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Edited Transcript of TEAM earnings conference call or presentation 25-Jul-19 9:00pm GMT

Q4 2019 Atlassian Corporation PLC Earnings Call

LONDON Jul 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Atlassian Corporation PLC earnings conference call or presentation Thursday, July 25, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ian Lee

Atlassian Corporation Plc - Head of IR

* James A. Beer

Atlassian Corporation Plc - CFO

* Jay Simons

Atlassian Corporation Plc - President

* Michael Cannon-Brookes

Atlassian Corporation Plc - Co-Founder, Co-CEO & Director

* Scott Farquhar

Atlassian Corporation Plc

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Conference Call Participants

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* Alexander Kurtz

KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst

* Arjun Rohit Bhatia

William Blair & Company L.L.C., Research Division - Associate

* George Michael Iwanyc

Oppenheimer & Co. Inc., Research Division - Associate

* Gray Wilson Powell

Deutsche Bank AG, Research Division - Research Analyst

* Gregg Steven Moskowitz

Mizuho Securities USA LLC, Research Division - MD of Americas Research

* Heather Anne Bellini

Goldman Sachs Group Inc., Research Division - MD & Analyst

* James Derrick Wood

Cowen and Company, LLC, Research Division - MD & Senior Software Analyst

* Joe Goodwin

JMP Securities LLC, Research Division - Analyst

* John Stephen DiFucci

Jefferies LLC, Research Division - Equity Analyst

* Jon Philip Andrews

Needham & Company, LLC, Research Division - Senior Analyst

* Keith Frances Bachman

BMO Capital Markets Equity Research - MD & Senior Research Analyst

* Michael Turits

Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst

* Rishi Nitya Jaluria

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Sanjit Kumar Singh

Morgan Stanley, Research Division - VP

* Sui Ying Cheong

BofA Merrill Lynch, Research Division - Analyst

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Presentation

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Operator [1]

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Good afternoon. Thank you for joining Atlassian's Earnings Conference Call for the Fourth Quarter of Fiscal 2019. (Operator Instructions) 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 Ian Lee, Atlassian's Head of Investor Relations.

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Ian Lee, Atlassian Corporation Plc - Head of IR [2]

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Good afternoon, and welcome to Atlassian's Fourth Quarter Fiscal 2019 Earnings Conference Call. 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 fourth quarter and full year fiscal 2019. These items were also posted on the investor relations section of Atlassian's website, at investors.atlassian.com.

On our IR website, there's also an accompanying presentation and data sheet available.

We'll make some brief opening remarks then spend the rest of the call 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 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 or 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 is included in filings we make with the Securities and Exchange Commission from time to time, including the section titled risk factors in the most recent Form 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 number of limitations related to the use of these non-IFRS financial measures versus the nearest IFRS equivalents, and they may be different from non-IFRS and non-GAAP measures used by other companies. A 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. I will now turn the call over to Mike for opening remarks before we move to Q&A.

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Michael Cannon-Brookes, Atlassian Corporation Plc - Co-Founder, Co-CEO & Director [3]

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Good day. Thanks everyone for joining today. Fiscal 2019 was another outstanding year for Atlassian. We surpassed 150,000 customers and exceeded the $1 billion revenue mark for the first time in a fiscal year. We achieved this while generating more than $400 million in free cash flow during the year. I'm incredibly proud of the work of more than 3,600 Atlassians who come together each day to build the great products that our customers love. Our customers have always been our guiding light. Over the past 17 years, our commitment to these customers has led us to make pragmatic decisions about the evolution of Atlassian and our products. Today, they're leading us towards the cloud. Demand for our cloud products is increasing, both from new customers and from existing customers using our on-premises products. It's natural that the cloud is our primary focus and a key driver of our growth.

In fiscal 2020, we will continue to invest deeply in improving and expanding our cloud offerings and platform. We will also be investing to serve larger customers in the cloud as well as to accelerate the pace of migration of server and data center customers to our cloud. Our pricing and packaging strategies will be thusly aligned with these goals. Scott and I have always been focused on driving sustainable growth over the long-term. Our increasing cloud focus, supports this long-term view. In James' section of the shareholder letter, we outlined the financial implications of our cloud strategies in fiscal 2020, and we encourage you to read his commentary. And with that, I'll pass the call over to the operator for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Bhavan Suri with William Blair.

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Arjun Rohit Bhatia, William Blair & Company L.L.C., Research Division - Associate [2]

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Actually Arjun Bhatia on for Bhavan. Just wanted to start off with the freemium model that you talked about in the shareholder letter. It seems like this is a nice shift to the strategy. Just wondering why this is the right time to go freemium in the cloud for specific cloud products? And then what do you think is the benefit over offering a 1-week or 1-month trial for customers?

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Michael Cannon-Brookes, Atlassian Corporation Plc - Co-Founder, Co-CEO & Director [3]

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Arjun, it's Mike. I can take that. Sure. I guess I would start by saying it is not really a shift in the strategy. We have free versions of a whole series of cloud products today, and we have always tried philosophically to have the lowest entry point price that we can. A lot of our cloud investments over the last couple of years have made this possible. So this is sort of the -- from that point of view the culmination of a longer-term journey in the cloud. We've always tried to get after the Fortune 500,000. We've got to have as an many on ramps as possible to get customers on board as frictionlessly as possible at the low end, and we deliver them value in terms of the products and then as they grow, they will start to become customers. That is always been our pricing desire. So this is just another step on that journey in terms of getting us to Fortune 500,000.

