Atlassian Corporation (TEAM) Earnings Call Transcript & Summary

Good afternoon. Thank you for joining us for Day 2 of Baird's Global Consumer Technology and Services Conference. I'm Rob Oliver. I follow the SaaS and software sector at Baird. It's my pleasure to have Martin Lam from Atlassian here. Martin, thanks for coming to the conference. Really appreciate it.

Thanks, Rob. Happy to be here.

Making the time. Atlassian's consistently one of the most talked about companies when we're around road marketing, always top interest, one of the most exciting stories I follow. And typically, I wouldn't ask a $45 billion innovator leader in product growth model to say what you do, but maybe just for the purposes of the room, if you could just maybe tell people what is Atlassian and what do you guys do?

Sure. So at Atlassian, our mission is to unleash the potential of every team. So we think a lot about teamwork. What makes teams tick, how our teams formed, how do they get work done together. So much so that our ticker symbol is TEAM. And so what we try to do is facilitate teamwork. And so how do teams communicate together, how do they collaborate together and how can they work more efficiently together. And so that's what our portfolio of products tries to address. 20 years ago, we got our start with software developers. But now our portfolio has brought in quite a bit. Now we're addressing 3 distinct separate markets. There's agile DevOps, as we call it; ITSM and work management. And again, all of our products center around how do teams work better together.

Great. Helpful. Maybe we could just talk briefly about the macro environment. I think it's always interesting to hear from you guys about the macro because I sort of think of you guys as like sort of the kind of the most sensitive like the gravitational needle because you have this -- you have so many monthly customers, you have a lot of like sort of lower end customers. So maybe talk about the macro and how it's played out for you guys and what you see?

So we've seen macro impacts in our business in 2 primary areas. The first one is being new customer conversion. So we offer 3 versions of all of our products today. And so we're seeing a slower rate of conversion from people upgrading from those free products to paid plans. I think it's important to remember, at the top of the funnel, the number of people clicking into trying versions of our products and stepping into those free instances of our products, that continues to grow in a really healthy way on a year-over-year basis. But there is a lower conversion [ rate ] of people hesitating to convert into one of the paid plans. The other area where we've seen macro impact in our business is on paid seat expansion from existing customers within existing products. So if you decompose our drivers of growth, that is our biggest driver of growth. That organic seat expansion after a customer has landed and adopted one of our initial products. Other areas of our business like cross-sell and upsell and cloud migrations, which I'm sure we'll touch on, like those areas have not been impacted by macro to date. But that paid seat expansion is our biggest driver of growth. And it's largely due to as customers fuel budgetary constraints, whether it's due to hiring freezes or risks, no longer adding users at the same rate at which they once did. There's still absolute expansion, but just at a much lower rate than we've previously seen.

Your founders have always taken a very long-term focus of the business. And that's largely been to the benefit of the company and to everyone. When you think about the move to having a free solution, is that something where when you guys kind of offer that free solution? Is that something where now you're seeing like maybe a potential longer-term benefit of that because a customer that might have been paying you that moves to free is still within the Atlassian ecosystem? In other words, you don't lose that customer.

Most definitely. I mean that's one of the advantages of [ free ] -- and that's what we try to trap for. Monthly active usage is probably one of the top metrics that we try to track for, that continues to grow and be healthy. And as you're pointing out, those customers are still within the Atlassian ecosystem, still on the Atlassian platform and not churning off to a competitor.

Got it. The other source of pressure that you mentioned was organic seat expansion. Help us understand that a little bit better. I mean, a typical land maybe what -- is it with a developer team? Should we think of this more as that like because growth is slower for companies. There's fewer projects and fewer developer teams or is it just more that like people are hiring less right now? How do you guys think that?

