Atlassian Corp Q2 FY2024 Earnings Call

Good afternoon, and thank you for joining Atlassian's Earnings Conference Call for the second quarter of fiscal year 2024. As a reminder, this conference call is being recorded and will be available for replay on 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 Second Quarter of Fiscal Year 2024 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; Chief Financial Officer, Joe Binz. Earlier today, we published a shareholder letter and press release with our financial results and commentary for our second quarter of fiscal year 2024. 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 insights 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. 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 business performance and financial results is included in the 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 include non-GAAP 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 Investor Relations section of our website. We'd like to allow as many of you to participate in Q&A as possible. Out of respect for others on the call, we'll take one question at a time. With that, I'll turn the call over to Scott for opening remarks.

Thank you for joining us today. As we've already read in our shareholder letter, Q2 was full of significant milestones for Atlassian. When we first went public 8 years ago, we had just over $100 million in quarterly revenue and supported 54,000 customers. Fast forward to today, and we've just posted our first $1 billion revenue quarter; Jira Software crossed $1 billion in Cloud ARR, and we surpassed 300,000 customers. These accomplishments are a true testament to our amazing team, our diverse and passionate customer base, and the high-value mission-critical products we deliver. Mike and I are extremely proud and thankful for every single Atlassian who has helped to get us here. In Q2, our R&D engine continued to deliver incredible innovation across our Cloud platform. We rolled out Compass, Virtual Agent capabilities in Jira Service Management on our first phase of the Atlassian Intelligence capabilities into general availability. We also welcomed Loom to the Atlassian family and have been thrilled to see the team deliver on their ambitious AI vision with many new features including an enhanced editing experience that makes updating video as easy as editing a text document. Customers see the value where we're delivering in the Cloud and are turning to us for strategic guidance on how we can unleash the potential for their teams. We're excited by the momentum we are seeing across the business and remain laser-focused on executing against our key strategic priorities: Cloud migrations, serving the enterprise, IPSM, and now AI. And we're in a great position to tackle these with massive market opportunities, strong customer commitment to the Atlassian platform, a unique ability to combine over 20 years of insights with the immense power of AI, and most importantly, a world-class team. With that, I'll pass the call to the operator for Q&A.

Your first question comes from Keith Weiss from Morgan Stanley.

Congratulations on a lot of milestones this quarter and what looks like a solid quarter. In the shareholder letter, you talked about even absent Loom still expecting an acceleration in the Cloud business into the second half. It sounds like you saw some signs of stabilization in the quarter, but I was hoping you could drill in a little bit further on what gives you guys the confidence to expect that acceleration into the back half of the year? And what still seems to be an uneven macro environment?

Yes. Thanks, Keith. This is Joe. Let me start with the Cloud revenue results in Q2. They were up 27.5%. Loom contributed about 1 point of growth. So our results excluding Loom landed in the middle of our guidance range for the quarter. There were a few cross currents in that performance. So let me walk through them in terms of customer segments and growth driver trends to try and help. And then I'll transition into your question on the confidence around H2. From a customer segment perspective, we had very strong sales execution in the quarter, which drove healthy performance in our enterprise customer segment. This resulted in better-than-expected billings on annual and large multiyear deals, a significant portion of which landed on the balance sheet as unearned revenue. This also drove healthy upsell to premium versions of our products. Results, conversely in SMB were slightly lower than we expected, and that was driven by paid seat expansion and a mix shift from monthly to annual subscriptions, which, as you know, signals stronger customer commitment but also carries lower pricing. And as you know, dynamics in the SMB business, good or bad, are largely realized in the quarter given the linearity in that part of the business. In terms of the trends on our key growth drivers in the quarter, migrations from server and data center exceeded our expectations, and that's driven by the significant investment and execution focus we put there. In terms of paid seat expansion, while the overall rate of paid seat expansion remained lower than the prior year, the pace of deceleration or slope of that trend continued to moderate from Q1. And within that trend, as mentioned earlier, enterprise was better than expected and SMB was slightly worse. We also saw the rate at which customers convert from free to paid at the top of our funnel stabilize relative to Q1 and that's another positive leading indicator. And then finally, other Cloud growth drivers like cross-sell and customer retention churn and monthly active usage continued to be very healthy and performed in line with our expectations. And beyond that, we didn't really see anything noteworthy in terms of linearity in the quarter or across products, regions or verticals that were largely in line with our expectations. In terms of the confidence around the H2 guide, the midpoint of our H2 cloud guidance range excluding Loom does assume slightly accelerating growth rates. The factors that give me confidence are the recognition of those strong Q2 billings on annual and large multiyear agreements rolling off the balance sheet, the increasing momentum on Cloud migrations as we focus on unblocking more customers for moving to the Cloud, and continuing to bring new innovation and value to our Cloud offering, the benefit of price increases that are laddering into the model and the momentum we're seeing in enterprise driving healthy upsell to premium and enterprise versions of our products. I talked about the slope of the trend line on paid seat expansion rates, and that continues to moderate quarter-over-quarter. And I also mentioned the leading indicator around free-to-pay conversions at the top of the funnel. So those are the types of things that give me confidence in the ability to deliver accelerating cloud revenue growth in the second half of the year. And I hope that helps.