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Arjun Rohit Bhatia, William Blair & Company L.L.C., Research Division - Associate [4]

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Okay. And then may be a quick follow-up. I'm just trying to get a better understanding of where customers are in the migration path, especially larger customers from server or on premise to cloud. Is this something that your larger customers haven't -- have planned already? Or are we still too early for that? And something you would expect to play out over the next few years here.

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Jay Simons, Atlassian Corporation Plc - President [5]

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Arjun, it's Jay. It's been playing out over a while, I think, the signal that we articulated in the letter is that we're seeing increasing demand from a lot of on-prem customers, many of them larger, to consider moving to the cloud. And that's been ongoing, and we anticipate it will be ongoing. And maybe there's a couple of great examples of like really large U.S.-based asset firm that's beginning planning to move to the cloud, and that's a large existing server customers that has 8,000 users of Jira, and 10,000 users of Confluence, and on the other side of that cloud journey, they can anticipate taking it up to 15,000 users. There is a large European athletic clothing manufacturer that's going through the same journey, and a lot of the catalysts for it is just the broad secular shift that's been happening around us in the market, where 90% of new customers are in the cloud. But a lot of it is these large customers, see the investments that we made in cloud, and then the advantages that cloud brings them in terms of performance, the ability to have the service managed and updated for them and then more reliability in some cases.

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Operator [6]

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The next question comes from Gregg Moskowitz with Mizuho.

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Gregg Steven Moskowitz, Mizuho Securities USA LLC, Research Division - MD of Americas Research [7]

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So I was at Atlassian's summit a few months ago where you offered all attendees up to 2000 free cloud software licenses to a company that are on-prem licenses, and obviously it looks like you've now opened this offer up to your entire community, and on a matching basis as well. Would it be fair to conclude that as a result you've seen high levels of interest in activity from that promotion a few months back? Any color kind of around that in terms of what you've seen from customers would be helpful.

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Jay Simons, Atlassian Corporation Plc - President [8]

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Gregg, this is Jay. I think it -- it probably was response, it is in response to a lot of interest in the cloud and the goal of just making the journey that customers are considering easier for them. And part of that is in the offer that you mentioned and the matching free cloud trial license that we're offering existing server customers so they can begin to plan a migration. The other component is just the investments that we made in product and migration tooling. We've -- the migration tooling has come a long way from where we've had the opportunity for customers to export and import, and now I think some really innovative work in helping them move project by project pieces of Jira and Confluence from their on-prem installations into the cloud. Being over the broad backdrop of that is in response to where customers are signaling they want to go, and our goal is to make that as smooth and as friction free as possible.

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Gregg Steven Moskowitz, Mizuho Securities USA LLC, Research Division - MD of Americas Research [9]

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That's really helpful. And then congrats as well on 150,000 customers, and you've now provided another long-term goal of more than 100 million active users versus over 10 million cloud that they use today. And we look forward to obviously tracking their progress as you continue to grow. But my question there is if you could talk to the investments required in infrastructure and engineers and in acquisition that you think are required to make this goal a reality? Also does this require an accelerated multiyear investment in cloud? Or would you say that you're currently on a good pace from an investment standpoint?

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Scott Farquhar, Atlassian Corporation Plc [10]

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Gregg, Scott here. I can take that. Look, the investments we're making on the cloud, we've been a cloud company for 10 years, and we're making continued investments in improving our cloud for our customers. As Mike mentioned earlier, some of the investments around Vertigo we talked about, which was moving our cloud off our own data centers into third-party data centers, has allowed us to reduce our COGS so we can now offer a free version. Investments we made in infrastructure and platform have allowed us to bring access -- our user management product to market. Have also allowed us to get a premium product to market as well. So we've made a lot of investments over time that are paying off now. As Jay mentioned, we're making investments in migrations, as mentioned in our letter, that Confluence, we've got a great migration tool and we're continuing to improve it, that's going really well. We're investing in Jira migrations tool as well, which we expect to be similarly successful. And over time, one of the things this year is going through that journey of migrating customers with some of the largest customers of ours to the cloud, and through that, we'll -- I'm sure there will be little things we will discover that we'll be working with our customers on. But broadly I don't see a change in our investment mix in an order to do this, it's more of continuing what we've been doing all along.

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Operator [11]

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The next question comes from Heather Bellini with Goldman Sachs.

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Ian Lee, Atlassian Corporation Plc - Head of IR [12]

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Heather, are you there? Heather. Operator, could you move to the next question first, please?

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Operator [13]

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The next question comes from John DiFucci with Jefferies.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [14]

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So Mike and Scott, you talked about the opportunity to help your customers migrate to the cloud. I guess, given your new name is there -- are there any thoughts around the undersea opportunity? That's a bad joke. I'm really sorry. But I'm -- the real question is...

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Scott Farquhar, Atlassian Corporation Plc [15]

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John, it's all right.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [16]

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The real question is this, is there a reason that cloud is better for Atlassian, like pricing stickiness? Or is this just doing what customers want which seems to be part of your DNA and part of your success all along? Or is there something else though that from a financial perspective cloud would be better than on-premise deployments?

