Atlassian Corporation (TEAM) On Q2 2016 Results - Earnings Call Transcript

| About: Atlassian (TEAM)

Atlassian Corporation (NASDAQ:TEAM)

Q2 2016 Earnings Conference Call

February 04, 2016 05:00 PM ET

Executives

Ian Lee - IR

Scott Farquhar - Co-Founder & CEO

Mike Cannon Brookes - Co-Founder & CEO

Murray Demo - CFO

Jay Simons - President

Analysts

Heather Bellini - Goldman Sachs

Sanjit Singh - Morgan Stanley

Richard Davis - Canaccord

Brent Thill - UBS

Bhavan Suri - William Blair and Company

John DiFucci - Jefferies

Michael Turits - Raymond James

Matt Carletti - JMP securities

Operator

Good afternoon, ladies and gentlemen. Thank you for joining Atlassian's earnings conference call for the second quarter of fiscal 2016. As reminder this conference call is being recorded and will be available for replay from the Investor Relations section of Atlassian's website following the call.

I will now hand the call over to Ian Lee, Atlassian's Head of Investor Relations. Please go ahead, sir.

Ian Lee

Thank you. Good afternoon and welcome to Atlassian's second quarter fiscal 2016 earnings conference call. On the call today we have Atlassian's Co-Founders and CEOs, Scott Farquhar and Mike Cannon Brookes, our Chief Financial Officer, Murray Demo and our President, Jay Simons. As this is the first earnings call since our IPO in December Scott and Mike will begin by providing an overview of Atlassian's business and strategies in addition to recapping some of the highlights from the second quarter. Murray will then cover Atlassian's financial results for the second quarter and provide our financial targets for the third quarter and full year fiscal 2016. Following our prepared remarks we'll have a brief question-and-answer-session. Jay will also be joining for Q&A. The press release with our results for the second quarter was issued earlier today and is posted on our Investor Relations website at investors.atlassian.com. There's also an accompanying presentation and data sheet available on our ir website.

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. In addition during today's call will discuss non-IFRS financial measures. These non-IFRS financial measures are in addition to and not as a substitute for us 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 the nearest IFRS equivalents. For example, other company's may calculate non-IFRS financial measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-IFRS financial measures as tools for comparison. A reconciliation between IFRS and non-IFRS financial measures is available on our earnings release and in our updated Investor Data Sheet on the Investor Relations section of Atlassian's website.

Further information of 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 company's form F-1, previously filed with the SEC in connection to our IPO and form 6-K report that we filed with the SEC.

I will now turn the call over to Scott.

Scott Farquhar

Good afternoon. We're excited to be here today on our first earnings call as a public company. We met many of you on our IPO road show but for those that we didn't we'll begin with a brief introduction to Atlassian and what makes us unique. Atlassian's mission is to unleash the potential in every team. Our software helps teams organize, discuss and complete their work. All of our product categories are focused on teams and the work teams do together. We have five product categories, JIRA for the planning and project management, Confluence for content creation and sharing, HipChat for messaging and communications, BitBucket for code sharing and management, and finally JIRA's Service Desk to service and support applications. Our products do for team productivity what Microsoft Office did for personal productivity. Beyond our products, Atlassian stands apart from traditional enterprise software companies through our unique combination of product strategy, distribution model, and company culture. It's this combination that has propelled our innovation and growth over the past 13 years and we believe it is core to our future growth and success. Our product strategy is founded on the simple belief that the best products win. We believe software should be bought and not sold. We invest heavily in R&D, substantially more than our traditional enterprise software company peers, to build great products that companies can easily adopt and love to use. Our unique automated distribution model gives us the ability to pursue the largest possible market and we reach customers in every corner of the globe.

Now, unlike many enterprise software companies we sell products online rather than through costly human powered sales infrastructure and our model removes friction at every point for the customer and allows us to target not only the Fortune 500 but the Fortune 500,000. This high scale model has resulted in a base of over 54,000 active customers using our products. We added more than 5,600 net new customers so far in fiscal 2016 and these numbers are an order of magnitude higher than the custom accounts of many of our enterprise peers. As a reminder, our definition of a customer is an organization that has at least one active and paid license or subscription for which they pay us more than $10 a month. Finally, our strong culture of innovation serves as a long term advantage in running our business. Our five core values drive a companywide approach that is open, innovative, dedicated to our customers, team driven and long term focused. We continue to be recognized as a great place to work and I'm really proud of that.

