optimistic about our long-term prospects than ever. The action plan we initiated to stem attrition has delivered meaningful improvement over the last quarter. And while we're making progress with the execution challenges we outlined, we recognize that it will take several quarters to regain top line momentum in the business. Adding to the challenge is a global macro environment that we anticipate becoming worse before it improves. Brett will talk more specifically about what we're seeing in our business in terms of the macro environment and the more cautious approach we're taking to our business outlook. We view these issues as short-term in nature. We continue to focus on the long term while making the necessary adjustments to the business in the near term, including our commitment to meaningfully higher profitability and cash flow. One constant is that identity will remain a critically important element to organizations. At Oktane22 earlier this month, we officially unveiled our simplified two-cloud approach to the market: the Workforce Identity Cloud and the Customer Identity Cloud, two clouds, one Okta. This alignment has alleviated prior confusion in the field and sets us up to build on these two powerful pillars. More importantly, this strategy has been enthusiastically received by our go-to-market team, customers and partners. A great proof point is the upward trend line of the number of sales reps that have closed Customer Identity Cloud deals over the past three quarters. The feedback that I personally received in my conversations with dozens of partners and customers at Oktane was overwhelmingly positive, and we firmly believe that it will only get better with time. Identity matters to every part of an organization, which is why it's such a strategic decision. CIOs care about high-performing IT. CMOs care about conversion and customer acquisition. CTOs care about innovation. CFOs care about costs and efficiency. And CEOs and their boards care about all of these things. Identity can help address all of these. And having one account executive to speak to all of these decision makers will help drive a more cohesive identity strategy across the entire organization. Turning to our Q3 results. We added 650 new customers in the quarter, bringing our total customer base to over 17,000, representing growth of 22%. 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 S&P Global, McKesson and Zoom. In Q3, we added 215 customers with $100,000-plus ACV, our total base of $100,000-plus ACV customers now stands at over 3,700 and grew 32%. Here are just some notable examples of customer wins in Q3, which come from a wide range of industries. KeyBanc, a Fortune 500 financial services company, was a significant Okta Workforce new business win. They sought a cloud-based identity solution to help modernize their legacy systems, eliminate redundancies across tool sets and support their cloud-first initiatives. Okta's Workforce Identity Cloud will provide a unified identity system while also enhancing security through adaptive multi-factor authentication for KeyBanc's 25,000 globally distributed employees. A Fortune 100 global entertainment conglomerate was a big upsell this quarter. As a result of many acquisitions, the company has disparate identity providers that resulted in its employees having multiple different log-ins to access corporate apps resulting in friction, unpleasant user experiences and slowed business outcomes. Having leveraged Okta Workforce for several business units, this customer is now deploying Okta Workforce Identity Cloud to cover its more than 200,000 employees. Today, they are one of our largest customers and we believe there is significantly more opportunity to unlock as we partner with them going forward. We also closed our biggest Customer Identity Cloud deal ever with a multinational technology company. This company began using Okta back in 2019 to better connect with its business partners. The company then sought to consolidate onto a single identity provider while accelerating revenue, moving to the cloud and enhancing its security posture. The Okta Customer Identity Cloud will help increase security and harden authentication for this customer amid increased security concerns, while maintaining the ease of their end user experience. We also had another strong quarter with our public sector vertical. Year-to-date, our business with public sector organizations has increased over 65% with great wins across both, Workforce and Customer Identity Clouds. A great workforce upsell in Q3 was with a huge federal agency that will cover tens of thousands of their employees. The agency is modernizing its legacy on-prem identity technology. We see significantly more opportunity to expand our relationship with this agency and the even larger agency that it rolls up to. We also continue to have success with state and local agencies, as they replace legacy identity solutions for both, their employees and their citizens. In Q3 alone, cities like Birmingham, Charlotte, and Tampa all turned to Okta. We got to meet with some of these customers just a couple of weeks ago at Oktane22 in San Francisco. This was our 10th Oktane and we had nearly 10,000 registrants for the in-person and online event, a sold out partner event, and 9 million views of the live opening keynote stream. During the event, we announced numerous new products, features, and functionality that we believe will elevate Okta's market leadership position. In our strategy to build the primary cloud for identity, we now cover the most use cases of any company and help solve the most challenging identity issues that are being driven by the increasing deployment of cloud technology, the adoption of Zero Trust security and digital transformation projects. As Okta invests in both of our clouds and develops purpose-built functionality for app building, IT and security teams, we're also investing in connecting our clouds. This interoperability and connection have the ability to create greater value for customers and flexibility and security, and it can also become the catalyst for rapid innovation that drives business outcomes. The foundation of this interoperability is the Okta Identity platform where shared platform services and the Okta Integration Network reside. As the Okta Identity platform evolves, additional services will be available for customers, emphasizing capabilities that unlock even more use cases. Core to Okta's success is our independence and neutrality. The Okta Integration Network is the foundational technology that supports customer choice. It was innovative when we launched it 13 years ago, and it still offers the broadest selection and deepest integrations available. The success we're having with customers around the world is directly related to the Okta Integration Network. Monolithic platforms try to imitate the Okta Integration Network, but they can never replicate it. In fact, we're now taking the power of the Okta Integration Network to the next level with the power of our two clouds. By having both clouds together, we further enable this open ecosystem of choice. Workforce customers get the functionality they're craving, like seamless Zero Trust security, continuous authentication, and fine-grain authorization, all working out of the box. And for the SaaS builders, they know what enterprise readiness looks like because we define it in the Customer Identity Cloud and can plug into the Workforce customers around the world. All of this pushes the identity industry forward, resulting in more standardization that benefits everyone. And finally, I want to thank Susan St. Ledger for her dedication to Okta over the past two years. We wish her well in her retirement at the end of this fiscal year. We're initiating a search, but if a successor isn't in place at that time, I will step in to lead the go-to-market organization in the interim. Susan will stay on as an adviser to provide for a successful transition. We're looking forward to bringing on the next leader who will help Okta further penetrate the massive market opportunity. To wrap things up, we're pleased with our Q3 financial results. We've made some early progress to improve our execution challenges, but we recognize we still have a lot more work to do to regain our business momentum. I want to thank the entire Okta team for their tireless work. I also want to thank everyone who came out to support us at Oktane22. Now, here's Brett to walk you through more of Q3 financial details and our outlook for meaningfully increased profitability in Q4 and next year.

