HubSpot Inc (HUBS) 2017 Q4 法說會逐字稿

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 Fourth Quarter and Full Year 2017 Earnings Conference Call.

(Operator Instructions) I will now turn the call over to the Director of Investor Relations, Charles MacGlashing.

You may begin your conference.

Thanks, operator.

Good afternoon, and welcome to HubSpot's fourth quarter 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 within the meaning of the Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended.

All statements other than 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 and business outlook including our financial guidance for the first 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 November 1, 2017, 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 as defined by Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure used or discussed, and the reconciliation of the differences between each of the non-GAAP financial measures and the comparable GAAP financial measures can be found within our fourth quarter and full year 2017 earnings press release in the Investor Relations section of our website at www.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 Fourth Quarter and Full Year 2017 Earnings Results.

Let's get right to it.

HubSpot ended 2017 on a strong note.

Fourth quarter revenue increased 39%, and non-GAAP operating income margin improved to a positive 4%.

The fourth quarter closed out a great year of performance, where HubSpot's full year revenue grew 39%, total sales and marketing customers surpassed 41,000 and non-GAAP operating margins grew to a positive 2%.

Very, very happy with HubSpot's performance over the last year.

Okay.

Let's unpack those 2017 results in a bit more detail so you can see how we're thinking about HubSpot in 2018 and beyond.

We'll start with what we've been doing on our freemium model.

It really started to move the needle here.

Investors often ask me why a freemium model makes sense for HubSpot.

You've likely heard me talk about this before, but it bears repeating.

Humans are changing the way they live, the way they work, the way they shop, the way they buy.

This is as true in the SMB space as it is for consumer markets.

More and more, companies want to try before they buy and, sometimes, even before they talk to a sales rep.

That's why millions of consumers got started with services like Dropbox or Spotify, where they use a free version for a while and then fall in love with it and then upgrade to the paid versions over time.

The good news is our freemium model is a total win-win for SMB users and for HubSpot.

Why is that?

Well, for customers, it's a lighter, easier and more natural path to getting value out of a product before having to commit to a contract.

For HubSpot, it allows us to sell to users, people who are actually using the product and getting value out of it as opposed to leads.

This helps lower our overall cost to acquire a customer, an important component of our customer unit economics and a metric we obsess over here at HubSpot.

It also serves to protect us from disruption from below, which adds to our competitive moat.

Think of it as adding a particularly angry alligator to the moat surrounding the HubSpot castle.

And strategically, freemium attracts tons and tons of users.

And all those users, even the nonpaying ones, attract more partners and ultimately increase the value of our entire ecosystem surrounding HubSpot, something I'm very excited about.

All sorts of goodness with our move into the freemium model.

We got off to a pretty good start with the freemium motion in 2017.

We added loads of free users to the platform, and we increased the amount of revenue that's originating from our free products as well.

It took a bit of time to figure it out, but our sales team has made a lot of progress on this front, and momentum is really starting to gain steam.

In 2018, we're going to keep our foot on the accelerator with R&D investments we're making into the freemium product.

And we're going to keep making it as easy as humanly possible for a user to get started on that HubSpot platform.

Now a second key initiative for us is rather old-fashioned.

We are trying to even more deeply delight our customers.

You see, when I asked our customers about why they buy, more often than not, they say something to the effect of a colleague of theirs highly recommended it to them.

Now our own sales and marketing efforts are very effective, but our word-of-mouth is becoming our most important channel to market, so we're going to invest even more heavily in our customers' success.

And so beginning in 2017, we doubled down on our efforts across the full end-to-end customer experience to make sure word-of-mouth continues to work well for us.

A good example of this is how we've automated self-service onboarding for new users that weren't onboarded when HubSpot was initially purchased.

When someone starts using HubSpot after the onboarding period is over, they naturally don't do as well as the original user who was trained on the product.

So we're doing some really clever things to catch those folks and make them successful.

This has the ability to carry outsized leverage in helping new users get more value out of HubSpot, which drives increased usage and higher retention rates.

As we focus more on customer delight, we're discovering more and more ways where we can invest a little and gain a whole lot.

Now a third key initiative in 2017, focused on evolving HubSpot away from a single product company to a front office suite company with a goal of becoming the growth suite for SMBs.

We made really good progress on this front over the last year.

In fact, out of our 41,000 total customers, we've got nearly 10,000 of them using our Growth Stack, both the sales and the marketing products.

Having new products to sell has given the sales team additional entry points into altogether new prospects, and we've seen really strong growth and cross-selling really in both directions.

That's good for HubSpot, and it's great for customers because a lot of good things happen when a customer adopts the full Growth Stack.

With the full sales marketing in CRM stack, customers are able to grow bigger by having all the tools they need in a single place and grow better by making it easy to deliver a superior end-to-end experience for their customers.

And for HubSpot, customers using the entire front office suite carry higher levels of revenue retention, and they deliver higher lifetime value, which is great.

It's great for our customers and for our numbers, and it serves as further confirmation that we're headed in that right direction.

All right.

Now let's talk a little bit about this multi-phase journey that HubSpot's on and where we're headed in the next few years.

Back in 2006, the first phase for HubSpot began when Dharmesh and I were just starting out, and what we built was basically a marketing application company.

We built something very useful that delivered a ton of value to marketing customers and digital agencies all over the world.

