HubSpot Inc (HUBS) 2016 Q2 法說會逐字稿

Good afternoon, my name is Shantell and I will be your conference operator today. At this time I would like to welcome everyone to the HubSpot Q2 earnings call.

(Operator Instructions)

Charles MacGlashing, Director of Investor Relations, you may begin your conference.

Thanks, operator. Good afternoon and welcome to HubSpot's second-quarter 2016 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 John Kinzer, 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, including statements concerning our financial guidance for the third fiscal quarter of 2016 and the full-year 2016. Our position executing on our growth strategy, including development and adoption of our sales platform and our ability to maintain existing and acquire new customers and partners.

These statements reflect our views only as of today and should not be considered our views as of any later date. Please refer to the cautionary language in today's press release and our form 10-Q which was filed with the SEC on May 4, 2016, for a discussion of 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. There's a reconciliation schedule showing GAAP versus non-GAAP results currently available in our press release announcing the financial results for the second quarter ended June 30, 2016 which is located on the investor relations website at HubSpot.com.

Now it's my pleasure to turn over the call to HubSpot's CEO and Chairman, Brian Halligan.

Thanks, Chuck. Hi, everyone, and welcome to our second-quarter 2016 earnings call. Let's jump in and get straight to our results.

HubSpot finished up the first half of 2016 on a positive note. Second-quarter revenue increased 51% and non-GAAP operating income margin improved by 9 points year over year. We're continuing to see solid revenue growth along with significant margin improvement year over year.

HubSpot's marketing business is in the steep part of the S-curve which puts us in a strong position to be able to invest in future growth areas like HubSpot sales, while also still being able to show significant operational leverage. It's this operating leverage that allowed us to generate both positive operating cash flow and positive free cash flow, nearly a year ahead of our expectations. John will discuss cash flow and profitability in more detail later on the call.

I couldn't be more proud of the team for delivering these impressive cash flow results, along with continuing our rapid growth. The HubSpot marketing platform is growing strong and I think we're in the very early innings. This quarter we added 1,122 customers which brings us up to 20,444 total marketing customers. Our average subscription revenue per customer grew 18% year over year.

Our customers are spending more with us up front and growing their database which allows us to grow right alongside them. They are buying additional subscriptions and they are buying our add-on products. Our revenue retention, which began in the high 90%s in the second quarter, as up-sells and cross-sells nearly completely offset our customer revenue churn.

Those are all great financial results, but what's even more rewarding is how the story keeps on coming back to us from our customers and partners that the combination of HubSpot's software, our service, and our inbound methodology just works. You know, we talk a lot about the global inbound community and HubSpot has already grown way, way beyond the borders of the United States. You can see it in the numbers our international revenue grew 75% year over year in the second quarter of 2016, and now it represents 27% of HubSpot's total revenue overall.

Our EMEA headquarters in Dublin has just undergone a pretty hefty expansion. Our Sydney and Singapore offices are cranking along and in June we announced our new general manager for Japan, Yuri Akahira, who is leading the first class of HubSpotters in our recently-opened Tokyo offices. Welcome to HubSpot, Yuri and team.

Many of you have heard me describe the three Is of our go-to-market strategy that give us such a huge, huge advantage in the mid-market and gives us a lot of confidence that our model will scale globally over the long, long haul. We use inbound versus outdated outbound tactics. We use inside sales versus hiring expensive outside sales reps. We have a thriving indirect channel with more than 3,300 partners, giving HubSpot a reach and scale with our customers that will be pretty darn tough to replicate.

But there's even more in our toolkit that puts us at great advantage, like our ability to provide insight to our customers and drive innovation in our industry. When we started HubSpot we studied the modern buyer and realized that the way they lived, the way they worked, the way they shopped, the way they bought had fundamentally changed. And we built that insight into HubSpot to help our customers match their sales and marketing to the way people actually shopped and bought.

But change is obviously not a static thing and our customers look to HubSpot to continue to help them reach the modern buyer. We keep learning and innovating so that our platform continues to address how the modern human shops and buys.

One example of this is how consumers interact with technology. Looking back, when we first started our careers in the early 1990s, the browser was invented. Lo and behold, websites proliferated like crazy. In the 2000s Apple invents the App Store and billions of mobile apps emerge. We have such power at our fingertips.

I think today we're at the very beginning of the next huge wave that's going to be as big, if not bigger, than what we have seen to date. We're going to access information through messaging apps where powerful bots sit on the other side waiting to help, and frankly, it's already happening.

You can now build a bot on widely used platforms like Facebook Messenger slap. This led my co-founder, Darmesh, to work through weekends and evenings over the past several months to develop HubSpot's new bot.