Brett Tighe, CFO

Thanks, Todd, and thank you, everyone, for joining us today. I'll start with some commentary on the macro environment and then get into our third quarter results, followed by our outlook. With regard to the macro environment, while we didn't experience a meaningful change in sales cycles, we are seeing signs that the environment has further weakened since we spoke last quarter. For example, in Q3, new pipeline is more weighted towards upsells, and we're experiencing some softening demand in the SMB market in North America. Turning to our Q3 results. Total revenue growth for the third quarter was 37%, driven by a 38% increase in subscription revenue. Subscription revenue represented 97% of our total revenue. International revenue grew 39% and represents 22% of our total revenue. We experienced minor FX headwinds, which are incorporated into our reported numbers. RPO or backlog grew 21% to $2.85 billion. Impacting total RPO growth is the general shortening of term lengths of recently signed contracts and an increase in public sector contracts, which generally have a one-year term length. 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 34% to $1.58 billion. 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 fluctuations in invoice timing and contract duration. Calculated billings and current calculated billings grew 37%. 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 in the mid-90% range, despite experiencing some sequential weakness in the SMB market. Before turning to expense items and profitability, I'll point out that I will be discussing non-GAAP results going forward. Looking at operating expenses. Total operating expenses for the quarter were lower than expected and allowed us to return to non-GAAP profitability with slightly positive operating income. The better-than-expected profitability is primarily due to the combination of the past four quarters. Moving to cash flow. Free cash flow was $6 million. We ended the third quarter with a strong balance sheet anchored by nearly $2.5 billion in cash, cash equivalents, and short-term investments. Overall, we're pleased with our Q3 results. Now, let's turn to our business outlook for Q4 and FY24. This outlook incorporates the execution challenges we experienced this year, which resulted in lower-than-expected capacity build as we move through the year. We're also taking a more cautious stance on the macro environment, which we believe will get worse before getting better. We expect to continue to benefit from the spend reduction measures we started implementing in Q3, including significantly reducing our hiring plans, rationalizing our facilities footprint, and applying greater overall financial discipline. The reductions will help us further improve our operating margins and profitability in Q4 and beyond. For the fourth quarter of FY23, we expect total revenue of $488 million to $490 million, representing growth of 27% to 28%. Current RPO of $1.63 billion to $1.64 billion, representing growth of 21%. Non-GAAP operating income of $15 million to $17 million, and non-GAAP diluted net income per share of $0.09 to $0.10, assuming diluted weighted average shares outstanding of approximately 175 million. For FY23, we are raising our revenue outlook by approximately $18 million at the high end. We now expect revenue of $1.836 billion to $1.838 billion, representing growth of 41%. We are raising our profitability outlook by approximately $66 million at the high end. We now expect non-GAAP operating loss of $41 million to $39 million; and non-GAAP net loss per share of $0.27 to $0.26, assuming weighted average shares outstanding of approximately 158 million. Lastly, I want to provide a few comments to help with modeling Okta. We're providing a non-GAAP fully diluted share count for Q4 because we expect to flip to positive non-GAAP net income for the quarter. We will continue to provide a basic share count for FY23 because of the net loss position for the full year. We expect Q4 to be our seasonally strongest quarter for free cash flow and expect free cash flow margin to be in the low double digits. We also expect free cash flow margin for FY23 to be in the low single digits. We are increasing our calculated billings outlook for FY23 by approximately $25 million to $2.065 billion to $2.075 billion, representing growth of 28% to 29% when viewed on a like-for-like basis or 20% to 21% on an as-reported basis. As we've noted throughout this year, this will be the final time we provide a billings outlook. While we are in the early phases of financial planning, we would also like to provide a preliminary view of FY24. With our continued focus on expense control, we are focused on achieving non-GAAP profitability for FY24 and an operating margin in the low-single-digits. We are also targeting a meaningful increase to free cash flow and free cash flow margin over FY23 and will provide more specific cash flow comments on our Q4 call. From a revenue perspective, we are factoring in the execution challenges we faced this year, the go-to-market leadership transition, and the growing uncertainties of the macroeconomic environment. We estimate total revenue to be in the range of $2.130 billion to $2.145 billion or growth of 16% to 17%. While we had initially planned on providing an update on our long-term targets, we believe it's prudent to wait and revisit this once we have increased visibility and confidence in the macro environment, new global field operations leadership in place, and have made more progress on the integration. To wrap things up, we're confident we have the right action plan 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 Gennarelli, Senior Vice President of Investor Relations

In the interest of time, please limit yourself to one question so that we can get to everyone. You’re welcome to queue back up with additional questions afterward. So with that, we'll take the first question from Matt Hedberg at RBC. Matt?