It's primarily that latter point in that companies are hiring less. And as they feel that [ vigitary ] constraint, they're not adding users at the same rate, which they once did. The trends of digital transformation and work needing to get done within organizations. That clearly hasn't changed, right? Like people still need to progress and push forward the progress of work. And that overall trend of digital transformation certainly hasn't changed. I think it's important to also realize where we're seeing the headwind more pronounced as you talked to a little earlier, is within the SMB cohort, our cloud business does predominantly serve SMBs. Over the past several years, that dynamic has started to change more and more as larger and larger enterprises move from our server or data center deployment options over to the cloud. But historically, it has skewed much more towards SMB. And in the cloud business, we offer both monthly and annual billing. And so we've disclosed in the past about 70% of cloud customers opt for monthly billing. And so those are largely SMBs as those larger enterprises opt for annual billing. And as those SMDs in particular, haven't added users at the same rate they once did, you're seeing that reflect in revenue as those monthly billings roll through.

I should also mention if you've got a question, please send it to the e-mail in front of you, and I'll try to get that question to Martin. So you mentioned the cloud, and Atlassian is a cloud transition story. And I think at least software investors are familiar with cloud transition stories. In many regards, they've made money within cloud transition stories. You guys are a bit of a unique one in how you're approaching it. So maybe also to level set the room here, maybe talk about the transition for Atlassian and then where you are now in that...

Yes. So as I touched on a little bit earlier, we have 3 deployment models for our software products today. We have server, data center and cloud. And so we rolled out cloud versions of our products back in 2009. And then 3 years ago, we announced the end of life of our server offering. And so that's coming up in February of 2024, where we will no longer offer support for that server offering. It's still going to continue to be a migration story that plays out over the next several years because we'll still offer that data center offering. And that data center customer base is where many of our largest customers are today. So that migration is going to continue to play out well beyond February of 2024 as those biggest customers migrate over to cloud in future years. And that's what we're investing for today. We're going through an investment period right now as we try to facilitate more and more of those enterprise migrations, trying to deliver both scale, data governance and compliance, requirements so that those biggest customers can move over successfully.

And so you've got a big chunk of customers, some on-premise, some in data center. But the on-premise customers are going to be end-of-life for support in February '24. So those customers and they're going to have a choice. And I guess it's probably early still, but preliminarily speaking, what's the feeling within Atlassian around where some of those customers might choose to go? I know you guys been very adamant about not making your customers go one way or another, which is one of the reasons why your customers like you. On the other hand, you are putting some carrots in the cloud to get people focused on that. So help frame that.

Yes. So over the years, we've historically used a much more of a carrot approach to incentivize customers to move to the cloud. And as I mentioned earlier, over the past several years, that story has been playing out. Now there is more of a stick action here with the server product reaching its end of support in February 2024. But we'll continue to offer the data center offering, which is an on-premise behind the firewall offering. So those customers that aren't yet ready to move to the cloud, have a stepping stone that they can pause that before moving over to the cloud. I think as we just came off of our user conference back in April and a lot of the discussions that we had with our customers was general excitement around moving to the cloud. Several years ago, maybe there would have been more hesitancy because they needed to see our cloud platform mature a bit more. And now a lot of those conversations around kind of when, not if they'll migrate over to cloud. But I think as we think about that server customer base, over the next couple of months before that February 2024 end-of-life deadline, some customers will absolutely move to the cloud. Some will move to data center because it is kind of the path of least resistance. You can kind of upgrade the data center in literally 30 seconds. And then the timing of such migrations are going to have different implications for FY '24.

Got it. And so just -- I'll try to dig in a little bit on that. From an economic perspective, near term, does that -- I know, [indiscernible] probably if a customer wants to move to data center, they want them to move to data center. That's what they need to do. But from -- and it matters to investors to get your customers to the cloud. But does it matter -- what are the implications of a swing one way or another for you guys relative to, say, the next year and what that would mean for margin?