Your next question comes from Michael Turrin from Wells Fargo.

For Scott or Mike, there has been a lot of discussion and possibly too much emphasis on the server end of life. For investors inquiring about what comes next, the letter outlines some of that well. Perhaps you can share your vision on how the cloud migration benefits Atlassian moving forward. Additionally, Joe, regarding the migration benefits that the Cloud line has provided, how should we view that after the server end of life? Will it decrease, or will it simply transition more towards data centers? Any insights on this would be appreciated.

Michael, thank you for your question. This is Scott. To provide some context for those who are new to Atlassian, we've previously indicated that approximately 10 percent of our Cloud growth has resulted from migrations. In the upcoming quarter, we will be ending server support, marking the conclusion of a three-year process with our customers. In response to your question, I want to highlight three key points. First, migrations will persist for several years. We have noted that around half of our migrations to the Cloud originate from our data center customers. In the last quarter, despite many server customers migrating due to the end of support, 60 percent of our migrations were from data center customers. Therefore, we anticipate that migrations will continue for a long time. We have also invested significantly in research and development to facilitate this transition for our customers, and you will see us continuing to do so. We launched data residency in Canada recently, as well as Bring-Your-Own-Key secure software, which helps remove obstacles for our cloud customers and broaden the scope for migrations. The second point is that Cloud serves as the entry point to the full Atlassian experience. Once customers migrate to the Cloud, they truly access the best that we have to offer. We are consistently delivering innovations in Cloud, including growth in Compass, Jira Product Discovery exceeding 4,000 paying customers, developments in Loom, and various AI functionalities that are exclusively available in Cloud. This not only enhances the customer experience but also presents us with an excellent opportunity to offer additional products and features that significantly benefit them. Finally, the third point involves our enterprise relationships. Through these migrations and discussions about moving to Cloud, we have strengthened our connections with key customers, such as North American financial service firms and German automobile manufacturers. These interactions have positioned us as a strategic partner, leading customers to seek deeper collaboration. For instance, Mercedes Benz recently migrated 30,000 fleets from data center to cloud for Jira and Confluence. We are thrilled about how they are using our ITSM solution in this transition and have begun implementing it with their customers, further establishing us as a strategic partner for these large enterprises. Joe, would you like to discuss some of the factors to consider?

Yes. Thanks, Scott. Michael, it's really too early to give a specific number on the migration impact to cloud revenue growth beyond FY '24. I would just echo what Scott said; we continue to expect migrations to be a significant driver of cloud revenue growth in FY '25 and beyond. That's driven primarily by the significant size of the data center installed base. There's a lot of opportunity there because those are some of our very largest customers. And for them, it's more a question of when and not if they move to the cloud. So we continue to expect to see migrations be a significant driver of cloud revenue growth beyond FY '24.

Your next question comes from Gregg Moskowitz from Mizuho Securities.

Okay. Maybe I'll focus on the data center business. So it's impressive that that business is still actually growing 30% plus, even after adjusting for the net benefit from migrations, obviously, 41% reported. Joe, when you look at that strong growth, how should we think about the relative contributions from installed base expansion versus pricing versus net new logos?

