Earnings Call Transcript - TEAM Q2 2020

Operator, Operator

Good afternoon and welcome to Atlassian's Second Quarter Fiscal 2020 Earnings Conference Call. It's great to join this incredible team. On the call today, we have Atlassian's co-Founders and Co-CEOs, Scott Farquhar and Mike Cannon-Brookes; our Chief Financial Officer, James Beer; and our President, Jay Simons. Earlier today, we issued a press release and a shareholder letter with our financial results and commentary for our second quarter of fiscal 2020. These items were also posted on the Investor Relations section of Atlassian's website. On our IR site, we have also posted a supplemental presentation and data sheet. During the call, we'll make brief opening remarks and then spend the remainder of time on Q&A. Statements made on this call include forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements 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. Further information on these and other factors that could affect the company's financial results are included in filings we make with the Securities and Exchange Commission from time to time, including in the section titled Risk Factors in our most recent 20-F and Quarterly Report on Form 6-K. In addition, during today's call, we will discuss non-IFRS financial measures. These non-IFRS financial measures are in addition to and not a substitute for or superior to measures of financial performance prepared in accordance with IFRS. There are a number of limitations related to the use of these non-IFRS financial measures versus their nearest IFRS equivalents, and they may be different from non-IFRS and non-GAAP measures used by other companies. Reconciliation between IFRS and non-IFRS financial measures is available in our earnings release, our shareholder letter, and in our updated investor data sheet on our IR website. During Q&A, please ask your full question upfront, so that we can more easily move to the next person. With that, I'll now turn the call over to Mike for opening remarks.

Mike Cannon-Brookes, Co-CEO

Thank you, Matt, and welcome, everyone. We’re excited to share our results for the second quarter of fiscal 2020. Our teams have continued to work tirelessly to meet the demand for our products, and we remain focused on delivering value to our customers. The momentum we've built over the past couple of quarters gives us confidence in our growth trajectory. As we look forward, we’re committed to expanding our capabilities and product offerings to better serve our customers.

Derrick Wood, Analyst

Great. Thanks. James, I wanted to ask about the comment in the shareholder letter about the pull-forward effect. And you did mention you pulled forward from second half 2020 and fiscal 2021, but you did raise the fiscal year guidance by more than your Q2 beat. So just trying to get a little sense of where that shows up? I suspect maybe more on the bookings and deferred and billing side. If you could give us any color on how to think about the impact to billings growth as we move into the second half, that would be helpful.

James Beer, CFO

Well, first of all, I'd like to start by saying how pleased we were with the overall level of demand right across the organization across our products, across our deployment options and indeed across our geographies. And so, yes, there was some pull-forward activity that played out in Q2. But even with that, we were pleased to be able to record the revenue result versus our original guide. And in terms of the guide for the full year, yes, you're quite right. We were able to add both the degree to which we beat in the quarter as well as some additional money. And that's really reflective of our overall level of confidence in the top line environment.

Nikolay Beliov, Analyst

Hi. Thanks for taking my question. James, could you comment on the behavior of the data center customers this quarter? What are your expectations in light of their first price increase? Long-term demand rates came in a bit higher than before, and I understand you were trying to limit the number of multi-year deals. What did you observe in that regard? Thank you.

James Beer, CFO

Yeah, sure. Certainly, our data center business had a strong quarter. We've recorded an impressive volume of new unit sales. But you're right, yes this was the first price increase that we had rolled out for our data center products a few months back. And so we did see pull-forward activity related to our data center customers. These customers tend to be larger than the average for us. And I think the degree of second quarter activity in terms of pull-forward is somewhat related to the fact that those types of companies, larger scale companies take a little longer to get through their decision making and approvals process.

Ittai Kidron, Analyst

Thanks. Congratulations on an excellent quarter and impressive results. Regarding the pull-in effect, I'd like to approach this from another angle. Each year, as you assess potential price adjustments before the end of the calendar year, you likely have certain outcomes in mind. It appears that this year significantly exceeded your expectations. What insights can I gather regarding your final price adjustment? Could it indicate that your price increases were substantial enough to compel a larger portion of your customer base to pull in their orders earlier than planned?