Yes, as of just a few weeks ago HubSpot has a chatbot. We're calling it GrowthBot. You can access it on Facebook Messenger, SMS, and on HubSpot itself. It's for marketers and salespeople who need fast accurate answers to the most pressing business questions. How's your site traffic looking? What's your biggest competitor up to? Just ask GrowthBot. GrowthBot knows. And GrowthBot is ready to help marketers and salespeople get the insight they need to make better decisions. We'll be talking a lot more about our insights and innovations at the INBOUND event, so we hope you'll be joining us in Boston in November.

Okay. Let's talk about HubSpot sales, where things are going great. Our free CRM product continues to fuel and feed our paid Sales Pro product. I'm happy to say we've already exceeded our goal of $10 million in run rate for the sales business exiting 2016.

There are a few things that get me really excited about the HubSpot sales business. First, we are continuing to see strong levels of penetration for the sales product among our 20,000-plus marketing customer base. And second, we are seeing some terrific early traction with customers discovering HubSpot through our free CRM offering, buying HubSpot Sales Pro and then ultimately moving over into our core paid marketing product.

Again, its early innings but roughly 20% of our new marketing customers in 2016 started using HubSpot CRM before purchasing a HubSpot marketing subscription. And roughly a third of our total new marketing customers in 2016 are using our CRM product.

These trends are super important for metrics like our marketing product customer retention, where we're seeing a nice uplift in the revenue retention of our marketing customer that has purchased our sales product versus a standalone marketing customer. But, and this is just as exciting, it clearly indicates a huge opportunity to cross-sell the thousands of great fit sales customers coming into HubSpot through our marketing product over time. I personally believe that this is one of the more interesting dynamics playing out at HubSpot right now.

It reminds me a whole lot of a conversation I had a while back with Katie Cooper and Brett Cornwright from Mobile Reach. Mobile Reach specializes in developing and extending back-end enterprise apps and data to mobile devices to improve mobile business processes and mobile workflows. You have an enterprise app that needs to be optimized on a mobile device, they are the ones you call.

In 2015 Katie and team at Mobile Reach had a tough decision to make with their CRM system. It's just too complicated, it's too full of bugs. As Katie put it, the product was simply unfixable. It was time for us to move on.

Lucky for us, we had a HubSpot champion at Mobile Reach in Katie. Up until this point she'd been quietly subscribing to our marketing and sales blogs, using our free educational resources to help her refine her personal sales process, and sharing our content with her colleagues as they struggled to solve bigger-picture issues, like how to break down the barriers between sales and marketing teams and how to grow their business. She said, HubSpot stood out like a shining star in this regard and had my complete trust, long before I purchased anything, which gave me a huge head start on introducing HubSpot formally to my company when the time was right.

Their first step was replacing their legacy CRM system with HubSpot's. You fast-forward them to today and Mobile Reach now has their entire sales and marketing stack on HubSpot. Their marketing department is using HubSpot for marketing their content creation and lead generation. Their sales team is using 10 seats of our Sales Pro edition tool to nurture leads and close deals. And they're using the HubSpot reporting add-on to create custom dashboards and centralized reporting.

Best of all, they use HubSpot software and methodology to establish a whole new way of doing integrated inbound marketing and sales at Mobile Reach. And I'm so proud of that. I love that HubSpot was the trusted source of information for Katie long before her team got on board with HubSpot. And love that she found HubSpot because of our CRM, the channel that didn't exist for HubSpot just two short years ago.

I personally believe that this blurring of the lines between marketing and sales divisions is only going to accelerate. And that's going to keep creating significant opportunities for HubSpot down the road. I want to thank the Mobile Reach team for their business and for sharing their great story.

To wrap things up here, we're only halfway into the year and I feel pretty darn good about our momentum. But there's still a lot of work to do. I am still really excited about the platform approach and the opportunities it's been opening up for us these days.

With that, I'll turn it over to John now to take us through the financials and our guidance.

Thanks, Brian. The second quarter of 2016 was a landmark for HubSpot from a cash flow standpoint. As Brian mentioned, the business delivered $8.6 million of operating cash flow and $2.9 million of free cash flow. It's great to see the Company deliver positive cash flow while continuing to grow rapidly. More on cash flow later in this discussion.

From a top-line standpoint second-quarter revenue grew 51%, driven by 55% subscription revenue growth while services revenue grew 11%. It's important to note, services growth was impacted by some large one-time services engagements in 2Q of last year.

HubSpot ended the quarter with 20,444 marketing customers, up 29% year over year. Average subscription revenue per customer continued to grow rapidly, increasing 18% to $11,978 from the second quarter last year. Subscription revenue per customer continues to benefit from customers adding contacts to their database, buying additional subscriptions for their multiple URLs, adopting our add-on products and from the improving mix within our installed base as our smaller customers tend to churn at a higher rate than those that stick with us.