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Scott Farquhar, Atlassian Corporation Plc [17]

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John, look, we have always been customer led in whatever we do and that's why we have both deployment options at the moment, and we are not trying to push our customers one way or another from a financial perspective or any other reason. We were very happy with kind of both sides of our business. The demand is there for customers to go to cloud. I do think that as -- when customers are in cloud, it allows us to get the feature-usage information that allows us to be a bit sharper with our R&D investments. It doesn't show up in any balance sheet or P&L or anything like that, but it does allow us to kind of build better products quicker. I mean it allows us to cross sell our products a lot easier because they are on the same system. They can certainly -- we can expose them to Opsgenie without needing to set anything up in their environment. So it allows us to do that better. And from a virality perspective and helping people sign up to products, it allows us to effectively -- with all the analytics we've got, we can make sure that people go through that journey a lot quicker. And I think we've shared in our shareholder letter that the financial results over the long term are marginally better for us at Atlassian, and we feel good about that as well.

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Operator [18]

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The next question comes from Nikolay Beliov of Bank of America Merrill Lynch.

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Sui Ying Cheong, BofA Merrill Lynch, Research Division - Analyst [19]

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This is actually Jacqueline on for Nikolay. Two questions, first in light of the fiscal '19 billing seasonality, how should we think about fiscal '20 billing trajectory? And number 2, how do we think about use cases of the premium edition? Will the channel be involved in the selling premium?

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James A. Beer, Atlassian Corporation Plc - CFO [20]

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Jacqueline, I can take the first one. Now just a reminder, obviously, we very much focus much more on revenue than billing. And that's for the, of course, deferred revenue is relatively small part of our overall sales picture, particularly the long-term deferred revenue because we really don't enter into very many multiyear contracts at all. And then when you add to that, of course, the cloud business growing very strongly, as we've been discussing and more than 3 quarters of that comes with a monthly subscription. So those are some of the key reasons why we really focus on revenue as opposed to billings. So as you know, we don't guide to billings in fiscal '20. But what I would just observe is that in the last couple of years, the billings pattern has moved around somewhat based on the timing of price increases that we rolled out.

So for example in fiscal '19, last year, we announced some price increases in the middle of September. And so there, we saw pull-forward activity occurring to benefit Q2 and that benefit was pulling activity from the second half of fiscal '19 and in fact from fiscal '20 and even beyond there. Now conversely in fiscal '18, we announced price increases a little earlier, right at the start of September, and in that year, the pull forward benefit was really balanced between both Q1 and Q2. And that benefit was pulling in part from Q2, but then more so from Q3. So that's really all I would just remind everyone on. Obviously, we haven't made any price increase announcements for fiscal '20, but that gives you a sense for recent historical pattern, and how price increase activity can impact billings by quarter.

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Jay Simons, Atlassian Corporation Plc - President [21]

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Jacqueline, this is Jay. I'll tap on to the second part of your question. There is 2 kind of unique components of the premium cloud editions. The first is kind of common across them, which are platform capabilities that offer a higher level -- higher service and support level, and in some cases depending on the product, higher storage levels as an example. The second component is premium features that really target more advanced and sophisticated users that are specific to products, and so roadmaps in Jira or usage analytics in Confluence are 2 of the examples. And so the customers that premium editions target are -- can be small and just more sophisticated users, but more often than not will be larger. So actually we're targeting absolutely the channels engaged in selling and supporting customers, both upgrading from standard cloud to premium editions, but in many cases just starting with premium.

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Operator [22]

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The next question comes from Keith Weiss with Morgan Stanley.

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Sanjit Kumar Singh, Morgan Stanley, Research Division - VP [23]

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This is Sanjit Singh for Keith Weiss. Congrats on a very strong Q4. I have 2 questions. The first is on the sort of cloud unit economics, if you will. You had a really nice chart in the earnings letter that basically shows a breakeven time between cloud and server of about 2 years and about 40% higher lifetime value. So to maybe dovetail on John's question, what do customers get for that for paying that extra 40% over 5 years? Is it more about the performance scalability? Or some -- is there a feature functionality aspect of this as well that gives the maintenance-based customers that nudge to move over to cloud?

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Michael Cannon-Brookes, Atlassian Corporation Plc - Co-Founder, Co-CEO & Director [24]

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Sanjit, look, from a pure value point of view, probably the biggest difference they get is, obviously, we're doing all the operations and maintenance of the software for them. So if you think about someone paying the licensing fee they then have to download, have their own server in-house, run their own upgrades, patches, et cetera, of the software that takes time as well as integrating it, connecting it to other things, administering it, that is a large lift that we can take off them. It's often well more than the price of the software itself. Obviously, we can provide that at a small uplift over a multiyear period, as you said, but we can scale that cost across many, many instances, right? Obviously, we're deploying tens of thousands of servers, if you want to think about it virtually on a constant basis we've automated all of it, and we can spread that cost across a lot of customers. At the same time, they get a better updated, more frequently updated application that should be faster, more secure, more scalable without them having to do anything, right? That's the goal of the cloud is it they just sign up with 10 users, and they can go all the way to 10,000, without really having to think too much about that scale effect. That's exactly what we do in R&D, and engineering teams make sure that that will happen for them. And obviously, any new innovations all the way through to new security patches get applied instantly. They just appear sort of magically for them. So it's a far better offering, it's generally the premise behind cloud software.

