Okta, Inc. 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that are based upon current plans, expectations and beliefs that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the section titled “Risk Factors” under Part II, Item 1A in this Quarterly Report on Form 10-Q and Part I, Item 1A in our Annual Report on Form 10-K. Our fiscal year ends January 31. Overview Okta is the leading independent identity provider. Our Workforce Identity and Customer Identity Clouds are powered by our category-defining platform that enables our customers to securely connect the right people to the right technologies and services at the right time. Every day, thousands of organizations and millions of people use Okta to securely access a wide range of cloud, mobile and web applications, on-premises servers, application programming interfaces (“APIs”), IT infrastructure providers and services from a multitude of devices. Developers leverage our Customer Identity Cloud to securely and efficiently embed identity into the software they build and to provide their customers with more modern and secure experiences online and via mobile devices, allowing them to focus on their core mission. Employees and contractors sign into the Workforce Identity Cloud to seamlessly and securely access the applications they need to do their most important work, and to collaborate with their partners. Given the growth trends in the number of applications and cloud adoption, and the movement to remote workforces, identity is becoming the most critical layer of an organization’s security. Our approach to identity allows our customers to simplify and efficiently scale their security infrastructures across internal IT systems and external customer facing applications. As of October 31, 2022, more than 17,050 customers across nearly every industry used Okta to secure and manage identities around the world. Our customers consist of leading global organizations ranging from the largest enterprises, to small and medium-sized businesses, universities, non-profits and government agencies. We also partner with leading application, IT infrastructure and security vendors through our Okta Integration Network. As of October 31, 2022, we had over 7,000 integrations with these cloud, mobile and web applications and IT infrastructure and security vendors. We employ a Software-as-a-Service (“SaaS”) business model, and generate revenue primarily by selling multi-year subscriptions to our cloud-based offerings. We focus on acquiring and retaining our customers and increasing their spending with us through expanding the number of users who access our Workforce Identity and Customer Identity Clouds and up-selling additional products. We sell our products directly through our field and inside sales teams, as well as indirectly through our network of channel partners, including resellers, system integrators and other distribution partners. Our subscription fees include the use of our service and our technical support and management of our platform. We base subscription fees primarily on the products used and the number of users on our platform. We typically invoice customers in advance in annual installments for subscriptions to our platform. Impact of COVID-19 Pandemic The extent of the impact of COVID-19 on our future operational and financial performance remains uncertain and will depend on certain developments, including the duration and spread of COVID-19 and variants of concern, related public health measures, including vaccine mandates, the manufacture, distribution, efficacy and public acceptance of treatments and vaccines, and their impact on the macroeconomy, our current and prospective customers, employees and vendors. None of these impacts can be predicted with certainty. Our revenue is relatively predictable as a result of our subscription-based business model, which constituted approximately 96% of total revenue for the nine months ended October 31, 2022. Future growth may be impacted by longer sales cycles, which we have experienced, which in turn, could result in delays in deals closing, creating near-term headwinds for cash flow, RPO and billings growth as well as potential future impacts on revenue growth 27 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) and other key metrics on a trailing basis. While we see risks associated with more highly impacted companies and industries, we are also seeing new interest from other organizations, driven by rapidly changing work and business environments. As workforces have transitioned to fully remote and hybrid work models, Zero Trust has become an increasingly important security model and identity an increasingly critical service. We believe we will be able to continue to deliver our cloud-based platform and support to our customers, without compromising our employees’ safety. For most of fiscal 2021, we established mandatory work-from-home procedures for our global office locations, and our employees had the necessary tools and technology to remain connected and productive. In addition, in fiscal 2021 we shifted our customer, employee and industry events, including our annual user conference to virtual-only formats, resulting in cost savings. We further experienced cost savings driven by reductions in employee-related expenses as our sales and marketing activities shifted primarily to an online-only sales format and our employees shifted to work-from-home procedures. In fiscal 2022, as the administration of vaccines increased, we reopened our offices to partial capacity, allowing our employees to voluntarily return and resumed some in-person sales and marketing activities. In fiscal 2023, we shifted to hybrid in-person and virtual sales formats and experiences for our annual user conferences. See the section titled “Risk Factors” for further discussion of the potential impact of COVID-19 and its related public health measures on our business. Acquisition of Auth0 On May 3, 2021, we completed the acquisition of Auth0. The acquisition date fair value, net of acquired cash, was approximately $5,671.0 million, including shares of our Class A common stock, cash, and assumed equity awards. In addition, we issued unvested restricted stock and assumed unvested equity and restricted cash awards, which are subject to future vesting and will be recorded as expense over the period the services are provided. A portion of the total consideration was held back by us to secure the indemnification obligations of the Auth0 securityholders and was paid in