Mike Cannon-Brookes, Co-CEO

Well, as we've spoken about before, when we rolled out those price increases for FY 2020, we expected the total aggregate effect on our revenue growth rate in fiscal 2020 to be about the same as that which we saw in fiscal 2019. And that breaks down across our deployment options a little differently. This is the first year for data center price increases. Server price increases were driving approximately similar outcomes in fiscal 2020 versus fiscal 2019. And on the cloud side, we projected a lesser impact on revenue growth rate in fiscal 2020 versus fiscal 2019. And things continue to play out along the lines of our original expectations, so nothing particularly to observe there.

Jay Simons, President

And maybe the only thing to add, we've said it before, like naturally any given year there's lots of puts and takes. Some products are going to move up, some are going to stay the same. Some tiers of products will move up some will move down, so there's sort of lots of different dials that we're turning. Just a reminder that the pricing philosophy for us is bedrock and that doesn't change. We want to remain the high-value low-price leader. Give people ways customers easy ways to start and lots of great ways to grow with us. There's no change there. I think maybe another question you're not asking or maybe asking or someone will ask later customer response to all of those changes in line with expectation I think that's the result of the time that we put into planning these changes and the really customer-centric, customer-friendly approach to how we deploy them.

Keith Weiss, Analyst

Thank you, guys. Very nice quarter, I think you were taking the question. I have a question about subscription growth as it relates to maintenance growth. What I mean by that is subscription growth has been really solid at 50% plus growth. You guys continue to drive that really well. Maintenance growth hasn't diminished at all because of the sustained really solid 20%-plus growth there. I was always under the impression that part of this price increase was trying to push guys from on-premise into the cloud. It doesn't seem like there's any real dedication in that maintenance space. Does any of the subscription strength come from maintenance customers switching over? Or will we see that at any time in the future just become more like maintenance customers pushing over towards more cloud solutions?

James Beer, CFO

Yes, Keith, thanks for the question. You're right. Certainly, the maintenance line continues to be quite steady. Now, there are a few things going on within that line. First of all, we continue to be quite pleased with the progress of the rate and pace of customers coming over from our behind-the-firewall options of our data center over to the cloud. And so, within that maintenance line, that obviously reflects server renewals, we're benefiting now from three or so years of price increases. And so, that's offsetting the natural gradual decline in the unit volume as some of those customers move over to the cloud. Absent that effect, we continue to record very high renewal rates for the rest of the customers who continue to utilize our server products at the moment.

Hannah Rudoff, Analyst

Hi, guys. This is Hannah on for Rishi. Thank you for the question today. I'm just following up on the previous question. If you could talk about what kind of conversion rate and success rate you've been seeing pre-cloud trials for existing customers. Do you have any quantitative color you can give?

Jay Simons, President

Hey, Rishi, it's Jay here. No specific quantitative color, other than qualitatively we're really happy with how it's performing and how it's opening the aperture on more and more customers beginning to try the free additions of products that we've introduced. And over the long term, that's a good thing. It just means we're getting more people to try the product that we can grow.

Alex Kurtz, Analyst

Yes. Thanks for taking the question. If we just look at the subscription growth of 50% in the quarter, obviously, we spent a lot of time here talking about the pull-forward effect. But maybe dive into expanded seats, new product expansion, different types of larger customers, anything else that we can kind of look at beyond just the price increase, and what may have happened this quarter?

Mike Cannon-Brookes, Co-CEO

I would say all of the things that you mentioned were at play in the quarter as they should be. I think for the type of quarter that we turned into in addition to the pull-forward effect that James mentioned; just the underlying performance of the businesses was where we wanted it to be. So, no specific rabbit holes to chase on any of those things. They were all working in the way that we win.