Thank you, Gregg. You're correct; we had another solid quarter for the data center, exceeding our expectations. This was mainly due to stronger-than-expected migrations from servers, although this was partially balanced out by significant migrations to the Cloud, as you noted. After considering the net migration impact, the primary driver for growth is really seat expansion. This aligns with my earlier point about the strong performance in paid seat expansion within the enterprise segment this quarter. We see this as a reflection of the macro environment, our capability to serve customers effectively, and the substantial investments we've made in enhancing our enterprise-grade offerings. These improvements address key areas such as scalability, certifications, data residency, and app integration, all of which greatly encourage customers to transition to the Cloud. As a result, customers are choosing to stay with us, using the data center as an interim step towards future migrations. Thus, we primarily view the growth as stemming from paid seat expansion once we account for the migration effects.

Your next question comes from Fred Havemeyer from Macquarie.

I wanted to ask, as we start this year, we've once again seen that layoffs in the tech industry have been picking up, although it was substantially lower scale than what we saw in the prior year. So I wanted to ask, as we look at your outlook and the cloud revenue growth, how comfortable do you feel that guidance is once again derisk for the potential impacts from any sort of layoffs in the tech industry. And secondly, have you seen any signs at all that these layoffs may be impacting anything in your free-to-paid conversion or anything else to date?

Yes. Thanks, Fred. We haven't seen a dramatically different impact than we expected coming into the year relative to the recent announcements. Obviously, it's something we keep an eye on and track. If you think about the guidance, we really haven't changed conceptually how we freshened the guidance ranges for the Cloud. Just to reiterate, the high end of our cloud guidance range for the year assumes healthy acceleration in H2 growth rates that we talked about with Keith. That's driven — led by less macro headwinds and the related impact that would have on improving paid seat expansion. It also assumes strong migrations from server to cloud following server end to support and continued strength in data center migrations, cross-sell, upsell, and customer retention. On the low end of the guide, that — for the year, that does assume increasing macro headwinds and the impacts you're talking about and the related impact that would have, not only on paid seat expansion but also areas of our business that have held up well to date, such as migrations and cross-sell and upsell. Lastly, I would assume we do a relatively weak result post server end to support on migrations from server to cloud. So at the midpoint of our guidance, we're assuming that paid seat expansion rates are kind of steady to where they are today, which drives slightly accelerated revenue growth. At the high end of the range, we get favorable macroeconomic outcomes that drive improvement in that and thus better revenue. On the low end, we assume that we see the headwinds and that impacts those paid seat expansion rates.

Just to add on to Joe there. He talked about SMB paid seat expansion being a bit weak. But we went over the enterprise business, and we're talking with our biggest customers. I see great excitement among them for what we're providing. It comes in a lot of different ways. It comes in competitive switch-out. We see a lot of our customers looking to us to replace more expensive versions of other products at this particular stage. I thought that might happen early in the economic cycle, but it's actually showing up pretty strongly now in a lot of the deals that we're doing, of replacing other products out there that might be older and/or more expensive. We're also seeing that in AI and the excitement around customers who are eager to use our AI features. The new products that we are delivering in Cloud are having great customer reception. But it's still very early days. I think that Jira Product Discovery is a great example we talked about, where we're delivering innovation and value to these customers in Cloud, and they're picking it up and running with it. So there are strong areas that I think are sort of counter to any layoffs in technology.

Your next question comes from Karl Keirstead from UBS.

I'd like to focus on the remaining server cohort. The sequential decline in server maintenance of $10 million was at least a little bit less than I was modeling. Are you surprised by that stickiness? Can you offer us any help in sizing the cohort that will likely not migrate at the end of the support date and continue to run on supported versions and perhaps offer a little color as to what that cohort looks like in terms of customer size, vertical, anything?

Yes. Thanks, Karl. This is Joe. I'll go first, and Scott can chime in if he has anything to add. In terms of the server performance that you referenced, server delivered much better results — than expected results in Q2, and it's certainly been more resilient than we expected over the course of the last year. I'd highlight this that it's not because of slower migrations to cloud and data center; those remain squarely on track, if not ahead of where we expected to be. In general, what we're seeing is better renewals, better customer retention, and less-than-expected churn, which highlights the mission-critical nature of our product and customer commitment to Atlassian's road map and platform. Of course, it also means mathematically, we have a bigger opportunity than we originally thought in terms of future seat migrations to the Cloud, which is a great position to be in. In terms of the end of support moment, we're about 2 weeks out. Really, there's been no change from what we discussed last quarter other than that we're seeing those stronger renewals and customer retention. We end of server support in a couple of weeks. There's been no change to our focus around migrating as many of those server customers as possible. The customers that remain on that server installed base are predominantly larger, more complex accounts that are typically blocked from the Cloud at the moment. So we continue to expect most of those customers that migrate will migrate to data center. We continue to hold prudent assumptions to account for customers who will choose not to migrate in FY '24, and that's also factored into our guidance.