There's a lot of opportunity in the marketing space among SMBs because so many SMBs are just now discovering the value of matching the way they market and sell to the way customers shop and buy.

Businesses are still working on adapting to the massive changes going on in human behavior that we [saw for] like the shift from e-mail to messaging, from PR to social, from text to video, so on and so on.

The second phase for HubSpot really started back in 2014 when we introduced our free CRM product.

This is when we really started down the path of transforming ourselves into a front office suite company, where folks could run all of their customer-facing activities on HubSpot.

We've expanded the value we create for marketers and agencies to now include salespeople and sales management.

There's still a ton of opportunity here to create value as we have a lot of work to do including delivering on our third line of business, the Customer Hub.

With the Customer Hub, our full suite of products will enable HubSpot to support the next step in the inbound customer journey and help companies turn customers into promoters.

We're on a good trajectory towards becoming a suite company, and the opportunity is just tremendous.

All right.

To wrap up what I'm excited about in 2018, we have a clear plan with a detailed set of plays that I have confidence we can execute against.

First, we want to continue to bring users onto the platform in a lighter touch, more modern way with our freemium offerings.

This is starting to work really well, but we want to lean even more heavily into freemium in 2018.

Second, we want those folks who use and buy the product to be delighted.

Delighted customers are our best source of new customers and our best channel to market.

Then third, once we bring customers onto the platform, we want to show them the incredible value that comes with using the entire Growth Stack across marketing, sales, CRM and customer service.

Ultimately, when we look out beyond 2018, we continue to see a ton of opportunity, some of which we'll be able to share with you at our INBOUND event in September.

But suffice it to say, we don't feel like we're anywhere close to being done with where we can go with our products, the company, this vision and the value we can deliver for our customers worldwide.

Now before I hand it over, as I'm sure you've seen, John will be leaving HubSpot at the end of 2018.

I'd like to provide a few thoughts about his departure and the transition that will be taking place over the coming months.

First, we've initiated a search process for a successor, and we're confident we'll find a great replacement.

Second, on behalf of HubSpot, the Board of Directors and the more than 2,000 HubSpot employees, I want to thank John for his significant contribution since joining HubSpot in 2013.

He was instrumental in our transition from a private to a public company and has been a great partner in the company's development.

Third, I want to tip my cap to John on how he is leaving HubSpot.

He's leaving a great team behind him that's super productive and capable.

He's leaving at a time when the company is as healthy as it's ever been, and he's leaving us plenty of time for a nice long transition.

I look forward to working with John through the remainder of 2018, and I look forward to being friends with him through the rest of our long days.

Okay.

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

I appreciate the kind words, Brian.

Before I get into the financials, I want to thank Brian, Dharmesh and the entire HubSpot team for giving me the incredible opportunity to be CFO of this amazing company.

It's been the best professional experience of my life, which has made this decision all the more difficult.

With that said, I'm at a point in my life where there are a lot of things outside of work that I'm passionate about, including spending more time with my family and dedicating even more time to the nonprofit and board work that I'm currently involved in.

In addition, last year, my family and I made the decision to move back to the D.C. area.

As a result, I've been making the commute back and forth from D.C. to Boston, which, as you can imagine, can be difficult at times.

Now feels like the right time for me to move on.

The company is executing extremely well, and I have high confidence in both the management team and the finance team to continue performing at a high level.

I'm also very confident that we will find a great CFO to succeed me, and I'm very much looking forward to working with him through the end of 2018 to ensure a smooth transition.

Again, I want to thank all of you on the call and the more than 2,000 HubSpoters that have made my time here so incredibly rewarding.

Okay.

With that out of the way, let's jump into the results.

The fourth quarter capped off another strong year here at HubSpot.

We delivered strong revenue growth, full year non-GAAP profitability and over $22 million of free cash flow, all while continuing to make significant investments for our future growth.

Fourth quarter revenue grew 39%, driven by 40% subscription revenue growth and 20% services revenue growth.

Revenue growth exceeded our expectations given a strong Q4 as well as a 2-point tailwind from FX.

HubSpot ended the quarter with 41,593 total customers, up 48% year-over-year.

Average subscription revenue per customer was down 4% year-over-year and 1% quarter-over-quarter to $10,255.

As we've discussed in the past, the reduction in annual subscription revenue per customer is the result of adding a bunch of lower price sales and Marketing Starter customers through our freemium motion.

While these customers start at a lower price point, they tend to increase their subscriptions as they grow their usage and add new products over time.

Deferred revenue growth came in at $139 million, growing 44% year-over-year.

While calculated billings, defined as revenue plus the change in deferred revenue, came in at $126 million, up 41% versus the fourth quarter of 2016.

The billings growth exceeded our expectations due to a strong finish to the year and just about a 5-point tailwind from FX.

As always, remember that billings growth will vary from revenue growth due to changes in billing terms, currency rates and product mix.

For the remainder of my commentary, I will discuss non-GAAP results.

Now let's take a look at our margins.

Fourth quarter gross margin came in at 81%, up 2 points year-over-year.

Fourth quarter subscription gross margin came in at 86%, up 2 points from a year ago.

And services gross margins came in at a negative 18%, up 3 points year-over-year.

Fourth quarter operating margins improved 6 points to a 4% margin when excluding the impact from the INBOUND event in the fourth quarter a year ago.

International revenue performance continued to be strong in the quarter, growing 65% year-over-year and representing 35% of HubSpot's total revenue.

