HubSpot, Inc. (HUBS) Q2 2018 Earnings Report, Transcript and Summary

Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the HubSpot Second Quarter Earnings Conference Call. [Operator Instructions] I will now turn the call over to Charles MacGlashing, Director of Investor Relations for HubSpot. You may begin your conference.

Thanks, operator. Good afternoon, and welcome to HubSpot's second quarter 2018 earnings conference call. Today, we'll be discussing the results announced in the press release that was issued after the market closed. With me on the call this afternoon is Brian Halligan, our Chief Executive Officer and Chairman; and Kate Bueker, our Chief Financial Officer. Before we start, I'd like to draw your attention to the Safe Harbor statement included in today's press release. During this call, we'll make statements related to our business that may be considered forward-looking, within the meaning of section 27A of the securities act of 1933 as amended and section 21Eof the securities exchange act of 1934 as amended. All statements other than the statements of historical fact are forward looking statements, including statements regarding management's expectations of future, financial and operational performance and operational expenditures, expected growth in business outlook, including our financial guidance for the third fiscal quarter and full year 2018. Forward looking statements reflect our views only as of today and except as required by law, we undertake no obligation to update or revise these forward looking statements. Please refer to the cautionary language in today's press release, and to our Form 10-Q, which was filed with the SEC on May 10, 2018, for a discussion of the risks and uncertainties that could cause actual results to differ materially from expectations. During the course of today's call, we'll refer to certain non-GAAP financial measures as defined by Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure used or discussed in a reconciliation of the differences between each non-GAAP financial measures and the comparable GAAP financial measures can be found within our second quarter 2018 earnings press release in the Investor Relations section of our website at hubspot.com. Now, it's my pleasure to turn over the call to HubSpot's CEO and Chairman, Brian Halligan.

Thanks Chuck, and good afternoon, folks. Thanks for joining us today as we review HubSpot's second quarter 2018 earnings results. Let’s get right to it. Q2 is another strong quarter with 38% revenue growth, 5% non-GAAP operating margins, and over 48,000 customers going 40% from the prior year. And I really love about these great results as we are trying to see the fruits of our increased investment in R&D. R&D is really cranking. This time last year we had a full marketing up starter, basic, pro enterprise editions, I mean we had toe in the water on sales up just to start addition. Since then, we've added a sales of professional relaunch marketing hub starter with email capabilities, and we launched a brand-new third hub with our Service Hub professional product. Also this time last year we had about 83 party integrations. Today we have more than 175 integrations either alive or in beta including some major ones like Facebook, Shopify, Slack and Stride. These R&D investments are enabling us to shift our value prop from helping companies generate leads online to helping companies craft a remarkable and complete buying experience to their customers online. Okay, let me say a couple of things about Service Hub, it’s a very important addition to our line. Our approach to product innovation has always been a bit different. Traditionally you go out to a prospective customer's, to marketers, sales managers, customer support teams and ask them what they want and need? At HubSpot we study human behavior, how our customers are changing away they shop and buy, and then we help the companies figure out how to change the way they market and sell to match that. That's what we did back in 2006. We noticed that people were getting much better at filtering out marketing, and that they were taking the research for buying products into their own hands. Inbound marketing created a whole new way for growing businesses to get found with useful content at the search box and in the social feet. The Internet had opened a giant wormhole of opportunity for companies to generate leads in a whole new way and HubSpot helped those companies go through it. Today we see another major shift happening in the way people make purchasing decisions that we believe creates enormous opportunities for small and medium-sized businesses. Today a vendor's customers are the most important source of information for their prospects. Think about it. When you're trying to figure out if a product or service is worth buying, what do you do first? You probably go online and read the customer reviews and what customers are saying has a huge impact on your buying decision. You ask your trusted colleagues, what they think and lean heavily on that advice. More and more, customers, not vendors, drive the demand. And in this world the old funnel model is making less and less sense. Today you've got to delight your existing customers, turn your best customers into word-of-mouth promoters and leverage them to pull new accounts in. The buying process these days works more like a flywheel than a funnel. And what ultimately spins that flywheel is a seamless delightful customer experience. The more customers you have, of course successful, the more delighted they are, the faster that flywheel turns. And it feeds on itself. Customers are one of the greatest growth opportunities for companies today, and HubSpot's product now enables that. This flywheel phenomenon is the inspiration behind extending our offering to include Service Hub. But our Service Hub product isn't designed to match the old way humans wanted to interact with companies. It's designed to match the new way, not long ago it was just fine to let your customers call, wait and hold for 10 minutes, describe their problem in great detail, not have their problem solved, get transferred, hold again for 10 minutes, describe their problem in great detail again, not have that problem solved et cetera, et cetera. That just doesn't fly in 2018. Customers want extreme convenience. They expect to be able to Google and find the answer. If not there, chat on your site with someone or something to get the answer. And if all that fails, then they expect to call a clue full human who has a context needed to answer their question on their first try. That's exactly how we designed it. It's got the knowledge based chat functionality, a ticketing system, a feedback system, all in one, it's built right into our CRM system, it's super slick. I was talking to one of our customers, Jennifer Lenihan, a V.P. of Midaxo, a fast growing M&A software and service company here in Boston. Who says, the relationship between customer delight and word-of-mouth referrals is central to their growth playbook. She goes on to say, a typical customer is type A. They want to move fast, they have no time for anything. And like anyone, they get impatient with repeating the same information twice. For example, take their goals. The customer shares them in great detail with our sales rep during the sales process, and doesn't want to have another conversation later with one of the customer success managers about those goals. With the HubSpot platform, our customer service managers are able to easily reference the goals and any other pertinent information that we set forth early in the conversation with customers, which is incredibly important for building trust. Jen goes on to say, right now, we're in a phase where we're seeing a lot of blue ocean opportunity, lots of new accounts. However, our plan is to grow seat numbers by 10x once we get a customer onboard, which occurs largely from internal word-of-mouth referrals. As such, we expect the revenue mix to shift over time for the majority of our growth is coming from existing accounts. What's more, the M&A business is fairly infectious with lots of people moving around within the industry, and people maintain relationships across companies. So, word-of-mouth is a critical factor in how we attract new businesses. I want to thank Jen, and the Midaxo team for being a HubSpot customer since 2015, and also for being one of the first customers to adopt Service Hub. You can see how the customer's success team is already making use of it to complete their flywheel. So the existing customers are fueling new sales within accounts and then new accounts as well. An excess growth is aligned with the modern way buyers learn and make buying decisions through word-of-mouth. We think this is an inflection point, just like Inbound was an inflection point. Back then, we were the only ones who had figured it out. People were using blogging tools, doing SEO, email automation. But we were the leader in bringing all of these tools together and then all-in-one marketing system for SMBs. We're also not the first ones to figure out that the customers of the true engine of growth for companies as we scale. People have been hobbling together desperate tools to improve customer service experiences for a while, but the HubSpot growth Suite is built specifically for SMBs and is seamlessly tied to your sales and marketing data to give all your customer facing reps unparalleled context, really, really great stuff. As I mentioned, I am incredibly proud of what the HubSpot team has built over the last year and there's a lot more to come. Speaking of more to come, I encourage all of you to join us at the first week of September for our 2018, INBOUND event, and Analyst Day, here in Boston, on September 5. We have some great presentations focused on our business, during the Analyst Day portion, we have some amazing speakers from great companies like LinkedIn, Facebook, Google, Microsoft, Amazon, and Stride. INBOUND 2018, is going to be our best year, yet. I hope to see you all there. Okay, with that, I want to end by welcoming Kate Bueker to the HubSpot team. As many of you know, Kate joined us in June as our new Chief Financial Officer, replacing John Kinzer. Kate brings almost 25 years of financial and operational experience to HubSpot. She's a rare financial leader with a proven track record of helping businesses scale and deliver results. And we're confident that her extensive experience will help us take HubSpot to the next level. Really excited to have Kate aboard, welcome Kate, now I'll turn it over to you to go through the financials in our guidance.