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Sanjit Kumar Singh, Morgan Stanley, Research Division - VP [25]

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Understood. That's really helpful. And if I could revisit the pricing strategy question. So for the last 2 years, I think, about 2 years ago we moved to this cadence of the annual price increases, and the view was that it was going to be more predictable for the customer base to expect that on an annual basis. It seems like this year is a little bit of an anomaly, and I'm wondering is this sort of a -- should we look at this fiscal year '20 as a sort of anomaly given the sort of push to cloud and that we will visit that annual price increase on the server base after fiscal year '20? Or has the cadence on pricing changed with this cloud push?

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James A. Beer, Atlassian Corporation Plc - CFO [26]

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Well, the first thing I would say, Sanjit, is that as we think about pricing and packaging, we continue to be very focused on remaining the high-value, low-price leader. And we have said in the past and continue to believe that well, within that construct have continuing opportunities to make price changes very much commensurate with the value that we're delivering to our customers. Now obviously we've been talking quite a bit on this call already about our focus on the cloud and continuing to really bring more and more customers be they current, via migrations, or new customers into the Atlassian frame. And so I would expect that benefits around price increases on the cloud side of our business would probably be less so in fiscal '20 than was the case in fiscal '19.

Now again, we haven't made any announcements about price increases more broadly. But I think that's a reasonable thing for you to consider.

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Operator [27]

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The next question comes from Michael Turits with Raymond James.

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Michael Turits, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst [28]

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I think when you drilled down on Gregg Moskowitz question about any change in financial impacts in the quarter and investment. Then maybe we just extend it to the long run. Obviously, moving to cloud, in any case, seems like an acceleration. But is there anything different we should think of in the long term either OpEx or CapEx framework, anything that will create an impact on gross margin, the amount of CapEx we anticipated, or any breaks that we might expect in terms of significant changes over a multiyear period?

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James A. Beer, Atlassian Corporation Plc - CFO [29]

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Yes. So Michael, as we think about the cloud continuing to become a larger and larger proportion of our overall business, I would expect that to have some impact on our gross margins. You would expect, obviously, as Mike was pointing out, we're doing all the work of operating the software on behalf of the customer. And so you would naturally expect there to be an increase in the proportion of cost of goods sold. And indeed, we have in the last couple of years been investing quite significantly in the sort of physical infrastructure to make sure that our cloud customers wherever they are in the world have the sort of response time, the reliability that they would look to receive from our cloud services. But at the same time, I'm very pleased with how -- as we work with AWS, we find significant opportunities to continue to make more efficient usage of the cloud infrastructure. And so you can expect us to continue to be focusing on that over time. And then of course, there are other lines embedded within cost of goods sold and will -- areas such as support, and we will continue to seek efficiencies there as well. And so it's a mixture of a variety of effects around gross margin. Net-net I have been pleased with how we continue to progress on the gross margin line. And in terms of capital expenditure, the way our relationship now works with AWS, really the capital expenditure related to cloud infrastructure sits with AWS on their balance sheet. Our capital expenditure is very much driven by our own physical facilities around our primary offices. So I wouldn't expect the growth of our cloud business to particularly be driving that CapEx line per se. We'll see that effect flow through operating expenditures as we work with AWS.

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Michael Turits, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst [30]

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And then James, a follow-up for you on the guidance for this year, and I don't know if this is related to the cloud push or not. But you're guiding your margins, op margins, EBIT margin down a point. I assume some of that is from the Agile acquisition and maybe you can specify how much that impact is? But if you look at the cash flow from ops guidance, it actually comes down about 6 points. Now I understand based on the math you gave us that about 2 of that $30 million comes from higher taxes, but there's still more impact to cash flow even ex taxes, maybe you can specify that for us.

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James A. Beer, Atlassian Corporation Plc - CFO [31]

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Michael, the first thing I'd say about margins is very pleased that we've been able to grow in fiscal '19, both the operating margin up a point and the free cash flow margin up 2.9 points year-over-year. As you know, we've been saying how we will continue to look to build our margins, both operating and free cash flow over time. And so the guidance that we put out today, as you correctly indicated, in your question, on the operating margin line, one of the key impacts there is the acquisition of AgileCraft now branded Jira Align because remember, that has more of a services component to the business model. And of course, for certainly the first 3 quarters of fiscal '20, we'll be working through that typical deferred revenue haircut that comes along with an acquisition. So that will particularly impact that and then on the free cash flow guide, again, you correctly referenced there a quite sizable swing in cash taxes year-over-year. So in fiscal '19, we actually received $7 million of cash related to taxes. I would expect that to return to much more normal situation in fiscal '20, and so net-net between the 2 years, it will be a swing of around $30 million approximately in cash taxes. So that will have an appreciable impact on the free cash flow margin. The other thing I would note on free cash flow margin, of course, is the capital expenditure, we've indicated would be $30 million for fiscal '20, so that will be down quite substantially year-over-year and that just reflects, going back to my facilities point, that we've worked our way through some of the key facilities projects that we've been working on in fiscal '19, hence a smaller capital expenditure projection for this year.

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Michael Turits, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Infrastructure Software Analyst [32]

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All right, James, just -- there is still a gulf, in other words, you are still coming down a lot more on cash flow margin than you are on EBIT margin, even accounting for the taxes swing. So I want to be...

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James A. Beer, Atlassian Corporation Plc - CFO [33]

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Yes. But the only thing I would further add, Michael, is that we're coming off a very strong year on cash flow. And so again, we would look for these margins to build over time, and we had a very strong build in fiscal '19.

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Operator [34]

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The next question comes from Alex Kurtz with KeyBanc.

