Atlassian Drops Some Products by Striking Deal With Slack

Collaboration and productivity software provider Atlassian (TEAM 0.10%) reported its fiscal fourth-quarter results after the market closed on July 26. Revenue and adjusted earnings continued to soar, and the company's guidance calls for more of the same in fiscal 2019. But that growth will be driven by one less product category: Atlassian is getting out of the communications market by striking a deal with rival Slack.

Atlassian results: The raw numbers

Data source: Atlassian. IFRS = International Financial Reporting Standards.

What happened with Atlassian this quarter?

• Atlassian ended the quarter with 125,796 customers on active subscriptions or maintenance agreements, gaining 6,638 net new customers during the fourth quarter.
• Subscription revenue was $117.4 million, up 62% year over year.
• Maintenance revenue was $87.3 million, up 21.8% year over year.
• Perpetual license revenue was $22.5 million, up 16.3% year over year.
• Other revenue was $16.6 million, up 53% year over year.
• Cash, cash equivalents, and short-term investments reached $1.73 billion at the end of the fourth quarter, up from $764 million at the end of the second quarter. The company raised cash by selling $850 million of senior notes in April.
• Atlassian produced $82.2 million of operating cash flow and $64.4 million of free cash flow. Free cash flow was up 45% year over year.

Atlassian announced a strategic partnership with Slack. Here are the details:

• Slack has acquired the intellectual property for Stride and Hipchat Cloud, Atlassian's communications offerings. Atlassian is exiting the market after deciding that the investment necessary to compete effectively would likely lead to lackluster returns.
• Stride and Hipchat Cloud will be discontinued, as will Hipchat Server and Data Center. Atlassian and Slack will work to migrate users to Slack's platform.
• The two companies plan to deepen existing product integrations and build new integrations, particularly between Confluence Cloud and Slack.
• Slack and Atlassian plan to work together on marketing, sales, and channel enablement.
• Atlassian has made an equity investment in Slack.

The Atlassian and Slack logos. Image source: Atlassian.

Atlassian provided the following guidance:

• For the first quarter: Revenue between $258 million and $260 million, up 33.6% year over year at the midpoint; non-IFRS EPS of $0.19, up from $0.12 in the prior-year period; non-IFRS gross margin of 86%; and non-IFRS operating margin of 21%.
• For fiscal 2019: Revenue between $1.146 billion and $1.154 billion, up 31.6% from 2018; non-IFRS EPS of $0.77, up from $0.49 in 2018; non-IFRS gross margin of 85% to 86%; and non-IFRS operating margin of 20%.

What management had to say

During the earnings call, co-CEO Mike Cannon-Brookes kept things vague when discussing how the Slack deal will affect the company's results: "[W]e're not making any comments specifically today about the opportunities in terms of working with Slack around go-to-market opportunities. I'd just like to say they're embedded within the guide that we've issued for fiscal 2019."

Cannon-Brookes also refused to give details on Atlassian's investment in Slack: "No, we're not disclosing that. It's relatively modest investment but we're not going beyond that."

CFO James Beer discussed the impact of cloud computing on gross margins: "We've said in the past and I would confirm that we would expect that there would be something of a gradual, very gradual decline in gross margin as cloud becomes a bigger proportion of the overall Atlassian revenue mix."

Looking ahead

Atlassian's deal with Slack won't have much of an effect on its growth. Beer said during the conference call that there would be a revenue headwind of just about $1 million in fiscal 2019, with some revenue from the migration process to Slack offsetting lost revenue from the shutdown of Stride and Hipchat.

Atlassian raised a ton of cash by selling senior debt earlier this year, which could potentially be used for a significant acquisition down the road. Management sidestepped a question on mergers and acqusitions during the conference call, but I'd be surprised if the company wasn't considering making a deal.

Atlassian expects to cross the $1 billion revenue threshold in fiscal 2019, although it's still producing losses on an IFRS basis. But with revenue growing at a strong double-digit pace, investors likely won't mind the continued red ink.