Atlassian Corp Q3 FY2023 Earnings Call

Good afternoon, and thank you for joining Atlassian's earnings conference call for the third quarter of fiscal year 2023. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Atlassian's website following this call. I will now hand the call over to Martin Lam, Atlassian's Head of Investor Relations.

Welcome to Atlassian's Third Quarter of Fiscal Year 2023 Earnings Call. Thank you for joining us today. Joining me on the call today, we have Atlassian's co-founders and co-CEOs, Scott Farquhar and Mike Cannon-Brookes; our Chief Revenue Officer, Cameron Deatsch; and Chief Financial Officer, Joe Binz. Earlier today, we published a shareholder letter and press release with our financial results and commentary for our third quarter of fiscal year 2023. The shareholder letter is available on Atlassian's Work Life blog and the Investor Relations section of our website, where you will also find other earnings-related materials, including the earnings press release and supplemental investor data sheet. As always, our shareholder letter contains management's insight and commentary for the quarter. So during the call today, we'll have brief opening remarks and then focus our time on Q&A. This call will include forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and assumptions. If any such risks or uncertainties materialize or if any of the assumptions prove incorrect, our results could differ materially from the results expressed or implied by the forward-looking statements we make. You should not rely upon forward-looking statements as predictions of future events. Forward-looking statements represent our management's beliefs and assumptions only as of the date such statements are made, and we undertake no obligation to update or revise such statements should they change or cease to be current. Further information on these and other factors that could affect our financial results is included in filings we make with the Securities and Exchange Commission from time to time, including the section titled Risk Factors in our most recently filed annual and quarterly reports. During today's call, we will also discuss non-financial measures. These non-GAAP financial measures are in addition to and are not a substitute for or superior to measures of financial performance prepared in accordance with GAAP. A reconciliation between GAAP and non-GAAP financial measures is available in our shareholder letter, earnings release and investor data sheet on the IR website. Please keep in mind that we'd like to allow as many of you to participate in Q&A as possible.

Thank you for joining us today. As you've already read in our shareholder letter, we delivered another solid quarter of financial results and continued the steady drumbeat of innovation to help our customers transform the way they work. We've just wrapped Team '23 our annual Atlassian conference, where we gathered with thousands of customers and partners. The investing community has never been stronger, and the enthusiasm for our product announcements was unmatched. We introduced Atlassian Intelligence, a virtual teammate that uses generative AI technology and leverages the Atlassian platform to accelerate customers' work in a way that is tailored to them. With 20 years of knowledge reflecting how hundreds of thousands of software IP and business teams plan, track and deliver work, Atlassian Intelligence is like a floodlight, lighting up new customer insights. We're excited to see how AI will unleash our customers' potential and strengthen our competitive advantage. In addition to Atlassian Intelligence, we also announced exciting new features and platform enhancements, including Confluence Whiteboards and databases; support for up to 50,000 users in the cloud; and Beacon, our new threat detection and mitigation products, just to name a few. It's incredibly exciting to think about the opportunities we have in front of us. With unique features and capabilities for Atlassian Intelligence and the platform innovations we're delivering, customers are more enthusiastic than ever to migrate to the cloud, and we look forward to helping them on that journey. With that, I'll pass the call to the operator for Q&A.

Your first question comes from Gregg Moskowitz from Mizuho Securities.

Okay. You mentioned in the shareholder letter that the Q4 guide includes an assumption of increasing headwinds for churn and for premium edition upsells, even though you've yet to see a significant impact in those areas. And I think that's prudent, but wondering if you could contextualize this a bit more for us. For instance, are you baking in modest incremental headwinds? Or would you say that it's more substantial than that?

Yes. Thanks, Greg. Really, no change to our guidance approach that we took back in February when it comes to the cloud guidance specifically. That cloud guidance range assumes the macroeconomic environment gets worse in Q4, and year-to-date trend lines continue into Q4. You're right to call out the fact that the low end of that range assumes continued weakness in the two drivers that we've seen to date around paid seat expansion at existing customers and free-to-pay conversions, but it also does include some macro impact to areas that have held up well year-to-date like churn upsell and migrations. So we do expect and have built in pretty substantial macroeconomic headwinds at the low end of that range. The other thing I'd call out really quickly is if you take that Q4 guidance, it puts our full year FY '23 cloud guidance at 37% year-over-year. That's squarely within the range of the 35% to 40% we provided in February. So really no fundamental change overall in our cloud outlook or our approach to guidance.