full during the nine months ended October 31, 2022. See Note 3 to our audited consolidated financial statements included in our Form 10-K filed with the SEC on March 7, 2022. Components of Results of Operations Revenue Subscription Revenue. Subscription revenue primarily consists of fees for access to and usage of our cloud-based platform and related support. Subscription revenue is driven primarily by the number of customers, the number of users per customer and the products used. We typically invoice customers in advance in annual installments for subscriptions to our platform. Professional Services and Other . Professional services revenue includes fees from assisting customers in implementing and optimizing the use of our products. These services include application configuration, system integration and training services. We generally invoice customers as the work is performed for time-and-materials arrangements, and up front for fixed fee arrangements. All professional services revenue is recognized as the services are performed. Overhead Allocation and Employee Compensation Costs We allocate shared costs, such as facilities costs (including rent, utilities and depreciation on assets shared by all departments), certain information technology costs and recruiting costs to all departments based on headcount. As such, allocated shared costs are reflected in each of the cost of revenue and operating expense categories. Employee compensation costs reflected in each of the cost of revenue and operating expense categories include salaries, bonuses, compensation related taxes, benefits and stock-based compensation. Additionally included in in the sales and marketing expense category are sales commissions and related taxes. 28 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Cost of Revenue and Gross Margin Cost of Subscription . Cost of subscription primarily consists of expenses related to hosting our services and providing support. These expenses include employee-related costs associated with our cloud-based infrastructure and our customer support organization, third-party hosting fees, software and maintenance costs, outside services associated with the delivery of our subscription services, amortization expense associated with capitalized internal-use software and acquired developed technology and allocated overhead. We intend to continue to invest additional resources in our platform infrastructure and our platform support organizations. As we continue to invest in technology innovation, we anticipate that capitalized internal-use software costs and related amortization may increase. We expect our investment in technology to expand the capability of our platform enabling us to improve our gross margin over time. The level and timing of investment in these areas could affect our cost of subscription revenue in the future. Cost of Professional Services and Other . Cost of professional services consists primarily of employee-related costs for our professional services delivery team, travel-related costs, allocated overhead and costs of outside services associated with supplementing our professional services delivery team. The cost of providing professional services has historically been higher than the associated revenue we generate. Gross Margin . Gross margin is gross profit expressed as a percentage of total revenue. Our gross margin may fluctuate from period to period as a result of the timing and amount of investments to expand our hosting capacity, our continued efforts to build platform support and professional services teams, increased stock-based compensation expenses, as well as the amortization of costs associated with capitalized internal-use software and acquired intangible assets. Operating Expenses Research and Development. Research and development expenses consist primarily of employee compensation costs and allocated overhead. We believe that continued investment in our platform is important for our growth. We expect our research and development expenses will increase in absolute dollars as our business grows. Sales and Marketing. Sales and marketing expenses consist primarily of employee compensation costs, costs of general marketing and promotional activities, travel-related expenses, amortization expense associated with acquired customer relationships (including unbilled and unrecognized contracts yet to be fulfilled) and trade names and allocated overhead. Commissions earned by our sales force that are considered incremental and recoverable costs of obtaining a contract with a customer are deferred and then amortized on a straight-line basis over a period of benefit that we have determined to be generally five years. We expect our sales and marketing expenses will increase in absolute dollars and continue to be our largest operating expense category for the foreseeable future as we continue to invest in acquiring new customers. In the short-term, our sales and marketing expenses may increase as a percentage of our total revenue, however, over time, we expect this percentage to decrease as our total revenue grows. General and Administrative. General and administrative expenses consist primarily of employee compensation costs for finance, accounting, legal, information technology and human resources personnel. In addition, general and administrative expenses include acquisition and integration-related costs, lease impairment charges, non-personnel costs, such as legal, accounting and other professional fees, charitable contributions, and all other supporting corporate expenses, such as information technology, not allocated to other departments. We expect our general and administrative expenses will increase in absolute dollars as our business grows. Interest and Other, Net Interest and other, net consists of interest expense, which primarily includes amortization of debt discount and loss on early extinguishment and conversion of debt (in comparative periods prior to the adoption of ASU 2020-06), amortization of debt issuance costs, contractual interest expense for the Notes, interest income from our investment holdings, and gains and losses from our strategic investments. 29 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Provision for (Benefit from) Income Taxes Our provision for (benefit from) income taxes consists of federal and state income taxes in the United States and income taxes in certain foreign jurisdictions where we operate, and is determined for interim periods using an estimate of our annual effective tax rate, adjusted for discrete items occurring in the quarter. The primary difference between our effective tax rate and the federal statutory rate relates to the net operating losses in jurisdictions with a valuation allowance against related deferred tax assets. 