The companies with less than 1,000 employees, we were recognized as the number two best place to work in all of the United States. And in Australia, across companies of all sizes, we were awarded the number one best place to work for two years in a row, the first for any company. Our unique business has led to our strong financial model and we have a track record of consistent revenue growth combined with over ten years of profitability and free cash flow. Murray will touch more on our financials momentarily.

And now I'll hand the call over to Mike who will cover our growth opportunities and the highlights from the second quarter.

Mike Cannon Brookes

Thanks, Scott. Let me echo how excited we are about being a public company. Once again, I would like to thank our employees, customers, and partners who have helped us grow to a company that is transforming how teams work around the world. Atlassian's early success was founded in serving software teams, helping developers collaborate with other non-developing teams. As more non-developer teams are exposed to our products, they adopt and extend them to new use cases within their organizations. Today our products serve teams in virtually every industry and business function, from software and technical teams to IT and service teams, from sales and marketing teams to HR, legal, and finance teams. For instance, leading job site, indeed uses Atlassian's products for HR, finance, legal, and customer support. And direct response market company, Guthy-Renker, uses our products across its entire organization including teams in engineering, product management, HR, legal, IT, and even marketing itself.

As Scott mentioned that we've already achieved great scale. We believe we're just getting started. When you consider the teams within every company and across every industry are seeking better ways to work together, we're truly just scratching the surface. There are two main growth drivers we focus on as a business.

The first driver is our ability to land within an organization through a variety of key entry points. Our large investments in R&D allow us to build great products that customers want to use. We make it easy for customers to find, try, and buy our products via our online distribution platform without the need to haggle over pricing or complex documentation with a salesperson. This enables us to target a large volume of customers and also a wide variety of entry points within any organization. The second driver is our ability to expand from each initial land opportunity, offering additional products to existing teams and reaching a variety of other teams within an organization. Building great products that work well builds loyal customers. These are customers who not only love our products and want to buy more but who also want to share them with other parts of our organization and this leads to viral adoption within an organization, across teams and across functions. With momentum across these growth drivers, the second quarter was another strong quarter for Atlassian.

We recorded revenue of $109.7 million, up 45% year-over-year and we achieved the non-IFRS operating margin of 18.5% and a free cash flow margin of 26.2%. We added more than 2,600 net new customers, bringing our customer count to more than 54,000 from over 160 countries. In terms of the breakdown of customers by deployment, over half our existing customers are cloud-based and approximately three quarters of the new customers in fiscal Q2 were from the cloud. Our new customers span everything from small start-ups like digital commerce agency, PulsarFour, to the Fortune 100 like Dow Corning. Our focus on the Fortune 500,000 gives us a customer volume not typically seen anywhere in enterprise software. In addition to new customer growth, we continue to see great cross-sale and expansion within existing customers. Historically, on average, a customer who spends $1 to make an initial purchase will spend another $7 with us over the next five years.

During the second quarter we enhanced a land and expand opportunity for our flagship product JIRA through the launch of three distinct JIRA offerings, JIRA software for software teams, JIRA Service Desk for IT and service teams, and JIRA call for business teams. In a 2014 survey of our customers over one-third of teams identified the use of JIRA beyond their software teams, validating the expansive opportunity for JIRA within and beyond our existing customer base.

We also saw strong momentum in our Atlassian Marketplace, which is one of the largest enterprise marketplaces behind Salesforce and Amazon. We continue to invest in this vibrant ecosystem with the launch of HipChat Connect, which enables third party developers to create apps directly within HipChat that integrate with their existing applications and systems. We have continued our investment in R&D across both our products and our online distribution platform. In fact we just announced the hiring of a Chief Technology Officer, Sri Viswanath, who joins us from Groupon. Sri's experience in developing large scale technology platforms will allows us to continue to scale our products as our customer volume scales. He will add even more strength to our world class engineering organization and ensure we take full advantage of trends such as the growth of our cloud business.