Matt Hedberg, Analyst

Congrats on the bounce back quarter here. Maybe, Brett, for you, on the revenue guide, thank you for that preliminary look, I think that's super helpful. Can you provide maybe some of the underlying inputs in that? How you're thinking about like customer adds, NRR, anything to kind of give us a little better sense of sort of how you came up with that? I think it was 16% to 17% growth.

Brett Tighe, CFO

Yes, absolutely. Todd McKinnon: Hey Matt, I know you asked Brett, but let me quickly share my thoughts before turning it over to Brett. First of all, we are very optimistic about the long-term opportunity. Identity is crucial for many aspects, including companies moving to the cloud, embracing technology, launching customer initiatives, and improving their security measures. So, as we discuss our business outlook for the fourth quarter and the upcoming year, there are some challenges we can address, but the long-term potential is very promising, and we are genuinely excited about what lies ahead. Yes, I can take it from here. Thanks, Todd. Before I discuss fiscal year 2024, let's connect it to our previous quarter's discussions. Last quarter, we addressed a few challenges: issues with integration, specifically regarding customer identity, attrition rates, and lastly, macroeconomic factors, which were less significant. Now, 90 days later, let's evaluate how these factors have progressed as they impact our guidance for next year. Regarding attrition, as mentioned earlier, we've seen significant improvement, but it’s just one quarter, so we remain cautiously optimistic until we observe a longer trend. For the integration of the Customer Identity Cloud, there's been early progress with more sales reps involved in customer identity deals. However, we are still being cautiously optimistic based on just one quarter of data. In terms of macroeconomic factors, we've noticed a notable worsening compared to our last discussion, and we anticipate further decline in this area. The fourth factor we are considering for our guidance is the transition in go-to-market leadership. When we compile all these elements, we expect revenue growth between 16% to 17%. It's important to note that we are still in the early stages of our financial planning process, with final numbers to be fleshed out in the next couple of months. I want to emphasize that for the first time we are also sharing margin expectations at this point for the upcoming fiscal year. Traditionally, we have only provided a preliminary revenue outlook. This time, we are also focusing on margins. Specifically, we anticipate low positive single-digit non-GAAP profitability, which would mark a significant improvement over fiscal year 2023. Indeed, if we compare our initial guidance for non-GAAP operating profit for fiscal year 2023 to where we are now, there's been over a $140 million improvement in just a few quarters. We aim to enhance margins further while prioritizing profitable growth in the coming years, alongside a meaningful boost in free cash flow margins. We will provide additional details during the Q4 earnings process.

Dave Gennarelli, Senior Vice President of Investor Relations

Let's go to Gray Powell at BTIG.

Gray Powell, Analyst

Thank you for taking my question. I wanted to follow up on Matt's inquiry and delve deeper into the revenue guidance. The projected growth of 16% to 17% appears quite conservative. I understand there’s considerable uncertainty, and I appreciate the early visibility you’re providing compared to many companies. Could you elaborate on how secure you believe that number is? Additionally, within that guidance, how should we view the growth between Workforce and Customer Identity? Thank you.

Todd McKinnon, CEO

Hey Gray, I think this is a good time to be very, very cautious, in my opinion. And you heard Brett's comments about the conservatism and the pragmatic approach we've taken to the forward outlook. There's something else that he didn't mention directly, which I think is important, which is, like every other company in the world, we are looking at our investments, particularly the investments around growth and really stack ranking them and saying, what are the most likely to have high ROI? And what should we double down on that we think is going to be the most productive? And some of the things that maybe in years past we would have embarked upon that the likelihood of a higher ROI isn't as high, we're not going to do those things. So, you're also seeing a focusing and prioritizing of the initiatives of the company and that means on margins less investment and also less opportunity for growth.

Gray Powell, Analyst

Got it. Okay. Thank you very much.

Todd McKinnon, CEO

Regarding Customer Identity and Workforce Identity, I recall that was part of your question as well. When we consider the macro situation and the likelihood of it worsening before improving, the impact on both business lines is fairly balanced. We observed a greater impact in the SMB segment for both areas. There are various factors at play; we’ve seen instances where the economic climate leads to careful budget scrutiny and delays in project initiation. Conversely, there are also cases where companies are motivated to consolidate and invest more aggressively due to a heightened focus on expense control and the desire to work with a single vendor. Predicting the outcome is challenging as the conservative economic and recessionary conditions can benefit some areas while negatively affecting others. This uncertainty is why we believe it is wise to be extremely cautious in our outlook.

