Okta (NASDAQ:OKTA) reports its third-quarter results after the markets close Dec. 5. The past four quarters have seen the identity management company deliver positive earnings surprises of 64%, 50%, 10% and 55%, respectively. It’s a big reason why OKTA stock has doubled over the past 52 weeks.
The consensus estimate calls for Okta to generate a non-GAAP loss of 12 cents in Q3 2020 from $143.6 million in revenue. That would be a 200% increase in its loss for the quarter with a 36% year-over-year increase in revenue.
Sure, it expects its losses to increase over last year, but it’s still building to scale. And while revenue growth won’t be nearly as substantial — 58% in Q3 2019 compared to 36% in Q3 2020 — Okta continues to attract large companies willing to fork over more than $100,000 per year in recurring revenue.
Eventually, that will be money in the bank. In the meantime, I wouldn’t get too hung up about the latest quarterly numbers. They will be what they will be. However, as predictions go, I do think that it will beat on both the top- and bottom-line. We will know more shortly.
For now, I’m going to focus on a couple of things I think are vital to the OKTA stock price moving higher in 2020.
Operating Expenses Must Slow
Any company that’s following a pathway to profitability has got to figure out how to balance revenue growth while controlling expenses. No business can lose money indefinitely. Eventually, even some of the best ideas run out of money.
In October, I stated that Okta needs to turn its operating margins from negative to positive if it wants to hit $188.71 in 2020. Mind you, this doesn’t have to happen immediately, but I would hope by the end of 2020 or early 2021, it would be delivering healthy operating margins.
In the first six months of fiscal 2020, Okta had a gross margin of 72.2% and an operating margin of -35.9%. Also, its cost of revenue increased 41.3% while its operating expenses grew by 51.7%. On a positive note, its negative operating margin increased by just 30 basis points in the six months. Meanwhile, its sales grew by 49.1%, and its gross margin increased by 150 basis points.
All Okta shareholders need to see are slight incremental improvements in each of these over the next 4-8 quarters and it likely will have found its pathway to profitability.
Let’s assume it grows sales by 25% in each of the next four quarters while its gross margin improves by 150 basis points a quarter and its operating margin stays where it is at -35.9%.
Based on trailing 12-month sales of $490 million, in four quarters, its TTM sales would be $613 million, its gross profit would be $479 million and its operating loss would be $220 million.
That means that its operating expenses would be $259 million, considerably lower than the $405.5 million it incurred in 2019.
Do I think this is going to happen? I can’t say.
What I do know is that if it keeps chipping away at its expenses, the profits will come.
Growth in Customers
As of July 31, Okta had 7,000 customers on its platform. Of those, 1,222 of them had annual contracts in excess of $100,000, 46% higher than in the same period a year earlier. The 1,222 customers represent 17.5% of its entire customer base. In the first six months of 2019, Okta had 837 customers with annual contracts above $100,000, or 16.3% of the 5,150 customers on its platform.
Another figure that I’ll be keeping an eye on in the coming quarters is the dollar-based retention rate. Essentially, it indicates how much additional revenue it’s garnering from its existing customers.
It’s not enough to have a portion of your customers forking over more than $100,000 a year. That’s because if they’re dissatisfied with the products and services, they’ll leave, reducing the $100,000 to zero in a heartbeat.
In the first six months of 2020, Okta had a dollar-based retention rate of 118%, which means the customers its retaining are, on average, spending 18% more than they did in the same period a year ago. You want this number to remain above 100%.
The Bottom Line on OKTA Stock
As I said in October, Okta is an interesting bet despite being a money-loser. Over the next four quarters, I expect the company to continue to push all the right buttons on its pathway to profitability.
Therefore, regardless of what it delivers in the third quarter, I would say that unless the numbers are off-the-charts bad, which I doubt will come to pass, Okta stock remains an interesting stock to follow as we head into 2020.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.