The next question comes from Brent Thill from Jefferies.

Joe, EMEA grew 22% this quarter. I think last quarter was 30%. It seems like you had some weakness in the region. Can you just give us a sense what happened there? And maybe I'm just reading too much into the numbers, but anything to call out there?

Yes. Awesome. Thanks, Brent, and great to hear from you. I'll start, and then I'll let Cameron chime in. In EMEA, revenue trends tend to be quite volatile quarter-to-quarter than the U.S., and the reason for that is pretty simple. EMEA has been slower to adopt the cloud, so there is more data center revenue in the EMEA sales mix. And DC, as you know, is inherently more volatile for two reasons. One is revenue recognition, 20% of DC license value is recognized upfront. And then secondarily, customer purchasing behavior around data center pricing changes also create some volatility. So I wouldn't read too much into that. It's typically just a function of quarter-to-quarter volatility, but I'll pass it to Cameron for more of the customer insight.

Yes. Repeating what Joe said there, but I would like to speak just to the cloud adoption in EMEA. Obviously, we do see cloud adoption lagging behind the U.S. and the Americas. But in general, over the last year, as we've done things like data residency in Germany as well as higher requirements for financial services organizations, we've been able to see more and more of our larger customers in Europe choosing to go to cloud. We actually worked at a very large European bank over the last few months, getting them signed up for cloud, and we're starting to migrate them today. So I will say that although they're lagging, we are seeing that adoption continuing to increase more in line with the U.S. numbers.

The next question comes from Keith Weiss from Morgan Stanley.

Excellent. I was hoping to sneak in two questions. One kind of more tactical and short term in nature and one longer term. On the short term, this is going off of Gregg's question, I think what a lot of people are trying to understand what the shape of the quarter was and how demand held up through the quarter and whether that influenced more conservative Q4 guide. So maybe if Cameron gives a view on kind of like how the quarter progressed. The longer-term question comes from sort of, I think the debate that all of us are having around large language models and generative AI on whether they're going to be disruptive or complementary to a lot of existing businesses. You guys have already rolled out functionality when it comes to the ITSM side of the equation. So how do you guys think about that question about sort of the risk of being displaced by people utilizing these new technologies versus your ability and what's going to make you sticky and being able to benefit from them? And does that necessitate at all kind of changing the pricing model, moving away from the per seat pricing model maybe to better sort of account for the value that you're adding that doesn't take place with the agent itself, but takes place on the platform, actually doing a lot more of the work?

Thanks for the question, Keith. This is Joe. I'll take the first part with Cameron, and then Mike will chime in on the second. In terms of the linear nature of the quarter, we did not see anything unusual about the linearity of our billings in the quarter nor did we see anything unusual in the month of April, where trends were consistent with Q3. Cam?

Yes, I'd say the only thing is, as all of you know, we did a price change on our server and data center licensing in mid-February. That, of course, causes some behavior throughout the quarter, but nothing significant throughout the quarter beyond the reaction to the price change. Mike?

Yes. Thanks, Keith. Great question. Well, quite clearly, what I can say from Atlassian's point of view, we think that AI, large language models, as you mentioned, is a huge opportunity for us as a business. If you look at our fundamentals, we've always tried to solve human problems, not technology problems, right? This means we have a lot of customer knowledge and data entrusted to us over the last two decades. We have a fantastic platform to build on top of that connects that knowledge together, and we have a fantastic R&D team to build features on top of these things. So AI allows our customers to be significantly more efficient to get to our mission of unleashing the potential of every team. That's what we believe it will do. So from our point of view, we think our best opportunity to grow our business through the Atlassian Intelligence feature set is to drive customer growth, right? We have a goal of, in the long term, winning the Fortune 500,000, not the Fortune 500, and we think that these technologies will help us get there. That's why we're including the features in all editions rather than as a separate SKU. It's not a good customer experience, and we think will slow adoption to put it that way around. We also obviously have a major trend, as you're all well aware of the migrations to the cloud in our business. Our largest customers in data center have the most amount of knowledge and data built up over time, which hence they can get the most amount of efficiency. And with this feature set being only available in the cloud, it's a further reason for them to migrate or bring forward their migrations. And as we know, the migrated customers have really great economics for Atlassian, faster expansion rates, etc. So that's the reason we're looking at it that way. Fundamentally, yes, a huge advantage for our customers, which is why we're in this business in the first place. And secondly, that's how we're looking at growing Atlassian's business through the Atlassian Intelligence feature set.