James Beer, CFO

Yes. And just on the pull-forward, there would be a modest element of that $10 million revenue total that I mentioned earlier from the pull-forward that would accrue to the subscription line, because recall that the data center business is accounted for there and so that's what drives a little bit of pull-forward effect there. But the larger single beneficiary of the pull-forward revenue effect was of course the license line.

Arjun Bhatia, Analyst

Hey guys. Thanks for taking my question. James maybe this one is probably for you. But I think you had mentioned a 1% headwind from some of the cloud initiatives that you're rolling out this year during the Q4 call last year. If I look at the growth rate in the first half of the year, it's obviously held up very well, definitely I imagine to some of the demand trends that you've been talking about. But is there any reason that we should think that that 1% headwind from the cloud initiatives plays out in the back half of the year or should we think of that as being embedded in the first half numbers that you've put up already?

James Beer, CFO

Thank you for the question. I want to remind everyone about the three factors contributing to the revenue growth challenges we discussed during our initial fiscal year guidance. Firstly, we observed a shift in our customer mix, anticipating a greater growth in cloud services compared to our other deployment options. This change impacts revenue recognition, especially considering that over three quarters of our cloud customers opt for a monthly subscription. Secondly, we are in the process of rolling out updates for both Jira Software and Confluence, and we are also providing free trials of our cloud products to customers currently using our server products. These are the three key drivers. It's important to note that two of these drivers will become more significant in the latter half of the year, as the updates have been gradually introduced recently, and we plan to continue this rollout through the year. The mix effect will also have a gradual impact felt throughout the year.

Heather Bellini, Analyst

Great. Thank you. And Jay congrats and best wishes on your future endeavors. I had a question. I wanted to start with Mike. I was wondering if you can give us your view of how you see the market for collaboration software evolving and there's a lot of companies going after the market from different parts or different angles. And I guess I'm wondering how do you see these converging at some point down the road do you see that happening? And if so, how do you see it playing out? And also how are you feeling about the pace of adoption that you've seen as you start to add some of these adjacent offerings such as Trello and Opsgenie? How have they been doing in comparison to what you would have expected? And then I've got a follow-up for James.

Mike Cannon-Brookes, Co-CEO

Look, Heather, it's great to get a question from you. Look, I mean on the market side of things for collaboration, I still think we're in very early innings right? If you think about knowledge workers, how much work is still done in spreadsheets and email and other documentation is both knowledge work is digitized, business processes are digitized in all departments in companies around the world. There's a reason that we talk about targeting Fortune 500,000 and the 800 million to 1 billion knowledge workers on the planet today, let alone that number itself growing. We obviously feel very good about where we're positioned and how that market is evolving in lots of different spaces from Trello all the way up through Jira Software across Confluence and JSD horizontally et cetera. So I think we're incredibly bullish on the overall space and opportunity. If I was to spread between that and your question on Opsgenie and Trello and other things in terms of adoption across our base, I would go back to our long-term philosophy, right? We’re rolling that out pragmatically across the base and across the products over Q2 and then through Q3 and Q4 as we learn, right? We're big on test, measure, learn, taking slow steady steps and learning and moving forward. It's no different when it comes to the integration of acquisitions, it's no different when it comes to new products, part of the durability and strength of our business has been creating a very efficient business over a long-term that's patient and thinks about the future. It's no different when it comes to integrating Trello, integrating Opsgenie et cetera. Obviously, we've got some great Trello numbers and Opsgenie numbers in the letter. We're very excited about where we are. And both were great product additions to our family for the long term. But at the same time we think about them over a 5- to 10-year time frame and doing the right thing by the customers over the long term.

James Beer, CFO

Yes, Heather. As you say, we don't guide to that line. But directionally, the deferred revenue, sequentially, in Q2 was obviously very strong. And so, of the order of about $25 million more than was the case in Q2 of last year. And recall that Q2 of last year was the quarter in which we saw effectively the totality of the pull-forward effect.

Brent Thill, Analyst

Hi. This is Luv Sodha on for Brent Thill. Congrats on the quarter and congrats to Jay. It's been great to speak with you over the years. I had two quick questions. One was on the M&A strategy. This quarter has been a solid quarter in terms of cash flow generation. So could you maybe talk about how you were thinking about deploying that cash over the next few years? And whether the philosophy is still doing tuck-ins? Or whether you're sort of thinking about doing something really transformational on that side?