Deferred revenue of $77.2 million grew 54% in the second quarter compared to the second quarter of 2015. While calculated billings, defined as revenue plus the change in deferred revenue, came in at $68.2 million, up 48% versus the second quarter of 2015. It is important to reiterate that billings growth will vary from revenue growth due to factors such as billing terms, product mix and the timing of revenue recognition versus billing.

Now let's take a look at our margins. Second-quarter non-GAAP gross margin came in at 78%, up 280 basis points year over year and up 50 basis points sequentially. Second-quarter non-GAAP subscription gross margin came in at 84%, up 260 basis points year over year and flat sequentially. This was not unexpected, given the significant one-time improvement in non-GAAP subscription gross margin we saw in the first quarter of 2016. Remember, we gained almost 3 points of gross margin improvement last quarter as we leveraged the new AWS agreement and fine-tuned our hosting infrastructure.

Second quarter non-GAAP services gross margins came in at negative 17%. We continue to see pressure on services margins as we ramp up headcount for our sales business, international expansion, and to deliver recurring services in our marketing business. As we grow into these costs, we expect to see incremental improvement in services margins and eventually run this business at a moderate loss to break even.

Second quarter non-GAAP operating margin improved 200 basis points sequentially to a negative 4% margin in the second quarter of 2016. The sequential improvement came primarily from leverage in G&A and sales and marketing.

International revenue performance continued to be strong in the quarter, growing 75% year over year. International now represents 27% of our total revenue and should continue its strong growth, given our global expansion.

At the end of the second quarter of 2016 we had 283 employees outside the US and a total of 1,431 employees at HubSpot, up 43% year over year. We continue to hire at an aggressive pace globally in the quarter to meet the significant long-term opportunity we see in front of us.

The improvement in operating loss, coupled with the timing of hosting and semi-annual bonus payments resulted in record operating and free cash flow. CapEx, including capitalized software, was $5.7 million in the quarter as we continued to build out our facilities in Cambridge, Dublin, and Singapore. CapEx spend should be lower in the second half of the year and will run about 8% of revenue for the full year. Given the aforementioned timing benefits, we continue to expect full-year 2016 operating cash flow as a percentage of revenue to come in at the high end of our 4% to 5% guidance.

With that, let's dive into guidance for the third quarter of 2016. Total revenue is expected to be in the range of $67.2 million to $68.2 million. Non-GAAP operating loss is expected to be in the range of a loss of $5.2 million to $4.2 million.

Non-GAAP net loss per share is expected to be in the range of $0.14 to $0.12. This assumes approximately 35.4 million basic shares outstanding. And for the full-year guidance of 2016, total revenue is expected to be in the range of $263 million to $265 million.

Non-GAAP operating loss is expected to be in the range of a loss of $20 million to $18 million. Non-GAAP net loss per share is expected to be in the range of $0.55 to $0.51. This assumes approximately 35.2 million basic shares outstanding.

A couple of items to keep in mind as you adjust your models. Our INBOUND event is in the fourth quarter this year instead of the third quarter, which will impact marketing expenses and cash flow timing relative to prior years. It will also impact third-quarter billings, as the third quarter will not have the same tailwind as the prior years from the INBOUND event. We expect third-quarter free cash flow to be slightly positive and fourth-quarter to be negative, given the inbound expenses.

With that, I'll hand the call back over to Brian for his closing remarks. Brian?

Thanks, John. This June we reached a big milestone, our 10-year anniversary. The number of lessons we've learned in the last 10 years could fill an encyclopedia. But if I had to point to one thing that stands out more than all the rest, it's this. If you want to be the great Company the one that literally transforms the way bid market businesses grow, you got to put the customer in front of everything.

Like my co-founder and friend, Dharmesh, says, people don't value marketing sales software they value marketing and sales success. I think he is spot on. I think if you want to deliver true, measurable success, the kind of success that is sustainable and at scale, you have to put your customers first.

There's another milestone this quarter that means as much to me if not more, reaching the 20,000 customer mark. Because you know without those customers we wouldn't be here talking to you. We're laser-focused on delivering more and more value to our customers by becoming the indispensable platform for their continuing growth. That means we have to keep solving for them each day by helping them with their marketing and sales success and delighting them all along the way.

So in closing today's call, I want to thank our 1,431 employees, our partners, our investors and you guessed it, our customers, for helping build the HubSpot we know and love to this day.

Operator, could we please open the call for some questions?

(Operator Instructions)

Brent Thill, UBS.