Your next question comes from Fatima Boolani from Citi.

Mike, maybe for you or Scott, on the Jira Service Management product pillar, a lot of activity and action is really boosting use cases that JSM can be deployed in specifically around external customer support use cases, and we're familiar with certain vendors in that market. So I'm curious what else needs to happen to really drive more monetization scale in JSM and particularly in the context of some of your very large customers who are working to really headcount retrenchment process where JSM can be a very labor inflationary investment. And then a quick follow-up for Joe, if I may.

Sure. I can certainly address that for you, Fatima. We remain very optimistic about our position in the IT Service Management and Application Service Management spaces, with Jira Service Management being a significant component. As customers look to become more efficient with their spending during uncertain economic times, this will create advantages for Jira Service Management, and we are actively promoting these benefits. We've made substantial investments in Atlassian Intelligence features and virtual agents, along with various other technologies that enhance customer and agent efficiency, enabling them to handle more requests daily and hourly while maintaining high customer satisfaction. This optimism is one of the reasons we're feeling very positive at the moment. Additionally, Jira Service Management primarily serves IT teams but has significant potential for expansion into other areas of the organization such as HR, finance, marketing, and legal—departments that are inherently service-driven and have internal customers within the organization. This has been our long-standing belief. Furthermore, we believe there are many more agents within a company than many other vendors recognize, as we are not solely focused on the IT team. Nonetheless, we have a strong foothold within the development and IT organization, and we continue to observe growth this quarter as more customers utilize Jira Service Management beyond IT teams, which is a key factor for our long-term growth.

I appreciate that detail. Joe, the question for you is just on the cloud trajectory. I know a lot of us have been grappling with how that segment is digesting and absorbing the pretty meaningful moderation you've seen in seat expansion. And I know you alluded to in your shareholder letter that churn levels necessarily have not increased. But can you help us sort of understand or at least maybe put some sort of a downside cap on how you're thinking about that dynamic, where you're really actively trying to manage gross seat turn in order to support that growth in that segment?

Yes. Thanks for the question, Fatima. When we look at the churn rates, especially customer churn, it's been very consistent and stable throughout the year. That suggests there's nothing that's changed from our structural competitive position. Customers continue to come to our sites, try our products, our monthly active users, our free instances, all of that seems very healthy and strong. So churn has not been a big issue for us. The primary driver of the pressure that we're seeing in that cloud segment is really around paid seat expansion at existing customers and the free-to-paid conversion rates that we talked about. The remainder of the business, whether it's migrations or upsell or cross-sell, all those drivers, pricing, all those drivers continue to be very healthy from our perspective. So that's really been the core issue that we've been working through.

The next question comes from Michael Turrin from Wells Fargo.

Great. Maybe one for me on margin. We entered the year expecting mid-teens operating margin. You just delivered a second consecutive quarter of 20-plus percent. Maybe, Joe, if you can speak to what's driving that uplift. And then as a second part, at the investor session, there was a comment around fiscal '24 as a year of continued investment. So any color in helping us square that with just anything else you're doing to help optimize on the cost side as we're thinking through the puts and takes of margin trajectory and some of the offsets you have within your control?

Yes, that's a great question. Thank you for asking. In terms of our operating margin performance for the quarter, we exceeded our expectations by 6 to 7 percentage points, with 5 points attributed to lower operating expenses and improved operating leverage. The favorable operating expenses came from two main areas. First, we experienced lower-than-expected payroll-related costs due to reduced bonus expenses and headcount, which included around $10 million in savings from our restructuring efforts. Secondly, we saw lower discretionary costs in areas such as professional services and travel and entertainment, in line with our previously discussed plan to respond to macroeconomic impacts on our business and align our cost structure with revenue growth. Now, I’ll let Scott address the comments regarding Team '23. Lastly, I want to emphasize that our team's focus has been on maximizing the return on every dollar spent, making disciplined prioritization and resource allocation decisions, and driving operational efficiencies. I truly believe the team has excelled this year in these areas, which is reflected in the favorable operating expenses we reported.