Brett Tighe, CFO

Yes. I would add to that. I think from a macro perspective, like you heard me say a couple of minutes ago, I would probably be less focused on Customer Identity versus Workforce Identity. It'd probably be more along the lines of which segments they're in, right? We saw that softening of demand kind of in the small and medium-sized businesses in North America. On the flip side, you saw some really large customer wins in the quarter, actually a fair amount of them. We saw the greater than 100,000 number grow at a very healthy clip. So, it's kind of a tale of two worlds right now in terms of segments. That's probably where we're seeing the biggest differentiation rather than by product.

Gray Powell, Analyst

All right. That's really helpful. Congrats on the improved execution this quarter. Thanks.

Dave Gennarelli, Senior Vice President of Investor Relations

Let's go to Jonathan Ho with William Blair.

Jonathan Ho, Analyst

Can you maybe give us a little bit more color? As you start to think about this progress that you've made on the go-to-market and sales realignment improvements, maybe what were you most proud of in terms of accomplishments and maybe what is still a work-in-progress when it comes to that go-to-market side?

Todd McKinnon, CEO

I believe the clarity of our message has had the greatest impact. We began clarifying our message around four or five months ago, and we had a chance to showcase it at Oktane. The clear message is that we have Workforce Identity and Customer Identity, two top-notch offerings that are stronger together. This resonated well with our field organization, customers, and partners; everyone understands our strategy. They recognize that we are currently the leading independent neutral identity platform, and this positions us to solidify and expand that lead over time. This clarity has resulted in measurable improvements, such as a sequential increase in the number of sales representatives closing Customer Identity Cloud deals over the last three quarters, which is a positive indicator. The reduction in attrition is also encouraging. As we consider our outlook and adopt a cautious stance, it's important to note that the more time go-to-market personnel have, the better they become at understanding our products, recognizing customer challenges, and articulating our value propositions. Each opportunity enhances their strength and capability. Therefore, we need to provide our exceptional go-to-market team with more time and opportunities to succeed. With our clarified positioning, which had previously been somewhat ambiguous, they will now get the chance to engage more often and significantly boost their productivity in the future.

Dave Gennarelli, Senior Vice President of Investor Relations

Let's go to Hamza Fodderwala at Morgan Stanley.

Hamza Fodderwala, Analyst

Hey guys. Thanks for taking my question. And way to throw the kitchen sink on the guide. I wanted to talk a little bit about the profitability. So, you're going to be growing high teens next year. It sounds like there's still some capacity build that needs to take place because of the attrition this year. And there's probably going to be a little bit of a drag on sales force productivity. So, I'm just curious if you could put a finer point on how you're driving that incremental leverage in FY24?

Brett Tighe, CFO

I would say the focus shouldn't be on capacity build, but rather on productivity. As Todd mentioned, it's about maximizing the output of our more experienced representatives. A representative who has been with us for three years is significantly more productive than someone who has been here for nine months. While both are in training, the longer-tenured rep brings much greater productivity. Additionally, we're concentrating on improving productivity throughout the organization. We're still in the early stages of our planning for next year, but one of our main goals is to enhance automation and increase productivity not just in the field, but also within teams like R&D. This is a crucial way we anticipate margins will improve over time.

Dave Gennarelli, Senior Vice President of Investor Relations

Let's go to Rob Owens of Piper.

Rob Owens, Analyst

Todd, obviously, a lot of management turnover over the last six months. So at a high level, just address what's transpired? What's first in terms of your agenda as you rebuild this team?

Todd McKinnon, CEO

I believe the team is incredibly strong, and I am very pleased with them, especially Susan. I hold her in high regard and want to express my gratitude for her contributions. She is an outstanding person and executive. After 30 years in operational roles, she is retiring to focus on Board positions. She is currently on a Board and will likely join more in the future, and I am confident she will be an excellent Board member. Additionally, one of the reasons I feel this way is because of the impressive team she has built, which has a strong pool of talent ready to continue executing our strategy and vision. The entire team will perform exceptionally well. While it is always difficult to witness someone of Susan's caliber retire, we must move forward, and we will begin searching for her replacement, considering both internal and external candidates. Although finding someone of her caliber will be challenging, we will conduct a thorough search, and I am confident we will succeed.

Dave Gennarelli, Senior Vice President of Investor Relations

Let’s go to Joe Gallo at Jefferies.

Joe Gallo, Analyst

Hey guys. Thanks for the question. And I appreciate the comments on macro and prudence and baking in a worsening environment before it gets better. Maybe based on your conversations with customers, what is their viewpoint on cyber budgets in 2023 and when it can get better? Or is this malaise more of a long-term new normal? Thanks.