Thanks, Brian. On sales it sounds like you're having really good traction there. Can you expand on some of the milestones that you're encouraged by?

I know you're throwing up the caution flag for all the substitute side on the revenue side. How should we think about this over the long term? How you're finding the opportunity versus marketing?

Sure. Nice to hear from you, Brent. The sales business is very interesting.

This year we made it a -- I call it a startup inside of HubSpot. It's run standalone. What we wanted to do in that business was get the growth going and get the unit economics so that the customers are highly profitable for us.

And we've really exceeded expectations on that. We've really got that thing growing fast. We've got the premium model starting to work.

We're really happy with the way it's going. I think the exciting opportunity ahead of us on the sales side is we have a very small team working on that today. As we look forward, getting the full force of HubSpot behind those sales products, our relatively large inside sales team, our very large agency partner team, and getting them selling, not only our marketing products, but our sales products.

We're feeling very good about it. I like the potential revenue it can drive.

I like the fact that we're going to have customers that are full-stack customers that rely entirely on HubSpot to grow their business. I think we become much more strategic to them when that happens, so feeling great about it.

And real quick, for John. Not to nitpick, but the customer number growth fell below 30% for the first time. And while I realize the comps are big and you've had some seasonality Q1, Q2 in terms of net new customers adds.

Anything to read into that, seasonality? Or the number's, from what you're seeing, not really relevant?

Yes, Brent. A couple of things on that. First of all, if you remember throughout last year customer retention -- overall retention was improving and the underlying customer retention was improving. So that was really buoying those numbers.

Three or four quarters ago we got to the high 90%s, 100% range and we have been there since then. Obviously a good level to be at in SMB space. Underlying that, the customer retention inside of that was in the low 80%s. Once again good place to be in SMB. So we're no longer getting that additional benefit from a customer growth with that improvement in the underlying customer retention.

The other thing to remember is we purposely give out marketing customers, so that our average subscription revenue per customer can be tracked over time. You guys can see the progress we're making there. But the one thing by doing that is we don't talk about sales only customers.

Obviously Brian just talked about all the success we've had there. We have lots more relationships we're building that are future customers that we can sell additional sales products into. As we talked about on the call, we can sell marketing into as well.

A lot more customer relationships than just we're reporting on the marketing side. But we feel like we can continue to grow customers from here on out.

Stan Zlotsky, Morgan Stanley.

Hey, guys, good afternoon, and thank you so much for taking my questions. A high-level question on billings and a quick follow-up. I realize billings is a secondary metric for you guys but I'm sure we'll all be getting a question from investors tomorrow.

Since we saw 1% quarter-on-quarter growth, walk us through some of the puts and takes of billing dynamics that you saw in the quarter. And what happened quarter on quarter with that metric?

And then a quick follow-on. Some qualitative commentary on the different marketing add-ons and what kind of momentum you're seeing there. Thank you so much.

Yes, Dan, it's John. I'll start with the billings question.

First of all, if you think about it, the impact of FX, we had about a 1 point headwind from FX and that flip-flopped the first quarter. We actually had a 2 point tailwind. So if you look at those two numbers there's a little bit of normalization that has to go between those two quarters.

The second thing is we also obviously had really strong comps coming out of last year. We were growing in the high 50%s in the second quarter. I think that even accelerates to 60% in the third quarter of 2015.

So people should keep in mind as they think about the third quarter there. Another thing to keep in mind is as the sales business continues to really do well, it actually puts a little bit of headwind on the billing side. Because those customers are generally monthly billed customers.

And you might get a month or two up front from them versus the marketing customers where we've gotten six to seven months up front. All of those things contributed. Having said that, in a business of this scale still growing billings in the high 40%s, we feel really good about where we are.

Great. (Multiple speakers) Thank you.

How you doing, Stan? It's Brian. I would say that add-ons are doing well. I wouldn't say they were spectacular but solid. And I'd give you some color around three of them.

Reporting is going well, lots of our customers are buying it. Good news there is there's a lot more functionality to come on reporting. I think there'll be a lot of value creation for our customers over time there -- very new product, is pretty raw, with high potential.

AdWords product, good news on that is in the last week or the week before the Google product team certified our AdWords product and blessed it. So now we can let the horses go on that product. There should be some good momentum there going forward now we have LinkedIn ads and Google ads that are all set up.

In the third, on the CMS, that's been solid growth. Last week -- just last week -- there's a company called G2 Crowd which when I think of the like the internet, Yahoo is to restaurants as the G2 Crowd is to software.

G2 Crowd came out and said that our content management system was the best one on the market. They rated as number one over every other content management system on the market. Incredibly valuable when you buy our website management system with the marketing product.