Yes. We clearly have put cloud as our North Star. That's ultimate end goal for our customers. Again, the data center offering is going to be important, kind of stepping stone for some of these customers. Relative to the server offering, there is generally a pricing uplift associated with a customer moving from server to cloud. Similarly, there is also an uplift if a customer moves from server to data center. So I think there's attractive economics as customers migrate off of the server offering. Now the cloud does have lower gross margin profile than data center as we have to incur the hosting costs in a cloud world versus data center where customers are incurring that. They can host that on their own servers, in their own private instance of AWS or own private instance of Microsoft Azure. And so structurally, there may be a lower gross margin profile. It doesn't really have tremendous outcomes on the overall operating margin profile, mainly because what we're doing this year is continuing to invest to facilitate those migrations coming in future years. So we continue to allocate resources to help those customers move from data center to cloud, trying to drive initiatives like FedRAMP. That's an initiative that customers want to see before they will move over to cloud in future years. So we'll continue to invest in this period, albeit at a much more moderated pace than you've seen us higher in over the past couple of years.

Got it. You guys have HIPAA, right? And so FedRAMP still out there, HIPAA, but you guys have been knocking down a lot of those key points for the big companies that might consider cloud.

Yes. If you think about why a customer may not be ready to yet to move to our cloud, there's generally 3 buckets that customers fall in, right? One is on scale. Today, we can support up to 50,000 users per cloud instance on data center. There are customers with north of 50,000 users. If you rewon time several years ago, we could only support up to 2,000 users per instance. So we've been slowly ramping up that on the scale side of things. On the data governance and compliance side, as you're alluding to, kind of joke internally that every quarter, we're delivering a 3, 4-letter acronyms, whether it's HIPAA or data residency and certain geo like Singapore this quarter, we kind of have to continue shipping those out. The next big milestone that customers are asking for is FedRAMP compliance. And then the third bucket is on the extensibility side. We have a really robust marketplace with several thousand apps for customers to customize their own and extend their capabilities of their own instances as well as larger customers that have built their own customization over the years. And so if that cloud equivalency is not available yet, they're not going to move over to the cloud. But sometimes a customer may need to build that same customization in the cloud world or third-party developers have to build that. So that could potentially be a blocker. On the customer side of things, there's no shortage of IT projects going on within our customers. So we're one of many projects. Of course, we want them to get -- our project to get to the top of that list. But in this macro backdrop, especially. They need IT resources to be able to move over to the cloud, whether it's internal IT resources or third-party resources to help them get to the cloud.

And on that extensibility part, how ahead of the curve, would you say your partners are on getting -- those are very important plug-ins and add-ons that make Atlassian's ecosystem thrive the way it needs to cloud ready?

Yes. I think we've made a lot of progress in that space. If you look at 2 years ago, the number of apps available in our marketplace for server outnumbered the number of apps available on the cloud. And that gap has closed and where now there are more cloud apps available in the marketplace relative to server. So I think we've done a really good job of trying to incentivize more third-party development for the marketplace. But again, I think that the next stepping stone is probably within these larger customers, their own custom-built apps that will never see the light of day for -- in the marketplace because they build it for their own custom use cases and then being able to build that in the cloud is the next stepping stone.

Got it. And just -- you can just maybe lay out for us like if a customer is right, they've got everything figured out internally, but it's either they're going to go data center or they're going to go cloud. Are there some things that they're not getting at data center or -- what are they going to get at cloud that they might not get a data center? I know AI might be one. I want to talk about that.

No. So if you look at where we've been delivering innovation over the past several years, the lion's share of R&D budget has been allocated towards cloud. So analytics capability, automation capability, and now degenerative AI capabilities, all only centered in the cloud. On top of that, a lot of our new product innovation is also centered around the cloud. So this past year, we've announced new products, Atlas, Compass, Jira Product Discovery, Beacon, all these new products that we're delivering and shipping they're only available on the cloud. So I think customers recognize and as I alluded to earlier, it's very clear. I think the direction that we're shifting towards and where we think the best customer experience will be, and customers are recognizing that as well, as they evaluate their migration plans and say, "Okay, hey, I want access to generative AI capabilities. I really need to think about my cloud migration plans."

