Atlassian Corporation (TEAM) Earnings Call Transcript & Summary

We've got Martin with us, Atlassian. I really appreciate you making the trip and this is a chance for you guys to ask questions as well, so raise your hand and can jump in. I guess just for me, I can keep going, interrupt me, this is for you and not for me. But I'll go through a list of questions and if you have, again, just jump in.

But the cloud is the biggest focus for us. I know you're probably tired of talking about it. But ultimately, I think investors want to better understand kind of where are we going to see kind of this inflection? It feels like every quarter we're kind of [ gaining ] a little bit of a lower tick, and I know Joe will fight back and say, well, we didn't really lower tick, but the high end of the guide came down. So we're just getting the question of it. At one point, kind of when can we get confidence that you've kind of set the number low enough where that could be achieved?

Happy to take that. That's a long question. Look, so we've, over the past year, have seen headwinds in our cloud business from lower conversions of free to paid customers as well as on seat expansion within existing customers within existing products, which is where Brent's talking about. And that's always been the biggest driver of growth across all products, but specifically within cloud. Other areas of our business within cloud drivers like cross-sell, upsell and migrations, those haven't seen any macro impact. So those continue to hold up well. But that seat expansion dynamic is the biggest driver of cloud growth and is where we're seeing headwinds. I think every quarter, we continue to be vigilant about those macro pressures. But now we do have a clear trend line of quarter-on-quarter, it has continued to get worse in terms of macro impact. Q3 was worse than Q2, which was worse than Q1. And so we'll continue to monitor. Look, I think in terms of our guidance, we have assumed that macro will continue to get worse. And we've also at the bottom end of our cloud revenue guidance, have assumed that -- or have allowed us room for those areas that haven't seen impact, to see macro impact.

And many asked us kind of what innings are we in, in this migration? And you do have a hard deadline in '24 to get people to move. They don't have to all go to cloud, but they then go other places as well, right? So can you just talk about this hard deadline combined with where we're at in the migration environment.

So for everyone not familiar, we have announced the end of life of our server products. We announced that almost 3 years ago now. And so that is coming up in February 2024. We will no longer offer support for our several products. So there's been no consideration around pushing that end-of-life date. We'll no longer offer support for our server. Those server customers will have the option to go to cloud, which is, of course, where we would like them to go. But in this macro environment, I think we're cognizant that some customers will go to data center in the near term, and that's something that we have seen play out as well as the timing of such migrations, right? So like if a customer reaches February and then they realize that they actually have to get off, when do they actually make the move to either cloud or data center. So there's a lot more variability in this year because of the macro backdrop and as well as the timing of those migrations. I think where we've been impressed is while we have seen greater server to data center migrations over the past year, we've seen actually significantly greater data center to cloud migrations. So when you think about cloud migrations over the past year, about 50% of those migrations are now coming from data center. So that's really encouraging because that tells us that we're making the right investments knocking down the blockers that are allowing those biggest customers that are on data center today to get over to cloud.

And one of the things that we picked up at the conference today as was it seems like there's -- as you would expect, some of these larger enterprises are dragging their feet a little more to cloud. Are you seeing some of the larger customers may be waiting, want to get more confidence in cloud security or migration costs. Is that -- something we picked up, I don't know if it's something you see in here as well that maybe there's some big large enterprises that are kind of holding out towards that deadline date.

Yes. And so I think there's always 2 camps, right? One is, is it something that we don't have yet in the cloud that's blocking them from coming, and I'm happy to address those. There's normally 3 buckets -- 3 categories that encompass those. Or is it something on the customer side where they don't have the budget or they don't have the IT resources right now to be able to move to the cloud. So on our side, there's normally scale. I think a couple of years ago, we could only accommodate up to 1,000 users in the cloud instance. Today, we can accommodate up to 50,000 users. So we've been steadily raising up that -- the capacity there, and we need to continue to raise that up as -- on data center in particular. We have customers with north of 50,000 users. There's the data governance and compliance bucket. And so every quarter, we check off a new 3-, 4-letter acronym of HIPAA data, residency in Singapore. So every quarter, we're delivering something there. But the next biggest one on our road map is FedRAMP compliance. I know that's a big one that customers want to see. And then the last one is on the extensibility side. So we have a very robust marketplace where we sell third-party apps as well as customers that build their own apps for their own environment. And so being able to facilitate those in the cloud, that's an important step to unlock for those customers to be able to move over to cloud.

And the FedRAMP piece comes when?