I think it's going well. I think we need to continue to execute and hit the gas on those products, continue to innovate and sell them. And I think it will be a good story.

That's great. Thank you very much.

Mark Murphy, JPMorgan.

Thank you very much and congratulations on the solid ongoing results, including the positive cash flow. So Brian, I wanted to ask you, regarding your Bot which you mentioned in your script. Do you have any thoughts on the pricing and the potential for widespread adoption there?

I'm just wondering also, would that remain internal-facing for marketing professionals? Or is that is something that you think could address customer questions on a website over time?

That's a really good question, there. Here is generally how I think about bots. It's sort of like when the 1990s websites came out and people started accessing information via websites. In the early -- I forget what you call zero to 2000, zeros, what you call that, John?

Aughts.

Aughts? Is that what you call it?

You had the proliferation of mobile apps and you access information through those. I think over the next 10 years these Bots are going to be a third way to access information. And it will be a really good way.

It's early innings today and it doesn't seem like it's going to come to fruition. But in the background there's all kinds of new technology happening that I think this will be a big deal. The way I think of the Bot today is it's a third way to access your information in HubSpot.

And by the way, you can also access information on other systems, like Google AdWords and Google analytics and different websites. So it's an overall GrowthBot where you can access information inside of HubSpot and inside of other marketing apps. In terms of where it goes in its adoption, you bring up an idea that we've tossed around too that -- hey, you can navigate your website today via a traditional menu structure, and that's how you can navigate.

There could be a whole new way to navigate a website and that's via a Bot. And so that something we're keeping an eye on and I think it's an interesting opportunity.

In terms of pricing, for now we're giving it away. It just doesn't feel like something we should charge for. We're seeing how it goes very early in its life cycle.

And we're going to keep an eye on how the industry develops, how our Bot does. It may just be another way to get at your HubSpot information and information on the internet or it may be something we can monetize. We're going to have to come back to that question later because it's a little too early to answer it.

Okay, great. I actually had a quick follow-up. John, I was just wondering if you might have any incremental thoughts on how to model billings growth in Q3, even qualitatively, because we are mindful it's an unusually tough comp and temporarily. And so you mentioned the timing of Inbound falls differently than this year.

The billings growth sequentially was about 14% last year. Is there any way -- presumably we would trend it below that level for this particular Q3 -- but is there any other guidance you might give us on that?

Yes, Mark, obviously we don't guide to billings but let me give you some things to think about. Like you said, Inbound was in the third quarter last year. It was in the first week of September, so had a lot of time throughout the month to actually get the benefit of that.

Obviously this year it's in the fourth quarter, so that definitely takes away some opportunities for our salespeople to interact with customers and things like that. We grew billings in mid to high 40%s this quarter. I would definitely be careful on that, given the tough comp.

If anything, billings were accelerating from the second to third quarter. 60%, like you said, was a really big number. So definitely I'd be cautious on that front as you all think about third quarter.

But as we go to fourth quarter, maybe longer-term, we think that 40%s is a good place to be.

Ross MacMillan, RBC Capital Markets.

Yes, thanks. I had a question for Brian. Given the early success you're seeing with sales and given that a lot of the sales deals seem to be conversions from the free CRM product, how are you thinking about when you actually open up the sales products to all your channel partners? When does this product really become what I think of as sort of fully GA where every partner in theory could be selling this and you unleash it on the market in totality?

Very good question, Ross. I suspect next year would be good timing for that. We need to get ready for it and get our systems ready for it.

But I think next year we could see it being pushed through all the channels of HubSpot. The other thing I think will be interesting that is in front of us is they use the free CRM as the tool today to generate customers for our sales products. We can also use the free CRM to generate customers of our marketing product.

We haven't done much with that so there's some nice opportunity with that.

Thanks a lot.

Brad Sills, BofA Merrill Lynch.

Hi, guys, thanks for taking my question. Just another question on sales. What history have you seen there where new customers are coming in?

What are they typically coming from? Are these what you would describe as additive or replacement? And if replacement, where are they coming from?

And if greenfield, where are they coming from as well? How are they managing sales without packaged software?

Great question. It's a variety. Like the call we had -- the call I mentioned on the prepared remarks, that was someone coming actually from SugarCRM over. And we've got people coming from all different CRMs.

There's a lot of low-end CRMs that people have used and didn't love that were really built for tracking sales not for helping people make sales. And they start trying our CRM, really like it, see how it accelerates the sales reps activities and behaviors in ways they hadn't seen before. And so there's a fair amount of swapping out of other systems.

There's a fair amount of it's their first CRM they've ever purchased. there's a lot about that's going on, that hey, we started the company two years ago and we've got three sales reps and we've been using spreadsheets or Google Docs or something to track. We need our first CRM.