Todd McKinnon, CEO

Yes. As I mentioned earlier, the conversations we are having vary significantly by customer. Some customers, especially in the SMB segment, are postponing purchases or reassessing their needs. On the other hand, Q3 was one of our strongest quarters for large deals. For instance, a major entertainment conglomerate that has acquired several companies over the years, all of which were Okta customers, now recognizes the necessity of standardizing to advance their entire global organization. This transition unfolds over several years, driven by acquisitions, success, and consensus-building within the company. When the decision is made, it occurs regardless of the current macroeconomic challenges facing that company. Another example is KeyBanc, which is consolidating several legacy vendors and disparate identity tools. They are responding to the economic climate by deciding to unify onto one identity platform, which is beneficial for them. However, other customers are opting to maintain their current systems a bit longer. Overall, this reflects the long-term trends that have consistently fueled our success, which we believe will persist in the future, but there is still considerable uncertainty regarding how these developments will unfold in detail and the timing of progress over the next few quarters.

Dave Gennarelli, Senior Vice President of Investor Relations

Next up, John DiFucci at Guggenheim.

John DiFucci, Analyst

Todd, our field work, we're hearing that customers really want to buy IGA from Okta 2. But they really want to buy the whole suite. And so, they're waiting until PAM is ready. I guess, first of all, do you agree with that? And secondly, can you give us any update on the PAM product release?

Todd McKinnon, CEO

I think it's encouraging to hear that because it aligns perfectly with our strategy of wanting to create the best identity product across various categories and establish a comprehensive identity platform. We are already the largest independent, neutral platform, and we have the opportunity to expand that lead and develop one of the most significant companies in identity, which has never been done before. We are very excited about this long-term vision. Regarding the products, we discussed the Customer Identity Cloud and Workforce Identity Cloud, particularly in Workforce, where our access management products such as single sign-on and advanced multifactor authentication are clearly leading the market. Identity governance, which is a newer product for us, has been available in North America for just a quarter or two and will be generally available by the end of this year. This product is off to a very strong start, exceeding our expectations. Its success is due to its natural synergy with the leading access management product, making it easier to sell and deploy alongside it. The same person or team that purchases access management is usually closely associated with the governance purchase, which creates significant advantages. We are also excited about the progress of our PAM product announced at Okta, which will offer early access in about six months, specifically in Q2 of 2024, and will be generally available by the end of next year. This product is really going to complement our offerings by covering additional resource types, vaulting credentials, and being tightly integrated with the reporting capabilities of access management and IGA, enhancing our resource coverage beyond just applications to include servers, root accounts on servers, and Kubernetes clusters. We're optimistic about the progress of PAM; although it's taken longer than expected, we believe in the timelines we've provided and are very hopeful based on the early feedback from the customers we've talked to about it.

John DiFucci, Analyst

Is there any way to speed that up, instead of the end of the next year? It just seems like a long time. Sorry, I won't do that again.

Todd McKinnon, CEO

No, it's all right. I appreciate the feedback. Yes, it's got a big focus. And I think that like a lot of the forward-looking dates and estimates and modeling we're doing, I think that's a very prudent and achievable date.

Brett Tighe, CFO

I wanted to add to what Todd mentioned about IGA. Workflows have been a key component of IGA for a long time and have been one of our most successful products. When we assess the stickiness and win rates associated with workflows, which is a part of IGA, we see a lot of success. As Todd mentioned, we are off to a really fast start, and we are excited about the direction we are headed.

Dave Gennarelli, Senior Vice President of Investor Relations

Let's go over to our new customer, Eric Heath at KeyBanc.

Eric Heath, Analyst

Todd, I mean, you previously talked about kind of expanding the sort of channel partners you work with to more of the, call it, the new school channel partners, the GSIs and marketplace. Just curious if you can give us an update on how that avenue performed, that indirect sales motion performed in the quarter? And maybe if you can just kind of give us an update on how much of that business today is kind of coming from these newer channel partners versus maybe the traditional channel partners?

Todd McKinnon, CEO

I believe the trends for the quarter align with what we have previously observed. The Amazon Marketplace is performing exceptionally well, reflecting a customer preference for purchasing through large cloud platforms and obtaining solutions from there. This is a trend we are focusing our investments on. We are also making significant efforts in the customer identity segment, particularly with the Customer Identity Cloud, which presents a compelling long-term opportunity for partners. As we've mentioned repeatedly, the development of applications and platforms creates substantial prospects for large system integrators. However, in discussions with major global system integrators, it often seems that the cloud modern workforce identity business is perceived as too straightforward. They may lean towards legacy systems where they can generate more service revenue. Consequently, attracting interest from major system integrators has sometimes been a challenge for Okta. While we have made progress, the potential for assisting in workforce technology deployment remains relatively small compared to the vast opportunities on the customer identity side, where companies are eager to create solutions and seek assistance in launching transformative customer-facing projects. It is crucial to initiate this process on the partner side of the Customer Identity Cloud business.

Brett Tighe, CFO

Yes. I would like to add that we continue to see an increasing portion of our business coming from the indirect channel. Additionally, as Todd mentioned, the marketplaces are expanding rapidly. It’s an intriguing way for customers to purchase from us.

Dave Gennarelli, Senior Vice President of Investor Relations

Next up, Peter Weed at Bernstein.