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Alexander Kurtz, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [35]

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I'm going to go back to the opportunity around cloud within sort of expansion rates within existing customers. Can you just kind of outline for us again what you see as far as adoption in expansion rate maybe by users within your larger customers when one customer goes the cloud path and the other one goes the on-prem part? I mean, is there a way to quantify that for us a bit?

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Scott Farquhar, Atlassian Corporation Plc [36]

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Alex, it's Scott here. I won't give any specific numbers around that but I can use some anecdotes that are very exciting for us. We've got a growth team here at Atlassian who run lot of growth experiments maybe similar to what you see in some consumer-type companies, and that team is growing pretty substantial over the last year. And we've had some really successful experiments, cross selling, say, Jira into the -- Confluence into the Jira base, which very well overlapping product in server, very well overlapping product in cloud. Because we're running those products in the cloud, we have the opportunity to run these experiments where we can adjust the interface, promote something in product, and see if it works before we spend the effort in productionizing it and rolling it out to our entire base. And so we've seen that work in those particular pair of products over the last year, which is a focus area. We are expanding that to look at other product comps in the coming years and again, stuff that we can do in the cloud that we have done in the server, but it's a lot harder and takes a lot longer to see the returns.

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Alexander Kurtz, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [37]

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Okay. And the comment in the shareholder letter around the 1 point of revenue headwind for the year around these changes that you guys have outlined today, is there some way to kind of outline -- is this a base-case assumption on the uptick in subscription in cloud? Is it back-end loaded as far as how you think that headwind is going to play out during the year? Any kind of additional context would be helpful.

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James A. Beer, Atlassian Corporation Plc - CFO [38]

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Yes. I would say, obviously, we talked in the letter about there being really 3 drivers of that 1 point. So the free editions, the free cloud trials to our current behind the firewall customers, and then the revenue recognition mix effect. That mix effect would be occurring throughout the year. Obviously, the free cloud trials and the free editions that will start to play through as we implement those initiatives. So you'll see that come in the fullness of time during the year.

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Operator [39]

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The next question comes from Jack Andrews with Needham.

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Jon Philip Andrews, Needham & Company, LLC, Research Division - Senior Analyst [40]

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I want to ask a kind of a high-level question just about your overall product development efforts. Can you shed some light on I guess it's a framework perhaps that you're using for resource allocation. I mean you've got a lot of things going on in terms of, besides the push to the cloud, you are introducing net new categories, things like Align and in some cases to a new user base. So I mean, can you just talk about how you're prioritizing spending more time and efforts on some of these other efforts versus adding incremental functions to your existing products? Is it a way to kind of rank order your product development priorities?

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Michael Cannon-Brookes, Atlassian Corporation Plc - Co-Founder, Co-CEO & Director [41]

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Yes. Mike, I can take that. Look, there's no simple and easy way to communicate that. It's -- I would say it is something that we spend a lot of time thinking about. We've got a lot of history of doing that. You mentioned a few acquisitions, obviously, we realized it's very important to integrate acquisitions in the right time frame. Sometimes that's faster, sometimes that's slower. If you look at something like Trello we've invested a lot in growing the Trello business, but not so much in integrating it in the short term, and in Opsgenie it's the opposite way around. And so we make, I would say, horses for courses' decisions depending on what that is. We at the same time, do obviously try to lean into the future, so you can see a lot of our resource allocation is going into the cloud whilst at the same time, being practical about making sure that our on-premises customers get the improvements that they need in those applications. I would say we are constantly making decisions on how we move resources around while also at the same time growing. We also have a global problem to constantly manage where resources are around the globe. We've been doing very well in Bengaluru. I was just there a couple of weeks ago, we've passed 200 staff there now in India, and continue to grow really strongly, and where we put resources around the world and how new those resources are can affect how or what projects we can put them to. So I would say we're really good at managing out on a global basis now, and pretty comfortable where we sit, but there's no singular framework we use.

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Jon Philip Andrews, Needham & Company, LLC, Research Division - Senior Analyst [42]

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Thanks for your perspective and just as a follow up, is there any update in terms of how you're thinking about the Enterprise Advocates role at Atlassian? Do you feel you need to add any more resources in this area? Or just given again the emphasis of the cloud, changes in pricing, things like that?

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Jay Simons, Atlassian Corporation Plc - President [43]

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This is Jay. We're growing the team, and we've been growing the team over the past handful of years. There won't be a material change, but we'll continue to add Enterprise Advocates in sort of direct sales as we attack the opportunity. I think, keep in mind that the business model -- I think what makes our business model so powerful is the combination of 3 things. This high velocity flywheel that really focuses on enabling customers to self-serve and that just allows us to reach massive global volume of customers that can start easily on their own that's number 1. 2 is our direct Enterprise Advocates sales teams and they can focus on targeting high-value expansion opportunities that exist within our largest customers. And the third is the channel. And often times our direct teams are working hand-in-hand with the channel on expansion opportunities that tend to be accompanied by some service delivery work that the channels enable to help with. And that's what makes it so great as we can land even the largest accounts really efficiently, and we create this really fertile ground for our channel and our direct teams to expand from.

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Operator [44]

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The next question comes from Derrick Wood with Cowen and Company.