They try ours, it's really easy to try it on the web, the experience is nice and then they up-sell to HubSpot. We're not trying to go in to the enterprise and rip and replace existing well-implemented CRMs.

It's more coming from below. It's more of a ground swell play from the bottom.

Great. Thanks, Brian. Then one more if I may.

On ASP, obviously you're seeing real traction there with sales and some of the add-on products. What about the tiered volume adds? I know it's been over a couple of years now since you made that pricing change.

Could you describe how that business has been going as well? Thank you.

So it's John. When we look at the up-sells, the contact tier upgrades are still the biggest driver of our up-sell. So that is still going well.

Customers getting more successful with Inbound marketing, adding more contacts to their database. Then as we look down the up-sell, we still are getting customers buying second URLs. We are starting to get some of those add-ons that Brian talked about.

And then we are getting some people buying the sales product, though it hasn't been active. And this is definitely something that is still in front of us to really sell those sales products back into the marketing base.

Alex Zukin, Piper Jaffray.

Hey guys, thanks for taking my questions. First question around the partner channel. We've heard of some of the changes that you guys have made in the partner program that are designed to further improve your go-to-market.

Can you talk about those changes? What has changed and what is working better now than it was?

Sure, thanks a lot for the question. I think the first big change we made is we put a new leader in place, a guy named Dave McNeil, a gentlemen we hired from salesforce we really like. He is digging deep on it.

One of the things he did recently that I thought was awesome was he went to the West Coast, spent a bunch of time at Google with their partner folks at AutoDesk and with Intuit, really learning how to build a highly scalable partner system. We got a partner system today that's about $100 million business. And you think about, how do we create a partner model that's an order of magnitude bigger than the one we have today?

The thing that's working really well for us is our tiered partners, the diamond and platinum are doing awesome, selling really well. I think where we've got room to really improve is to think about which partners to bring on, how to bring them on, how to teach them and bring them up to speed and work with them. I think that needs some work and I think there's some real low-hanging fruit that he's going to be able to develop to get us some nice growth in that partner program.

Got it. Thanks, Brian. Then John, one for you.

Another acceleration in ARPU growth to 18.3%. What's the right way to think about the sustainability of ARPU growth this year? Is 18% the right number? Is there some reason it would fluctuate get below that meaningfully in the back half of the year?

Good question, Alex. As you think about our ARPU, remember, that's an average subscription revenue per customer. As you think about it, given it's a revenue-based metric, revenue's influenced by what's happened over the last four quarters based on the nature of revenue recognition. And so we've really been benefiting from the accelerating growth throughout last year.

As we look at that going forward, we would expect that to be in the mid teens, potentially coming down a little bit. But we think we can continue to grow revenue per customer in the future.

Got it. Thanks guys.

Bhavan Suri, William Blair.

Hey, guys. Thanks for taking my question and nice job there. Just a follow-up on the partner channel. When you look at the agency partners, have you guys thought of quantifying how much of their customer base has been penetrating, what that opportunity looks like? I'd like to understand how that captive opportunity could play out over the next three to five years.

It's something we are looking at. There's two opportunities there.

One is when a partner agency comes on and they've got a handful of customers. How do we work together to get them on the HubSpot platform? And that's one initiative we're working on and I think there's opportunity there.

The other initiative is how do we get them going and building a funnel of net new accounts. So both of those we think there's opportunity to improve there. I don't think it's one or the other.

The other thing that happens with the partner channel that they probably don't get enough credit for, is the partners also spend a fair amount of time calling on the existing customer base. And they go to a customer and say -- hey, you want to redo your website? We can help you with that.

Hey, you want to run a campaign? We can help you with that. So partners not only bring in new accounts but they go and grow our existing accounts.

So they are very, very valuable for us. I think we can grow along a number of dimensions there.

Yes, what I was getting to, even with their existing accounts, as you think about then going to them and saying -- hey, we can do XYZ for you and put you on the HubSpot stack. How far do you guys -- or have you thought through how far that option is penetrated?

And the quick follow-up. Is there anything you need to do to partners? Someone brought up the question about enablement but is there any sort of training, education, increasing go-to-market to get them get behind the CRM offering? Thanks.

Yes. It's early. I think there's definitely an opportunity, as you point out, to go sell to more of our agency partners' customers. The platinum and diamond ones, boy, they've done a great job of selling, not only to their customers, but going out, partnering with us to gather lots and lots of new customers. I think we need to improve and there's a nice opportunity to do that with the newer partners.

In terms of the CRM, the sales, it's sort of the same story. The bigger agency has been around for a while with that have a bit of a sales [bench], are starting to offer the CRM and sales offerings. But we don't have a formal program yet.