Thank you for the warm welcome, Brian. I'm thrilled to be a part of the HubSpot team. Before we get into the financials, I wanted to start by thanking all of the HubSpoters, especially those in the finance team, who have welcomed me and helped to make my transition as seamless as possible. Well it's only been 45 days, since joining. My early interactions with the team have given me a lot of confidence that our business is in excellent financial condition. And I'm excited about the great opportunity ahead for our customers, employees, and shareholders, as we work toward our mission to help millions of organizations grow better. Okay, let's turn to our second quarter financial results and our guidance for the third quarter. Overall, we're pleased with the strength of our second quarter results. As Brian, highlighted, we delivered strong revenue growth, over $5 million of free cash flow and $6.5 million of non-GAAP operating profit. Second quarter revenue grew 38%, driven by 38% subscription revenue growth, and 27% services growth. Foreign exchange continue to be a tailwind to revenue in Q2 and revenue growth in constant currency was 34%. HubSpot ended the quarter with 48,091 total customers, which was up 40% year-over-year, while average subscription revenue per customer came in at $10,004, which was down 2% year-over-year and flat to Q1 levels. International performance continued to be strong in Q2, with international revenue growth of 61% year-over-year or 51% in constant currency. International revenue represented 37% of total revenue in Q2, up 1 point from last quarter. Deferred revenue as of the end of June was $153.8 million, a 38% increase year-over-year. While calculated billings defined as revenue plus the change in deferred revenue was $125.6 million, up 32% from Q2 of last year. It's important to note that currency movements within the quarter resulted in a headwind to deferred revenue in calculated billings. Calculated billings grew 34% in constant currency, in line with Q2 constant currency revenue growth. As we have said in the past, billings growth can diverge from revenue growth in any quarter due to movement in foreign exchange rates as well as changes to billing terms, product mix, or the timing of revenue recognition versus billing. We continue to expect billings growth and revenue growth to generally track in line over the long term. The remainder of my comments will refer to non-GAAP measures. Second quarter gross margin was 81%, consistent with Q1, and up 1 point year-over-year. Subscription gross margin was 86%, also consistent with Q1 and up slightly year-over-year. While services gross margin was negative 17%, down two points year-over-year. Second quarter operating margin was 5.3%, an increase of 2.5 points year-over-year and flat to Q1 operating margin. As Brian mentioned, we continue to make significant R&D investments across our suite of products, and believe the investments we're making today will help to lay a strong foundation for future growth. At the end of the second quarter, we had 2441 employees, up 37% year-over-year. We had another strong quarter of hiring coupled with continued lower than expected attrition, which positions us well to execute on our growth plans. CapEx, including capitalized software was $8.3 million in the quarter. We still expect CapEx as a percentage of revenue to average about 7% for the year. Moving on to earnings, non-GAAP net income was $7.4 million or $0.18 of earnings per diluted share. With that, let's dive into guidance for the third quarter of 2018. Total revenue is expected to be in the range of $125.6 million to $126.6 million. Non-GAAP operating income is expected to be between $1 million to $2 million. Non-GAAP diluted net income per share is expected to be between $0.03 to $0.05. This assumes approximately 43.1 million fully diluted shares outstanding. And for the full year of 2018, total revenue is expected to be in the range of $496.8 million to $498.8 million, up from our previous guidance of $489 million to $492 million. Non-GAAP operating profit is expected to be between $24.3 million to $26.3 million, up from our previous guidance of $22 million to $25 million. Non-GAAP diluted net income per share is expected to be between $0.63 and $0.67. This assumes approximately 42.5 million fully diluted shares outstanding. With a strong performance in the second quarter free cash flow, we now expect full-year free cash flow to be between $34 million and $35 million. As you adjust your models for 2018, keep in mind the following. As Brian mentioned, we will be holding our 2018 INBOUND event during the third quarter this year and anticipate it will have three points of negative impact to the third quarter operating margins. In addition, we would expect free cash flow to be breakeven to slightly positive in the third quarter, given the timing of certain Inbound related payments. We expect the fourth quarter to be a strong quarter for free cash flow. Our current spot rates -- currency would be neutral to Q3 year-over-year revenue growth and a modest headwind to revenue growth in Q4. Given the increase in our stock price, the dilution from our convertible bond and the associated warrant, we're now forecasting a fully diluted share count of 42.5 million shares for the year. With that said, we still expect our stock-based compensation expense to be about $75 million for the full year. The convertible debt we issued in 2017, will continue to impact non-cash interest expense, which we expect to be about $5.1 million in Q3. The expense will increase slightly each quarter as long as the debt is outstanding, but given it is non-cash expense, it will be excluded from our non-GAAP results. To close, we delivered another strong quarter of operational and financial performance, which positions us well for the future. With that, I'll hand the call back over to Brian for his closing remarks. Brian?