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James Derrick Wood, Cowen and Company, LLC, Research Division - MD & Senior Software Analyst [45]

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My first one, James, it was a little surprising to see maintenance growth actually accelerate this quarter, and then on the flip side, a steeper deceleration on subscription growth. Are there any puts and takes that you'd call out in terms of the revenue mix this quarter? And then how should we think about, how much license and maintenance growth steps down next year as you focus more on the cloud?

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James A. Beer, Atlassian Corporation Plc - CFO [46]

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Yes. So for Q4, we are pleased with the maintenance growth rates. Obviously, you're starting to see the price increases from really the last couple of years layering into that figure now. On the subscription growth rate, the behind the firewall component of that subscription revenue line had a particularly strong comp back in Q4 of fiscal '18. And so that's really what drove the result there in this past quarter. We're continuing to be very pleased with our cloud business, our marketplace business, and our data center business in terms of growth. As we've been discussing now for couple of years or so, we would expect that gradually over time the license maintenance side of the business doesn't grow as strongly, and you see that flowing through in the strong growth of the subscription growth line that we gave you a steer on for fiscal '20 with growth expected there of greater than 40%.

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James Derrick Wood, Cowen and Company, LLC, Research Division - MD & Senior Software Analyst [47]

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Great. And I guess more of a product question regarding the new free cloud license for on-premise customers, can you give us a sense as to how long these customers will get the free license and at what time period they'll have to start paying added fees for the cloud service?

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Scott Farquhar, Atlassian Corporation Plc [48]

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It's Scott here. The freemium model, there's many different ways that the companies do that. We have free trials for many of our products and we have freemium for many of our products. For the free trials, there are generally couple of weeks, but what we're talking about here is moving many of our products from a free trial approach to a freemium approach where there is effectively a feature or user limited version of our products that are free forever. And we've found through the experiment we've done over long period of time and the fact that we have multiple products with different pricing models that the freemium approach whilst it has some short-term headwinds in terms of revenue for us actually provides the best long-term sort of revenue for us as a company. And as Mike mentioned earlier, when you're after the Fortune 500,000 and the markets are so large, that's a trade-off we will make every day of the week, trading off some short-term revenue for long-term customer acquisition. So that's what we're talking about. We have free trials and moving to a freemium feature and user-based model.

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Operator [49]

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The next question comes from George Iwanyc with Oppenheimer.

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George Michael Iwanyc, Oppenheimer & Co. Inc., Research Division - Associate [50]

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So you had really strong growth with your larger customers, the ones over 50,000 and 500,000. Can you give us a sense of the factors that are driving the expansion there? And maybe also a sense of the penetration of your newer products with those larger customers?

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Jay Simons, Atlassian Corporation Plc - President [51]

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Well, the factors are a couple of things like one we've created in both the on-prem business and now in cloud with premium editions, really important upgrade opportunities for those customers as they continue to scale. And so that's 1 factor. We've also expanded the portfolio. So we have more products to talk to those customers about that are meaningful. And we're doing that well. As I think those are the kind of the 2 things that are contributing to growth in both. Customers are spending more than 50K and customers are spending more than 500K. There's a lot of latent opportunity for us to do that. And in concert with the stronger signals of cloud, I think, we're really excited about the opportunity for premium editions in the cloud as both a similar upgrade path for just the existing cloud-base that's on standard, it's on the version of cloud that exists today. But also as server customers consider the move to cloud. They have got the opportunity to either stay on-prem with an upgrade path to data center or to move to premium version of our cloud products. And both those are opportunities, I think, to increase the 2 cohorts that you described.

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George Michael Iwanyc, Oppenheimer & Co. Inc., Research Division - Associate [52]

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So with the multi product opportunities that are opening up can you give us a sense of just the competitive landscape? Are you seeing yourself go up against more companies with the larger customers?

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Jay Simons, Atlassian Corporation Plc - President [53]

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Not materially. I think the competitive landscape as we've described before is different by product and by category. I think we've got a really strong, I think, advantage with just our existing base and where we're expanding from. A lot of these products are deeply connected into as an example, Jira. And so the Jira affords us an opportunity with a champion and a kind of a key fanatical base inside of our customers where they're going to look for the best product that actually allows them to extend or to weave kind of capability into an adjacency like IT operations management or incident management. So Opsgenie as an example, benefits a lot from the existing Jira software base of 65,000 customers. And part of the momentum that we're seeing in Opsgenie is exactly related to that. And so the competitive landscape doesn't change, I think, we lean into our advantages, and we're focused on building the best product in any category and then using all the levers that we can to introduce that product to the customer.

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Operator [54]

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The next question comes from Keith Bachman with BMO Capital Markets.

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Keith Frances Bachman, BMO Capital Markets Equity Research - MD & Senior Research Analyst [55]

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James, I'm going to start with you. You did mention or talked about the pricing impact to subscription. I wanted to extend that. If you thought about the guidance that you gave, is pricing net-net still a tailwind as you think about the overall opportunity associated with FY '20?

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James A. Beer, Atlassian Corporation Plc - CFO [56]

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Yes, it is. That's -- it's a reasonable way to think about it.

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Keith Frances Bachman, BMO Capital Markets Equity Research - MD & Senior Research Analyst [57]

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And specifically you said subscription would probably less so in '20 than '19. Is that broadly true of the balance of the portfolio as well?

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James A. Beer, Atlassian Corporation Plc - CFO [58]

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Well, just to be very clear, my comment was around the cloud part, and now remember there are 2 parts of the subscription revenue. There is data center as well as cloud. But for the cloud part of the business, I would expect price increase activity to drive less growth for us than was the case in fiscal '19.