Yes. Just to add some color there. I think Joe has talked to the financial aspect of it. Obviously, with an end-of-life moment, it's hard to predict week-by-week basis exactly what happens. So we've put a lot of effort into looking at every single customer that still exists on server and what it will take to get them across the Cloud in an ideal sense or to data center or if they can't move there. As Joe referenced, we have really come to the stickiness of our products, and it's kind of a testament to what we've built and how valuable we are for our customers that we haven't seen churn there. For many of these customers who can't move to Cloud, data center is a drop-in replacement that does not require many months of planning. Customers can leave it to the last minute and switch out to data center, and I expect to see a lot of that happen as we cross the end of server support threshold in the next few weeks.

Your next question comes from Kash Rangan from Goldman Sachs.

Congratulations on the results. The Cloud migration presents a significant opportunity. However, examining the trend over the past five to six quarters, Cloud growth has slowed from around 49% in Q1 of last year to 27%, largely due to migration issues. In contrast, the underlying Cloud growth rate has decreased while the data center segment remains strong, declining from approximately 54% to 41%. Could you clarify the reasons for this discrepancy? Is there a preference among customers for the data center product? If so, what does that imply for the company's long-term outlook? Usually, companies tend to excel in either cloud or on-premise solutions, but perhaps Atlassian is an exception. Can you shed light on your strategic direction concerning your customers? Where do you aim to guide them, and what plans do you have to achieve that?

Yes, Kash, this is Joe. Customers are not choosing data center over cloud. What's happening here is server migration to data center and cloud both exceeded our expectations. And so we don't see more customers choosing one over the other. If there was any weakness in our cloud performance versus expectations, it's that paid seat expansion has been lower than we expected. This quarter, it was slightly lower than we expected, particularly in SMB. DC strength on the other hand, as I mentioned earlier, was also driven by stronger migrations from server as well as paid seat expansion. So we feel really good about the fact that customers are looking at data center as a stepping stone to the Cloud, and ultimately, we want to get those customers to the Cloud, because that's where our customers receive the best experience, the most secure experience from Atlassian, and it gives us a chance to add more and more value over time, as Scott discussed earlier in the call.

Let me add to that, which is every customer I've talked to, whether from a German bank, which we would consider on a more conservative end of the scale, to small, medium-sized businesses out there, even in regulated environments. All of them are telling me the Cloud is the future. If you went back 5 years ago, we were telling customers Cloud is the future. These days customers are calling me regarding that case. In many cases, they either need the time to plan a migration if we've got tens of thousands of users; that is a chance not only to migrate to the product we have in Cloud but expand your usage of Atlassian and look at other products that we can replace; and we see a lot of that happening, but that takes a little bit of time at the largest customers or in some cases, but decreasing. Our customers have bought some Cloud, and they are pushing us to say, 'Oh, I need data residency or a certification or FedRAMP.' We are thinking about a lot of that with our customers.

Your next question comes from Nick Altmann from Scotiabank.

Awesome. I wanted to circle back to sort of the stabilization in the free-to-pay conversion. I guess when you think about how in the quarter, you saw that stabilize. Do you think that was an anomaly? Just because perhaps as a stronger spending period for software? Or do you see it stabilizing over the next coming quarters?

Thank you for the question. We view this as a stable and lasting factor. We believe it's crucial because it serves as a leading indicator of success. Today's land and new customers present tomorrow's expansion opportunities. We fundamentally think much of this is driven by macroeconomic factors. Additionally, we've made significant investments to enhance our funnel's efficiency and improve the rate of converting free users to paying customers. Kudos to the team at Atlassian for their outstanding work in driving improvements in this area. While some of this is influenced by external factors, a considerable portion is a result of our execution. Overall, we are optimistic about its sustainability moving forward.

Your next question comes from Ryan MacWilliams from Barclays.