Thanks, Kate. And again, welcome aboard. I think you're joining HubSpot at a great time. We've got a pretty good flywheel spinning rate now. Successful customers are making it easier than ever to attract even more customers. Energized employees are making easier than ever to attract even more quality employees, and a rock solid technology basis making it easier than ever to deliver new solutions. Sometimes people ask me if I yearn for those good old start up days. And I say, absolutely not. Kate, these are the good old days right now. With that in mind, I want to close by thanking our customers, our partners, our investors, and all the HubSpoters around the globe, for helping us with our mission to help millions of organizations grow better. Operator, can we please open the call for some questions.

[Operator Instructions] Your first question comes from Richard Davis from Cannacord.

Brian, last year I thought you made a good point at Inbound. And what you kind of explained that, saying no to a project is almost as important as saying yes. Kind of what are some of the things that you've kind of said no to or at least postponed? That'll be helpful, thanks.

Yes, we say no to lots of things all of the time. In fact, our mission I have an unlimited number of potential projects that you could possibly imagine the number of projects in our head that we’d love to do, but there's only a certain amount of resources going around. But lots and lots of ideas for example for new hubs, lots of lots of ideas for new opportunities for go-to-market motions, lots and lots of ideas for what we can do at the platform. We both feel like I’m sort of feeling the very early days of its development. And the stuff in our head is still very early in what we think we can do for our customers in the market. So there's a lot to no going on here at HubSpot, Richard.

Your next question comes from Bhavan Suri from William Blair.

Thanks and a good quarter there, just and apologize for background noise. But just a follow-up on Richard's question, a little bit more. You've chosen to make investments in growth and product growth in lots of area. So think about the sales motion, think about the customer hub motion, I guess I just have to understand with my first question is as you think about sales, marketing, Inbound customer support, all those lines are blurring and you have competitors out there. What are you seeing either today in competition or in competitive response to your approach to say hey, we should pull these things together which makes kind of sad, but you have large competitor small competitors I love to understand what you see in the competitor environment?