At the end of the fourth quarter, we had a total of 2,081 employees at HubSpot, up 30% year-over-year.

CapEx, including capitalized software, was $7 million in the quarter, up from $4 million last year as CapEx related to our facilities build-out picked up in the quarter.

We expect CapEx to average about 7% of revenues for the full year 2018, which is a slightly lower percentage of revenue than we have seen in the past due to the timing on our facilities build-outs.

With that said, we still anticipate CapEx as a percentage of revenue to average closer to 7% to 8% over the medium to long term.

With that, let's dive into guidance for the first quarter of 2018.

Total revenue is expected to be in the range of $109.2 million to $110.2 million.

Non-GAAP operating income is expected to be between a profit of $4 million to $5 million.

Non-GAAP net income per share is expected to be between $0.10 to $0.12.

This assumes approximately 40.3 million fully diluted shares outstanding.

And for the full year of 2018, total revenue is expected to be in the range of $481 million to $485 million.

Non-GAAP operating income is expected to be between $20 million and $24 million.

Non-GAAP net income per share is expected to be between $0.51 to $0.59.

This assumes approximately 40.7 million fully diluted shares outstanding.

As you adjust your models for 2018, keep in mind the following.

We expect free cash flow to be about $30 million for the full year.

As you think about quarterly timing, consistent with 2017, we anticipated strong free cash flow in the first and fourth quarter, and free cash flow to be more muted in the second and third quarters given a material vendor payment we make in the second quarter followed by the payments associated with our INBOUND event in the third quarter.

We anticipate stock-based compensation will be approximately $76 million.

Lastly, as a result of the adoption of the new revenue recognition guidance, ASC 606, we anticipate a couple of point benefit to operating margins, which is included in our guidance.

Keep in mind that there is no impact to cash flow as a result of the adoption of the new guidance.

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

Brian?

Thanks, John.

You may have seen that we got a couple of great shout-outs in 2017.

Glassdoor says we're the seventh best place to work for.

Comparably says we're the second best place to work for.

HubSpot's secret sauce has always been our people.

We're really fortunate to have such a special crew that work for one another and are driven around HubSpot's mission to help SMBs grow better.

I want to close by thanking each and every one of those HubSpoters, all 2,000 plus of them; all our customers; all our partners; and all our investors.

We are here on a mission to help companies grow better, and we're thrilled to be in business with all of you.

Operator, can we please open the call for a few questions?

(Operator Instructions) Your first question comes from Bhavan Suri with William Blair.

John, best of luck.

We've got a year to still work with you, but we will miss you, sir.

Thanks, Bhavan.

I want to touch on just the overall inbound marketing opportunity.

One of the things we've been hearing more about is that small businesses are now sort of doing their own blogging and search engine optimization.

I guess when you look at that space, the freemium has done really well.

But if you look at that core business that was a little above sort of these entrants, what I'd say is slightly bigger or small businesses.

Are you seeing any pushback on the core offering?

Are you seeing any sort of them saying, we can do some more of this ourselves?

Or are any of the partners suggesting they're seeing any of that?

Bhavan, I'll take that.

It's Brian.

I would kind of cut the market into -- in my mind, I cut it into 3 pieces.

There's the 1 to 10 employee market; the 10 to, let's call it, 1,000, 2,000 employee; and then 1,000, 2,000, up.

We play largely in that 10 to, let's call it, 1,000 or 5 to 1,000 in there.

And they typically have a full-time marketer, a little marketing department.

And the problem they had when we first started HubSpot is even worse than they have today.

The problems they're dealing with are, first, their buyer is changing.

The way humans are evaluating their products, the way they live, the way they shop, the way they buy is really changing, and they're having a hard time keeping up with it.

So that's the first problem they're dealing with.

The second problem they're really dealing with is it just is the plethora of tools they have to deal with.

So let's say they want a blog on their own.

They can do that.

They can use WordPress for their blog.

But then they're hiring an SEO consultant, and then they're buying a social media application, and then they're putting in a lead management solution, and then they're buying a data solution, then they're putting in their own CRM and e-mail marketing.

And the next thing you know, they have 8, 9, different pieces of software.

That's like buying a car by buying an engine from one company, a steering wheel from another company and putting it together for yourself.

So I think these companies from 10 to 1,000, what I hear, need us more than ever, that they want an all-in-one solution.

They really value the ease of use.

They want one bill to pay, one company to deal with, one user interface to learn, all of that kind of together.

So I think our value prop has stood the test of time, frankly.

Got it.

That's really helpful.

And then one follow-up from me.

Just flipping it the entire other way.

With Sales Professional -- and despite sort of your guys' focus on the mid-market, this obviously is a higher end offering.

I'd just love to get some idea of reception.

And then also by the partners, how are they finding -- I know it's early days, but early traction with that product?

Yes, great question.

We released -- just to refresh folks' memory.

We released the Sales Professional product at INBOUND, started selling it in October.

So we've got a sales starter product.

It's $50 per user per month, bought one user at a time.

The new Sales Professional is $80 per user per month, and the initial purchase is bundled with 5 users.

That's gone exceptionally well.

That had sold very well through Q4.

The big difference between that product and the starter is the workflows tool has been put in it, and they can do lead routing with it, and it has gone really well.