We've also expanded our Board during the second quarter, adding three new Board Members with experience well matched for our stage of growth. The new Board Members are Steve Sordello, the CFO at LinkedIn, Shona Brown, a former executive of the Google team, and Heather Fernandez, the CEO and Co-Founder of a start up in the digital health space and a former senior executive at Trulia. Together they bring an impressive background in reaching large customer audiences, scaling fast-moving businesses and building lasting cultures. To close where Scott began, our combination of unique product strategy, distribution model and culture has allowed us to deliver great products for customers and is a huge competitive advantage for the company. We will continue to leverage that model by focusing on R&D, innovation, and delivering great products that sell themselves. We'd again like to thank our customers, our employees, and partners for their commitment to fundamentally changing our teams work.

And with that, I'll turn the call over to Murray, our CFO.

Murray Demo

Thanks, Mike and good afternoon. I'll cover Atlassian's fiscal Q2 2016 financial performance and our financial targets for the third quarter and full year fiscal 2016. Total revenue for the fiscal second quarter was 109.7 million, up 45% year-over-year. As many of you are aware, our revenue over the past couple of years has benefited from some pricing optimizations to JIRA and Confluence that we initiated in calendar year of 2012. Approximately 12 of the 45 percentage points of revenue growth in the second quarter of fiscal 2016 were attributable to these pricing optimizations. By comparison, in the first quarter of fiscal 2016 and in the last two fiscal years, revenue growth, excluding the impact of these pricing optimizations, was in the mid-30s percentage range. Turning to revenue by line item, I will provide a brief overview of each. First, subscription revenue, primarily relates to fees earned from sales of our cloud products. A small portion of subscription revenue also relates to the sales of our data center subscription products. We recognize subscription revenue rate ably over the term of the contract. For the quarter, subscription revenue was 33.9 million, up 69% year-over-year. The growth in subscription revenue reflects the transition of more of our customers to cloud as well as strong growth and data center offerings during the quarter. Second, maintenance revenue represents fees earned from providing customer updates, upgrades and technical product support through our perpetual license products.

The first year of maintenance is purchased concurrently with the purchase of our perpetual licenses and subsequent renewals extend for an additional year in most cases. For example, an initial $1 purchase of a server product would represent $0.50 of license revenue and $0.50 of maintenance revenue with the $0.50 maintenance portion continuing beyond the first year if renewed. Maintenance revenue is recognized rate ably over the term of the support period, which is typically 12 months. For the quarter, maintenance revenue was 53.5 million, up 39% year-over-year. Maintenance revenue has been the primary beneficiary of the prior pricing optimizations to JIRA and Confluence.

Third, license revenue is related to fees earned from the sale of perpetual licenses for our server or behind the firewall products and is recognized at the time of sale. For the second quarter of fiscal 2016, license revenue was 15.6 million, up 9% year-over-year. While the majority of our revenue today is from sales and maintenance of server products, we are experiencing a transition to cloud as more customers choose that deployment option. Consequently, our license revenue growth rate this quarter is reflective of this transition. And finally, other revenue includes our portion of the fees received for sales of third party add-ons and extensions in the Atlassian marketplace and for training services. For the quarter, other revenue was 6.6 million, up 124% year-over-year. Strong performance of the Atlassian marketplace was a key contributor to the growth of other revenue in the second quarter. I'll next spend a few minutes reviewing our margins, operating expenses, and our results of operations. Unless otherwise noted, all references to our expenses and operating results are on a non-IFRS basis and are reconciled to our IFRS results within the tables posted in our earnings press release and on our Investor Relations website. All comparisons listed here are with the second quarter of fiscal 2015 unless otherwise noted.

Gross margin in the second quarter of fiscal 2016 was 86% compared to 86.7% last year. Second quarter operating expenses were 74.1 million, up 46.9% from 50.4 million last year. Now, looking at operating expenses in more detail, R&D expenses for the second quarter was 40.1 million or 36.5% of revenue compared to 25.4 million or 33.4% of revenue last year. Marketing and sales expense was 18.6 million or 17% of revenue compared to 15.2 million or 20% of revenue last year. And G&A expense was 15.4 million or 14% of revenue compared to 9.9 million or 13% last year. Total employee head count was 1,514 at the end of the second quarter. The increase was across all operating expense categories with the largest increase in R&D.