I think there's a nice opportunity. Today we have 3,300 marketing agency partners. We still need to build a whole agency program that brings on sales partners.

And I think of sales partners, I think of the tens of thousands of sales training companies out there. How do we leverage into that channel the way we leverage into the marketing channel? So that's a nice opportunity.

You'll see action on that in the next couple of quarters, I suspect.

That's really helpful. Thank you, guys. Appreciate it.

Richard Davis, Canaccord.

Thank you. Two questions. One, to what degree do you aspire to move up-market into higher price points, especially in a world where you're going to see, more than likely, some turbulence against firms ostensibly are adjacent to guys, whether it's Marketo or Bronto, whomever and stuff like that.

And then the second one is, I've seen a bunch of these, I guess you would loosely call, the sales enablement apps companies out there that are really more features than businesses. How do you think about buy versus build and sales enablement? Thanks.

How are you doing, Richard? We don't actually want to go up-market. Here's my rationale for it, if I look at the software industry, it's breaking out into there's enterprise software companies and there's these big platform companies.

IBM's a platform company, Oracle, certainly salesforce, Microsoft, Adobe. There's a bunch of them out there and they sell lots of applications and help businesses run their operations and grow. There's lots of companies that sell to little companies, everything from GoDaddy that went out today, to Constant Contact.

And there's lots in the sell to you on a one- or two- or three-person company. [Intuit's] a fair amount of that. We think there's a big, big, big white space in between these mid-market growth companies that we can build our own platform company.

We can build a company sort of like Oracle or sort of like IBM or Microsoft where we started in marketing. We started really at the top of the funnel in marketing and moved down to the middle of the funnel into marketing automation. Now we moved into the bottom of the funnel, into CRM and sales.

So we think there's a big, big opportunity to build a platform company, a la the way the Oracles and the salesforces and the IBMs and Microsofts have done. So we're not anxious to move up and tangle with those guys. We like where we are, we think we can build something good.

Second question you asked is actually a really good one around sales enablement. There are indeed lots of these app companies popping up and we're watching them carefully. And a couple comments on that.

One, as if they're building something that is unique, has some special access to data or maybe is using artificial intelligence in a smart way or has something that's hard for us to build, we may pick it up. But for the most part we're pretty good at building software at HubSpot.

We got a great R&D team, we have great access to talent here in Cambridge. We're having a good time recruiting here in Cambridge and we have a terrific team. So we're not rushing to go and cobble together a bunch of other sales-enablement systems.

The other reason we don't rush to do it is one of the reasons that HubSpot is so powerful is it's very much all in one. We built it from the ground up with a really nice user interface.

You don't have to go deal and learn a whole bunch of the UIs, it's really nice. So we want to be careful not to ruin not. Having said that, if we find something really special we would pick it up and buy it.

I guess one more comment, Richard, because it's such a good question, my friend. We see ourselves as a stack company. Most of those sales enablement companies that you're probably looking at are the same ones I'm looking at.

They're mostly built to work on top of salesforce.com and salesforce.com's done a nice job there. We want to build our own stack. We want to be able to make it really easy for customers to come in, one user interface, one bill to pay, one number to call in support, make it very simple for a mere mortal businesses to take advantage of the Internet and really grow.

Sorry, I droned on a bit there, John.

Great.

Brendan Barnicle, Pacific Crest Securities.

Thanks so much, John, I apologize if this was covered in the comments. I was late getting on today. Pro Services were sort of flattish sequentially or up more modestly than what we have seen.

Is that the way we should be thinking about that going forward? Have you guys gotten to the saturation point? More and more of it can go to the channel?

And we talked a lot on this call about how successful you guys have been, building out that channel.

Yes, that's a good question. I mean, the first quarter to second quarter can have some seasonality to it. The first quarter gets a huge benefit from delivering what we sell in the fourth quarter.

And then the second quarter really builds off of the first quarter which is usually slightly lower quarter from a services standpoint. You didn't quite see that last year because, as we talked about, there were some large deals. That definitely weighed in on the services growth rate from that standpoint.

But, yes, we're focused on growing a subscription revenue. We think the services definitely will grow at a slower pace. And we really look at services as a way to enable customers to be successful, really make sure we try to keep our customers as long as possible, make them successful.

So that's why you see it in the margins as well. We really think we can get that margin closer to breakeven over a longer term, but we're never going to maximize that services margin. We really just want to maximize that subscription line item and make those customers successful.

Terrific. Thanks for the additional clarity.

No worries.

Tom [Roderick], Stifel.