Great to see data centers driving more than 60% of Cloud migrations at this point. So in the shareholder letter, and you've just been mentioning how you've been unblocking some of the largest customers on data center to help them move the Cloud. Do you have a rough idea of what percentage of data center revenue you would consider blocked today? And if unblocked, will these customers be willing to move to the Cloud after recently moving to data center?

Yes, Ryan, I can't provide that information at the moment. Please continue, Scott.

No, it's okay, Joe. You go ahead.

Yes. Ryan, I was going to say we're not going to be able to provide a breakdown today on what that blocked percentage is. Keep in mind, those data center customers are primarily our largest and most complex. So you can imagine it's all the things we're investing against and making progress on. I mentioned earlier, scalability, data residency, certifications, app integration, a lot of investment, a lot of effort going into unblocking that. That's why we're confident in our ability to continue to grow migrations from data center to cloud. So we feel very confident in our ability to continue to drive migration over the next coming years.

And Ryan, this is Mike. I want to add that it's important to highlight our long-term partnerships with our customers, especially the largest ones. Customers have expressed their appreciation for our delivery of enterprise capabilities in the Cloud over the past 3 to 5 years. We have a public cloud roadmap that includes FedRAMP delivery, data residency, and compliance across all the regions we serve. Last quarter, we achieved 100% of our delivery goals on time, which is helping us build strong strategic partnerships with our biggest customers. We believe that our enterprise business for the next decade and beyond will focus on nurturing these partnerships based on trust and consistent delivery. Our customers, as Scott pointed out, see Cloud as their long-term future and are progressing at various rates towards that goal. A significant portion of our migrations is coming from data centers, and our engineering delivery has been crucial in strengthening our partnerships. We aim to maintain this momentum moving forward.

Your next question comes from Keith Bachman from BMO.

Congratulations on a strong quarter and guidance. Joe, I wanted to ask you about the guidance you've provided for the June quarter, which comes after the expiration of the server. What are your thoughts on how reasonable it is to use the June quarter as a proxy for the FY '25 growth rate? I'm not asking for specific numbers for '25, but are there any unusual factors in the implied growth rates for Cloud and data center that we should consider for our '25 estimates? Specifically, will the February deadline accelerate any revenues, or is there anything else we should keep in mind regarding the June quarter exit run rate?

Yes, thank you. It's really too early to discuss FY '25 in detail. Generally, regarding individual segments, we anticipate that growth rates in the data center will continue to slow down as server to data center migrations essentially reach zero and data center to cloud migrations increase as we work on overcoming Cloud blockers. We've mentioned that migrations are a multiyear process, so I won’t go over that again. Additionally, there are several other factors influencing this model. Primarily, the expansion of paid seats among current customers is the largest driver, even surpassing the migrations we've discussed. This area has significantly felt the impacts of macroeconomic challenges over the last year. Much of your perspective on '25 will depend on macroeconomic conditions. Our potential to cross-sell more products to our over 300,000 existing customers and our capability to upsell premium and enterprise versions of our products are also important growth factors. There are other lesser influences like the conversion from free to paid, recent price increases, and the introduction of high-growth products such as Compass, Jira Product Discovery, and Loom. I want to emphasize that we're in a highly dynamic environment right now, with many opportunities to create value through strong execution. We are confident in our ability to achieve healthy revenue growth in the Cloud over multiple years. Of course, server revenue will effectively end in two weeks when we reach the end of support for servers. That's the perspective I have for now; we will keep you informed over the next six months, but that captures our current mindset and directional thinking.

Your next question comes from Fatima Boolani from Citi.

I just wanted to shift gears to Jira Service Management. You're clocking in about 50,000 customers since about 3, 3.5 years from launch, about 20% of your base. But I was hoping to ask some more quantitative color as to how the monetization curve looks like? And when should we expect a JSM to become as large a contributor in terms of revenue to the business as Jira and Confluence?