Second quarter operating income was 20.3 million or 18.5% of revenue compared with 15.3 million or 20.2% of revenue last year. Non-IFRS net income was 19.1 million or $0.11 per diluted share compared to 14.3 million or $0.09 per diluted share for the second quarter of fiscal 2015. Moving over to the balance sheet, Atlassian finished the quarter with $682 million in cash, cash equivalents and short term investments. This includes 431.4 million of net after expenses from our IPO in December. Free cash flow for the second quarter of fiscal 2016 was 28.8 million, comprised of cash flow from operations of 31.9 million, less capital expenditures of 3.1 million. Free cash flow margin, defined as free cash flow as a percentage of revenue, was 26.2% for the second quarter. With regard to capital expenditures, the timing of some investments in facilities and our data centers that we planned in Q2 is now anticipated to occur in the second half of fiscal 2016. This shift of capital expenditures from Q2 is included in the full-year free cash flow target that I will discuss shortly. Now I'll provide our financial targets for the fiscal third quarter and full year fiscal 2016. For the third quarter of fiscal 2016, our financial targets are as follows, for total revenue we expect a range of approximately 113 million to 115 million. For gross profit margin we expect approximately 82% on an IFRS basis and approximately 86% on a non-IFRS basis.

For operating income margin we expect approximately minus 9% to minus 8% on an IFRS basis and approximately 11% to 12% on a non-IFRS basis. For share count we expect the weighted average share account to be in the range of 231 million to 233 million shares on a fully diluted basis. For net income per diluted share we expect approximately minus $0.05 on an IFRS basis and $0.05 to $0.06 on a non-IFRS basis. For the full year fiscal 2016 our financial targets are as follows, for total revenue we expect a range of approximately 443 million to 447 million. For gross profit margin we expect approximately 83% on an IFRS basis and approximately 86% on a non-IFRS basis. For operating income margin we expect approximately minus 4% on an IFRS basis and approximately 15% on a non-IFRS basis. For share account we expect a weighted average share account to be in the range of 202 million to 204 million shares on a fully diluted basis. For net income per diluted share for fiscal 2016, we expect a range of minus $0.11 to minus $0.10 on an IFRS basis and $0.30 to $0.31 on a non-IFRS basis. We are also providing an annual target for free cash flow, for fiscal 2016 we expect free cash flow to be in the range of 80 million to 83 million.

And with that I will turn the call back to Scott before we move to Q&A.

Scott Farquhar

Thanks, Murray. As we discussed today, Atlassian is a unique company with a special mission to unleash the potential in every team. We do that through software products which help all teams across virtually all industries to organize, discuss and complete their work more effectively and efficiently. Our unique company is centered around three pillars, our focus on R&D and innovation, that centers on our belief that everything starts with building great products, a high velocity, highly automated distribution model, and a transparent, customer-focused company culture. Together this focus has enabled us to create a sustainable competitive advantage and build a financial model that has delivered consistent revenue growth and profitability.

With that, operator, we'll turn the call over to Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Heather Bellini from Goldman Sachs. Please go ahead.

Heather Bellini

Great. Thanks so much for taking the question and welcome to the public market. I wanted to ask you a little bit about the success that the company has been having expanding outside of the developer-customer base that I think people most typically think that you're going after, can you share with us maybe some examples of how you have been able to increase the penetration outside that core market to talk a little bit about how broad your products have become? Thank you.

Jay Simons

Yes, hi, Heather, this is Jay. So in part, as we mentioned, I think, previously, in a 2014 survey of JIRA customers, over a third had indicated they had usage of JIRA beyond software teams, and a lot of that kind of drove the direction of JIRA with the JIRA 7 launch where we packaged JIRA purpose-built for software teams, IT and JIRA Core. I think we're really happy with the response that we've seen in the launch and I think that's also reflected in the revenue growth that you saw in Q2 that we're really excited about and it reflects the lot of broad expansion within the base of 54,000 customers where more and more teams are seeking better ways to work with our products.