That’s an awesome question. If I kind of roll the clock back to why we started the company? We saw big opportunity to help companies change the way they market to match the way people shop first off. In the early, nearly the first eight years of HubSpot we’re around how do we help companies generate a lead no it was big arbitrage opportunity there and we did really well. We feel like the new arbitrage opportunity for companies these days is how do you create a delightful end-to-end experience for your customers, that is very smooth and that’s how you build a big company. And I think of myself like this morning I woke up on my Casper mattress and then I reached over and put my Warby Parker glasses on and then I grab my iPhone and I put on Spotify and listened to the music. And then I went in and shave with Dollar Shave Club Razor and then I put my trunk club clothes on. And then I took an Uber to the office all of those companies are winning and disrupting their industries with delightful end to end beautiful customer experience. And so HubSpot part of the reason our R&D investments have gone up and part of the reason I think we’re going to really have a long durable growth path here is we’re going to solve a problem that's a big, big opportunity for our customers to improve the way they go-to-market and their go-to-market motion. So that’s kind of what’s going on. In terms of competitors, the main competitors really gosh I got to glue all kinds of applications together. There is a company out there called Blissfully that tracks the number of applications companies use in your average midmarket company has 35 different apps that they glue together to try to create one of those experiences, it's exceptionally difficult to do. We create sort of the all-in-one experience and everything works together and the offering is pretty unique in the marketplace. And so that the competitive environment has been pretty good I feel like we’re winning lots of deals and lots of growth to come.

The funny thing is you see a bunch of your competitors comment on or bargain bunch of same guys. And you think about sort of like that world and the instinct question ultimately will be how many more are left, right. So I wake up in the morning and there is 99,000 of these companies and then in five years there is 5,000 companies. It will be interesting to see how that plays out. I guess my question - my second question my follow up is like about cross-sell. So obviously you guys have reasonably unique model even compared to competitors about how you leverage the partners, whether its agency, digital partners et cetera. I love to get some color on the cross sell especially with CRM it seems you doing quite well and the move up market. What you're seeing out there from your partners for the CRM product. And then couple with that sort of the move up market with CRM which may not be possible in the core marketing inbound offering but certainly its possible in the CRM marketing just some color there would be great? Thank you.

Sure I actually get back to your first point. I think the opportunity left a lot of these consumer industries have been transformed. The B2B world is still very much marketing and selling in the same way they did four or five years ago. So the opportunity we see the next big wave is how do we help mere mortal B2B companies with 50 or 100 employees transform their go-to-market and their customer experience to match the way people actually shop and buy today. So we feel like it's super early innings for B2B and that the lessons learned from B2C are very applicable. In terms of partners, we are doing great. We've got – I don’t think we’ve updated the number but at least 3,000 partners these days. Most of the partners started as marketing agencies recently starting to sign up more IT partner, CRM partners, sales partners. So feeling good about that channel going forward.

Your next question comes from Brad Sills from Bank of America.

I just wanted to ask another for Service Hub's out. You have had sales hub out for quite some time with CRM. Are you starting to see larger organizations within your target range of your 20 to 20,000 employee size company? Are you starting to see more activity from the higher end of that and kind of departmental sales now that you have a full end to end suite and other still work to be done in rounding it out, but with the components that you've added more recently?

I would say in the sales hub side we started out with a sales hub starter product. Mostly startups were bottling that and they were doing pretty well with it. Over time we enhanced it and last I think its November or October I can’t remember we came out with sales hub professional. And we started to move up to slightly larger company's there and departments of bigger companies and slightly larger seek commitments there. Service Hub still early, but I think it follow with similar trajectory that the Sales Hub followed. Our focus sort of is why - and one of the things I like about HubSpot is that Pro layer product that's sort of our bread-and-butter. It’s a great fit for a company between call it 10 employees and a couple of 100 employees but starter product is you know five to 25 and overlaps a little. The enterprise product maybe 100 to a 1,000 overlaps a little in there. And there has been a ton of optimization around the middle a little bit of optimization on the bottom lot more room to go and a lot of room to optimize on the top. So we feel like it’s still pretty early days particularly on the Sales Hub and the Service Hub.

And there's been some focus on GDPR a potential impact and I know heading into the quarter you guys were saying small impact expected. Just if you could talk a little bit about how you saw that play out during the quarter that be helpful please? Thank you so much.

We weren't sure exactly how it would play out to be very honest with you. And on the topline it really didn't have much impact and my theory on that is twofold. One, most of our customers really do inbound marketing right instead of buying a list and cold calling people are buying a list and spamming people which is the real no-no with GDPR, they pole leaves in, in a very inboundly way so Inbound and GDPR you know their friends. The second thing is GDP the way the GDPR language was set up is if you have a list of contacts that's less than two years old you're in good shape, it’s the older contacts that you’ve never touched and the vast majority of our European customers are less than two years old. So it was barely any noise on the topline in terms of GDPR. We actually saw a little bit noise more on the bottom line. You want to talk about that Kate.

Sure. We did see some modest COGs spend in the quarter as we came into compliance with GDPR you could see sort of modest compression in our product gross margin in Q2. A little bit of that will linger into Q3 and we think we’ll back on track by Q4.

Your next question comes from Mark Murphy from JPMorgan.