I can take that. Look, we remain incredibly excited about JSM and the service management market broadly, both in terms of IT service management and enterprise service management for all functions within the business. I think we've done a really good job at continuing to grow that business alongside our other businesses that we have. It's always hard when your plan catch-up. It's got about a decade to catch up on Jira software in the Agile and DevOps market. It certainly has the potential to do that, and we continue to see it being our fastest growing broad market that we have. It's also worth noting that for a lot of our customers, our strength is in the combination of the markets. So people who buy Jira Service Management, some of them, as Scott mentioned, are migrating off expensive and legacy tools, and we see increasing numbers of switch outs, which is always comforting to see but more importantly, they're buying it because of our connection to developers in connection to the work management market and broader connectivity across their organization. Increasingly, you're going to see a blending of this as software and technology become the core strategic advantage, and operating and delivering on that service alongside that is incredibly important. So I think we are very bullish on the long-term monetization of Jira Service Management and the ITSM and ESM spaces broadly, both because of our competitive positioning as we've seen and demonstrated this quarter and last quarter and the quarter beforehand. We also consider that our connectivity to the two adjacent markets is strategically why we're there in the first place. Scott may have some customer color that you want to add on top of that?

I want to remind everyone that ITSM fits perfectly within Atlassian's core offerings. It integrates seamlessly with Jira Software, which is aimed at development teams, along with our other products that work closely with IT teams and are increasingly doing so. We are unique in delivering this in the market, and we've received recognition for it recently. We were identified as a leader in Forrester's ESM Wave, earning the highest score for strategy. Although we have been in this space for some time, it is reassuring to see acknowledgment for the unique solutions we provide. Analysts have recognized us, and we've seen compelling stories from customers who have switched to JSM, including a travel company that moved away from a major competitor after 15 years and a large logistics provider that transitioned 1,400 agents to JSM. Historically, we've performed well in the SMB space, which is where we began, and we are now also seeing growing strength in the enterprise segment, supported by industry analysts' recognition.

Your next question comes from Alex Zukin from Wolfe Research.

I would like to discuss the changes related to the operational expenses and cost of goods sold after the migration. Considering the increased COGS activity, sales teams are concentrating on migration, which enables us to shift our focus to Cloud solutions, cross-selling, and upselling, along with the additional research and development costs that have been invested in the platform over the past few years. What is the best way to evaluate that potential impact on operating margins and the operational expense portfolio as we move forward into the next few quarters?

Yes, thanks, Alex. This is Joe. Let me start by sharing our perspective on the second half of the year regarding operating expenses. I will address your question about the leverage points we see in terms of operating expenses and cost management. We expect operating expense growth to accelerate in the second half, driven by two main factors. The first is the continued growth and investment in our key strategic areas, such as Cloud, enterprise, artificial intelligence, and IT service management. The second factor is more structural; we are comparing our current performance to the benefits we experienced in the second half of last year from restructuring and lower bonus expenses. As I've mentioned previously, our approach to managing operating expenses focuses on maximizing the return on every dollar spent. We remain committed to disciplined prioritization and resource allocation and enhancing operational efficiencies as we scale. Additionally, it's worth noting that over time, after significant multiyear investments in Cloud and enterprise capabilities, we will have opportunities to reallocate that investment to other areas to foster long-term growth. This will serve as another potential leverage point for us. Regarding gross margin, it will generally align with our revenue mix. The gross margin for Cloud is structurally lower than that of our licensing business. As Cloud revenue becomes a larger portion of our overall revenue, it will exert pressure on our blended gross margins. However, we aim for consistent year-over-year improvement in cloud gross margins through substantial investments in engineering to optimize our cloud infrastructure and enhance support. Indeed, we are making significant investments in post-sale activities to drive deployment, usage, and engagement. We will be able to redeploy and achieve greater efficiency over time, which will be part of our narrative. This outlines our general framework for how we view the Cloud cost of goods sold and operating expenses moving forward.

Alex, maybe I can just add a small bit of color from an engineering point of view. Look, philosophically, I think all world-class engineering organizations in any large fast or SAP-type company should be working on continuing to optimize engineering costs. As we're running an incredibly large Cloud platform that's now geographically diverse, as you see from all the data residency improvements and other things, there are opportunities to save money effectively by running things more efficiently over time. Some of that learning comes from scale, some of that learning comes from deployment, some of that learning comes from new technologies. We certainly have a large investment as a world-class, world-leading R&D organization continuing to do the things we did last quarter cheaper, better, faster, and more efficiently. Sometimes that money has returned, as Joe said, in the finances. At other times, it's invested in other things. It might be we learn how to do things more efficiently and run systems and services more efficiently, that then allow us to do things like that a residency in a global sense. Other times in things like Atlassian Intelligence, a lot of the AI features, it's about getting the features out first and then working out how to cost optimize over time as we watch customer usage patterns. We can work our head of scale and make that more efficient. It's certainly something in engineering; we spend a lot of time working on, and we've had great results over the last 2 to 3 years as our Cloud platform has grown increasingly more complex, but also that gives us more leverage.