Peter Weed, Analyst

Congratulations on the continued progress that you're making. One of the things that I was really impressed with is the continued leverage that you're getting in OpEx. I completely understand the sales and marketing side. But I think we saw it continue to strongly come through in R&D and G&A. I wanted to kind of hear how you're thinking about that, particularly on the R&D side. Was that coming from freezing of hiring? Was that kind of an increase in churn of people in R&D? And then kind of on the right level going forward, I think my quick penciling out is you're in the high-teens percent subscription revenue on a non-GAAP basis right now. Is that kind of the level that you want to keep it at? Is that too lean and you're thinking about bringing in a bit more next year? Is this something you're trying to get even more? Like, how are you just thinking about that on the R&D side, given the criticality of these people kind of to the future platform?

Brett Tighe, CFO

Yes. I'll let Todd discuss the second part of that question, but I can address more of the financial aspects. When we last spoke, we mentioned some cost efficiency measures we implemented, which you will see reflected not only in Q3 results but also in our guidance for Q4 and FY24. We slowed down hiring, and the quarter-over-quarter increase was about half of what it had been in the past four quarters. This was a response to moderated growth. Balancing growth and margin is a principle we've applied historically, and it’s evident in FY23 and heading into FY24. This strategy affected not just R&D but other areas across the P&L as well. We also streamlined our real estate footprint, which has an effect even though it’s not directly allocated in the P&L. Therefore, you are observing cost-saving initiatives that have significantly contributed to our profitability, making us slightly positive this quarter and guiding for a positive outcome in Q4. Now I'll let Todd address the second part of your question regarding the right level.

Todd McKinnon, CEO

One critical aspect of our strategy, when examining the income statement and R&D expenses, is the importance of the Workforce Identity Cloud and Customer Identity Cloud. We strongly believe these are vital markets to dominate and add value throughout our identity platform. It is essential for us to lead in both areas, which is why we are making significant R&D investments. While we could try to enhance efficiency by merging the two R&D teams, we believe that the better strategy is to develop best-in-class solutions for each of these use cases. Over time, we will integrate common components within our Okta Identity platform, establishing shared services that deliver value across both areas. In summary, we believe the increased R&D investment is justified as we aim to lead this market, and in the coming years, you will see more shared services and improved R&D efficiency.

Peter Weed, Analyst

I understand you are suggesting that while you’ve gained more leverage from R&D, you find the current level appropriate and are considering maintaining it. It appears you might not increase spending next year as you expect to gain more efficiency from sales and marketing and potentially reallocate some of those savings to increase R&D spending as a percentage of revenue.

Todd McKinnon, CEO

It's accurate. Yes, it feels right to us at this level.

Dave Gennarelli, Senior Vice President of Investor Relations

Next, we'll go to Alex Henderson at Needham.

Alex Henderson, Analyst

I wanted to explore the topic we were just discussing. Your headcount increased by 32% year-over-year, but only by 4.5% from the previous quarter. For you to achieve leverage next year, the growth rate of headcount on a quarterly basis would need to stabilize. Considering the anticipated top-line growth of 16%, 17%, or 18%, are we looking at headcount growth in the range of 5% to 10%? If so, how will you manage these additional headcount resources? Additionally, could you provide more details regarding attrition rates and wage levels?

Brett Tighe, CFO

Yes. I mean, when we look at the cost structure, Alex, I mean, it's really majority is headcount, right? I mean, we're a typical software company. You guys probably know the standard ratios, right, of how much of that is headcount. So yes, obviously, when we look into next year, we're evaluating what the right thing to do is from a headcount growth perspective. We're still early in the planning process. We still have a few months to go on that. But ultimately, we're evaluating the cost structure, and we'll let you guys know more in next year when we get into, obviously, the Q4 earnings. But ultimately, not just evaluating headcount, we're evaluating all the other spend as well to be able to make sure that we can grow these margins in the right direction.

Alex Henderson, Analyst

Well, if we're not going to go in that direction, maybe you could just give us some sense of the differential between domestic and international growth, which is kind of hard to evaluate over the last couple of quarters because of the M&A, so we can get there.

Brett Tighe, CFO

We had a strong quarter in EMEA, largely due to several large deals that contributed to our growth. International revenue accounted for 22% of our total revenue, although we faced a slight negative impact from foreign exchange, which has begun to affect our revenue. Overall, EMEA performed well, and as we look ahead, international markets remain a priority for us. Our main goals this year include customer identity, federal initiatives, and global acceleration, all of which we are actively pursuing. We've seen federal growth of 65% year-to-date, and international numbers reflect our progress in global acceleration. EMEA's success, underpinned by significant deals, is just the beginning of our international potential. There's a wide range of opportunities to explore as identity is a global issue, not limited to the U.S. We need to continue focusing on this area.

Dave Gennarelli, Senior Vice President of Investor Relations

Great. We still have a long queue here. So, I got to ask again to keep it to one question. Josh, over to you at Wolfe.

Josh Tilton, Analyst

Hey, guys. Thanks for squeezing me in here. I really appreciate the derisked numbers for next year. So thanks for that. Just a simple one for me. When we look at this new guidance, how should we think about your ability to outperform these numbers as we head into next year?