Heather Bellini

And then is there any way you could just follow up a little bit on the Service Desk opportunity? I know that's been one of the fastest ramping products that you have had to date. Can you share with us kind of where do you see those incremental, where those opportunities are coming from? And are these competitive deals or are these deals that just didn't have solutions in place before?

Mike Cannon-Brookes

Sure, Heather, it's Mike. Look, Service Desk is the fastest growing product we've had in company history so we're very excited about the progress that it's had, obviously, over the last two years that it's been in the market. It does land largely within IT and service teams within an organization again, we've got Twitter and Sotheby's and lots of other examples where it's gone to many, many teams around the organization. So I think it just shows our example of being able to do both. Some of those are certainly rip and replace-type deals. Some of those are displacing systems, processes that were done with spreadsheets or email or something else.

Heather Bellini

Okay. Great. Thank you so much, gentlemen.

Operator

And our next question comes from Sanjit Singh of Morgan Stanley. Please go ahead.

Sanjit Singh

Congrats from me, guys, as well on a very nice start as a public company. I wanted to ask about the JIRA Core, JIRA software and JIRA Service Desk, since you've rolled that out in the last couple of months. Any sorts of patterns that you're seek in terms of sales cycles, oval cycles, and, also, do you see your core to your software customers, how are they, sort of, looking at these various options and deciding which one's is the best use case for them?

Scott Farquhar

Great question. [Indiscernible], this is Scott Farquhar here, the point from Mike, the reason we did is that people were using our products in all sorts of manners well beyond software and so this change was really driven by customer demand. And what we've seen is that the response from our customers in terms of the feedback they have given us, top of the funnel, all those things have been really positive in the change. Service Desk previously was an add-on top of JIRA. We've now seen that as we've separated that out that people can just buy Service Desk and it's a much clearer evaluation path and so that's been really successful for us.

On the flip side, there is, with any change, there's some customers that take a little bit longer in their evaluation cycles as well. So we're seeing really positive numbers and I'm really excited about the opportunity we have across the entire business, particularly for the sort of general business user where our products maybe have been more tailored for software and technical teams, this process has enabled us to make a simpler version of JIRA and that's been really well received by sort of more general business users in HR and other areas.

Sanjit Singh

Great. I appreciate the answer. And Murray, we're seeing sustained revenue growth in the mid-30% range for a very long time and the margins continue to come through. I was wondering if you could just walk us through, in terms of, the areas of investment over the next couple of quarters or through the rest of fiscal year 2016. How should we think about investments, where you -- what areas, whether it's product road map that investors should be thinking about?

Murray Demo

Yes, so just in terms of the expenses, we're going to continue to invest in our business. Obviously we've got a great opportunity over the long-term here. And so we'll continue to invest in all of the areas, R&D, sales and marketing and G&A but the primary focus is going to be in R&D. That's the lifeblood of the company, is our products. And we've got customers in a growing market that we want to serve.

Sanjit Singh

And would that be to -- is that ahead of a new product road map or is it more investments back into your existing products?

Scott Farquhar

Scott here again, the way we think about it is our existing products have incredible market opportunity and so we continue to invest in improving those products, even as you saw from JIRA 7, but well beyond that, in all of our products to make them more attractive to potential customers. So that's the lion's share of our R&D and obviously, you know, new product introductions is not something that we talk about publicly.

Operator

And our next question comes from Richard Davis of Canaccord. Please go ahead.

Richard Davis

Maybe on that same theme, just, you know, I mean, spending a lot of money development is the best path, I think, to creating a mode. But when you think about it at scale, as you scale, you'll be putting a lot of bodies against a handful of products. Can you kind of talk about how you think about optimizing your DEV teams? Because, you know, you can't just throw thousands of people to write like one line of code as you're developing software. And then, how do you kind of break off teams to pursue new product and modules? Just more kind of strategy-wise on that would be awesome, thanks.

