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Atlassian's Q2 Earnings: Operating Profits Were Too Strong for Management's Tastes

By Anders Bylund - Jan 27, 2020 at 11:37AM

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Rather than allowing surprisingly rapid sales growth to fall all the way to the bottom line, management would have preferred to invest the excess income into more R&D engineers.

Business collaboration software specialist Atlassian (TEAM 5.51%) reported earnings on Thursday, Jan. 23. The report covered the second quarter of Atlassian's fiscal year 2020. The company crushed Wall Street's expectations across the board, alongside a mixed slate of guidance targets.

Atlassian's second-quarter results by the numbers

Metric

Q2 2020

Q2 2019

Change

Analyst consensus

Revenue

$409 million

$299 million

37%

$389 million

GAAP net income

$124 million

$45 million

175%

N/A

Adjusted earnings per share (diluted)

$0.37

$0.25

48%

$0.27

Data source: Atlassian. GAAP = generally accepted accounting principles.

Breaking down the headline figures

Analysts tend to stick close to official guidance targets. In this case, the midpoints of Atlassian's second-quarter guidance pointed to adjusted earnings near 0.27 per share on total revenues of approximately $388 million.

Atlassian's perpetual license sales rose 13% year over year to $29 million while maintenance fees increased by 20% to $117 million and subscription revenues landed at $229 million -- 50% above the year-ago period's reading. Like most software companies these days, Atlassian is leaning heavily into the subscription space while moving away from traditional single-payment license sales. Subscription revenues accounted for 56% of Atlassian's total second-quarter sales, up from 37% in the same period of 2019.

Operating margins stopped at 10.2%, up from just below breakeven a year ago. Management called this an "area for improvement," because Atlassian would have hired more engineers to its research and development operations if it had seen these strong top-line gains coming.

"While a strong result on paper, we'd prefer to have invested more toward our long-term goals," the company stated in the earnings report. "We posted strong quarterly results in Q2. But we're most proud of our long-term progress toward creating awesome products customers love through a cloud-first platform."

Two young people smile while chasing hundred-dollar bills fluttering around them.

Image source: Getty Images.

Tax effects

The GAAP bottom-line profits jumped much faster than the adjusted earnings thanks to a quirk in Atlassian's financial management. The company records changes to the fair value of its exchangeable debt papers as "other income" for taxation purposes. Since share prices rose 57% over the last 52 weeks, it's easy to see how the fair value of these senior notes increased.

Atlassian may want to rethink this strategy in the long run because it boosts the company's taxable income and leads to a larger tax bill. For example, Atlassian's taxable operating income rose fivefold in the second quarter. Cash payments for income taxes landed at $10.4 million, up from $743,000 in the year-ago period.

Guidance updates

Looking ahead to the third quarter, Atlassian set its guidance targets roughly in line with current analyst expectations. Adjusted earnings should rise approximately 28% to $0.20 per share on revenues near $397 million. That's $0.02 below the Street's earnings view but right on the nose in terms of top-line sales. Take these targets with a grain of salt, though -- the company has a habit of beating both analyst projections and management's guidance targets by a wide margin.

On the other hand, Atlassian boosted its full-year views. Adjusted earnings are now seen landing near $1.06 per share on sales near $1.60 billion. That's up from an earlier earnings target at $1.00 per share and a revenue estimate of $1.57 billion.

The upshot: If you build great products, the customers will come

Atlassian's word-of-mouth marketing strategy continues to pay huge dividends, supporting strong top-line growth and 7,000 new customers in the quarter. The stock doesn't look cheap at 112 times forward earnings estimates but you get what you pay for -- a fantastic growth stock whose management calls it a problem to be fixed when the company's operating income rises faster than its R&D budget.

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