So we have it on our road map. We have a public-facing road map. So that's actually a good point in the sense that we're very transparent about the different deliverables that we have in the cloud. You can Google it, maybe you look at the Atlassian cloud road map. So these customers can actually plan out their migration as they see when we're delivering FedRAMP. I think it's a way for 2024 right now.

Got it. Macro, I guess, there's been various conversations here. Some are saying that the headwinds are getting less worse. Some are saying, "Hey, they're the same". I mean what's the sense of what you guys are feeling overall in terms of just -- are things stabilizing? Or are they -- have they gotten a little worse? How would you characterize just overall tone and inflection of your customers?

Yes. So as I mentioned earlier, quarter-on-quarter, we have seen greater macro impact in our cloud business. So we've built that into our guidance assumptions, and we have seen that play out. And so we'll continue to expect that. I think it's interesting.

You're expecting it gets worse in the back half based on the [ cap ].

That's what we've assumed in our guidance right now. Yes. And so we haven't seen anything that would make us change that assumption at this point. If you think about our cloud business, it does skew much more towards SMBs, and so that's predominantly where we felt the pain within that SMB cohort. Within our cloud business, we also offer monthly and annual billing terms. And so about 70% of cloud customers choose monthly billing. So especially within that SMB cohort, as those customers pick monthly billing and have stop adding users at the same rate at which we previously did. It has rippled through cloud revenue quite a bit faster than if we only offered annual billing terms where you would have a bit more of that shock absorber. I think macro, obviously, is the wildcard here where if macro were to stabilize or even were to improve, then you would start to see that ripple to our benefit the other way. So I think we're quite vigilant and continue to monitor this. I think in contrast, you've seen on our data center business, that's been more resilient in the sense that those are our biggest customers. We haven't seen the same macro headwinds on seat expansion there within our data center business. Those customers continue to add users, which I think highlights the reason why we won't need to accelerate our cloud migration timeline. So we get those largest customers over to cloud. But thus far, that's where we're seeing the greatest macro impact is in the cloud on that seat expansion component.

At the user conference, your founders, when asked about investments and would you let the margin go higher, they were clear, hey, we want to continue to spend. We want to invest. We shouldn't expect margins skyrocket from this level, but there was a lot of questions around kind of the interpretation of what he meant. And I don't know if you can just clarify there because I get a lot of questions about is he just going to keep the pedal down on expense, we're going to see no margin, or how do we -- how should we think through this?

Yes. So for everyone's background, if you look at our track record, we -- for 6, 7 years, we had a track record of expanding margins and then very strong operating and free cash flow margins. About a year ago, we made the conscious and deliberate decision to lower margins as we're going through an investments period, especially to facilitate these cloud migrations, which we've talked through. What Brent is talking about is as we got asked about FY '24, what we're trying to express is that we will continue to invest and continue to hire. Now we've laid out that we would moderate the pace of headcount growth, and we've done that. Over Q1 and Q2 of fiscal '23, we were adding about 1,000 net new employees each quarter. So hiring quite significantly. But over Q3, you saw us add about 280 net new employees. So you've seen us moderate that pace of headcount growth, and I think that's more representative of the pace you would expect to see going forward. The point though that we're trying to make is that we will continue to hire, continue to invest. There's a lot of talent that's suddenly available in the market. As you hear about layoffs across different tech companies, we want to scoop up that talent, kind of bolster us and set us up for the long term. And then as we've talked about in terms of migrations, we want to kind of bend the curve on migration. So we think it's important to continue to invest against that because of course, we need to get customers over the cloud, but that also has nearer-term revenue impacts, right? That has implications on top line. And so if we think about reinvigorating cloud revenue growth, the faster we can unfold migrations that has implications there.

Can't have a fireside chat without AI. So you showed and talked about this at the conference in Vegas about your aspirations here and there's a tailwind, but there's also this perceived headwind of ultimately what can happen. So can you just walk through the tailwind of what you think you can see and we can talk about the potential headwinds?