Yes. Just to reiterate what you've mentioned, Michael, for those that weren't at our investor call or at our team conference, we did say that we see FY '24 being a continued investment year. We still see huge opportunities out there in those areas. We talked about migrations, enterprise, ITSM that we're being aggressive in investing behind, and we expect those investments to continue through FY '24 of course taking into account everything closely.

Your next question comes from Kash Rangan from Goldman Sachs.

I have a couple of questions. The cloud growth rate appears to be slowing down in Q4. Looking ahead to next year, do you think there is a chance for the cloud growth rate to pick up again in fiscal '24 based on your evaluation of migration timelines and product readiness? Additionally, regarding generative AI, can you offer any insights into whether this might lead to a need for fewer developers and service personnel? This raises the idea of a shrinking total addressable market, yet you could gain market share because your technology might replace workers who lack generative AI capabilities. Alternatively, could this actually expand the market, as the number of developers might increase if the barriers to software development are lowered, allowing more people to start developing? I hope that's not the case. How should we consider the total addressable market in terms of headcount implications due to generative AI and its effects on developers and service workers?

Kash, this is Joe. Thanks for the question. Obviously, we aren't providing specific quantitative guidance on FY '24, but I would offer up the following how to think about it directionally, specifically as it relates to the cloud space. The big caveat I always offer here is on revenue. There's lots of moving parts, but the biggest being the macroeconomic outlook, which is highly uncertain. And as you've seen in FY '23, that can have an impact on our business. We're not immune to those factors. Beyond macro, I'd have you think about the following. Mathematically, we will have easier comps as we move through the next year. We will have a significant event in the second half of the year with the server end of life, and our focus there is really on migrating those customers to either our cloud preferably or data center offerings. We'll also have some benefit from pricing as prior price increases and less loyalty discounts layer into the model. And then lastly, the decisions that we've made this year around rebalancing and reprioritization to reinvigorate revenue growth will begin to land and have positive impact as we move through FY '24. So in the end, macro is going to play a big role, and we'll see what that ultimately brings. But hopefully, that helps you think through some of the other dynamics that will relate to cloud revenue in FY '24. Mike?

Yes. Kash, I can chip in if you're looking for prognostication; that's probably my column. I would answer two ways, personally. Firstly, the software world, if you want to think about it, you ask if there's going to be fewer developers, etc. My view and our house view, I suppose, is no, right? The simple answer to that is software is not demand-constrained, it is supply-constrained. We are constrained by the supply of developers in the world, not the demand, the number of ideas or pieces of software we could create. So when you create tooling that makes it possible for efficiency of any form, you will soak up more of that demand with the existing supply. Okay. The supply won't go down. The number of developers, I don't think it goes down. That's not the way human creativity, which is ultimately how the software works. Secondly, when you make software developers more efficient, if you're talking about artificial intelligence or large language models with code assistance and writing code, etc., or creating parts of software, that makes far more software. The more software there is in the world, that's good for Atlassian in a generalized sense. We're not necessarily working on individual developers. Again, in Jira Software, about 1/4 of the audience are software developers. The more software you have, the more need you have for designers and program managers, and making sure that we have the right software that we're building. You now have a lot of software to operate, run, and manage. So the more software there is in the world, that's generally, I think, a good thing for Atlassian. There will be puts and takes across this world as a flow-through, but those would be my two fundamental points. We maintain incredible optimism for artificial intelligence and what it can do for us as a business to help unleash the potential of our customers, to help them create and manage more software in that market of Atlassian markets.

Your next question comes from Michael Turits from KeyBanc.

I wanted to just talk about data center versus cloud. You're seeing that some of those impacts on expansion free-to-paid impacting cloud. Data center beat in the quarter, and it sounds like you're looking for only a minor deceleration for data center going into next quarter. So could you tell us what's supporting that growth on a relative basis versus cloud?