The way the market is kind of split out is, let's say, you've got between 5 and 25 employees or 5 and 15 employees, you've got maybe 2, 3 sales reps, they're tending to buy that sales starter product.

And then companies, let's say, between 15 and 20 and, let's say, 100, 200 employees, they seem to be buying that professional version of product.

And it's being well received and feeling very, very good about it.

On the second side of your question is regarding partners.

So far, so good.

The way I kind of think about the partners is when we first started, if you wind the story all the way back to the beginning of HubSpot, we're really a marketing application software company, and we went to market directly, also with agency partners.

And those agency partners were largely website designers, search consultants, social media consultants, PR agencies that work with us to go implement inbound marketing inside these companies.

Some of them are really rooted in marketing and want to stay in marketing.

Let's say they have real design chops, and they don't want to get into sales.

But a lot of them, and particularly a lot of our best partners, have moved down the funnel with us and are not only selling our marketing products but really starting to sell our sales product, the Sales Professional product, and selling much more of an end-to-end solution on helping people transform not only the way they market but how they sell and go-to-market in a more holistic way.

So, so far, so good on the partner side, feeling quite good about that over the long haul.

The next question is from Mark Murphy with JPMorgan.

And John, I just want to thank you for all your great work at HubSpot over the years.

Thanks, Mark.

So my first question is just on the magnitude of the revenue upside, the strength of the revenue guidance.

There really was billings acceleration.

It was very noticeable this quarter, and I understand there's a little FX benefit.

But still, it just seems like the business kind of accelerated into a higher trajectory this quarter.

And so I'm curious maybe what surprised you positively in the quarter.

Is it -- do you think Growth Stack is resonating faster than we expected?

Or is it more the low-touch strategy?

Or perhaps you detected a little better spending climate overall in the background or something?

Yes, Mark.

Let me start that off and then I'll turn it over to Brian.

I mean, yes, we saw about a 5-point benefit to billings and about 2 points to revenue.

So that definitely helped.

But we did have a strong quarter, and I'll let Bryan talk a little bit about that.

I'll give you an old-fashioned answer.

I think our products have gotten better over time.

We solve a real problem that lots and lots of companies have.

The way we solve it is unique relative to our competition.

It's a big, big underserved market.

We've really invested in R&D, and we're starting to get a return on some of those investments.

I think it's just sort of old-fashioned.

I think the team at HubSpot, all the employees have executed quite well.

So I wouldn't say I'm super surprised by it.

I'm happy about it, but I feel like we're starting to get a return on some of the investments we've made over time.

And then as well, could you walk us through the time frame for your customer service or what you're calling Customer Hub?

That offering, the time frame for that to be introduced, when do you think it would contribute to bookings?

Yes.

We're going to release that -- we're sticking with our schedule, first half of the year this year.

Feeling good about it.

I think the product will be great.

I would just say I suspect it will be similar to the way we released our sales product.

So we released the sales product a while ago.

It's tens of millions of dollars, and it's growing very fast, and it's really, really exciting what's going on there.

I wouldn't expect that, this year, there's this giant surge of revenue from it.

I think -- but I think it will be a big, big business for us over the long haul.

So schedules haven't changed.

Feeling bullish about it.

Hoping it's a repeat of what we did on the sales product side and working hard on that.

Your next question comes from Brad Sills with Bank of America Merrill Lynch.

John, I'll echo the comments.

We'll miss you.

Thanks.

You've done a great job.

Thanks, Brad.

Yes, I just wanted to ask, guys, the ASP has kind of been holding at this 4% decline, but the volume business, the volume of customer adds has been significant.

What are you seeing in terms of the effort to sell marketing into the sales base?

I know with Sales Pro, that might make it easier.

And I know also that, that's a new focus for the company.

Yes.

So, Brad, yes, I think you're right.

We always talk about ASRPC being an output versus an input.

Really strong customer growth, and we're bringing in a lot of -- through the freemium motion, Marketing Starter and Sales Starter customers.

As we think about the effort, I think Brian and I were talking earlier like we used to give ourself a B- on the effort to sell marketing into sales, and maybe that's moved up to a B-ish.

We'd like to keep getting that up a little bit more.

It takes some time, but definitely starting to resonate, and it's definitely starting to see some success on selling that marketing product into the sales customers.

Yes, I'd echo that.

We've got 40,000-plus customers.

About 10,000 of them are Growth Stack.

And so yes, that's going well.

There's a lot of people buying both upfront a little more than we expected, I think you might say, and there's a lot of people buying marketing first then buying sales and sales product and then the marketing product.

I agree with John.

I'd probably give us a B on that, up from a B- on the last call.

I think that's super, super promising.

One of the things I really like about what's going on inside of HubSpot is we started as a marketing product and then we built the sales product.

When we built the sales product, we said, "Let's build the sales product." Most people do this as a second line of business.

Let's sell it into the marketing installed base.

What we challenged that team to build was something that is remarkable, and so good that not only will we sell into the marketing-installed base but it would be a magnet for new customers that we could eventually sell the marketing product into.

And that has largely played out quite well.

That sales product and the free CRM product are bets that are working.

Great.

And then one more, if I may please.

Just any color on how the upsell or cross-sell motion is going with the sales base now that you've got some history here, customers that are 1-year plus?

Are you finding that these folks are adding more users at the pace that you would expect?

And just any color there would be great.

Yes.

Overall, I'd say it's going pretty well, actually.