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Keith Frances Bachman, BMO Capital Markets Equity Research - MD & Senior Research Analyst [59]

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Okay. And if you could just answer that, broadly speaking, is that true for the rest of the portfolio? Or...

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James A. Beer, Atlassian Corporation Plc - CFO [60]

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No. I wouldn't really extend the commentary beyond that. Obviously, we haven't made any pricing announcements yet to our customers. We just wanted to give you a sense for what might be helpful to some of your modeling.

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Keith Frances Bachman, BMO Capital Markets Equity Research - MD & Senior Research Analyst [61]

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Okay. Great. My second question is, could you provide any update on Align? Just any kind of traction or metrics associated with that particular offering?

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Jay Simons, Atlassian Corporation Plc - President [62]

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Keith, this is Jay. No metrics. But in terms of traction really pleased with just the response that we've seen from customers, and the momentum we saw in the first quarter. I think the timing of the announcement with Summit certainly helped. And I think you heard, I think you were absent, but you heard some of the interest is directly from like ANZ Bank on the stage when we talked about their interest in Agile transformation and the consideration set around Jira Align and AgileCraft prior to that. Q1 was our first full quarter with the team integration, pipeline, channel enablement, all those things are humming. We're pleased with the results.

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Keith Frances Bachman, BMO Capital Markets Equity Research - MD & Senior Research Analyst [63]

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Okay. Yes, Jay, there did seem to be a lot of interest at your user group event.

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Operator [64]

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The next question comes from Rishi Jaluria with D.A. Davidson.

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Rishi Nitya Jaluria, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [65]

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Nice to see continued strong results. 2 kind of broad classes of questions. First on the cloud migration and then I got a follow-up on Trello. But on cloud migrations side, to kind of piggyback off Sanjit's observation earlier, in the chart that you gave us was very helpful when you talk about -- it essentially comes out to about a 1.4x uplift from server to cloud or even if you look at year 5 maybe closer to 1.6 to 1.7x uplift. I know with other software companies when they've talked about migrations to cloud, they've talked actually about a 2x to 3x. So maybe just help me understand what -- why the delta -- feels silly complaining about it, but why is that uplift not bigger? And alongside that, in terms of driving the migrations, should we start to see something like cloud-only features or cloud-only products as an incentive to help customers migrate? And then I've got a follow up on Trello.

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Scott Farquhar, Atlassian Corporation Plc [66]

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Actually the first part, which is that cloud migration from the uplift. I will, firstly -- it's an illustrative example. We put into the document in each segment, there is different pricing characteristics. Two is that we have always been patient for revenue with our customers and making sure that there are less barriers to move across to the cloud is very important for us as well. And so a lot of the pricing we set there is to help customers move across to the cloud.

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Rishi Nitya Jaluria, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [67]

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Okay. Got it. And then just in terms of -- from a product perspective anything in terms of should we expect to see cloud-only features or cloud-only products to help kind of incentivize customers to migrate?

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Michael Cannon-Brookes, Atlassian Corporation Plc - Co-Founder, Co-CEO & Director [68]

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Yes, we -- it's Mike here. We do have a series of cloud-only features and products if you think about it. So Opsgenie, StatusPage, Align are all cloud-only products that are aligned to support on premises instances in terms of the data it can attract. And then you've seen us introduce specific cloud-only features like Access and within -- even within the Jira family within Confluence, there is some slight feature differences between on-premises products and cloud products. So yes, there are already I guess, some feature differences but by and large if you're using Confluence or Jira software or Jira Service Desk they are still largely the same product on both sides. We do make sure that data compatibility is really important, so for the customers that are migrating we mentioned the Confluence migration assistant we released a few versions of during the year and the upcoming Jira migration assistant that requires us to be able to move especially for the large volume of smaller customers to move that data automatically. So we do make sure that data compatibility is really important. But there are feature differences between the 2, for sure.

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Rishi Nitya Jaluria, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [69]

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Got it. That's helpful and then just quickly on Trello. You did mention in the materials that you had an uplift in customers or paying customers with the results of kind of the board limits. Could you be -- I think just help us understand what kind of the result of that and was that a conversion of free to paying, was that something else? And then maybe talk a little bit about the traction you're seeing with Trello Enterprise?

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Michael Cannon-Brookes, Atlassian Corporation Plc - Co-Founder, Co-CEO & Director [70]

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Sure. Look, Trello is continuing to power along strongly. We're very happy with how it's going. As we've said, look our primary goal with Trello is still to continue to establish Trello as a brand, Trello as a product, and continue to grow the momentum that it has as a standalone business. We are doing more and more integration over time, but that's a long-term journey. We did introduce some pricing changes throughout the year. You've seen some of the impact of that as we've called that in a customer number this quarter. Some of that is a onetime benefit that we've talked about because -- while the flow of Trello customers will be marginally higher, we are changing some of the free to paid conversion rates and that's from a large existing freebase. Obviously, you get some of the existing base converting over to faster, a faster rate, which is what we've called out in a customer number there. At the same time, we are focused on Trello Enterprise. We've had a really good couple of quarters in Trello enterprise as we continue to invest in features there, we put that into the shareholder letter as well. As businesses adopt Trello with tens of thousands of users and beyond, they do have different sets of requirements that we continue to work with the customers on establishing when you have hundreds of thousands of boards across the customer, you need methods of organizing their content, finding their content, managing large-scale users, et cetera, which is exactly what we've been doing in the Trello Enterprise product and obviously with such a large installed base in Trello that has a very good future.