Scott Farquhar, Co-CEO

Right. Thanks for the question. It's Scott here. I'll just remind you, like we're really proud of Atlassian. We have built out the capability to build products internally, which we've shown over a long period of time. We have an ecosystem and marketplace that allows us to augment our products with things created outside Atlassian. We had $1 billion of lifetime sales. And one of my proudest moments of doing this deal is when you meet people outside the business who have built their entire careers building around Atlassian. And then of course, we have the ability and track record of bringing in acquisitions and successfully introducing them to our existing customer base and integrating with our products to create a solution and experience that is harder to do outside having the products under our table. So we've got a pretty good track record of M&A. We've done dozens of acquisitions over time. We have a great team here. And I'm always reminded that the statistics are against the companies having accretive shareholder value to M&A. So we're always very careful about how we think about it. And culture fits the most important thing that we think about and first and foremost. Then we look at do they share our mission? Our mission is only the potential to retain. So can we accelerate their mission by bringing us together. And then we will get – did that have a similar business model to us. And then afterwards we then look at geographic footprint and technology and so forth. So that's the philosophy we've taken. I think we've done a really good job. As we looking forward, as you would know, we wouldn't be talking about any potential candidates on our call like this. But just know that over time, we'll continue to do M&A in a similar fashion to what we've done historically.

Luv Sodha, Analyst

Great. Thank you. And just one quick follow-up. I know margins were really strong. And obviously, some of that was because of the headcount that you guys are pushing that into the back half of the year. But over the longer term, should we expect to see sort of more leverage on – especially on the R&D side in terms of – on the margin expansion?

Mike Cannon-Brookes, Co-CEO

No, I would just reiterate really what we've been saying now for some time and that over time, we would expect the opportunity to expand our free cash flow and operating margins. But we are very focused on this very large market that is in front of us. We're exceptionally well positioned to go after it. And we want to make sure that we're making the right moves that will allow us to do so to the best of our ability and that will be a very good outcome for our shareholders in our view. So no change in our perspective around margins.

Michael Turits, Analyst

Hey, guys good evening. Of course, Jay congrats and good luck on all things. Two questions. First one for Mike and Scott. A lot of the development and acquisition has been, let's call it on the ops side. And yet you do have lots of products in the more technical dev side what you call co-built and shipped Bitbucket SourceTree Bamboo. And there's been a lot of visibility of companies in that space building consolidated platforms. Can you talk for a minute about your strategy in that more developer-centric side of the business?

Scott Farquhar, Co-CEO

Thanks for the question, it's Scott here. The trend known as DevOps is becoming increasingly recognized. To provide some context for those who may not be familiar, in the last two decades, we've seen a shift where various departments are collaborating closely with HR due to the evolving demands of business. This started around 20 years ago with Agile, where software developers began working alongside business analysts and other business units to enhance efficiency and speed. Now, as customers transition to the cloud and integrate more software into their operations, development and operations teams are joining forces to shorten cycle times. As this is a relatively new market, there's a lot of activity and numerous players focusing on specific areas. Our strength lies in our broad portfolio of products, which engage people throughout the entire lifecycle. When we consider DevOps, we go beyond merely combining development and operations; we also focus on integrating the entire business to facilitate understanding of these processes. Our product lineup ranges from business EVO using Confluence for requirement gathering to Opsgenie, which alerts teams in emergencies. This comprehensive coverage is why customers choose us; they're not just after narrow solutions. As the market evolves, we maintain partnerships and ecosystem integrations that allow us to work seamlessly with those specialized solutions that may not warrant our development efforts. Atlassian serves as the backbone for how work flows through organizations, even when some niche products are used.

Michael Turits, Analyst

Okay. Thank you. And then very, very quickly for James, I think you made similar commentary on this last year. But you did say pull forward out of fiscal 2021 as well. So how should we think about that at this point which is obviously early?