Got it. Okay. Let's talk a little bit about AI now. You guys made a bunch of announcements, the Team 23 about that. I know in talking to Joe afterwards, it sounds like there was a lot of real customer interest about it, that might be an incremental driver to cloud. Maybe help us understand what it was you rolled out there in terms of generative AI functionality? And when we can expect that to start to be usable by Atlassian customers if it isn't...

So we announced that Team 23 conference generative AI capabilities in Confluence, one of our core products as well as Jira Service Management. So those 2 products initially. So for those of you not familiar, Confluence is really a tool that is used for documenting, storing information. And so generative AI gives the ability to summarize a lot of that data. Well, allows you to draw upon answering questions because companies store -- again, where do we keep our insurance information? How do we document the steps that we took to build x product or integrate different pieces of software together. So it's really a knowledge repository and again, generative AI can pull a lot of that information out of there. And that's really compelling when you think about these customers that are migrating over to cloud. They're bringing with them in many instances, 12, 15 years of data with them in Confluence. And so I think that's quite compelling. Within Jira Service Management, we rolled out virtual agent capabilities. And so we rolled that out internally, and we call that Atlassian Intelligence. And the kind of efficiencies gained within our own IT team, it's pretty tremendous. And I think customers took note of that at our Team 23 user conference. And I think that's pretty exciting. And so when we think about monetization with AI, I think we think a lot more broadly than a lot of other companies. We're not going to charge for it as a stand-alone SKU. We're going to put it across our various additions of our cloud products. So today, we offer a free addition, a standard edition, a premium addition and now an enterprise edition of our cloud products. By putting it across all the additions, I think that's going to be really compelling for attracting net new customers because then customers -- net new customers can get AI capabilities at a very attractive price point. It's also going to be, as Rob is pointing out, a pretty big carrot, I think, for migration, right? Like there's compelling economics when a customer shifts from either server or data center to cloud. And I think a lot of these customers are rethinking their migration time lines, especially now with the new AI announcements.

Thanks. Keep the questions coming. I've got a bunch here. There's a couple on competition. So why don't I ask it this way, we can kind of get a competition, but also get it somewhat kind of 3 product areas that you laid out. So start agile DevOps, IT service management, work management, 3 of the faster-growing areas within software, also 3 areas where there's a lot of competition. So maybe if you could kind of break down how you think about those 3 and like who your competitors are in each of those 3, that would be helpful.

Sure. So the competition, it varies depending on what market you're looking at, right? So the competition in DevOps is different than it is in ITSM, which is different than Work Management. In each of those categories, it really ranges from kind of legacy incumbents to new point solutions to -- if you think about how a lot of work gets done, it still gets done in spreadsheets and e-mail, right? Like that's how a lot of people get and track work amongst their teams. And so there's a lot of that greenfield opportunity where a lot of customers come to us today. Within DevOps and agile DevOps, there's, of course, Microsoft. They have a product called Azure DevOps, which competes with Jira Software, our flagship and kind of flagship product, but it runs the gamut all the way from new point players. Within ITSM, I think we oftentimes get questions from investors around ServiceNow. That's obviously an incumbent within the ITSM space. Happy to talk about that. But if you think about where Jira Service Management shines within ITSM, it's the ability to connect your IT and operations teams to your development teams. And so that's the #1 value prop of Jira Service Management, bringing those 2 teams closer and closer together, especially as we move forward into a much more software-centric world, whereas a lot of IT practices, traditionally, we're tracking hardware and different components like that. And then in Work Management, I think that space gets a lot of attention. That's by far the biggest market opportunity in terms of the number of users we can potentially address. That one is also -- has a lot of different point players that have cropped up over the years. I think we think about it quite a bit differently in the sense that we do so in a much more disciplined way in terms of economics within that space and how we acquire incremental customers. We often times are able to reach those nontechnical workers or nontechnical users after we've landed within -- with our core products. So it's not uncommon for a software team to bring in, let's call it, Jira Software. And even within Jira Software, 46% of Jira Software users are nontechnical in nature. So software team may bring it in or a software developer may initially bring it in. But increasingly, there's IT operations. There's program managers, designers, a whole host of people that are supporting software projects that aren't the ones [ right in code ]. And so that's how you first reach these nontechnical users. And over time, a product marketing person that's working with the development team can then pivot around and say, "Hey, I was using this great product over here at Jira. Let's try bring in Jira Work Management over here to the marketing department." And that tends to be how we organically spread into those nontechnical areas. And then increasingly, we've been introducing new products that are able to land with those nontechnical teams. For example, we have a product called Trello, which is a lighter weight, more flexible work management offering that has the ability to land with those more technical users as well.