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Operator [71]

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The next question comes from Heather Bellini with Goldman Sachs.

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Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [72]

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Great. I just wanted to apologize for missing the slot earlier. I just wanted to ask real quickly about Opsgenie. You commented about how it accelerated the pace of additional paid users, and I was just wondering if you could talk a little bit about how you are seeing that cross-sell opportunity into your Jira install base? And like is there any color that you could share about kind of where you're seeing the success of kind of cross sell across those products?

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Scott Farquhar, Atlassian Corporation Plc [73]

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Heather, I can't get into the specifics, but as you mentioned, we mentioned in our shareholder letter that we've doubled the pace of customer acquisition, and we feel really good about that acquisition. If you look through our internal charts, there is a distinct change when Opsgenie became Atlassian and we feel great about that.

If you -- in chatting with customers, it's a great product sometimes as mentioned that acquisition -- sometimes you require something and you have to add features to it or make it enterprise ready and Opsgenie actually scales better than any of the other products out there in the market, and so for us it was just a matter of getting it in front of our customers. Now still very early in the journey of putting it on the Atlassian platform. We're really happy with the pace that we've only sort of acquired it less than a year ago. We've already done identity and user interface and stuff like that. So we're sort of at the still the start of what I think of -- in terms of cross selling into our existing base.

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James A. Beer, Atlassian Corporation Plc - CFO [74]

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And then I, Heather, I would just add that when we announced the acquisition of Opsgenie we noted that it would drive a point of revenue growth on the then revenue guidance for fiscal '19. And I'm pleased to say that we achieved that. So strong momentum.

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Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [75]

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Okay. That's great. Just a quick follow-up is there -- so net new customers that you're getting from this 2-plus expansion into the installed base do you see the opportunity on both fronts. Is that correct?

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Michael Cannon-Brookes, Atlassian Corporation Plc - Co-Founder, Co-CEO & Director [76]

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That's right.

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James A. Beer, Atlassian Corporation Plc - CFO [77]

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Yes. That's right and very much so.

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Operator [78]

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(Operator Instructions) The next question comes from Pat Walravens with JMP Securities.

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Joe Goodwin, JMP Securities LLC, Research Division - Analyst [79]

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This is Joe Goodwin on for Pat. I just wanted to ask real quickly about how is the relationship with Slack going and could you speak to some of the opportunities that may be on the horizon?

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Jay Simons, Atlassian Corporation Plc - President [80]

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Joe, it's going great. I mean, we've got I think a good relationship, great integration that we continue to improve between the products. We are in the market, I think, talking to customers at both of our user conferences and events about the relationship that exists and the value for customers when they integrate them more deeply. You saw that at Summit where we talk a lot about just how we use Slack internally and extend their products and they are users of our products at the same time and doing the inverse. So it's good.

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Joe Goodwin, JMP Securities LLC, Research Division - Analyst [81]

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Great. And then just a quick follow-up. Is the monitoring space that you guys would enter into?

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Scott Farquhar, Atlassian Corporation Plc [82]

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Scott here. At the moment, that's not an area that we're actively looking at. There are a lot of players in that space and there's no clear winner. We benefited a lot more from integrating with the leaders in that space, and we have a great relationship with all the leaders in that space.

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Michael Cannon-Brookes, Atlassian Corporation Plc - Co-Founder, Co-CEO & Director [83]

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Again, it's Mike. I might just add. Philosophically if you look at our history we do try to solve human and people problems, not technology problems. And so where we stray into areas where you're solving a technology problem, be it language-specific features or analytic-specific features, it's not our core DNA, right? We're a collaboration company around teams of people, something like Opsgenie where you're coordinating people is much more in our wheelhouse of strength in our DNA as a business around solving people and collaborative problems around technology rather than actually solving technology problems per se.

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Operator [84]

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The next question comes from Gray Powell with Deutsche Bank.

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Gray Wilson Powell, Deutsche Bank AG, Research Division - Research Analyst [85]

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You may have already touched on this I've joined a little bit late, but I just want to make sure I understood some context behind the fiscal '20 guidance. How should we think about the acquisition contribution to revenue growth in fiscal '20? And then is there any residual impacts on operating margins particularly from AgileCraft?

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James A. Beer, Atlassian Corporation Plc - CFO [86]

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Well, we haven't broken out any specific acquisition element of the fiscal '20 guide. Obviously, we have just been talking about how pleased we are with Opsgenie and Jira Align, and so we're looking for those both to continue growing strongly during fiscal '20.

In terms of the operating margin effect around Jira Align, in particular, we'll be working through the deferred revenue haircut that comes along with every software acquisition. And so that will impact the Jira Align revenue growth rate during fiscal '20. We'll still have some of that for Opsgenie as well, but we're 3 quarters further along that pathway with Opsgenie. So during fiscal '20, that their deferred revenue haircut should start to ebb.

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Operator [87]

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This concludes our question-and-answer session. I would like to turn the conference back over to the management team for any closing remarks.

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Scott Farquhar, Atlassian Corporation Plc [88]

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So thanks everyone for joining our call today. From the bottom of the sea to the top of the clouds we continue to work hard to deliver for our customers. We appreciate your time today, and look forward to keeping you updated on our progress.

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Operator [89]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.