Yes. Thanks for the question, Michael. This is Joe. You're right. Data center had another strong quarter of revenue growth that accelerated to 47% and was better than we expected. And that was primarily driven by two things: stronger-than-expected renewals and better-than-expected seat expansions at existing customers. We were helped a little by deal pull-forward, resulting from the price change in February, but it was largely consistent with prior year and only slightly higher than our expectations and certainly not nearly as significant or pronounced as it was two years ago. Having said that, migrations from data center to cloud remain very healthy. Year-to-date, over 50% of cloud migrations are coming from data center, and that's up from about 1/3 a year ago. So we've got good progress there as well. And then in terms of the guidance, we do expect growth rates there to moderate a little bit in Q4 and beyond, and that's really driven by increasing migrations from data center and cloud and server to cloud as we remove migration blockers and add compelling features and value to our cloud offering. And then secondly, in the data center, we are starting to lap strong prior year comparables in Q4, and so that's another factor in the growth guidance that we've given.

Yes, this is Cameron. I'll just add a little bit on the data center side. Just largely basically talking to customers, we were at Team '23 roughly a few weeks ago, where many of our largest customers are there. And many of those customers are still on data center and have been on data center for many years. I would just say the tone with those customers over the last few years, I’d say, last Team or a few years ago, 3 years ago, it was always about like, why should I move to cloud? What are the capabilities? Are you going to get to my data privacy requirements, you name it. I'd say that tone this year, just talking with all these customers is, okay, how do I get there, right? You delivered the new AI. We have these new functionalities. We're bought in, now help us guide us through this plan. And I just think that overall tonal shift has been super positive and helping get more data center customers moving to cloud going forward.

Your next question comes from Keith Bachman from BMO Capital Markets.

My question relates to what Cameron was just talking about. As you think about just philosophically in FY '24, would you expect data center to continue to outgrow cloud? Or do the comparison and some of the other feature set things you were just talking about? And then underneath that, you've talked pretty consistently about cloud is getting the benefit of 10 points of growth associated with conversions. As you think about what happens to that 10 points as you anniversary or get beyond the server date, which is mid-Feb a year away from now? Does that cloud conversion go to 0? Or is there a continued benefit as you migrate longer term from data center to cloud when you, in fact, perhaps move to enterprise version? So in other words, is there still a longer-term benefit of cloud conversion? Or does that 10 points go to 0?

Thank you. So this is Cameron. I'll talk to just largely the customer choice ahead of us, and you're absolutely right. So server end of life goes into effect February of next year, and we still have a variety of server customers still sitting out there on a variety of sizes that effectively need to make that choice between now and February, and many are doing it month by month. Obviously, many are going to wait until the last minute to make that choice, and they do have 2 choices. Now obviously, we're going to lead and try and get as many of those customers to choose cloud. But obviously, we have data center as a very strong capable version for them going forward. So I see that continued option out. Post 2024, we'll still have a sizable data center customer base allowing us to continue migrate customers to the cloud. So this migration journey that we are on does not stop February of next year. It is a multiyear journey as we continue to get all of our on-premises customers eventually to the cloud.

Yes. Thanks, Cam. I would say nothing more to add to that beyond. We continue to invest to grow and accelerate that migration to the cloud. We're removing blockers. We're making migration easier through tooling and support investments. We're also closing the gap on pricing between advantaged pricing on DC and cloud with our overall pricing strategy. And just overall, the cloud platform provides the best experience, whether it's analytics or automation or AI collaboration and better TCO. Those factors will only increase over time. And then just to reiterate what Cameron said, there's a lot of runway left on that cloud migration story, and we expect to continue to see that even after the server end of life.

Your next question comes from Fred Havemeyer from Macquarie.

I wanted to ask about Beacon. It caught my attention in your shareholder letter as an early access product, particularly its focus on cybersecurity within Atlassian's cloud ecosystem. This seems like an interesting area. With this early access program, are you seeing indications of demand from your customers for a broader array of cybersecurity solutions? Do you believe this is something that can be monetized? Also, is there a specific scale of customer that this applies to?

Thanks for the question. Scott here. Just a reminder, so firstly, there's a big demand for this sort of products from Atlassian from our customers, particularly at our user conference, and just customers are excited by this. And if you think about moving to cloud, customers want to make sure that their data is secured and the things that we can do and what we can do and we can see the shape of usage of our products that allow us to work with our customers on flagging things that might be of interest to them. As a reminder that this is not a generic security product. This is across our data and our cloud. Now we have advantages because we have one platform in the cloud, and we can offer Beacon across most of our products. So there's an advantage there from a sort of consolidation perspective and from an IT admin play in a similar way you've seen us to access on the user or authentication side. But this is really a product to help customers be very comfortable with how their data gets used in the cloud. And in most cases, all we can offer here is again ahead of what the customers could do themselves in a behind-the-firewall setting. And so this is just yet another example of how the cloud is overall better for our customers than what they can do themselves and another reason for them to migrate.