I’ll add my congrats and a warm welcome to Kate. So first off I wanted to start off just any commentary on Service Hub in terms of bookings or billings in Q2 or performance versus what you expected anything either qualitative or quantitative that would help us understand a little deeper level the trend line for service hub?

Doing well, you know came out and the reps were psyched about it and the customers were psyched about it. We sold more than we expected to right out of the gate it's going really, really well and the products early, but good that product is going to get a lot better. One of the things we've done in HubSpot one of the uses of proceeds on the R&D side is back last about a year ago or even earlier. On the underlying platform of HubSpot, we did a very careful job of creating a layer of services for email, a layer of services for social, for search, for web pages and what not. And so when we built this new hub - Service Hub we’re able to assemble those in a very clever way and move out relatively quickly. And so the product, what's nice about that is it rhymes so well with the sales hub and rhymes so well with the marketing hub. The user interface is the same, there's one view of the customer in there, and everyone's on the same page. So it's early, but it did pretty well right out of the gate, and that product is going to up, and I think it's going to be, I think it'll be similar to sales hub. It started out, SaaS so it started to flow and it build, takes a while, but I think that's going to be big business for us.

Just as a quick follow up, and coming back to Brad's question on the GDPR. Would you look back on it at this point and say that the GDPR risk factor or risk point is essentially behind us now? I mean in other words that, it came and went without much impacting you, you sort of understand it, its in the rearview mirror. Or would you say that, well it's sort of fading off as a risk, or is it somehow kind of still to be determined in your eyes, what will ultimately happen as a result of GDPR?

I think it's - the European side of it, there's a new legislation that's going to come onboard around privacy. But it's basically - it's basically in the rearview mirror in terms of risk in Europe. I think the nature of GDPR could find its way. Again, I kind of hope it finds its way into the United States. There is some legislation in California that is a little bit similar to GDPR and then if it passes, we're going to place in 2020. But I don't think we'll have a big impact from it if it happens. I would say it's largely in our rearview mirror. It was close to a nonevent for us. Cost is little more in COGS but almost a nonevent.

Your next question comes from Stan Zlotsky from Morgan Stanley.

Maybe just a follow-up on the question that we just got on the Service Hub, maybe in just a slightly different way of thinking about it. You had another quarter of talking to partners about Service Hub and the overall selling motion for the Service Hub. What kind of feedback are you getting from your partners? And inasmuch as you're already starting to see some early traction with the product, is that coming through partners or is that coming through more directly through your inside sales reps? And then I have a quick follow up.

That's a really good question. I think the course of it will rhyme with the way sales hub work. So, when sales hub came out of the gate, it was mostly - most of the revenue was coming from the direct sales force. It took the agency channel little bit longer to pick it up. Now they're starting to sell it pretty well. Same type of thing is happening with Service Hub. The direct side comes out of the gate a little bit more quickly, and then the agents side will pick it up. The agency business is interesting. Most of the agencies we have were started as marketing agency. And some of them are delighted to come into the sales business, the service business, and the end-to-end customer experience business, others just want to stick to their median marketing, and so starting out of the gate a little bit more towards direct. But I think it'll shift over time. The feedback I'm getting from customers in the reps is, they're liking it a lot. They like a couple of things. One, is instead of having to go out and buy a knowledge base and buy ticketing system, and buying an SEO tool, and buying Net Promoter Score surveys, and four or five different applications, they have to glue together, it all comes in one. The second thing they like, is it's completely - it's not integrated in, it's the same basic database, same view as the customer that you get whether you're in marketing or sales and service. So, a service person gets on the phone with somebody and, bang, they have all context, why did this person buy, what type of marketing campaigns have they gone. When the sales person gets on the phone, how many tickets do they have open, all that stuff, it's not syncing back, it's the same data. And that seems to be the magic. I think overall, the way the industry will go, is my prediction, is more and more companies will buy the whole thing together. Just like you don't use Gmail with Outlook calendar, you buy all of Outlook or you buy all of Google Services. I think more and more companies over the long haul will decide, all this stuff belongs together, just like the office productivity stuff, and they're going to buy it from one vendor. And the big value of it is having it all together.

And maybe just a quick housekeeping item. What was the revenue retention rate in the quarter versus the, the commentary that we heard in Q1, it being somewhere in the high 90s?

So, I think that you've heard the team say that we expect that revenue retention is going to bounce around from quarter-to-quarter, and that sort of not to focus so much on the number within a specific quarter. We did actually happily see revenue retention come back above 100% in Q2. That was driven both by increases in customer dollar retention, as well as an improvement in our up sell rate, specifically our cross sell rate. We're going to continue to see that bounce around from one quarter to the next. But we do believe that we can over the long term, keep revenue retention sort of at that 100% plus.

Your next question comes from Ross MacMillan from RBC Capital Markets.

First question is just for Brian. I was just curious, you've introduced the marketing hub starter, which is a difference skew relative to the marketing starter product. I wondered if you could just maybe talk about the differences? And then - and what the intent is with that product? Why did you introduce that marketing hub starter product? Thanks.