30 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Results of Operations The following tables set forth our results of operations for the periods presented: Three Months Ended October 31, Nine Months Ended October 31, 2022 2021 2022 2021 (dollars in thousands) Revenue: Subscription $ 465,856 $ 336,702 $ 1,299,181 $ 879,881 Professional services and other 15,186 13,978 48,611 37,305 Total revenue 481,042 350,680 1,347,792 917,186 Cost of revenue: Subscription (1) 117,306 91,048 344,524 227,903 Professional services and other (1) 20,347 18,626 61,988 49,000 Total cost of revenue 137,653 109,674 406,512 276,903 Gross profit 343,389 241,006 941,280 640,283 Operating expenses: Research and development (1) 148,484 130,535 465,971 321,805 Sales and marketing (1) 289,984 203,878 807,110 548,749 General and administrative (1) 111,520 105,149 322,549 322,406 Total operating expenses 549,988 439,562 1,595,630 1,192,960 Operating loss (206,599) (198,556) (654,350) (552,677) Interest expense (2,805) (23,144) (8,588) (68,776) Interest income and other, net 4,235 1,056 10,660 7,622 Loss on conversion of debt — — — (179) Interest and other, net 1,430 (22,088) 2,072 (61,333) Loss before provision for (benefit from) income taxes (205,169) (220,644) (652,278) (614,010) Provision for (benefit from) income taxes 3,728 667 9,804 (6,785) Net loss $ (208,897) $ (221,311) $ (662,082) $ (607,225) (1) Includes stock-based compensation expense as follows: Three Months Ended October 31, Nine Months Ended October 31, 2022 2021 2022 2021 (dollars in thousands) Cost of subscription revenue $ 17,106 $ 13,455 $ 51,509 $ 33,843 Cost of professional services and other revenue 3,563 3,376 11,016 8,879 Research and development 69,208 56,573 208,330 129,998 Sales and marketing 41,515 39,248 120,299 101,602 General and administrative 39,593 43,133 120,533 133,289 Total stock-based compensation expense $ 170,985 $ 155,785 $ 511,687 $ 407,611 31 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) The following table sets forth our results of operations for the periods presented as a percentage of our total revenue: Three Months Ended October 31, Nine Months Ended October 31, 2022 2021 2022 2021 Revenue Subscription 97 % 96 % 96 % 96 % Professional services and other 3 4 4 4 Total revenue 100 100 100 100 Cost of revenue Subscription 25 26 26 25 Professional services and other 4 5 4 5 Total cost of revenue 29 31 30 30 Gross profit 71 69 70 70 Operating expenses Research and development 31 37 35 35 Sales and marketing 60 59 60 60 General and administrative 23 30 24 35 Total operating expenses 114 126 119 130 Operating loss (43) (57) (49) (60) Interest expense (1) (6) (1) (7) Interest income and other, net 1 — 2 1 Loss on conversion of debt — — — (1) Interest and other, net — (6) 1 (7) Loss before provision for (benefit from) income taxes (43) (63) (48) (67) Provision for (benefit from) income taxes — — 1 (1) Net loss (43) % (63) % (49) % (66) % 32 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Comparison of the Three and Nine Months Ended October 31, 2022 and 2021 Revenue Three Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Revenue: Subscription $ 465,856 $ 336,702 $ 129,154 38 % Professional services and other 15,186 13,978 1,208 9 Total revenue $ 481,042 $ 350,680 $ 130,362 37 Percentage of revenue: Subscription 97 % 96 % Professional services and other 3 4 Total 100 % 100 % Nine Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Revenue: Subscription $ 1,299,181 $ 879,881 $ 419,300 48 % Professional services and other 48,611 37,305 11,306 30 Total revenue $ 1,347,792 $ 917,186 $ 430,606 47 Percentage of revenue: Subscription 96 % 96 % Professional services and other 4 4 Total 100 % 100 % Three and nine months ended For the three and nine months ended October 31, 2022, the increase in subscription revenue was primarily due to the addition of new customers, an increase in users and sales of additional products to existing customers. Additionally, as our acquisition of Auth0 was completed on May 3, 2021, subscription revenue during the nine months ended October 31, 2022 includes nine months of Auth0 revenue while subscription revenue during the nine months ended October 31, 2021 includes approximately six months of Auth0 revenue. For the three and nine months ended October 31, 2022, the increase in professional services revenue was primarily related to an increase in implementation and other services associated with growth in the number of new customers purchasing our subscription services. 33 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Cost of Revenue, Gross Profit and Gross Margin Three Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Cost of revenue: Subscription $ 117,306 $ 91,048 $ 26,258 29 % Professional services and other 20,347 18,626 1,721 9 Total cost of revenue $ 137,653 $ 109,674 $ 27,979 26 Gross profit $ 343,389 $ 241,006 $ 102,383 42 Gross margin: Subscription 75 % 73 % Professional services and other (34) (33) Total gross margin 71 69 Nine Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Cost of revenue: Subscription $ 344,524 $ 227,903 $ 116,621 51 % Professional services and other 61,988 49,000 12,988 27 Total cost of revenue $ 406,512 $ 276,903 $ 129,609 47 Gross profit $ 941,280 $ 640,283 $ 300,997 47 Gross margin: Subscription 73 % 74 % Professional services and other (28) (31) Total gross margin 70 70 Three months ended For the three months ended October 31, 2022, cost of subscription revenue increased primarily due to an increase of $14.7 million in employee compensation costs related to higher headcount to support the growth in our subscription services, an increase of $6.1 million in third-party hosting costs as we expanded capacity to support our growth and an increase of $3.3 million in software license costs. Our gross margin for subscription revenue increased to 75% from 73% for the three months ended October 31, 2022 compared to the three months ended October 31, 2021. The increase was primarily driven by improved spend efficiency resulting in lower relative cost of subscription revenue. While our gross margin for subscription revenue may fluctuate in the near-term as we invest in our growth, we expect our subscription revenue gross margin to improve over