Scott Farquhar

Yes, Richard, great question. And the way we think about it is that we have huge opportunity in our products and so we don't anticipate aiming to slow down in our investment because of the size of the markets and the opportunity we have ahead of us. Now, obviously as you get larger, it's harder to scale R&D, even though it's key for us bringing in Sri who has run multi-thousand organization and engineering teams at Groupon directly before he came to Atlassian. And so I think he's going to be key to ensure we continue to be able to invest effectively in R&D like we have over the 13 years, you know, we have a track record of getting great returns on the R&D investments we have had.

Operator

And our next question comes from Brent Thill of UBS. Please go ahead.

Brent Thill

I didn't realize I changed my last name. But just as it relates to the distribution model, you have made a very conscience decision to be unconventional to many of the software companies that we've all grown up with. And one of the questions that I get a lot from your investors is when you launch a Service Desk or some of the other products, the awareness of the build processes of getting those key solutions out, how are you feeling about that push? And maybe just give us a sense of how you think that uptick is going with some of these new releases?

Jay Simons

Hey, Brent, this is Jay. You know, as we mentioned earlier, Service Desk is, you know, we're really excited about the growth, fastest-growing product in the company. And I think part of that is just the pent up demand that exists in the base of 54,000 customers that we have acquired and we continue to add a lot of volume to. And so wherever we're entering a new market or creating a new product, I think we're measuring the demand that already exists for that product. In this case Service Desk was an easy adjacent to JIRA, we had 40% of JIRA customers that had already configured it to support the Service Desk use case. So building kind of a purpose built product in the way we did, I think we already had kind of a market to grow into. What we did now with JIRA 7 is, I think we packaged it independently where we can start to build more reputation brand and awareness in the Service Desk market for new customers that we want to acquire. And we feel like that's going really well too.

Brent Thill

Okay. Great and for Murray, just in the quarter I think the customer add was just a little shy of what you added Q1. Can you talk about it, it wasn't far off but anything that you saw there that you thought was unusual? And maybe just talk a little bit about the price increase, it seems like that becomes less of an impact in the back half. Could you just walk through that dynamic?

Murray Demo

I'll ask Jay to comment on the number of customers, and I'll follow up on the price optimization.

Jay Simons

Yes, the short answer is we felt great about the 2,600 that we added in the quarter. It was in line with what we've expected. You see historically we've sort of added between 2,500 and 3,000. And again that 2,600 joins a base of 5,300 customers 5,200 customers that shows both the new market demand that we're capturing with the 2,600 but also just a significant sized expansion opportunity we continue to add to with the 50,000 plus. So nothing out of line. I think we're happy with the add.

Murray Demo

And, Brent just to follow up then, on the second part of your question was on the pricing benefit in the quarter?

Brent Thill

Yes, just if you could just walk through the dynamic for Q3 and then the back half of the year.

Murray Demo

Yes. So we grew 45% in the quarter, 12% approximately is related to this price benefit. And that's coming down from where we were in the first quarter where we had 15% price benefit, approximately related to these pricing optimizations on JIRA and Confluence, that we initiated in 2012. As we look at the remainder of the year we do see that there will be some ongoing benefit, additional benefit related to these pricing optimizations. The grandfathering that we spoke about earlier it all ended in Q2 so that's happened. But we are seeing some tail into of Q3 and into Q4, it's coming down like a steady slope, it's coming down relatively quickly but it is factored into our guidance for Q3 and the full year.

Brent Thill

Great. Thank you.

Operator

And our next question comes from Bhavan Suri of William Blair and Company. Please go ahead.

Bhavan Suri

Thanks. Hi, guys. Thanks for take my question. Can you hear me okay?

Jay Simons

Yes. Great.

Bhavan Suri

Just turning, first to the marketplace, obviously substantial growth there and that was great to see. Outside of that HipChat application you guys called out are there any other third party applications that are seeing significant sort of growth and usage there?

Scott Farquhar

Third party applications in terms of.

Bhavan Suri

Going marketplace.

Scott Farquhar

Mike, you want to talk to that?

Mike Cannon-Brookes

Sure, Bhavan, I mean we don't break that individual applications that is growing strongly in the marketplace but we have well over, I think it's 200 different vendors now they are all building businesses on top of our platform inside that marketplace. So we're pretty happy about how it's going, both the addition of new vendors and the growth of existing vendors. Again the main point of our marketplace for us is not necessarily about the revenue accretion as much as it is about customer value and stickiness. So we know that the more marketplace items a customer has the more happy they are with the value the products deliver as a collection. And then obviously the greater their stickiness is over time because of that value delivered. So that's really what we focused the marketplace team on doing.