Sure. So AI, I think the big question that Brent's alluding to is we often ask the question of how do you view AI impacting the potential pool of developers and the rate of growth within the developers. And so I think there's 2 ways that we think about this. It's -- one, I think the TAM will grow in the sense that there will be a lot more people like myself that will suddenly have access to tools that will allow them to have much more technical skills. And so that generally favors us. But I think when you think about the hardcore developers, those folks will become incredibly more efficient. They're going to be able to turn out significantly more lines of code. And so therefore, a lot more projects and ideas will suddenly be born. And as those projects and technologies come to fruition, there's generally a lot more problems to be solved. How do I bring this new technology to market? How do I integrate it with my existing stack? How do I productionize this? So that tends to be where we thrive of humans coming together to solve a technically oriented problem and having to collaborate around that. So that's, I think, the main question that we've been getting and Mike and Scott have talked to this at our investor forum back in April. We've also rolled out generative AI capabilities within our own products. The first products that we've announced this in is in Jira Service Management and Confluence. And we think of that as a pretty significant migration opportunity, the conversations coming out of Team 23, a lot of it was focused on AI and customers that previously had said, "Okay, I'm going to come to cloud, and maybe it takes me 2 or 3 years". Some of those customers are rethinking those migration plans as AI is a pretty meaningful [ carat ] given that it's only available in the cloud.

You have a lot of products. And so we get the question of this ability to kind of work -- all these products to work together and do a bundle and make it easier for someone inside enterprise to adopt your suite. Can you talk about the bundling and the halo effect you're seeing from these products working better together. What are -- what are you seeing from that perspective?

So about 9 months ago, we announced Atlassian Together, which is our kind of our first foray into offering a bundled approach. And so the Atlassian Together includes Confluence, Trello, Jira Work Management and Atlas. So it's across our work management offerings. It's offered at a very disruptive price point. So when you think about it, CIOs will have the ability to say, okay, I want -- I like Atlassian, I really want to standardize on Atlassian. I don't want to force upon my entire workforce one single tool because that's a very difficult proposition to say, okay. Everyone across the company needs to use Trello. Different teams are going to always have different collaboration needs. Their own -- I'm sure your team works differently than my team, which works differently than our marketing team. And so teams will pick what's the best work management tool for them, but Atlassian together allows someone to standardize [ on ] Atlassian, while allowing the teams to pick which is the right tool for their collaboration needs. And I think that's our first foray. I think it's still quite early with Atlassian together, given it's only been 9 months. I think as we kind of evolve as a company, I think we will continue to look at pricing and packaging. We have a pretty long history of evolving pricing and packaging. We sometimes increase prices, sometimes lower prices of products. And so pricing is always a dynamic component of our model. I think we'll always look at pricing and packaging.

I'm pumped about Atlas because as someone that works with a lot of people, I just -- we don't have a tool. And I think a lot of people ask us, like why aren't we hearing more buzz and excitement from the partners around this? What needs to happen for that to really because there's a lot of people in IT, but there's a lot more knowledge workers that can use this product, the TAM is ginormous. So I guess, what needs to happen for that to hit an inflection point?

Yes. So when we think about the work management market, we've always kind of looked at that as the longer-term opportunity. And we've always been cognizant if not to over-index and over-rotate towards the work management because we don't want to lose our position within DevOps, don't want to forsake that opportunity within ITSM. But to Brent's point, we've rolled out a new product. Jira Work Management was rolled out 2 years ago. Atlas came about earlier this fiscal year. And so we continue to invest in that work management category and do so in kind of a thoughtful, pragmatic way. Atlas is an interesting approach to the work management category because Atlas basically surfaces what a team is working on and the status of that work. Pretty simple, right? And so even if the individual team is using a different work management tool, it could be Trello, could be Confluence or it could be a competitive offering. Atlas basically sits on top of that and surfaces, again, what is the team working on? What is the status of that work? And so that serves as a common [ thread ] across different teams, no matter the work management tool that the team is using. And other teams and management teams and executives of teams can then see what is the status of that work. So pretty excited about Atlas. With all our new products, it takes time given our go-to-market motion. We don't have a Salesforce that we say, hey, start attaching this SKU to every single deal that you're doing. That's just not the motion that we deploy, right? And so it takes time for that organic adoption. It slowly compounds over time. And that's the approach that we're taking with Atlas.

Just on another follow-up on margins. You were in the mid-20s. Is there anything prohibiting you getting back there long term?

No, nothing structurally has changed. We obviously made the deliberate decision to lower margins as I talked to earlier, as we're going through this investment period to especially facilitate migrations first and foremost. We're investing quite a bit on developing enterprise product capability. I think that we recognize that there is a pretty significant opportunity, especially as those largest customers migrate over from data center to the cloud, to be able to offer more enterprise product capability in the cloud and then being able to charge appropriately for that incremental capability. And then thirdly, we talked about investing more in ITSM. I think that this momentum within ITSM with Jira Service Management has been pretty significant over the past 2 years. The customer response has been quite significant. Industry analysts like Gartner and Forrester are putting us in that top right leader quadrant. And so I think we want to continue on that momentum and push on Jira Service Management a bit more.