the long-term as we achieve additional economies of scale. For the three months ended October 31, 2022, cost of professional services and other revenue increased primarily due to an increase of $1.7 million in employee compensation costs related to increased headcount. Our gross margin for professional services and other revenue decreased to (34)% from (33)% for the three months ended October 31, 2022 compared to the three months ended October 31, 2021. Nine months ended For the nine months ended October 31, 2022, cost of subscription revenue increased primarily due to an increase of $59.3 million in employee compensation costs related to higher headcount to support the growth in our subscription services, an increase of $20.8 million in third-party hosting costs as we expanded capacity to support 34 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) our growth, an increase of $13.7 million in software license costs and an increase in amortization of acquired developed technology of $11.0 million. Our gross margin for subscription revenue decreased to 73% from 74% for the nine months ended October 31, 2022 compared to the nine months ended October 31, 2021. While our gross margins for subscription revenue may fluctuate in the near-term as we invest in our growth, we expect our subscription revenue gross margin to improve over the long-term as we achieve additional economies of scale. For the nine months ended October 31, 2022, cost of professional services and other revenue increased primarily due to an increase of $9.1 million in employee compensation costs related to increased headcount. Our gross margin for professional services and other revenue improved to (28)% from (31)% for the nine months ended October 31, 2022 compared to the nine months ended October 31, 2021. Operating Expenses Research and Development Expenses Three Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Research and development $ 148,484 $ 130,535 $ 17,949 14 % Percentage of revenue 31 % 37 % Nine Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Research and development $ 465,971 $ 321,805 $ 144,166 45 % Percentage of revenue 35 % 35 % Three and nine months ended For the three and nine months ended October 31, 2022, the increase in research and development expenses is primarily due to increases of $17.4 million and $132.7 million, respectively, in employee compensation costs related to higher headcount. Sales and Marketing Expenses Three Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Sales and marketing $ 289,984 $ 203,878 $ 86,106 42 % Percentage of revenue 60 % 59 % Nine Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Sales and marketing $ 807,110 $ 548,749 $ 258,361 47 % Percentage of revenue 60 % 60 % 35 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Three months ended For the three months ended October 31, 2022, sales and marketing expenses increased primarily due to an increase of $73.3 million in employee compensation costs related to higher headcount and an increase in travel expenses of $4.1 million. We expect sales and marketing expenses will increase in absolute dollars in future periods as we invest in acquiring new customers. Nine months ended For the nine months ended October 31, 2022, sales and marketing expenses increased primarily due to an increase of $178.1 million in employee compensation costs related to headcount growth, an increase in marketing and event costs of $19.9 million primarily due to increases in demand generation programs, advertising and brand awareness efforts aimed at acquiring new customers, an increase in travel expenses of $16.8 million, an increase in amortization expense of $9.9 million for acquired customer relationships and trade names and an increase in consulting expenses of $8.5 million. We expect sales and marketing expenses will increase in absolute dollars in future periods as we invest in acquiring new customers. General and Administrative Expenses Three Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) General and administrative $ 111,520 $ 105,149 $ 6,371 6 % Percentage of revenue 23 % 30 % Nine Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) General and administrative $ 322,549 $ 322,406 $ 143 — % Percentage of revenue 24 % 35 % Three months ended For the three months ended October 31, 2022, general and administrative expenses increased primarily due to lease impairment charges of $14.2 million related to our real estate optimization plan and the closing of duplicative sites and underutilized offices, partially offset by a decrease of $8.0 million in acquisition and integration-related costs incurred in the three months ended October 31, 2021, but not in the three months ended October 31, 2022. Nine months ended For the nine months ended October 31, 2022, general and administrative expenses was relatively flat, primarily due to a decrease in acquisition and integration-related costs of $37.3 million, offset by lease impairment charges of $14.2 million related to our real estate optimization plan and the closing of duplicative sites and underutilized offices, and an increase in employee compensation and related costs associated with headcount growth. 36 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Interest and Other, Net Three Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Interest expense $ (2,805) $ (23,144) $ 20,339 (88) % Interest income and other, net 4,235 1,056 3,179 301 Loss on conversion of debt — — — — Interest and other, net $ 1,430 $ (22,088) $ 23,518 (106) Nine Months Ended October 31, 2022 2021 $ Change % Change (dollars in thousands) Interest expense $ (8,588) $ (68,776) $ 60,188 (88) % Interest income and other, net 10,660 7,622 3,038 40 Loss on conversion of debt — (179) 179 (100) Interest and other, net $ 2,072 $ (61,333) $ 63,405 (103) Three and nine months ended For the three and nine months ended October 31, 2022, the change in interest and other, net was primarily due to a decrease in interest expense resulting from the adoption of ASU 2020-06. Key Business Metrics We review a number of operating and financial metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions. As of October 31, 2022 2021 (dollars in thousands) Customers with annual contract value (“ACV”) above $100,000 3,740 2,825 Dollar-Based Net Retention Rate for the trailing 12 months ended 122 % 122 % Current remaining performance obligations $ 1,579,388 $ 1,180,150 Remaining performance obligations $ 2,852,831 $ 2,350,207 Three Months Ended October 31, Nine Months Ended October 31, 