The next question comes from Alex Zukin from Wolfe Research.

This is Allan on for Alex Zukin. I just wanted to ask a financial question. If I think about the shape of NRR through the quarter. I know this isn't a metric you guys report to, but just to better understand the growth that you're seeing in the business. Can you just, at a high level, talk about what that shape looks like through the quarter and through April?

Yes. Thanks for the question. Unfortunately, no specifics to share with you today on the NRR. Given the macro pressure and headwinds, we do see on paid seat expansion, it is trending lower. There was nothing unusual about that trend in Q3 relative to Q1 and Q2. Those trends just continued into Q3. And I'd say lastly, the underlying fundamentals in our business remain very strong. We see no change to our structural competitive position. So we do expect those retention rates to recover once the macro picture stabilizes and improves.

Got it. Okay. And just a quick follow-up. I appreciate the color on the guide for Q4 of cloud growth benefiting 10 points from migrations. Just so we kind of have the numbers correctly here, do you mind just kind of telling us like what that exact benefit was in this quarter and the last two quarters or so?

Yes. We've consistently said we're getting overall approximately 10 points of revenue growth in the cloud business from migrations. That hasn't changed dramatically throughout the year.

Your next question comes from Ryan MacWilliams at Barclays.

Just on the vertical standpoint, any verticals worth calling out that may have impacted the quarter or the guide? And at this point, do you have a sense maybe what percentage of server customers might choose to remain on server even past the end of life for a couple of quarters after?

This is Cameron. I'll take that. Just from a customer perspective, as we mentioned, with over 250,000 customers and across all industries, geographies, the sizes of all type, we see that to have a massive competitive differentiation for Atlassian, giving us plenty of growth opportunities across the customer base for quite some time. Of course, the trends we've seen in seat expansion slowing down is broad-based across the entire customer base that we see today. One advantage we have is that as every company starts bringing in more and more technology to deliver value to their customers, we obviously have to take advantage of that as we are helping companies with technology teams and business teams to work better together going forward. Oh, and then the second part on the server end of life thing, largely, most of those customers we see, there will be some that have the perpetual license, and there will be some customers we believe that most will choose cloud. Some will go to data center. And obviously, some will continue to use the server licenses unsupported. Just about every customer size that I speak to largely is under a compliance requirement or just general IT guidances internally that they do not run unsupported software and that will be choosing cloud or data center post the end of life. So I really see that as a very small portion of the customer base.

Your next question comes from Adam Tindle from Raymond James.

Okay. Maybe one for Mike or Scott. Was going back to my notes from this time last year where you announced free additions of cloud products. And you talked about it echoing an approach from '08, '09, where you brought in your customer base by offering a $10 starter license? So if we fast forward 1 year later, your customer count is still growing, so you're certainly broadening the base like you did in '08, '09. So the question would be maybe take us back to the upsell motion from the starter license and compare and contrast that to upselling from the free cloud, what you learned then and what you can apply now to improve cloud upsell.

It's Scott here, Adam. Great question. Just a reminder for those who haven't followed the Atlassian story for a long time, back during the financial downturn in '08 and '09, we introduced free versions of our behind-the-wall products and launched $10 starter licenses. At that time, customers could pay $10 for access for 10 users, down from a few thousand dollars for our lowest-priced option. This was a significant pricing shift that was part of a long-term strategy because we sacrificed immediate revenue for future growth. Customers who once paid thousands were now paying $10. This strategy expanded our reach to many companies that wouldn't have considered our products otherwise, and as they grow, they begin to add more users and transition to different pricing tiers. Similarly, during the COVID period, we launched free versions of our products, reducing the cloud pricing from $10 a month to free. This decision also helped attract new customers. A common question that arises is how we convert more free customers to paid ones and improve that transition. Our approach primarily relies on usage and customer value, as users typically move from 10 to 11 users. One benefit of Atlassian's business model is that we earn revenue as customers use more features without heavily investing in sales outreach, which can be costly. Instead, we focus on refining our pricing and ensuring we deliver value to our customers, increasing their usage as time goes on. Recently, with the changing macroeconomic landscape, we strengthened our ITSM offerings and made them more affordable for customers migrating from higher-priced competitors. Our strategy centers on long-term market share growth rather than seeking quick conversions of free customers to paid ones in the short term.