Got it. Really helpful. Yes, keeping comment. I'll take the questions. On agile DevOps, Microsoft has been coming a lot -- up a lot in our conversations lately just because I think people probably didn't historically think of Microsoft as a software development platform or effective tool that could compete with Jira. So when you look at, say, like the combination of like Copilot, Azure DevOps, what Microsoft has done being an Infrastructure as a Service player. Is that -- what sort of competitive threat is that represent to you guys? And how do you think about that? You're not an Infrastructure as a Service player? Does that matter? How do you think about it?

I think we think about it quite differently. As I talked about at the very beginning of this conversation, like we would focus on the collaboration around how teamwork gets done, whether it's within a technical team or a nontechnical team, right? And so we never focused on just serving pure software developers. Again, it's all the people that surround the software developers, I think where we've shined over the years. And whereas Microsoft with Infrastructure as a Service is really focused on just purely serving developers, especially as an avenue to get them on to the Azure platform.

Got it. And then on IT Service Management. So ServiceNow at the high end, they've talked occasionally about trying to move down market. And I'm not saying you guys are only down market. You guys are all sorts of different places within the enterprise, but I get it connecting IT development teams to service teams. But do you see them more? Are you seeing them more? Are you bumping into each other more? Do you guys have done a little bit more with sort of bigger SIs and they've like talked a little bit about coming down market?

So I think we see them a little bit more. Now at the same time, Jira Service Management today has 45,000 customers. So we do focus on serving customers large all the way down to the small end of town. And that's always going to be a focus of ours. I think where we're having a lot of success is continually landing with small teams, even within larger organizations that have potentially an incumbent ITSM solution. And that's okay with us because what happens over time is then you start to seed more and more users. You have more and more instances of Jira Service Management that will pop up within that organization. And then over time, then you can have a much more compelling replacement conversation. At our user conference back in April, many customers shared how they've swapped out their existing ITSM solutions for Jira Service Management. And again, part of the draw of course, is to connect your IT team to your development team. Another big value prop of Jira Service Management is price. We're priced very competitively versus our competition, and I think that's quite a significant advantage for us. And then the third bit of feedback that we've been getting from customers that's been coming up in a lot of our conversations is time to value. So you can be up and running because of its ease of use and flexibility on Jira Service Management in a day, whereas oftentimes with a legacy offering, it may take several quarters for you to roll out a customization.

Got it. Very helpful. Keep the questions coming. There's a bunch on AI, so I'm going to try to consolidate them. I had one as well. But at least in my discussions, but having been on the road market in the last 3 weeks with mutual investors, you guys are kind of ground 0 of the debate on generative AI because software development has been one of the areas that sort of everyone sort of says, oh, I need fewer developers, right? And so let's attack that 1 first. We've seen these sort of tech evolutions in the past where we think it needs less but it really expands the market. I think of like Adobe, where you need to go into a shop and buy a $300 box of shrinkwrap software in order to do what today my kids do on their phone. So when you think about the software developer market and relative to the opportunity for Jira, does this reduce the opportunity for you guys? Or expand the opportunity for you guys and how?