2022 2021 2022 2021 (dollars in thousands) Calculated Billings $ 531,637 $ 388,679 $ 1,412,147 $ 1,115,067 37 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Total Customers and Number of Customers with Annual Contract Value Above $100,000 As of October 31, 2022, we had over 17,050 customers on our platform. We believe that our ability to increase the number of customers on our platform is an indicator of our market penetration, the growth of our business, and our potential future business opportunities. Increasing awareness of our platform and capabilities, coupled with the mainstream adoption of cloud technology, has expanded the diversity of our customer base to include organizations of all sizes across all industries. Over time, larger customers have constituted a greater share of our total revenue, which has contributed to an increase in average revenue per customer. The number of customers who have greater than $100,000 in annual contract value (“ACV”) with us was 3,740 and 2,825 as of October 31, 2022 and 2021, respectively. We expect this trend to continue as larger enterprises recognize the value of our platform and replace their legacy identity access management infrastructure. We define a customer as a separate and distinct buying entity, such as a company, an educational or government institution, or a distinct business unit of a large company that has an active contract with us or one of our partners to access our platform. For purposes of determining our customer count, we do not include customers that use our platform under self-service arrangements only. Dollar-Based Net Retention Rate Part of our ability to generate revenue is dependent upon our ability to maintain our relationships with our customers and to increase their utilization of our platform. We believe we can achieve these goals by focusing on delivering value and functionality that enables us to both retain our existing customers and expand the number of users and products used within an existing customer. We assess our performance in this area by measuring our Dollar-Based Net Retention Rate. Our Dollar-Based Net Retention Rate measures our ability to increase revenue across our existing customer base through expansion of users and products associated with a customer as offset by churn and contraction in the number of users and/or products associated with a customer. Our Dollar-Based Net Retention Rate is based upon our ACV which is calculated based on the terms of that customer’s contract and represents the total contracted annual subscription amount as of that period end. We calculate our Dollar-Based Net Retention Rate as of a period end by starting with the ACV from all customers as of twelve months prior to such period end (“Prior Period ACV”). We then calculate the ACV from these same customers as of the current period end (“Current Period ACV”). Current Period ACV includes any upsells and is net of contraction or churn over the trailing twelve months but excludes ACV from new customers in the current period. We then divide the Current Period ACV by the Prior Period ACV to arrive at our Dollar-Based Net Retention Rate. Our Dollar-Based Net Retention Rate is inclusive of ACV from self-service customers. Our strong Dollar-Based Net Retention Rate is primarily attributable to gross retention, an expansion of users and upselling additional products within our existing customers. Larger enterprises often implement a limited initial deployment of our platform before increasing their deployment on a broader scale. Remaining Performance Obligations (“RPO”) RPO represent all future, non-cancelable, contracted revenue under our subscription contracts with customers that has not yet been recognized, inclusive of deferred revenue that has been invoiced and non-cancelable amounts that will be invoiced and recognized as revenue in future periods. Current RPO represents the portion of RPO expected to be recognized during the next 12 months. RPO fluctuates due to a number of factors, including the timing, duration and dollar amount of customer contracts and fluctuations in foreign currency exchange rates. Calculated Billings Calculated Billings represent our total revenue plus the change in deferred revenue, net of acquired deferred revenue, and less the change in unbilled receivables, net of acquired unbilled receivables, in the period. Calculated Billings in any particular period reflect sales to new customers plus subscription renewals and upsells to existing customers, and represent amounts invoiced for subscription, support and professional services. We typically invoice customers in advance in annual installments for subscriptions to our platform. Calculated Billings increased 37% in the three months ended October 31, 2022 over the three months ended October 31, 2021, and increased 27% in the nine months ended October 31, 2022 over the nine months ended 38 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) October 31, 2021. As our Calculated Billings continue to grow in absolute terms, we expect our Calculated Billings growth rate to trend down over time. See the section titled “Non-GAAP Financial Measures” for additional information and a reconciliation of Calculated Billings to total revenue. Non-GAAP Financial Measures In addition to our results determined in accordance with GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance . We use the below referenced non-GAAP financial information, collectively, to evaluate our ongoing operations and for internal planning and forecasting purposes. We believe that non-GAAP financial information, when taken collectively with GAAP financial measures, may be helpful to investors because it provides consistency and comparability with past financial performance, and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement their GAAP results. The non-GAAP financial information is presented for supplemental informational purposes only, and should not be considered a substitute for financial information presented in accordance with GAAP, and may be different from similarly-titled non-GAAP measures used by other companies. The principal limitation of these non-GAAP financial measures is that they exclude significant expenses that are required by GAAP to be recorded in our financial statements. In addition, they are subject to inherent limitations as they reflect the exercise of judgment by our management about which expenses are excluded or included in determining these non-GAAP financial measures. A reconciliation is provided below for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance with GAAP. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures, and not to rely on any single financial measure to evaluate our business. We periodically reassess the components of our Non-GAAP adjustments for changes in how we evaluate our performance, changes in how we make financial and operational decisions, and consider the use of these measures by our competitors and peers to ensure the adjustments remain relevant and meaningful. Non-GAAP Gross Profit and Non-GAAP Gross Margin We define Non-GAAP gross profit and Non-GAAP gross margin as GAAP gross profit and GAAP gross margin, adjusted for stock-based compensation expense included in cost of revenue, amortization of acquired intangibles and acquisition and integration-related expenses. Acquisition and integration-related expenses include transaction costs and other non-recurring incremental costs incurred through the one-year anniversary of transaction close. Three Months Ended October 31, Nine Months Ended October 31, 2022 2021 2022 2021 (dollars in thousands) Gross profit $ 343,389 $ 241,006 $ 941,280 $ 640,283 Add: Stock-based compensation expense included in cost of revenue 20,669 16,831 62,525 42,722 Amortization of acquired intangibles 11,393 11,335 34,102 23,056 Acquisition and integration-related expenses — 658 459 1,316 Non-GAAP gross profit $ 375,451 $ 269,830 $ 1,038,366 $ 707,377 Gross margin 71 % 69 % 70 % 70 % Non-GAAP gross margin 78 % 77 % 77 % 77 % 39 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Non-GAAP Operating Income (Loss) and Non-GAAP Operating Margin We define Non-GAAP operating income (loss) and Non-GAAP operating margin as GAAP operating loss and GAAP operating margin, adjusted for stock-based compensation expense, non-cash charitable contributions, amortization of acquired intangibles, acquisition and integration-related expenses and restructuring costs related to lease impairments in connection with the closing of certain leased facilities. Acquisition and integration-related expenses include transaction costs and other non-recurring incremental costs incurred through the one-year anniversary of transaction close. Beginning in the third quarter of fiscal 2023, we updated our definition of Non-GAAP operating income (loss) and Non-GAAP operating margin to include restructuring costs as defined in the preceding paragraph. Three Months Ended October 31, Nine Months Ended October 31, 2022 2021 2022 2021 (dollars in thousands) Operating loss $ (206,599) $ (198,556) $ (654,350) $ (552,677) Add: Stock-based compensation expense 170,985 155,785 511,687 407,611 Non-cash charitable contributions 455 1,986 2,469 5,649 Amortization of acquired intangibles 21,262 21,204 63,711 42,795 Acquisition and integration-related expenses — 10,060 6,555 46,664 Restructuring costs 14,161 — 14,161 — Non-GAAP operating income (loss) $ 264 $ (9,521) $ (55,767) $ (49,958) Operating margin (43) % (57) % (49) % (60) % Non-GAAP operating margin — % (3) % (4) % (5) % Non-GAAP Net Loss, Non-GAAP Net Margin and Non-GAAP Net Loss Per Share, Basic and Diluted We define Non-GAAP net loss and Non-GAAP net margin as GAAP net loss and GAAP net margin, adjusted for stock-based compensation expense, non-cash charitable contributions, amortization of acquired intangibles, acquisition and integration-related expenses, restructuring costs related to lease impairments in connection with the closing of certain leased facilities, amortization of debt discount, amortization of debt issuance costs and loss on early extinguishment and conversion of debt. Acquisition and integration-related expenses include transaction costs and other non-recurring incremental costs incurred through the one-year anniversary of transaction close. Adjustments reflect the adoption of ASU 2020-06 under the modified retrospective method as of February 1, 2022, as applicable. Beginning in the third quarter of fiscal 2023, we updated our definition of Non-GAAP net loss and Non-GAAP net margin to include restructuring costs as defined in the preceding paragraph. We define Non-GAAP net loss per share, basic, as Non-GAAP net loss divided by GAAP weighted-average shares used to compute net loss per share, basic and diluted. 40 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) We define Non-GAAP net loss per share, diluted, as Non-GAAP net loss divided by GAAP weighted-average shares used to compute net loss per share, basic and diluted adjusted for the potentially dilutive effect of (i) employee equity incentive plans, excluding the impact of unrecognized stock-based compensation expense, and (ii) convertible senior notes outstanding and related warrants. In addition, Non-GAAP net loss per share, diluted, includes the impact of our note hedge and capped call agreements on convertible senior notes outstanding, as applicable. The note hedge and capped call agreements are intended to offset potential dilution to our Class A common stock upon any conversion or settlement of the convertible senior notes under certain circumstances. Accordingly, we did not record any adjustments for the potential impact of the convertible senior notes outstanding under the if-converted method. Three Months Ended October 31, Nine Months Ended October 31, 2022 2021 2022 2021 (dollars in thousands) Net loss $ (208,897) $ (221,311) $ (662,082) $ (607,225) Add: Stock-based compensation expense 170,985 155,785 511,687 407,611 Non-cash charitable contributions 455 1,986 2,469 5,649 Amortization of acquired intangibles 21,262 21,204 63,711 42,795 Acquisition and integration-related expenses — 10,060 6,555 46,664 Amortization of debt discount and debt issuance costs (1) 1,445 21,698 4,340 64,478 Loss on conversion of debt (1) — — — 179 Restructuring costs 14,161 — 14,161 — Non-GAAP net loss $ (589) $ (10,578) $ (59,159) $ (39,849) Net margin (43) % (63) % (49) % (66) % Non-GAAP net margin — % (3) % (4) % (4) % Weighted-average shares used to compute net loss per share, basic and diluted 158,708 153,756 157,344 145,782 Non-GAAP weighted-average effect of potentially dilutive securities — — — — Non-GAAP weighted-average shares used to compute non-GAAP net loss per share, diluted 158,708 153,756 157,344 145,782 Net loss per share, basic and diluted $ (1.32) $ (1.44) $ (4.21) $ (4.17) Non-GAAP net loss per share, basic and diluted $ — $ (0.07) $ (0.38) $ (0.27) (1) Reflects the adoption of ASU 2020-06 under the modified retrospective method effective February 1, 2022. 