Feeling good about it.

The thing that changed a hair is that people used to buy -- they only had one choice.

They could buy the starter product, and it's $50 per user per month.

Now a lot of our revenue is coming from that professional product, and they buy 5 seats upfront.

So the mix has changed a little bit starting in Q4, and I think you'll see that next year.

Overall, I think it's a good change, but it's a bit of a shift that's going on inside the model.

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

John, thanks for all your help and contributions as well from me and best of luck in the future even though I know today is not your last day.

Thanks, Ross.

Sure.

Maybe just a couple, one, just on the transition, if you will, of the pricing model in Q4 on the Sales Pro product to the 5 user, $80 price point.

Just curious, do you think that had any pull-forward effect at all?

And I guess subsequent to that, what was the sort of trend rate in the business for the latter stage of the quarter?

Yes.

So we definitely saw a bit of an impact in October.

That's when we announced it and we did a little bit of grandfathering for our old customers.

Then it was kind of steady the rest of the quarter, so nothing crazy the rest of the quarter.

But in general, we're seeing good reception to that.

We are seeing probably a bigger percentage of people with the Sales Professional than we expected.

I think it's over 50% of our sales business is coming from Sales Professional, which is obviously good, and I think you saw that in the results.

Great.

And then maybe just one other.

I get asked this question a lot, and it relates to your domestic growth versus your international growth.

We actually saw, I think, by my math, the domestic growth rate tick up a little bit here in Q4.

But obviously, it's been sort of hovering at that sort of 30% rate.

And I think the assumption is that the domestic market is where you'd see the greatest uptake of new products like sales.

So I was just curious.

When you look at that mix in your business between domestic and international, how do you feel about the sort of growth rate you're seeing domestically?

And are you seeing the -- I guess, are you seeing the adoption rates of sales in the domestic market sort of on plan or better than you thought?

I feel -- overall, I feel good about the domestic business.

I feel like we're well positioned and growing fast.

I feel even better about international, where we've made some huge bets over the last few years and starting to get a return on them.

I don't -- it's a really good question.

I don't think there's a huge, huge difference in our business between the adoption or pickup rate on something like the Sales Professional SKU in the U.S. versus international.

I don't think it's wildly different.

John, correct me if you think I'm wrong about that.

No, no, I think that's right.

And it was nice to see that, like you said, Ross, to see the domestic tick up a point to the 29%.

But as we talked about a lot, I mean, we've been investing heavily internationally.

The unit economics are slightly better there, and we've been hiring a bunch of salespeople, investing in marketing, localizing the product and creating native content, a lot of different things.

And to Brian's point, we're really seeing those investments pay off.

The next question is from Tom Roderick with Stifel.

It's actually Parker Lane in for Tom Roderick.

To piggyback on an earlier question actually, what have the early conversations been like on the pricing front with Customer Hub?

And how do you feel about the general preparedness of your salespeople to have another product in the bag?

Feeling good about it.

I think our sales org is getting a lot better at moving from selling a single-point product to more of a suite and being kind of a front office partner, and I think that (inaudible) organization (inaudible) and a great sales team.

(inaudible) in being able to sell (inaudible) for now.

Stay tuned.

But suffice it to say, we're going to have a paid product that's going to be a nice line of business for us that should grow well over the long, long term for HubSpot.

We're feeling really good about it.

Your next question is from Alex Zukin with Piper Jaffray.

This is Taylor Reiners on for Alex.

I just wanted to ask, one of the things what we picked up in our conversations with agency partners is increased excitement around growth in your ISV ecosystem, so companies like Databox are showing up quite a bit more.

I'm wondering, just kind of looking forward, how are you thinking about your ISV ecosystem?

Is this going to be an increasing area of focus and investment over time?

I'm feeling really good about it.

I agree with the agency partners.

Databox is one I'm kind of psyched about.

It's a guy who used to work at HubSpot, Pete Caputa, who left HubSpot and went and became CEO of this company, Databox.

And what Databox does is super cool.

They pull data out of HubSpot and Google Analytics and all different kinds of other apps and build dashboards of different applications and reporting.

And he's had really nice penetration selling into our partners and our customers.

And that's exactly what we want to see.

We've been opening HubSpot up over the years.

We have more and more API coverage of our product.

Those APIs are getting richer.

They're getting better supported and more consistent, and that's going to continue to grow.

And as that grows, at the same time, our user base is growing.

And we're just getting to be much, much more attractive for companies like Databox to integrate to and build their business around.

So I'm feeling that's a story we don't beat the drum loud enough on.

That's a story that's really developing and, I think, is quite exciting for us.

Got it.

And then just a quick follow-up.

I was wondering if you can talk a bit about the timing of INBOUND this year.

It fell kind of towards the end of 3Q.

It was a little bit earlier.

I was wondering if that had any impact on your pipeline or -- into the fourth quarter or your execution, and if that had anything to do with pulling it back a little bit more in 2018.

No, I mean, you can imagine, you have to book these things well in advance.

So I mean, it's pretty much when the convention center is available.

It's going to be around that early September/late August for the foreseeable future.

So it's more just based on timing.

Yes, the one time we had it in Q4, that was kind of a one-off actually.

It should usually be in September.

I think it's locked into September for the next 3 or 4 years.

I think that's right, yes.

The next question is from Jennifer Lowe with UBS.