James Beer, CFO

Yes. The long-term deferred revenue provides insight into what to expect in the second half of fiscal 2021 regarding that roll-off activity. For the short-term deferred revenue, I view Q3 as the main contributor of revenue into Q2, with lesser contributions in Q4 of FY 2020 and the first half of fiscal 2021.

Khanh Ngo, Analyst

Hi. It's Khanh Ngo filling in for Jack this afternoon. Thanks for taking my question. You guys made some previous comments that you don't expect material revenue in FY 2020 for cloud premium for Jira Software. Can you provide an update to the impact on the quarter of cloud premium? And separately for those that do choose to upgrade what's a typical uplift?

Mike Cannon-Brookes, Co-CEO

So I'll take the first part, no change to our view that our cloud premium products Jira Software Confluence JSD, we're very pleased with our launch of those products. But I wouldn't expect those to have a material impact on our fiscal 2020 revenue.

Jay Simons, President

Yeah. And then the uplift is – 2x is basically the entry point and then it diminishes there as you have more volume – you get into the higher tiers and have more volumes of users.

Gregg Moskowitz, Analyst

Thanks very much. Congrats everyone on the quarter. And Jay, you've been a tremendous add to Atlassian best of luck in whatever you do next. So, for Mike or Scott given that we're beginning a new calendar year, customer budgets being reset, strategic priorities being mapped out et cetera. I'm curious to hear your expectations as it relates to adoption of DevOps as well as broader collaboration across IT? Are you expecting continued steady progress or are there any changes in trajectory that you think we could see in 2020?

Mike Cannon-Brookes, Co-CEO

Yeah, mate, it's Mike. Look, I think continued steady progress is what we expect to see. Obviously, development as a whole, the creation of software technology-driven businesses extending into DevOps and how that flows through the rest of the business, is a growth area of investment for companies large and small all around the world. So that's a great space to be in. And our products that then work off that as we work to more and more teams is a very strong space. But I don't expect to see any major changes in that at a broad scale. From our perspective, obviously, we continue to see advocate for and feel pull from the customers over the move from server and on-premise products to the cloud and that's something that we continue to talk about, continue to see, and continue to work with customers to manage that sort of decade-long transition that's happening there. I think we're doing a really good job at the moment, but there's always work to be done. And you can see that in our continued enterprise releases on the cloud side, continued releases of migration tooling for our customers and our partners, to help those companies to move to the cloud and get access to all of those features and the benefits of running the software in the cloud.

Keith Bachman, Analyst

Hi, thank you very much. James, I wanted to direct this question to you. It concerns the revenue guidance for the March quarter and what differs from last year. Specifically, reflecting on the December 2018 quarter, the timing of the price increase was similar, and the effects of those increases were also comparable, possibly slightly higher in December 2018. However, when I examine the revenue and sequential growth from December 2018, it was around 12%. This quarter, you performed slightly better in that regard. Yet, you are forecasting a sequential revenue decline for the March 2020 quarter. Last year, you actually experienced sequential growth under the same conditions of over 3%. I'm trying to comprehend why you anticipate a 3% revenue decrease when revenues increased by 3% in similar circumstances last year.

James Beer, CFO

Yeah, Keith, I'd really bring us back to this discussion of the pull-forward activity that we've been talking of. Yes, we have that one point of revenue growth headwind that I referred to and broke out on one of the earlier questions. But the pull-forward activity is significantly more material to answering your question. And so really that's what I would point to. Recall that this was the first year where we had raised prices on our data center business. And that, as I indicated a little earlier, was really quite strong. Our partners around the world but particularly those in EMEA or in APJ really took that on board. In fact, we have given them additional incentives to drive data center business as we think about the margin structure that we share with our partners. So really that's what I'd point to as to the Q3 guide.

Scott Farquhar, Co-CEO

Thanks everyone for joining the call today. We really appreciate all your support and look forward to keeping you updated on our progress. I hope you have a great rest of the week and an amazing weekend.