Brett Tighe, CFO

Yes. I mean, when we are thinking about the guidance, obviously, you heard me talk about being cautiously optimistic, right? So being prudent in the guidance that we're giving you today, both on the revenue and the margin side, right? We are still doing our planning process. We are doing the same play we have done for you guys for years. And so, we still got a big quarter ahead of us, right, Q4, biggest quarter of the year, but we are being prudent with everything that's going on, whether it be the macro, whether it be some of the integration challenges that we’ve had. We see early signs of success, but we are not going to bank on them right now. We are going to be prudent and cautious, like you’ve heard us talk about throughout this call.

Dave Gennarelli, Senior Vice President of Investor Relations

Next up, we will go to Adam Tindle at Raymond James. We can't hear you, Adam. Adam, you are on mute.

Adam Tindle, Analyst

There we go. Double mute. I'll try to be quick here. One for Todd, the key point to generating leverage here that you are talking about or one of the key points is rep tenure, and attrition did improve during Q3. Susan talked about that at Oktane. And she mentioned adding more commission dollars in the pool, as one of the factors that helped to improve attrition. The message today that we are hearing is, understandably a focus on profitability. You've got this attractive profitability swing in fiscal '24. I'm just wondering how do you achieve that profitability swing while avoiding another attrition surprise that would derail that operating leverage story, especially with the end of the fiscal year coming up? Are there other options beyond the commission pool that would help with that?

Todd McKinnon, CEO

It's a great question. I believe there are various ways to ensure the entire team succeeds. As we've discussed in previous calls, sales attrition is significant, but sales are just part of the equation. Many elements need to align to support their success. The challenge isn't with sales itself, but rather with the clarity of our messaging. We've made strides in this area with clearer and more compelling positioning and enablement. Looking ahead to next year, we need to consider how much we invest and where, particularly regarding personnel and coverage. We must balance effective financial management with the resources allocated in the field against the anticipated returns and productivity. While commissions are an essential factor, they represent a relatively minor portion of the overall investment in our go-to-market capabilities, which ultimately influences our productivity and leverage within the model.

Brett Tighe, CFO

Yes. I would just add that that's one of those things you've heard me talk about, Adam, when we were discussing the guidance. We had a really strong quarter where we improved on various aspects, but we remain cautious about the future because one quarter doesn't establish a trend. I wish it did, as it would make our lives a lot easier.

Dave Gennarelli, Senior Vice President of Investor Relations

Let's go to Shrenik Kothari at Baird.

Shrenik Kothari, Analyst

You guys mentioned the 100,000-plus customers grew nicely 32% and the net new customer adds backed out. There was also sequentially better quarter-on-quarter, I think overall 22% year-on-year. And yes, I mean, that adds up with the number of sales reps that you said closing the customer identity deals, sequentially getting better over three quarters. One comment you made was the pipeline is more weighted towards upsells. And I mean, of course, we're seeing some softening in the SMB market. But are you already starting to see that SMB softening in the customer adds as well on that side of things as well? Yes.

Todd McKinnon, CEO

I don't know the exact mix of softening in upsells compared to new business. However, we are aware that the SMB segment of our business performed below our expectations this past quarter. Considering a variety of factors, we believe the overall shift towards being more upsell-focused is largely due to macroeconomic conditions, supported by both anecdotal evidence from conversations and quantitative analysis of our overall statistics.

Dave Gennarelli, Senior Vice President of Investor Relations

Next, we'll go to Fatima Boolani at Citi.

Fatima Boolani, Analyst

Brett, between you and Todd, you sort of talked a lot about the strength in the renewal side of the business and of course, the performance in the quarter being weighted more towards upsells, presumably coming from the installed base. So what I wanted to ask you was just around the conversations with respect to renewals. What we've heard from some of your peers is there is increasingly an orientation from customers to manage their cash flow, manage their OpEx budgets. So, I think we saw a little bit of this in your backlog and RPO because you called it out. But I'm curious from an invoicing standpoint, what sort of conversations are you having in your renewal dialogue? And then, as a related matter, and I think I've asked you this before, we've been seeing maybe more broad-based sort of employment contraction and layoff activity, and it seems a little bit more concentrated in certain sectors. But I'm curious how that's sort of factoring into some of your renewal conversations as well. Thank you.

Brett Tighe, CFO

Yes. I think there's a couple of things, and Todd, you can follow up because I think you probably have a thought or two here, which is in terms of renewals, we haven't really seen a material change in renewals. I think the good news is that gross retention rate remains in that mid-90% range like we've talked about at Investor Day, we talked about it today. And I think a quick reminder is, we're fortunate enough to have long contract durations, right? It's a little north of 2.5 years. And so, we have the opportunity to deliver value in these contracts. We don't have to deliver it in the first 30 days, right? We wake up every morning and say how can we deliver value, customer success? I mean, you heard me at Investor Day talk about loving our customers as a key customer, a key to Okta value. And you see that in these retention rates, right? I mean, you need identity. Every modern tech stack needs it, right? And so, that's why you see the strength in the gross retention. That's why you see the upsells and the net retention number of 122%, right? Because if you don't get to deliver on the original promise of the original deal, it's hard to get that upsell, but that's why you see these strong numbers on gross and net. In terms of your question directly around invoicing, we haven't really seen a material change on that either. Really, things have kind of more or less stayed the same here. But I think one of the things we've talked about is upsells continue to be a strength of our business, right? Once we get people in, they get successful. So, that's why you see these strong retention numbers.