There's a bunch of little enhancements that happened too, but the whopper one is we added email marketing to the product. And we added a new email editor in the product. That is really slick and really easy to use. Marketing hub starter, like a lot of our products, we put them out there, and we're like a lot of software companies, like Google, and others, where it's early and then iterate and make it better overtime. This was a huge step function iteration in this product to make it much, much better. And it just came out a couple weeks ago, but we're selling a lot more of the marketing starter than we were before. And the price point is higher than the marketing starter before. The theory behind, why are we playing this game down to the starter level? The reason we want to do this is what we imagine is, let's say, Ross, you go out and start a company with one of your friends, and you're getting going and it's a, boy, I need a lightweight easy way to start doing email marketing and putting forms in site. We want you to start with HubSpot and start with starter and move to basic and pro and to enterprise. You want to kind of get it early and grow. It's a little bit like AWS, how they do their business. They start you very early, and they scale up with you. What we haven't traditionally had is that entry point. We haven't had that starter layer. Over the last year we've added that starter layer, and I think that's going to pay huge dividends for us.

And then just, not so much of GDPR question for Kate, but just maybe an international growth question. I think I have international growth at 67% in Q1, I think there was a benefit from FX, so it was maybe something like 63% or so constant currency. And then this quarter it's down to 51%. So, is that just a - I don't know, like a law of large numbers that that business is just decelerating to that degree now or were there any other through puts and takes on the international revenue growth?

Yes, so we did see a big FX headwind on international. But I think your numbers are a little bit offset. Let me just make sure that we correct them. Our as reported growth for our international business this quarter was 61%, and that is down from 67%. As our constant currency growth is 51%, but that's down from 54%. So, it's really a three point deceleration in international and roughly half of what you're seeing in an as reported basis is the impact of FX.

Your next question comes from Tom Roderick from Stifel.

It's actually Parker Lane in for Tom. As we look at your professional services line the last three quarters, it's sort of accelerated and a bit more of a contribution that has last couple of years. I'm wondering if that is related primarily to the fact that you're relying on the channel little bit less for your newer products or if there is any other puts and takes there we should be aware of?

There's not a lot of, I don't have a lot of commentary on that. It may be because we -- more of our sales professional customers are buying professional services, something like that.

Yes, one of the other things is that professional services gets a bump into the first quarter, just given the fourth quarter, since we have seasonally strongest quarter of the year. So, we'll see the services attached to marketing. But at the end of the day, it's sub 5% of overall revenue. And frankly speaking, it's a line item and a division that we use to support our subscription growth.

It's not something we're necessarily trying to grow a lot. One of the traps - when we first started HubSpot, we had a Board member, really good guy, who was very successful guy. But at one point in his career, he had started a marketing software company. And he gave us some great advice. He said the trap that all these startups and marketing fail on, is they end up turning into professional services companies, and they're outsourced. And he said, build your software company, make the software easy to use, teach people how to use it. Build the channel around it, and we've stuck to that and I think that's been a -- that was some very good advice we got in the early days of HubSpot.

And then as sales start to mature and customer hub comes front of the picture as well, are you seeing any improvement in the motion of selling into the marketing product? Selling the sales customers on the existing marketing suite, and then you wish it perform?

Yes, we're starting to get better at it. It's slowly but surely getting better. What we're really good at, better than I expected is, selling both upfront. And I think it's a little bit like I was talking about before. Easier kind of an Outlook per scenario, Gmail person. I think more and more companies are making that call, like, hey, HubSpot's are go-to-market partner, we're going to buy the whole suite. That's gone very, very well. And the percentage of our business is coming from the growth suite. It's really encouraging in these days.

Your next question comes from Alex Dukan from Piper Jaffray.

I guess if I step back for a second, if I look at customer growth, which is trending north of 40% here for quite some time. And ASP is down a few percentage points, but I guess I want to get sense for, are we kind of basing now at 10,000 from an average subscription perspective, or do you see that going lower? And then as you look at the second half of the year and maybe beyond, is that 40% plus number sustainable in your mind in a service hub traction and sales hub traction continue to ramp, do we go higher? Then I've got one small follow up.

Okay, that's a great question, Alex. I'll start and maybe Kate can add. Those two numbers are going to be hard to pin down for all of you analysts. And I'm not trying to be evasive, it's just there's kind of pushes and pulls on them. And it's going to be a little bit hard to predict what they do. For example, last quarter we came out with service hub. And its professional edition product that we charge $400 a month for, and so that has one action on both of those numbers, like, more of that which cross sell, let's say, and there's a little bit of ASRPC lift from that. This quarter, we've got a new $50 to $100 marketing hub starter product. The volumes on that are very big, but that's going to push down the ASRPC. And if I were you, I would assume were not done releasing these editions. There'll be more of these. And some are going to push and some are going to pull. And so when I look at the business personally, I look at those numbers, I try not to get too wrapped around the actual base. I'm looking at, is that revenue continue to grow at a high rate, can we keep that high rate of revenue growing, what can we do to do that, can we keep the earnings growing at a steady rate on the bottom line. I try not to get too wrapped up about those two numbers because they're going to be very hard to predict.