Your next question comes from Peter Weed from Bernstein.

I guess there's two parts to this, kind of both focused maybe on a follow-on even with the new customers. You certainly had a nice uptick this last quarter relative to the prior one on net new customers. And I guess there's two parts of it. One is we were backing out in our model, what portion of the kind of new revenue growth was coming from the two. It looked like you are probably seeing kind of flat quarter-over-quarter revenue contribution from kind of new customers over the trailing 12 months, and most of the headwinds are really coming from existing customers. Does that seem about right, that the new customers were probably kind of flattening and it was mostly the existing customers' expansion that had been the issue?

Yes. This is Cameron. I'll speak to the net new customer number. So as we said before, the new customer number does jump around from quarter-to-quarter for a variety of reasons. That said, very glad to see the increase from Q2 to Q3 with over 6,500 net new customers. It's showing that there's continued demand for what we have that we still can convert those free customers to paid customers, and it's nice to see the quarter-on-quarter increase. However, I do want to call out that challenge that we've been mentioning for the last few quarters of our conversion rate from free plans to paid plans is still lower than it was historically before we saw these macroeconomic headwinds. As far as net new customers' impact into our short-term revenue, it is minimal. And today, where we always focus on the net new customer overall number is really a better guide for our long-term portion of our business.

Your next question comes from Ari Terjanian from Cleveland Research.

I have a question about cloud growth and expectations. First, considering the strong performance in data centers, which exceeded your expectations for the quarter, could this indicate that future migration to the cloud may not be as significant, since customers are renewing their data center contracts more than anticipated? Second, I noticed in the shareholder letter that there was mention of an impact from reductions in seat count. Do you think this is more indicative of current layoffs or the layoffs we experienced last year?

Yes, a multipart question here. This is Joe. I'll take a part of it, and then Cam will chime in. I'd say in terms of the data center to cloud migrations, not at all. We expect those to continue to be strong for the foreseeable future. Cam spoke earlier about the multiyear journey we're on. We continue to add a ton of value in the cloud. We continue to invest in migration tooling and customer support. We continue to invest in data residency and scalability and certifications and extensibility and all the things that are going to enable more customers in that data center category to move to the cloud. So we remain very bullish on that opportunity. Cam, do you want to take the next part?

Sure. I want to clarify that we are seeing customers choose data center as a further investment in Atlassian. Our ongoing transition of customers to the cloud is progressing well and aligns with our expectations, and we are continuously enhancing our ability to migrate customers every day. Regarding the reduction in seat count, the main focus for us remains on the expansion of paid seats. Customers are still increasing their seat count, though not at the same rate as before due to macroeconomic challenges. There are a small number of customers who have reduced their employee count recently, and when it's time for their renewals, they are opting for lower tiers compared to their previous renewals because they have fewer new users in their businesses. Nonetheless, this represents a small percentage of our overall customer base, and our main focus is on expanding paid seats.

Your next question comes from Jake Roberge from William Blair.

Just wanted to double click on that data center strength you saw in the quarter. Is that more a result of new customers starting to land there or upsells within existing customers? Or is that really just the server migrations going more towards DC than you expected the cloud? And then more of a high-level one, but what's driving the seat expansion for DC versus the headwinds for cloud? Is that primarily a result of the enterprise focus in DC?

Yes. Thanks for the question. This is Joe. As we discussed earlier, when you look at that DC strength and resilience, it's really driven by two things: better-than-expected renewals and then paid seat expansions at existing customers. Cam?

Yes, I want to highlight that in this quarter, we implemented a price change for data center services, which prompts customers to consider their options if they plan to add users in the future. This creates a significant reason for them to opt for data center solutions. We continue to demonstrate our capability to transition data center customers to the cloud. Over the past year, half of the seats we moved to the cloud originated from data center customers. Therefore, while it's great to see customers choosing data center solutions in this quarter, we believe that we can ultimately transition them to the cloud, and we are demonstrating this consistently.

Thank you. And that concludes our question-and-answer session. I will now turn the call over to Mike for closing remarks.

I just wanted to say thank you, everyone, for your questions. Thank you to those who came to our analyst function at Team '23, and I hope you all have a fantastic rest of your day.