Bhavan Suri

Sure. Sure. Do you ever consider using that as a test bed, so people are taking JIRA and customized JIRA to do Service Desk and then, obviously you guys saw the huge opportunity there and sort of brought that in, do you look at the marketplace at all as a place for idea generation for sort of new offerings?

Mike Cannon-Brookes

Sure. I mean, we certainly look at what's in there. I mean, one of the things the marketplace does really well is solve problems that we don't want to or don't have to. So we can sort of solve the core collaboration problem and it's really around the edges. We certainly innovate ourselves internally and have a big culture of doing that on a regular basis. But we have to look for ideas everywhere.

Bhavan Suri

Yes. And then a quick one, just you touched on the collaborative environment just the competitive environment in that space. Obviously some of the private guys, Slack, et cetera have been sort of putting up some interesting user growth numbers. Has that environment changed? Any new entrants, any change in win rates in that collaborative space?

Mike Cannon-Brookes

In the collaborative space or in the messaging space?

Bhavan Suri

Well, let's put them together because eventually collaborating and messaging I think sort of end up probably converging at some point. But say both, sure.

Mike Cannon-Brookes

Sure. I mean, look, we think we're at the early stages of a very big wave. We think we're putting up great numbers in the messaging space and we're really happy with the progress of HipChat there and especially how HipChat works with Confluence and works with JIRA to provide a really sort of comprehensive solution across the portfolio. And we continue to work really hard on that.

Bhavan Suri

Super. That's really helpful, guys. Thanks for taking my questions.

Jay Simons

Thanks, Bhavan.

Operator

And our next question comes from John DiFucci of Jefferies. Please go ahead.

Unidentified Analyst

Hey, guys, this is Zach [Indiscernible] for John. So just to touch on the pricing question again. You have been pretty clear about the impact there between the F1 and, again, on the call. With that winding down on the grandfathering, could you talk a little bit about what gives you confidence and implied accelerating growth for the year? I think normalized last year was about mid-'30s and this year mid-point the high '30s. Any color there?

Murray Demo

So in terms of this year, if you look at the first two quarters, we grew 50% in Q1, 15 points approximately related to this pricing benefit and if you look at Q2, 45% top line, 12% approximately price benefit. So, that's kind of in the mid-30s, if you look at the guidance for Q3, it's in the 34% to 37% range and we're expecting to see some continued pricing benefit in the third quarter and then diminishing again into the fourth quarter by a little there. So, I think if you look at that, we have been in the mid-30s and it's coming down when you adjust for things as you look in Q3 and Q4. And that's reflected in our full year targets, so that's how we're seeing it. In terms of how we're looking at setting our targets, we are targeting them where a great quarter is a 2% to 3% beat that is how we're thinking about it. We know that we had a strong Q2. We recognize that but now we're providing formal guidance and as we go forward we are looking at 2% to 3% is a great quarter for us in terms of a beat.

Unidentified Analyst

Cool. Thank you. And then if I could just follow up quick, you guys released the data center product line in 2014, I believe, larger deployments, term-based license. Could you talk about how those are doing, and maybe just general trends within larger enterprise adoption of Atlassian products?

Jay Simons

Yes, hi, Zach, this is Jay. The short answer, going really well. I think you saw that reflected in the growth of the subscription line even though we don't break it out. The data center product is a subscription-based licensing, term-based licensing and it's also a product that targets the largest of our customer base. So it's going to contribute to subscription. We're seeing nice growth in demand, not just of adoption of the data center products and two quarters ago we released the final data center product for the families. So now we have data center products for BitBucket, JIRA, Confluence and JIRA Service Desk and we see pretty even adoption of all those at the upper end of the market. In addition to data center we've also seen nice adoption of premier support, which is an enterprise grid support service for our largest customers and the technical account management program. So, overall really positive signals and positive endorsement of the investments that we have made in enterprise.