The only point I would add on top of that is that as we release products, the timeline for the impact on those two metrics is very different. So, the customer cannon is going to have a more immediate impact, the ASRPC will sort of take a while, just given SaaS business.

And then maybe just a quick follow up on the bottom line. If you think about some of the moves you guys have made and talked about being a more of a self service friction of sales motion. If I look at sales and marketing as a percentage of revenue, it seemed to increase sequentially. And I'm curious kind of what the progress has been on that initiative? How successful it's been and kind of how we should see sales marketing as a percentage of revenue trend, obviously beyond the third quarter where it has the impact from inbound?

Yes, I think that we have talked a lot about where we think the sales and marketing as a percentage of revenue will go over time. And we still think that's the place where we're going to get the leverage over time. We did see a step back a little bit in Q2 but we still think the long term trajectory that is the right one.

Yes I would pile on. We’re making a lot of R&D investments and we think they're going to pay off. We’re certainly see really good response to some of the product releases more stuff to come. And I think we can get nice leverage on the sales and marking line over time I agree with you on that.

And if I could sneak one in just on gross stack customer, is it possible to get a sense for your subscription dollar retention rate that you're seeing on the gross stack customers. Is it playing out that the up-sell or retention there's lot higher as they adopt multiple products? And then any high-level commentary on the growth rate of gross stack customers year-over-year?

Yes, I can start with the retention and then you can talk about the growth rates. We do continue - we don’t give a specific number on the retention for the gross stack customer. So we continue to see that retention sort of above single product customers.

Yes, not really I mean - yes its better it’s being going well both customers are stickier and happier and the word of mouth is better with them. And we’re really going to tell them upfront, I still think we have work to do on getting good at selling one product and then selling the other one in after and it’s an ongoing effort. We’ve got some stuff in place that we’re working on there, but I think that’s a future for HubSpot. How do you get him in early, how do you get him in a starter and then how you do sell him the whole suite and then how do you grow with them. I think I think the play is going to work.

Your next question comes from Terry Tillman from SunTrust.

This is [indiscernible] for Terry thanks for taking the question. I just had one on Service Hub correct me if I'm wrong, but Brian I believe you said in your prepared remarks that Service Hub was actually being sold to some net new customers if that is right. Is that an opportunity for you guys to actually lead on a new deal with Service Hub and if those are net new customers. Are they the same profile as your historical type customers?

Yes that’s a great question. Most of the ones that are buying Service Hub only are part of a very large pool of free CRM users of our already. And using the CRM and what they would do historically is they buy our sales product and kind of try to manage the customer relationships in there. But now we've got a natural fit for them we’re they going in and using their ticketing system and whatnot. I think much of the revenue in the short-term will be cross-sell on that, but over the long haul I hope it looks a lot like the sales business where there is as much of the business coming from the sales product that our net new dollars to our platform as a cross sold into our platform. We hope to make it such a good product that people stop there.

Your next question comes from Jesse Hulsing from Goldman Sachs.

I had a question about partners, I'm wondering Brian what the strategy is with these newer products and getting the partners - the channel involved and how that's going. Are you using the same partners to sell Service Hub as an example? Or are you going and recruiting new ones what's the approach there?

Yes, that’s great question. If I think about our agency partners we have today they split some of them just stick to their knitting a marketing and some move to sell the full customer experience suite. And they are both doing fine and we give them the choice of course we give them a little nudge that we hope they’ll come on the journey with us to sell the whole thing, but we don't make them do that. There's another initiative underway inside of HubSpot to sign up new types of partners not marketing agencies or web development agencies but IT companies that go do implementations of software CRM implemented sales coaches. There is a swap of new opportunity for us on the agency side and there is a project ongoing it start to go pretty well we’re trying to sign up different types of agencies the thing is good opportunity for us.

And a follow up on - I think Alex’s question around customer growth. If I look at net adds year-over-year they grew about 4% but my calculation versus five-ish I think last quarter. I guess maybe I would expect net adds growth to pick up a little bit with all these new products. Do you expect that to start to happen as you introduce more and more of these different types of packaging options and SKUs to market?

The marketing starter has gone really well this month so that might - you might see some of that. You’ve got - like I said you got puts and takes your marketing starter is going to be a tailwind to that number where there is going to be lots of lots of customers. But then we’re trying to really get good cross-selling the existing customers. So that's just the tough number to use as a proxy for how well we’re doing. There’ll be puts and takes over time, over time I expect that number of net new customers though over the long haul to grow.

Your next question comes from Jennifer Lowe from UBS.

I wanted to follow-up just on the net dollar retention rate and there was a comment that you know it continued to tick back above 100. And the piece that was doing really well there was up-sell in particular cross-sell and I think Brian you mentioned that it was a little bit better selling marketing into the sales customer base. Is that aid or were there other cross-sell opportunities that seems to have done a bit better this quarter. And is it potentially durable going forward that you just have those figured out a bit better now?