I just want to add my fond farewells.

I guess it's a little premature.

But, John, it's been a pleasure to work with you over the years, and I look forward to staying in touch as you move on to the next phase of your life.

Thanks, Jen.

So actually, I have a question for you.

But as I'm looking through the guidance on free cash flow and as you noted on the operating margin side where there's a bit of a benefit from the ASC 606 adoption, back of the envelope, it looks like it's about 230 basis points of margin expansion year-over-year but free cash flow margin looks pretty consistent in the guide relative to what you did in '17.

And, a, I guess I wanted to just see if I'm running that math right.

And b, to the extent there was a couple hundred basis points or a couple points of benefit from ASC 606, it seems like the guide is more sort of flattish on the margins.

So I was just trying to reconcile that with what sort of the incremental investments are in the year and then just versus sort of the broader framework that you've talked about in the past on margin expansion.

Yes.

Jen, so we're expecting 2-ish points on 606, so depending on where you exactly get on the range.

We could get 1 or so points margin expansion based on the guidance.

As you know, in general, in our guidance, I mean, there's a range of outcomes, and we'll endeavor to do better.

But specifically to next year, and we talked a lot about, and Brian's talked a lot about investing in R&D, and we expect to take R&D as a percentage of revenue up 200 or 300 basis points in 2018.

And we were really able to hit our stride in hiring towards the middle to the end of the year and just really been able to bring in a lot of really talented people, and I think that's why we're able to bring out the Customer Hub as quickly as we can and continue to build out that platform.

So we think it's the right thing for the long-term prospects for the business.

And -- but at the same time, we're committed to margin expansion year-on-year.

And maybe just one more for me.

Looking at the sort of steady acceleration in the customer metrics, is there any color there on what -- how much of that is Marketing Starter?

How much of it is uptake of sales?

How much of it is just sort of the core traditional marketing offering?

Any sort of directional signal on where you're seeing the greatest traction would be super helpful.

I mean, definitely on the acceleration, we definitely got that some from some of the starter products, but we're still seeing broadband -- broad-based customer growth.

And we talked a lot about the fact that, that put some pressure on ASRPC in the short term, but customers that we can upsell and cross-sell going forward.

So really encouraged on the customer number.

It set kind of a new record in the fourth quarter.

But generally, the fourth quarter is the highest, so we'd expect that to moderate a bit going into next year.

The next question is from Samad Samana with Stephens.

John, I'm going to take a different approach.

If I can convince you to stay, that would be great because you haven't missed a quarter as a CFO.

So that's my request.

Don't leave.

Samad, you're too nice.

Well, now come the annoying questions.

So I opened with a nice part.

I just wanted to get an idea, now that the Sales Professional, the higher dollar SKU, has been out there for a few months, are you seeing any difference in who you're either replacing with that product or, competitively, who you're finding yourself in deals with against that product?

And then maybe a follow-up question as well.

Samad, it's Brian.

A little bit.

There is some functionality in the starter product that, call it, a mid-market company with 50 employees wanted and needed.

And so we delivered some stuff in that new SKU that answered the mail.

So we're getting slightly larger companies with slightly larger teams and a sales ops department to adopt it.

And that sales starter product is smaller teams, typically driven by the rep, no sales ops department.

And so I think we kind of hit the nail on the head in terms of what we put in there.

And we're moving -- I wouldn't say were moving upmarket, but we're kind of matching the target market of our sales SKU, Sales Professional SKU, with that Marketing Professional SKU in a nice way.

Got you.

And then to that end, John, did you see a noticeable change in the net subscription dollar retention rate in the fourth quarter, since that was launched?

And maybe just generally, how that trended in the end of the year?

I don't think you've called that out on the call yet.

Yes.

So the fourth quarter was nice.

It was above 100%.

I think the full year, slightly above 100% as well.

If you look at retention, one thing that you should be thinking about is there are some new dynamics with that number.

A couple of things to think about.

First of all, on the Sales Professional product, as Brian said, people are starting with 5 seats, whether they actually have those seats or they just buy those seats.

So could be a little bit slower upsell after that because the old product had -- you just bought one at a time.

So that's something to think about.

Then the other thing to think about is, then, now that cross-sell is such a big thing, is if we sell the marketing product to a new customer, it doesn't impact retention.

If we sell the marketing product to a sales customer, it's great for retention.

So in general, I'd caution people to get too excited about 1 quarter here or there on the retention front.

But over the long term, more the annual numbers, I think it's still very important.

Yes, I'd say -- I'd add to that, the other thing that surprised us on -- maybe on the upside is the amount of customers who come in and buy that Growth Stack upfront, which has been more than I thought.

Anyway, feeling good about the cross-sell in the Growth Stack overall.

The next question is from Terry Tillman with SunTrust Robinson Humphrey.

Brian and John, can you all hear me okay?

We can hear you great.

In the spirit of trying to be differentiated, I don't want to say congratulations or we're going to miss you or any of that stuff.

I guess, John, will you invite us to your going-away party, or at least me to your going-away party?

And when is that?

It's going to be a roast, not a party, by the way.

If you have good material on me, you can come, Terry.

Yes.

And, Chuck, by the way, that wasn't one of my questions so don't ding me.

But anyways, Brian, it's great to hear what you just said to the last question about surprised by the Growth Stack, actually selling the Growth Stack together earlier on and initially with a new customer.