41 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Free Cash Flow and Free Cash Flow Margin We define Free cash flow as net cash provided by operating activities, less cash used for purchases of property and equipment, net of sales proceeds, and capitalized internal-use software costs. Free cash flow margin is calculated as Free cash flow divided by total revenue. Three Months Ended October 31, Nine Months Ended October 31, 2022 2021 2022 2021 (dollars in thousands) Net cash provided by operating activities $ 9,980 $ 37,120 $ 9,762 $ 90,587 Less: Purchases of property and equipment (1,884) (1,766) (9,377) (5,800) Capitalization of internal-use software costs (2,377) (1,970) (7,773) (2,348) Free cash flow $ 5,719 $ 33,384 $ (7,388) $ 82,439 Net cash provided by (used in) investing activities $ 21,489 $ 101,459 $ (47,223) $ (210,102) Net cash provided by financing activities $ 5,633 $ 9,214 $ 33,565 $ 58,447 Free cash flow margin 1 % 10 % (1) % 9 % Calculated Billings We define Calculated Billings as total revenue plus the change in deferred revenue, net of acquired deferred revenue, and less the change in unbilled receivables, net of acquired unbilled receivables, in the period. Three Months Ended October 31, Nine Months Ended October 31, 2022 2021 2022 2021 (dollars in thousands) Total revenue $ 481,042 $ 350,680 $ 1,347,792 $ 917,186 Add: Deferred revenue (end of period) 1,062,455 777,872 1,062,455 777,872 Unbilled receivables (beginning of period) 4,530 3,409 3,228 2,604 Acquired unbilled receivables — — — 2,327 Less: Deferred revenue (beginning of period) (1,011,284) (737,297) (996,222) (513,598) Unbilled receivables (end of period) (5,106) (5,085) (5,106) (5,085) Acquired deferred revenue — (900) — (66,239) Calculated Billings $ 531,637 $ 388,679 $ 1,412,147 $ 1,115,067 42 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Liquidity and Capital Resources As of October 31, 2022, our principal sources of liquidity were cash, cash equivalents and short-term investments totaling $2,473.2 million, which were held for working capital and general corporate purposes, including potential future acquisition activity. Our cash equivalents and investments consisted primarily of U.S. treasury securities, corporate debt securities and money market funds. Historically, we have generated significant operating losses and both positive and negative cash flows from operations as reflected in our accumulated deficit and condensed consolidated statements of cash flows. We expect to continue to incur operating losses and cash flows from operations that may fluctuate between positive and negative amounts for the foreseeable future. In February 2018, we completed our private offering of the 2023 Notes due on February 15, 2023 and received aggregate gross proceeds of $345.0 million, of which approximately $339.8 million principal amount has been repurchased or converted as of October 31, 2022. The interest rate on the 2023 Notes is fixed at 0.25% per annum and is payable semi-annually in arrears on February 15 and August 15 of each year, beginning on August 15, 2018. In connection with the 2023 Notes, we used a portion of the proceeds to purchase the Note Hedges. The cost of the Note Hedges was partially offset by proceeds from the sale of Warrants in connection with the issuance of the 2023 Notes. In September 2019, we completed our private offering of the 2025 Notes due on September 1, 2025 and received aggregate gross proceeds of $1,060.0 million. The interest rate on the 2025 Notes is fixed at 0.125% per annum and is payable semi-annually in arrears on March 1 and September 1 of each year, beginning on March 1, 2020. In connection with the 2025 Notes, we used a portion of the proceeds to purchase the 2025 Capped Calls. Concurrent with the private offering of the 2025 Notes, we repurchased a portion of the 2023 Notes and terminated a portion of our existing Note Hedges and Warrants. In June 2020, we completed our private offering of the 2026 Notes due on June 15, 2026 and received aggregate gross proceeds of $1,150.0 million. The interest rate on the 2026 Notes is fixed at 0.375% per year and is payable semi-annually in arrears on June 15 and December 15 of each year, beginning on December 15, 2020. In connection with the 2026 Notes, we used a portion of the proceeds to purchase the 2026 Capped Calls. Concurrent with the private offering of the 2026 Notes, we repurchased a portion of the 2023 Notes and terminated a portion of our existing Note Hedges and Warrants. On May 3, 2021, we completed the acquisition of Auth0. In connection with this acquisition, consideration included cash of $149.6 million, net of cash acquired of $107.4 million, and approximately 19.2 million shares of our common stock with an estimated fair value of $5,175.6 million. In addition, we assumed outstanding employee equity awards with vested fair value of $238.4 million. On August 2, 2021, we completed the acquisition of atSpoke, providing total cash consideration, net of cash acquired of $79.0 million. Of this amount, $13.4 million of consideration was held back as partial security for any adjustments and indemnification obligations and will be paid within 18 months of the closing date. We believe our existing cash and cash equivalents, our investments and cash provided by sales of our products and services will be sufficient to meet our short-term and long-term projected working capital and capital expenditure needs for the foreseeable future. Our future capital requirements will depend on many factors, including our subscription growth rate, subscription renewal activity, billing frequency, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the expansion of our international operations, the introduction of new and enhanced product offerings, the continuing market adoption of our platform, and the costs associated with integration of acquired businesses. We continue to assess our capital structure and evaluate the merits of deploying available cash. We may in the future enter into arrangements to acquire or invest in complementary businesses, services and technologies, including intellectual property rights. We may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital or generate cash flows necessary to expand our operations and invest in new technologies this could reduce our ability to compete successfully and harm our results of operations. A significant majority of our customers pay in advance for annual subscriptions. Therefore, a substantial source of our cash is from our deferred