Yes. We think it expands the opportunity. And the reason why is, like -- if you think about it, there's going to be a lot more people with access to technical skills that wouldn't have otherwise had it with, whether it's a Copilot or some type of assistant, providing that type of capability. So someone like myself will have access to technical skills. So think about more and more people will be able to touch and utilize the benefits of our products. On the other end of the spectrum, the hard core professional developer they're going to be significantly more efficient. They're going to be able to produce many, many more lines of code, right? And if you talk to any company, whether they're a tech company or a traditional company, there's no shortage of ideas and projects that they would love to bring to fruition, but they've always been constrained by supply. And so now as these developers become significantly more efficient and chew through more lines of code, more software is going to be born, more technology is going to be born. And that tends to play to our favor, right? If you think about where we thrive, it's around those human problems. So humans will have new problems to solve for around how do I bring this new software to market. How do I integrate this software with -- new software with my existing technology stack. How do I productionize this. So as more software comes to fruition, more problems are to be solved by humans.

I think we've got time to squeeze in a couple more. Thanks for all the questions. On the Atlassian Together offering, you guys -- it's a playbook we've seen from other companies moving to the cloud and sort of combining sort of bundling products. What is Atlassian Together? Why did you decide to choose the products that you did to bundle it and any early signs of what customers are hearing is?

Yes. So Atlassian Together is a new bundle that we rolled out. It was really our first foray into the bundling world, if you will. It includes Confluence, Trello, Jira Work Management and a new product we rolled out in the fall called Atlas. And if you think about the work management space, we think it's a very tough proposition for a CIO to say, "Hey, [ I'll show you ] use Trello." And every employee within the company has to use it. Of course, we would love for that to happen, but I think that's really tough proposition because every teamwork is too diverse, right? Like we intimately understand how teams work. And your team is going to work differently than my team, which is going to work differently than a marketing team. And everyone is going to have their own kind of collaboration needs to meet their teams' needs. And what Atlassian Together will do is give a company ability to standardize on Atlassian. I don't have a deep relationship with Atlassian, I would love to standardize on Atlassian without forcing any one tool on a user. So you may use Trello because it's better suited for your team. My team may use Jira Work Management because it's better suited for my team, all at a really disruptive price.

Got it. I think I've got time to squeeze one more in. Also, one came in on this, too, and that's the partner network, close to my heart because I've always enjoyed your partner network. I spent a lot of time on the events. You guys are very generous in a [indiscernible] let me attend these. But every time I talk to a private company and they know I cover Atlassian, that's what they want to talk about because you guys have really built this partner network, 700-plus global partners. Most of them aren't console names they make money a bunch of different ways with you guys. But talk about how that -- how that's going to help you with that cloud move? How are they helping with the cloud move? And then also, do economics change from them as they move to the cloud? Like what is -- where we look at these model and cloud transitions, we have to look at some of the potential opportunities and friction around these big networks to help us get comfortable with?

Yes. And it's funny. We are probably best known for our unique go-to-market in software, and we haven't even touched on that today in this conversation. Yes. So we're able to drive such an efficient go-to-market motion in large part because of this fantastic partner network that we have our channel partners, right? And so the partners touch a pretty significant part of our business. About over 1/3 of total revenues are touched by our partners. And so they play a really integral role in helping our customers build customization, helping them with deployments, helping them integrate it with their existing software. And of course, right now, they have a pretty significant opportunity in front of them as they help our customers move to the cloud. We touched on it a little bit earlier, I think there's going to be even more opportunity for them as they build more customer vision and integrations with our cloud products and again, our customers' internal stack of tools.

Got it. Martin Lam from Atlassian. Thanks. It was nice to see. I appreciate you making the trip [ last ] country for our trip for a conference. And please join me in thanking Martin.