What I'm curious about is there a different sales cycle.

Is it a longer sales cycle, though?

Even though it's a great benefit, it's a bigger ARPU.

But is the sales cycle lengthened some and so maybe this could mean, the way your quarters play out, it's a little bit more back-end loaded?

It's not materially different.

When someone buys one sales starter seat, that's a pretty short sales cycle.

They are using the free product and then they upgrade.

Sometimes they talk to a rep, sometimes they don't.

It's a little longer if they're buying the Sales Professional, but I don't see a huge difference, and I haven't spent a lot of time looking it up.

I haven't seen a huge difference between somebody who's buying Marketing Pro plus Sales Pro versus Marketing Pro.

It might be a couple of days, but it's offset by the Marketing Starter being faster and the Sales Starter being faster, if anything.

Okay.

And then just the second question.

It's just kind of a bigger picture question, just looking back and reflecting.

As you guys have had learnings on becoming a multiproduct story, selling Growth Stack, what is one of the learnings or a couple of learnings that you've noticed from sales and CRM, obviously the sales product which you monetized, that you will bring to bear and maybe could help you optimize getting out of the gate with Customer Hub?

Thank you.

I think one of the things we did right and wrong was when we came up with that sales product, we started it -- kind of like when you watch all those Apple movies.

We started it as like a skunkworks project away from the core marketing business and iterated like heck on it and got to the point in terms of revenue and growth and unit economics and motion that we pulled it back into the core company.

The good news about that was we did figure out a new freemium model, and we're able to take a lot of our learnings from that startup within a startup and apply it across the whole company.

So what's interesting kind of about that is, usually, you would take the new product and apply the old business model to it.

We kind of took the new product, figured out a new business model and then applied that to the old business.

In this case, we're not going to do that.

We like our business model.

We like this freemium motion.

We think we're in pretty good shape there, and so we're just going to take the Customer Hub product and apply the existing model to it.

So we don't have to completely go back to the drawing board and reinvent our go-to-market as well as come out with a new product.

That's the one kind of big aha, but it's going to be more straightforward.

The next question is from Nate Cunningham with Guggenheim.

Brian, based on the early conversations that you've had with partners, how excited are they about customer service?

And do they feel like that's something they know how to sell?

I'd say it's very similar to the early -- that was a great question -- very similar to the conversations I had with them about sales.

I remember when I first told the partners, yes, we're going into the sales business, CRM business.

Some of them were really excited like, "Oh, great.

We can increase our retainers.

It'll be stickier.

We'll deliver more value." And others kind of scratched their head and said, "Really?

Why?

You guys are doing great in marketing.

And we're a web design company.

We don't want to get into that." It's quite similar, where some of the bigger agencies that are more sophisticated are saying, "Oh, yes, now we can go into helping people with their entire customer life cycle from attracting leads to closing customers, to delighting those customers, treating those delighted customers into a marketing channel for you." And they're seeing it as, "Oh, we can increase our retainers from, call it, $10,000 a month to $15,000 a month." And, "Oh, it'll be stickier and more valuable." So it's very -- it rhymes with what happened on the sales side.

The next question is from Kirk Materne with Evercore ISI.

John, first of all, congrats on your next endeavor.

It's been a pleasure working with you.

My question for you would be just subscription gross margins have continued to track higher, and I think you were anticipating that.

I guess just at 86%.

How much more upside do you have to go on that front?

And I guess if -- it could be -- you're really not going to be getting as much leverage from that.

I assume we should sort of be looking more to sales and marketing given your comments around R&D.

Yes.

Kirk, I think -- first of all, thanks for your comments.

And yes, I think you're right on that front.

On the gross margin side, I think there's still a little bit of room as we -- as the mix continues to shift towards subscription.

I think the actual subscription gross margin mostly is played out.

There could be a little bit of room there.

But I think the leverage going forward, like you said, is sales and marketing, but it's also G&A.

There's some room there as well, just leveraging especially on the sales and marketing side as we lean harder to R&D and the freemium motion really kicks in.

Okay.

And then just one follow-up for Brian.

Brian, I mean your commentary around people buying the Growth Stack, perhaps, a little bit faster than you thought, Ross sort of asked this really, and I just want to put a fine point on it.

It seems like the adoption of that is pretty equal in the U.S. and international, I guess that's just somewhat surprising given international is perhaps a little bit earlier-stage market for you guys.

Yes, it may be a hair better in the U.S., but the international adoption has been pretty good.

One of the things we did when we rolled out the product is we don't roll it out in the U.S. and then figure it out and then roll it out internationally.

We kind of rolled it out everywhere.

And the way we build product and the way we internationalize product is pretty cool, where they basically build the English version, and at the same time, they get it translated into the other 5 languages that we support.

And so there's no lag time there.

There may be a little bit of difference, but it's relatively immaterial.

The next question is from Brian Peterson with Raymond James.

Kevin here on for Brian.

On the customer service offering, I realize it's still early there.

But how would you expect the ramp of the customer service cloud to compare to the CRM product from a longer-term perspective?

And I guess do you think there's anything maybe different on how those customers may buy a service product versus maybe the traditional sales and marketing?

Kevin, we won't know, of course, until it really hits the market.

But I -- my personal feeling is it will look similar to the sales product that ramped up over time.

And we continued to iterate it, and it got better and better, and then it kind of crossed the chasm and hit the mainstream.