Todd McKinnon, CEO

The workforce business operates on a per named user seat sold under a contract averaging 2.5 years across the entire customer base. Customer identity is defined as a monthly active user. When discussing scenarios where a customer has fewer employees and their contract is up for renewal, it’s expected that the number of seats they purchase will decrease. However, this does not prevent them from adding more products or extracting greater value by investing in solutions like Identity Governance and Administration or exploring new use cases such as multifactor authentication. While the workforce business is somewhat linked to seat expansion or contraction, there are numerous other avenues for growth available as well.

Dave Gennarelli, Senior Vice President of Investor Relations

Okay. Next, we're going to go to Rudy Kessinger at D.A. Davidson.

Rudy Kessinger, Analyst

What percent of your sales reps currently are what you would classify as fully productive? I know with the macro, maybe not anybody is really fully productive right now, but what percent are fully productive today? And when do you think you can get that within six months?

Brett Tighe, CFO

Yes. I don't have the exact figure in front of me, but as we mentioned last quarter, it was an all-time low for ramped reps as a percentage of the total. Considering the attrition numbers we've discussed today and the significant improvement there, we’ve started to recover. We're moving in the right direction, but we're still not where we want to be, which is why we remain cautiously optimistic. We need to increase the ramp level as a percentage of the total back to more historical figures, and that will require time. It's important to note that it's not just about the definition of being ramped; we have our own internal definition like any other company. It's about achieving specific thresholds in productivity, which typically comes with experience that sometimes extends beyond the official ramp period. Therefore, we need to continue supporting these individuals, presenting them with opportunities, and guiding them towards success. Ultimately, this will lead to our success as we'll have a more productive team in the upcoming quarters and years.

Dave Gennarelli, Senior Vice President of Investor Relations

Let's go to Keith Bachman at BMO.

Keith Bachman, Analyst

Todd, I wanted to clarify something with you. You mentioned that if a leader for the go-to-market team isn’t found, you would take on that role, but I assume that would be a temporary measure. You would likely continue searching for the right person since you have a lot on your plate. Now, regarding your guidance, I’m trying to understand the competitive landscape. Your CRPO guidance for Q4 is at 21%, and you’ve been slightly exceeding that, yet your revenue guidance for next year is lower. As the economy weakens, is your pipeline still strong? Are you noticing any shifts in the competitive dynamics? I'm concerned that as the macroeconomic situation declines, some users might switch to Microsoft if it offers a lower cost. I'm looking to understand that better. Thank you.

Todd McKinnon, CEO

Yes. So specifically on Susan's retirement and timing, what the plan is, is that she is in her job until the end of January. And so, we will be searching for a replacement, considering internal candidates, external candidates, finding the best person in the world. And if we don't find anyone by February 1, we'll keep searching, but I will be the interim until we find someone.

Keith Bachman, Analyst

Perfect.

Todd McKinnon, CEO

The competitive landscape has remained stable for several years. I often discuss this with those familiar with our journey. The market has made a choice between cloud solutions and on-premises options. For those preferring on-premises, there are solid solutions like Ping and ForgeRock, but we believe this segment is currently smaller and trends downwards as more users seek modern solutions. Another significant competitive factor is whether businesses prefer a monolithic platform that offers various applications and services or an independent, neutral entity focused solely on identity. This has been a longstanding distinction, and our strategy aims to strengthen our position over time. In a recessionary environment, it’s likely some will opt for monolithic platforms like Microsoft. We anticipate that every major cloud provider will eventually offer a version of Okta, as it presents a compelling business opportunity, and they will strive to deliver similar value. This reinforces our belief in the advantages of independent neutrality as a strategic opportunity. However, during economic downturns, some may favor monolithic platforms, which could be a downside. On a positive note, companies like KeyBanc are consolidating their identity vendors and are gravitating towards independent neutral leaders like Okta. Overall, though the competitive environment may fluctuate occasionally, I don't foresee significant changes; it should remain as stable as it has been over the past four to five years.

Brett Tighe, CFO

By the way, Keith, you just made my entire day by asking the relationship between current RPO and next year's revenue guide. Yes. No, but I will answer your question, we're being cautious. That's ultimately the answer, delta between the two, because pipeline is trending in the right direction, but we're being cautious at this point given everything we know at this point.

Todd McKinnon, CEO

One last thing on competition is that the Customer Identity Cloud business presents a significant opportunity for us, not only in terms of market potential but also in building this extensive platform. The competitive landscape in this area is quite distinct, characterized by a build versus buy scenario, and we have the best developer-focused platform, which makes it an exciting opportunity.

Dave Gennarelli, Senior Vice President of Investor Relations

Great. Well, that's it for this afternoon. But before you go, we just want to let you know we'll be at a few investor events this quarter. We'll be at the Needham Growth Conference on January 12th. We'll also be participating in several in-person and virtual bus tours over the course of December and January. So, we hope to see you at one of those events. And that's it for our time. If you have any follow-up questions, you can reach us at [email protected]. Thanks.

Todd McKinnon, CEO

Thanks, everyone.

Brett Tighe, CFO

Thanks, everyone.