The other one we sold Service Hub into a fair amount of our marketing and sales customers that helped as well. I think I agree with Kate, I think that number bounces around. For example a good example of that is marketing hub starter, I expect that not going to be a north of 100% retention business in and of itself. Although there will be lots of cross-sell opportunity with that. But I would expect the customer dollar retention on that to be below for example the normal customers. And there's going to be puts and takes that push that above and below 100%. Again I think over the long, long haul the business runs it over 100% but I think it will bounce around a little bit as we announce these new products and some pull it up and some push it.

And maybe just one more quick one as you – Jesse touched on a little but I think earlier you talked about bringing in IT partners and other partners sort of outside the traditional agency base. Where is that initiative at this point and what are sort of the opportunities you think those partners can get you into that agency partners and your direct efforts couldn’t?

I would say it’s the bottom of the first inning there is a team of six or seven people working on it. And there's a lot of them for example sales coaches there's 20,000 different companies in the United States most of them are bespoke little companies that do sales coaching. There's many, many CRM implementers in the United States. There are tens of thousands of companies that implement Microsoft products or implement G suite inside of company. So it’s sort of we’re pivoting our approach to try to attract some of those folks and early results were pretty good on it. We expanded that team a bunch at the beginning of this year and its going to get more resources.

Your next question comes from Brian Peterson from Raymond James.

Hi guys, Kevin here on for Brian thanks for taking my call. It looks like there is a little bit of incremental expense in the third quarter that's pressuring the amount of leverage I would have expected. Can you talk about what's going on there?

Sure why don’t I take that one. Kevin you heard both Brian and I talk about the fact that we’ve had really strong hiring in the first couple of quarters particularly on the R&D side coupled with really very low attrition across the company. We think it sets us up really well for the second half of the year and moving into 2019. But it obviously puts a little bit of pressure on Q3 expenses. And then there are couple of other items in Q3 that are - put a little bit of pressure on expenses, Inbound is obviously a Q3 item. And there are three points of pressure on margin due to Inbound and then we talked briefly about the lingering impact on the product COGs associated with GDPR. We think Q4 looks good, looks really strong from a profitability perspective and so that give us the confidence to bring up the full year number.

Your next question comes from Kirk Materne from Evercore ISI.

This is actually [Peter Rubin] in for Kirk, sorry if I missed it but can you tell me where the U.S. and North America growth was in the quarter. And as you looked at your international opportunity, what do you think the level of maturity is for marketing automation is today versus with the U.S.?

Yes, I’ll take the first part. U.S. growth was flat at 27 flat to prior quarter at 27%.

I think it's probably less penetrated internationally then it is in the United States, but I think it's early on both there is lots and lots of opportunity out there for both, but it's probably a little earlier in the cycle on international.

Your next question comes from Brent Bracelin from KeyBanc.

Thanks for taking the question here. One quick one for Brian on sales hub and a follow-up for Kate. On sales hub Brian obviously early days you think longer-term you’re going to bundle, but could you give us a sense on what's driving the sales hub growth this quarter kind of the mix between net new lands versus cross-selling has there been any sort of shift this quarter on that mix?

I think the big shift that’s happened over the course of the last year is sales hub professional products. So the sales hub started with a good product it was relatively simple. Delta professional is much richer it’s got automation in there and so slightly bigger companies are buying it with more seats are buying with couple seats and then buying more. And so the ASP is definitely way-way up year-over-year on that sales up product. The nice thing about the ASP going up is the sales reps are excited about it inside of HubSpot and they are out there pushing it and selling it. They are starting to use that product and really understand it. And so that product line is gone exceptionally well for us we’re really happy with it. We think it can be a ginormous business for us over time. And we’re hoping we can execute the same way in Service Hub.

Your next question comes from Derrick Wood from Cowen and Company.

I wanted touch back on retention and now that the original marketing starter product has been in the market and I think none of your metrics for over a year. I mean given this is targeted at the low end I presume the mix has been rising. How has that impacted your overall customer or dollar turn rates?

The marketing started product was okay and it wasn't a huge chunk of revenue or a huge number of customers. There is a material uplift in both the revenue and the customers from that product since we announced it a couple of weeks ago. A material uplift and so that's why I keep talking about it. I do think what's interesting about it is there's a lot more of these marketing starter customers coming in and they’re spending more per customer coming in. And so I think it's going to impact some of the ASRPC numbers in some of the total customer count numbers in interesting ways or a little bit hard to predict right now, but overall I think it’s going to be a very healthy business. The retention rates for the customers historically who brought marketing up starter were great quite honestly. I think the retention rates on the new cohorts of the new much more powerful marketing hub starter are going to be much better. It's not something a lot of people are talking about, but I think it’s going to have a nice impact strategically for us over a long, long period of time.

There are no further questions at this time. I will turn the call back over to the presenters.

I hope everyone comes to INBOUND. We look forward to seeing you there. It’s going to be a great event and thanks for joining us today.

This concludes today's conference call. You may now disconnect.