revenue, which is included on our condensed consolidated balance sheet as a liability. Deferred revenue consists of the unearned portion of billed fees for our subscriptions, which is recognized 43 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) as revenue in accordance with our revenue recognition policy. As of October 31, 2022, we had deferred revenue of $1,062.5 million, of which $1,044.6 million was recorded as a current liability and is expected to be recorded as revenue in the next 12 months, provided all other revenue recognition criteria have been met. Cash Flows The following table summarizes our cash flows for the periods indicated: Nine Months Ended October 31, 2022 2021 (dollars in thousands) Net cash provided by operating activities $ 9,762 $ 90,587 Net cash used in investing activities (47,223) (210,102) Net cash provided by financing activities 33,565 58,447 Effects of changes in foreign currency exchange rates on cash, cash equivalents and restricted cash (9,747) (494) Net decrease in cash, cash equivalents and restricted cash $ (13,643) $ (61,562) Operating Activities Our largest source of operating cash is cash collections from our customers for subscription and professional services. Our primary uses of cash from operating activities are for employee-related expenditures, marketing expenses and third-party hosting costs. In recent periods, we have supplemented working capital requirements through net proceeds from the issuance of the 2023 Notes, 2025 Notes and 2026 Notes in February 2018, September 2019 and June 2020, respectively. During the nine months ended October 31, 2022, cash provided by operating activities was $9.8 million primarily due to our net loss of $662.1 million, adjusted for non-cash charges of $685.1 million and net cash outflows of $13.3 million provided by changes in our operating assets and liabilities. Non-cash charges primarily consisted of stock-based compensation, depreciation, amortization, and accretion, amortization of deferred commissions and lease impairment charges. The primary drivers of the changes in operating assets and liabilities related to a $82.6 million increase in deferred commissions primarily due to increased sales and a $30.6 million decrease in accrued compensation, partially offset by a $66.2 million increase in deferred revenue, a $29.8 million increase in accounts payable, and a $15.0 million decrease in accounts receivable. During the nine months ended October 31, 2021, cash provided by operating activities was $90.6 million primarily due to our net loss of $607.2 million, adjusted for non-cash charges of $575.1 million and net cash inflows of $122.8 million provided by changes in our operating assets and liabilities. Non-cash charges primarily consisted of stock-based compensation, depreciation, amortization, and accretion, amortization of debt discount and issuance costs and amortization of deferred commissions. The primary drivers of the changes in operating assets and liabilities related to a $198.0 million increase in deferred revenue, a $42.0 million increase in accrued compensation and accrued other expenses, and a $16.6 million decrease in operating lease right-of-use assets, partially offset by a $92.2 million increase in deferred commissions, a $29.6 million increase in accounts receivable and a $17.3 million decrease in operating lease liabilities. Investing Activities Net cash used in investing activities during the nine months ended October 31, 2022 of $47.2 million was primarily attributable to purchases of investments of $872.0 million and purchases of property and equipment of $9.4 million, partially offset by proceeds from maturities of investments of $848.5 million. Net cash used in investing activities during the nine months ended October 31, 2021 of $210.1 million was primarily attributable to purchases of investments of $1,333.6 million and payments of $215.1 million, net of cash acquired, in connection with our Auth0 and atSpoke acquisitions, partially offset by proceeds from the sales and maturities of investments of $1,346.8 million. 44 OKTA, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Financing Activities Cash provided by financing activities during the nine months ended October 31, 2022 of $33.6 million was primarily attributable to proceeds from employee purchases under our ESPP of $19.0 million, and proceeds from the exercise of stock options of $14.6 million. Cash provided by financing activities during the nine months ended October 31, 2021 of $58.4 million was primarily attributable to proceeds from the exercise of stock options of $41.1 million, and proceeds from employee purchases under our ESPP of $17.4 million. Indemnification Agreements In the ordinary course of business, we enter into agreements of varying scope and terms pursuant to which we agree to indemnify customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the breach of such agreements, services to be provided by us or from intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain officers and employees that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. No demands have been made upon us to provide indemnification under such agreements and there are no claims that we are aware of that could have a material effect on our condensed consolidated balance sheets, condensed consolidated statements of operations and comprehensive loss, or condensed consolidated statements of cash flows. Off-Balance Sheet Arrangements As of October 31, 2022, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Critical Accounting Policies and Estimates We prepare our condensed consolidated financial statements in accordance with GAAP. In the preparation of these condensed consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations would be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss below. Our significant accounting policies are discussed in “Notes to Consolidated Financial Statements - Note 2. Summary of Significant Accounting Policies” in our Form 10-K. We no longer consider estimates related to our convertible senior notes to be a critical accounting policy due to the adoption of ASU 2020-06 effective February 1, 2022, which simplified the accounting for convertible instruments. There have been no other significant changes to these policies for the nine months ended October 31, 2022. Recent Accounting Pronouncements See Note 2 to our condensed consolidated financial statements “Accounting Standards and Significant Accounting Policies” for more information. 45