Hey guys, good afternoon, thanks for taking my question. I wanted to hit on the international segment here with my question. I apologize if you guys touched this in more details in some of the prepared comments.

Like Brendan, I had to jump on a little late. But I'm looking at the numbers from the Q and they look like you're up about $6 million sequentially even with some added revenue headwinds in total. And international continues to do very, very well.

What I'd love to hear more from you is as you guys have opened up yet another office in A-Pac and as you have more experience under your belt in international, what's the partner community looking like in those regions? How much success are you having establishing new partners there versus the direct sale? And how do you think about that opportunity on the agency channel partners going forward out in those regions?

Tom, that's a real good question. It starts with agencies overseas. So let's take Europe.

We basically started Europe with agencies and then we layered in direct. First we layered in direct in the UK with the English-language products. And then over time we built a French language and a Spanish language, a German and a Portuguese version of the product.

Then we started selling direct in addition to channel partners in Europe. As we move over to Asia, it's kind of a similar play book where we started in direct all over Asia actually. And just now we're starting to layer in direct sales forces. We layered in direct, I guess a year ago, we started in Australia, or a little longer, John?

Yes, a little bit longer.

Longer. We started Singapore two quarters ago and they are working on South Asia and we're just starting Japan. In fact, I'm heading over to Japan in three weeks to do the products in the office launch over there. And Japan, like the other countries, starts with agency partners and then we layer in direct.

So that's sort of the play book we use. It's working really well for us. We haven't seen a lot of pushback. The acquisition of new agencies in international has been good and their productivity has been real good.

Wonderful. One of the things I think we've gotten a number of questions on this call relative to the entry-level CRM product. Of course you guys have a nice relationship with salesforce.com.

Wondering if you can address as you gain more traction with your own CRM products, if you can address how that relationship is evolving with salesforce? And perhaps remind us as to the timeline of that relationship, how long that's locked in for.

Sure. We did a deal with salesforce, I guess about a year or so ago that was a five-year deal. Yes, five-year, sorry, I had to check with John. The way I would describe it is it's a purposeful coopetition arrangement, where we both agreed that we are going to cooperate like crazy on joint accounts and we both agreed that we would also compete from time to time on marketing and sales.

And we'll be adults about it and we'd all behave well and would solve for the customer. I take my hat off a bit to salesforce.com, they get that and they want to take care of the customers, as do we. Feeling good about the relationship.

I've personally got a good relationship with those folks over there and it's working just as we thought it would. We do cooperate a lot and we do compete a lot and I think it's working fine and really happy with the way it's going so far.

Eric Lemus, Raymond James.

Hey guys, thanks for taking the question. Question for you, John. Looking at the implied guidance for the fourth quarter on total revenue.

Correct me if I'm wrong, but it looks like there's a bit of a deceleration for the fourth quarter. Is there any one-time items that you can talk about? Or am I just looking too much into that?

Yes, as you look out, obviously we only guide to the next quarter. I know you can back in to it but we really focus on the next quarter. We talked a little bit about the billings challenge in the third quarter, given not having Inbound and the comp on that side as well.

It's still a ways out so that's about what's going to happen there.

Okay. Thanks.

Scott Berg, Needham & Company.

Hi Brian, [Brandon], John, congrats on a good quarter. One question in particular and I apologize if it's been asked. I, too, have been call jumping.

On your customer additions, you comment that 20% came from the free CRM products in the quarter. It's kind of a two-part question. One, what size customers are those coming from?

Are they your basic level customers? Are they more your professional customers? Or enterprise?

I'm trying to understand the sizes there. And then what's the right way to think about those conversions going forward?

Is it within the segment that you are seeing today? Or does that evolve over the next 12 to 24 months?

Really good question. The number we gave is of the new customers who signed up for our marketing product, 20% of them were using our CRM product before they purchased the marketing product. Which I think it's really encouraging, it's not something we focused on. It will be something we focus on down the road.

I suspect if you roll the clock forward, that percentage, I think it should go up and I'm looking at Chuck here to make sure he doesn't get mad at me. But I suspect that 20% should go up. Our CRM product is pretty early, it's getting a lot better over time.

We're going to start focusing on how to turn CRM users into marketing customers over time. So I suspect that 20% number has room to improve. I guess that's my first answer.

My second answer is the way I think of CRM is it started kind of low and will move up over time. It's sort of a classic bottoms-up play.

I'm going to guess that the CRM users are a hair smaller on average than the marketing customers. And as we add functionality to that CRM product, I think you'll see the average size of those customers signing up to grow as well.

Great. That's all I have at the moment, I will jump back in the queue. Thank you.

I want to thank everyone for jumping on the call and look forward to seeing you all at our Inbound conference in November. Thanks a lot, everyone.

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