Unidentified Analyst

Great. Thanks again, guys. Excellent quarter.

Operator

[Operator Instructions] And our next question comes from Michael Turits of Raymond James. Please go ahead.

Michael Turits

Hey, guys. Michael Turits. Two questions, I guess, one for Murray, one for Jay. Murray, can you talk a little bit about the leverage that you seem to be getting, which looks particularly strong both on the income side as well as on the free cash flow side? And for Jay, can you drill down a little bit more, if you would, on both the premium support and tam adoption? Is it picking up? And how is that balance working between with those customers who want to pay extra with those who are happy with the essentially self-serve?

Murray Demo

Yes, we had strong up margins in the first two quarters and big part of that is coming from the pricing optimization benefits that we've got. Also we were a little under on OpEx in Q2 for a number of reasons including FX and some expenses shifted from our plan in Q2 have shifted to Q3. So, we did see very good profitability in first half of the year as we're targeting the 11% to 12% in Q3, its coming down with this pricing benefit phasing out. But we continue to see that, we've got a good model here that has the potential to grow margins over time to achieve our long-term model targets of 20% to 30% in five years for OP margin. In terms of free cash flow, yes, we had a terrific quarter in free cash flow at 28.8 million. That really was a contribution of some good strong top line, lower expenses, and quite low capital expenditures in the quarter. Some of that has now shifted to the second half. But we're targeting 80 million to 83 million for free cash flow for the year and we continue to focus on that, as a management team, as an important metric in terms of our overall performance.

Jay Simons

And, hi, Michael, this is Jay. Good question. One clarification is that there is really no self-serve support, even free and starter customers, even evaluators get full service support through Atlassian support channels. What premiere support is for our largest customers of scale where they have got thousands of active users and we have become incredibly mission critical as to how a very broad set of teams work. We offer premiere support, which gives them a different channel into enterprise grade support services and that's an additional for-fee service. And the TAM program is an embedded strategic technical advisor to help them understand, growth and scale and how they think about deploying our products more broadly. Adoption of those two things is going well. One of the measures that we look at is just the NPS, the net promoter score, which is an indication of satisfaction across the, not just the account but the end-users within those accounts where we ask their end-users, how are you feeling about the products that your company chosen to use for you? And we see that that's going up, which I think is a good reflection of the investments we've made, not just in premiere, support and tam, but also in data center.

Michael Turits

Okay. Thanks, guys.

Operator

And our next question comes from Patrick Walravens of JMP securities. Please go ahead.

Matt Carletti

Hi, this is actually Matt on for Pat. Thanks for taking my question and congrats on a great quarter out of the box. Could you guys, maybe, just remind us why a customer might elect to deploy the solution on premise versus leveraging your cloud-based infrastructure? And also pretty much what types of companies are you seeing go on premise these days? Thanks.

Scott Farquhar

Good question, Matt. The way we think about it and I think it's the unique advantage of the Atlassian model is that we allow our customers to choose the deployment type, whether that is cloud or server and the largest part of that is driven by their existing infrastructure that they use. Some companies have made significant investments in their own internal infrastructure and that's the way they prefer to deploy their products. And some companies are moving the other way and trying to move out of their own internal infrastructure. And so, again for Atlassian, we really are agnostic to that change. We get the same dollars from them we have the same customer satisfaction across both them. When we look at the way it's going, we do have smaller companies and, sort of, more of our newer customers are adopting clouds so I think that's the, as you'd imagine, the way the general industry works, but it's still a huge advantage of us to be able to deploy in both places.

Mike Cannon-Brookes

Matt, I guess the only other thing that I would add, it's Mike, is the cloud is also chosen, obviously, by people who want to collaborate with certainly people outside their organization. So that's often a driver for some of the cloud usage as well, right. If you want to work with a marketing agency or you have an HR consultant or something outside the business, that's the reason that you would go to cloud to get out of your data center and work with other companies, which is strengthen of our product line. Almost each of our products allows us to work with teams in other companies, not just the teams in your own organization.

Matt Carletti

Great, very helpful. Thanks, guys and congrats again.

Operator

This concludes our question and answer session. We would like to thank the management for their time but the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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