You're pretty transparent about your pricing every year. You have a little bump. Any reason to believe if anything changes going forward? Or is it pretty consistent from what we've been seeing?

Yes. I mean, as I touched on earlier, pricing and packaging is something that we're always looking at. We have a pretty robust team that's looking at different options. But I think there's something to be said about having a steady [ regulated ] so customers can obviously plan for it, budget for it. So I think that's always the 2 sides of the coin that we're looking at as we think about pricing and packaging around our products.

Yes. The other big theme we keep hearing is cloud optimization, people stalling their journey to the cloud and [indiscernible] says, "well, if they stall their journey, are they going to stall Jira and the collection of Atlassian solutions because a lot of these products can help collaborate, get you from on-prem to the cloud." And I guess, are you seeing that as, hey, AWS, Microsoft and others have slowed that -- I mean, your cadence has slowed too. Do you feel like -- are you -- I know there's other factors that you're not one for one, but if the hyperscalers come back, doesn't it feel like as they come back, that our factory shuts this year, our AWS factory shuts, so we're not moving anything to public cloud.

No. I mean coming out of Team 23, all the customer conversations, there wasn't any conversation that said, "Hey, I'm not coming to the cloud." I think all of the conversations centered around we want to get to the cloud. It may not be for another 2 years in some scenarios, again, depending on the customers' resources, depending on budgetary constraints. But I think the end destination is clear, not only from our building the best experience in the cloud, but they all want to get to the cloud. We think about our investments over the past several years is around automation, analytics, now AI, all that is obviously only available on the cloud. And so customers want to continue moving to the cloud. I think the trend of digital transformation like that hasn't stopped. And again, it's just the timing of such migration.

And it slowed for sure. It's public, that it slowed. But when you think it doesn't -- as they come back online, it would seem like that's going to be a natural kind of boost for you guys because I would think that as they fire back up, they're going to probably drag you with on some of these deployments?

Yes. I mean, we don't tend to link our business too much the cloud providers, our cloud infrastructure is hosted entirely on AWS. But I think that trend and desire to move to the cloud, I wouldn't tie that necessarily to the public cloud providers.

Okay. I'm just thinking, in general, just is -- I would collaborate more of those moving to public cloud. Am I wrong?

No. I mean I think that's also part of the reason why we need to get customers to the cloud faster, right? A lot of the new products that I talked -- we've talked about, Jira Product Discovery, Beacon, Atlas, Compass. Those are only available in the cloud. A lot of them under the surface machinery of the recommendation engine to be able to facilitate cross-sell. We've built that in the cloud. So cloud migration has been the top priority and taking a lot of investment and energy right now. I think there becomes a bigger opportunity to be able to push on that cross-sell motion quite a bit more once we get those customers over to the cloud. So again, there's a lot more products to be able to sell them. There's a lot more ability to collaborate with customers within the cloud. And then I touched a little bit earlier on the enterprise product capability. So I do think there is -- it becomes a lot more of an opportunity to upsell to those customers once they get over to the cloud.

3- to 5-year journey. What are we -- what do you see that maybe we're all missing or you can see that we can't see that you would highlight and this is pretty compelling and you guys aren't picking up on this?

I think a lot of it is just kind of what I touched on earlier about as we get customers over to the cloud, the opportunity presents itself a lot more in terms of the expansion levers, right? A lot more products to cross-sell, facilitating that cross-sell motion, that upsell motion as we deliver more enterprise product capability. So I think that is something that we haven't been able to prioritize nearly as much because we, first of all, need to get customers over to the cloud. And then we touched a little bit on earlier, that data center base, right? That migration will continue to unfold over the next 3, 5 years as that longer tailed data center transition happens to cloud. And that is where our biggest and big customers are. And so I think that's pretty compelling, especially with those enterprise customers moving them over to cloud.

[indiscernible].

Sorry, can you repeat the question one more time? So I think the question is the post-migration organic growth, are we going to provide that any time. So I think a couple of things. One is we don't think of the end of life of server as the end of migrations as I touched on. There will be that data center to cloud migration story playing out over the next several years. And then I think that organic opportunity presents itself a lot more in the cloud as those expansion levers are really more available in the cloud. And then I think when we think about FY '24, which is the heart of your question, there's a lot more variability in this year, right? We talked about macro and how we think about macro continuing to evolve into next year as well as the end-of-life event around February 2024. There's going to be a lot more variability as customers move to cloud, move to data center and the timing of that, there's just more room for variability there.

Thanks, Martin.

All right. Thanks, Brent.