That sales product, tens of millions of revenue growing well over 100%.

But it took a couple of years to get there, and I think it'll -- my guess is it'll be a similar trajectory.

But we'll know more in 6 months, and we can talk about it then.

The next question is from Brent Bracelin with KeyBanc Capital Markets.

This is Alyssa on for Brent.

My question was really around the Growth Stack and Sales Pro.

Kind of based on the numbers you guys gave, it looks like your attach rate improved to about 24%, 25% versus 15% 2 quarters ago, which is really the most material step-up we've seen.

So I was wanting to understand if that's mostly a function of, now, kind of addressing more mid-market customers with the Sales Professional tier versus any other changes you're seeing with how you're selling the Growth Stack.

Yes, I think that step-up, that 15% to

(technical difficulty)

I'm sorry.

I got a little bit of feedback there.

I think that 15% to 24% was year-over-year versus quarter-over-quarter.

But -- I'm sorry.

We're just getting a little feedback.

I don't know if you guys are hearing

(technical difficulty)

Okay.

So -- I'm sorry.

So I said that the Growth Stack year-over-year had gone from 15% to 24%.

But I think the question was, is there anything we see in mid-market versus attach rate versus the lower end?

I mean, we see it kind of across the board.

I mean, I wouldn't say that, necessarily, we're seeing it one place than the other.

It's been -- it's resonated pretty much across our customer base.

Yes, I think that - I agree with your point.

I think what you're starting to see is when we had our starter product, the little companies were buying it.

In the core mid-market companies that were buying our Marketing Enterprise and Marketing Pro, it wasn't quite there.

The new functionality we released in the Sales Professional SKU is good, and it's what mid-market companies want.

And so you're starting to -- you're probably starting to see the mix change a little bit and that attach rate go up because of that.

Also, I just think the sales organization is starting to figure out how to sell it.

And not only that, but we invested in a growth team inside of HubSpot, it's a cross-functional team.

It's run out of our product, but it's really, really made a lot of investments, and they're really doing well.

CRM adoption has been good, and it's starting to really come together.

Your next question is from the line of Derrick Wood with Cowen.

This is Jim Fitzgerald sitting in for Derrick.

I just have a quick question on the competitive landscape, who you guys are seeing competitively in core sales and maybe how win rates have been trending there over time?.

And then I guess the same question for the customer service product, who you expect to compete against there when it comes out?

Jim, I'll take it.

It's Brian.

No huge changes since the last call in the competitive landscape.

We continue to cooperate and compete with Salesforce.com in the market.

If it's an SMB company, we do very, very well.

If it's an enterprise company, they'll do very, very well.

I think we're well positioned there.

I'm really happy with where we sit in the market.

We compete well.

No big change in win rates that I can tell.

I think it'll be a whole different set of competitors that we'll compete with on the professional services product, and I think we'll compete well there as well.

And kind of the touchstones for HubSpot, there's 2 really.

One is were obsessed with -- and this is a little bit weird.

We're a little bit less obsessed with our customer, more obsessed with our customer's customer, how are humans changing their expectations of how they're served.

Instead of calling and waiting on line for 15 minutes and then talking to someone and not getting a satisfactory answer and bumped to the second line of support and retelling your story, what your problem is.

People expect to be able to Google the problem, be able to chat with you, expect you to have memory about those problems.

So we'll be building a very modern perspective into our product.

The second thing, I think, that will be killer is it will all be in one.

So you'll have your entire end-to-end experience will be managed under the HubSpot umbrella, all of our software, our partner software.

It'll be very easy to manage, and you'll be able to create a really remarkable delightful end-to-end experience with HubSpot.

The next question is from Koji Ikeda with Oppenheimer.

Congrats, John, on the news, and best of luck.

I wanted to ask a question on the HubSpot Connect Program.

We see the app integrations have grown from somewhere around 100 in December to around 120 in January, and it looks like it's sitting around 135 here in mid-February.

So it looks like the Connect Program is scaling into a really nice ecosystem here.

And I guess, what's the best way to think about the growth in integrations and the future opportunity it presents for HubSpot?

And I guess thinking way into the future, and maybe this question is just way, way too early, but I want to ask it anyway.

Is there eventually a platform-driven applications ecosystem play here, similar to what we've seen with Salesforce.com and its AppExchange?

It's a really good question, Koji.

I would agree that it's going exceptionally well.

I'm really proud of the team there, and I think it's a function of a whole bunch of things coming together.

One, and I mentioned some of these, our API coverage and quality is improving, and there's a relatively good-sized investment in that going into HubSpot so it's easier for third-party developers to dig in.

Two, I wouldn't say we're ubiquitous by any means, but the number of users of HubSpot has grown quite a bit, and it's not just the paid user, but put the free users in there.

That's getting to be quite a large number.

And the larger that number, the more attractive we are to third-party Connect partners.

And four, we've invested in the team that works on that stuff, so work with third-party development partners.

So I think our value prop to third-party developers is increasing.

You'll see us continue to invest in that, and I would encourage you to come to INBOUND and stay tuned for where we go in the future.

There are no further questions at this time.

I will turn the call back over to Brian Halligan for closing remarks.

Great.

Thanks to all of you for joining the call and look forward to talking to you next month -- or our next quarter, I guess.

Thanks to all.

This concludes today's conference call.

You may now disconnect.