Your next question comes from Brent Thill from Jefferies.

An Atlassian Intelligence, I believe it's GA now. I'm curious if you could give us a sense of what you're seeing and the ultimately monetization path in AI. One of the questions we're getting is if you're seeing a faster move to DC versus Cloud; does this slow your AI adoption pathway down or not?

Brent, I'm glad. I can take that one. I was worried about you all not asking an AI question until well into the call. Just checking you're all updated. Look, Cloud, Atlassian Intelligence, and AI generally is a huge advantage for Atlassian. We are deeply, deeply grateful as a company that focuses on knowledge workers and unleashing the potential of the team; a company that has a huge amount of data that customers have entrusted us with. The ability to remix, summarize, and give that data back in different forms to customers using a lot of these large language models and machine learning technology is incredible. It's very exciting in terms of what we can deliver. As you mentioned, the initial Atlassian intelligence feature set largely went GA during the quarter, and it has had a fantastic customer reception. There's no other way to say that. We saw that when we announced it at Team '23 last year in Las Vegas, and we've continued to see that as we work with all of the early access program and the beta customers, and now being in GA. The ability to change how people do work in non-technical teams and in technical teams is just an unlock. When we talk about our mission to unleash potential in every team, it's literally doing that in fantastical ways. We had more than 20,000 customers that used the features during the beta period, which for us, as far as the beta goes, is off the charts in terms of interest, which is fantastic. As you mentioned, we do see the server and increasingly more data center customers. It being a factor in their movement, right? There is a clear logical understanding among customers, that the last language model-driven and machine learning-driven features are based in the Cloud, which means that the customers move to the Cloud in order to get access to those features. It is another reason in a whole tapestry of reasons why customers are looking to move. We've certainly seen great adoption of those features so far, really excited about Atlassian Intelligence. Really excited about virtual agents and Jira Service Management continuing to just drive straight efficiencies for customers and again, driving that movement up to premium enterprise additions as we've talked about beforehand.

Your next question comes from Ari Terjanian from Cleveland Research.

Strength in deferred revenue performance was notable. I was wondering if you could help unpack how much some of the newer initiatives around step-up credits, dual licensing, hybrid ELAs, as well as Atlassian Advisory services helped drive the strength in the larger enterprise deals there? How should we think about some of those newer programs flowing through to revenue over the coming quarters, meaning to the extent there was dual licensing, how does that flow through to DC and Cloud? Similarly, how does advisory services flow through to revenue, be it showing up in other or cloud or DC?

Yes. Thanks, Ari. This is Joe. You're right. We were thrilled with our billings performance in the quarter. It was higher than we expected and was a record for the company. As you mentioned, you see this performance in our unearned revenue balance, which accelerated to 30% year-over-year growth. You'll also see it in the remaining performance obligations, which increased over $1.9 billion. The outperformance this quarter was driven by great sales execution that we talked about earlier, which resulted in several large-multiyear agreements. Those are the agreements that you were referencing: hybrid ELAs, dual licensing, they're having a material impact on our ability to grow our business in the enterprise space. The way you're going to see that show up is primarily in the form of migrations because a lot of that is targeted at establishing those relationships with our customers over multiple years. Many of those customers are using data center as a stepping stone until they're ready to move to the cloud. It shows up both in a data center and our Cloud revenue rose from a P&L accounting perspective. We attribute revenue based on the relative list price between those two. So it's roughly 50-50, give or take, between those two things as you think about the mechanical accounting of it.

Thank you. That's all the questions we have time for today. I will now turn the call over to Mike for closing remarks.

Thanks, everyone, for joining the call today from wherever you're joining the world. We really, really appreciate you being here. As always, also appreciate thoughtful questions and continued support of Atlassian and analysis. A small note, we look forward to seeing all of you, hopefully, at Team '24 in Las Vegas at the end of April. And with that, have a fantastic weekend.