Earnings Call Transcript - HUBS Q3 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the HubSpot Q3 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chuck MacGlashing, Head of Investor Relations. Thank you. Please go ahead.

Chuck MacGlashing, Head of Investor Relations

Thanks, operator. Good afternoon, and welcome to HubSpot's third quarter 2020 earnings conference call. Today, we'll be discussing the results announced in the press release that was issued after the market closed. With me on the call this afternoon is Brian Halligan, our Chief Executive Officer and Chairman; and Kate Bueker, our Chief Financial Officer. Before we start, I'd like to draw your attention to the Safe Harbor statement included in today's press release. During this call, we'll make statements related to our business that may be considered forward-looking within the meaning of Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts are forward-looking statements, including those regarding management's expectations of future financial and operational performance and operational expenditures, expected growth, and business outlook, including our financial guidance for the fourth fiscal quarter and full year 2020. Forward-looking statements reflect our view 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 our Form 10-Q, which will be filed with the SEC this afternoon for a discussion of the risks and uncertainties that could cause actual results to differ materially from expectations. During the course of today's call, we'll refer to certain non-GAAP financial measures as defined by Regulation G. The GAAP financial measure most directly comparable to each non-GAAP financial measure used or discussed, and a reconciliation of the differences between such measures, can be found within our third quarter 2020 earnings press release in the Investor Relations section of our website. Now, it's my pleasure to turn over the call to HubSpot's CEO and Chairman, Brian Halligan.

Brian Halligan, CEO

Thanks, Chuck. Good afternoon, folks. Thank you for joining us today. While none of us could have foreseen the difficult path this year would take, as we enter the final quarter of 2020, I'm grateful for our customers, partners, and employees that have grown through it with us. Despite this challenging environment, HubSpot has grown very nicely. Demand trends have continued to strengthen in the third quarter as more companies digitized their end-to-end customer experience and built modern flywheels. Revenue growth was 32% in Q3, and non-GAAP operating margin was 7%. We had a record total customer growth of 39% year-over-year, surpassing 95,000, while multi-product adoption has also continued to grow nicely, representing over 45,000 customers. These customers have also become more embedded in the HubSpot ecosystem, as we reached nearly 2 million cumulative platform integrations. The year is not over, but I believe the growth we've seen in the third quarter is both a story of digital transformation tailwinds combined with excellent execution by our teams to build and deliver a terrific product for our customers. A big focus for 2020 is on building a CRM platform that couples an increasingly powerful enterprise back-end with an intuitive consumer-grade front-end. This is a rare combination unique to us in the CRM industry. That rare combination is a result of a few things. First, we hand-crafted HubSpot on a set of internal primary colors: reporting, content, messaging, data, and automation. These primary colors are combined to create our hub, which all work the same intuitive way. This is in contrast to traditional CRMs, which are coupled together through acquisition. Second, we have a large multi-year investment in user research and design that gives HubSpot that consumer-like feel. Third, our entire company is laser-focused on delighting our customers. Culturally, over the last few years, we've moved from a funnel mindset to a flywheel mindset, where our growth rate is heavily influenced by the value our customers are getting from our offering. The really exciting thing that happened since we spoke last was the release of Sales Hub Enterprise, which leverages these primary colors as custom objects, proposals, advanced sales automation, and integrations like NetSuite, QuickBooks, and Xero to our CRM. This release was huge for our customers and partners; in particular, the addition of custom objects changes the game for many of our customers. Custom objects were a significant investment for us that took well over a year to develop. Prior to this release, our customers had to fit their business model into a relatively rigid object model. Now, our customers can set our object model around their business model. This was a significant barrier for scaling businesses that we've knocked down. One customer, LegalZoom, an early Sales Hub Enterprise adopter, praised this intersection of power and ease by saying they have had 100% user adoption and couldn't be happier. Now, it's still early days, but we had a strong start with sales of enterprise net new AOR, reaching a record high in October. There is still a lot of uncertainty in the world today, so it's hard to predict the future, but one thing I'm certain of is that our approach to building products that delight customers is going to keep paying off. I want to thank you for your time so far today. We're proud of the momentum we've achieved in Q3 and remain optimistic and focused on closing out the year strong. Now, I'll hand things over to Kate to take you through our Q3 financial and operating results in more detail.

Kate Bueker, CFO

Thanks, Brian. Let's turn to our third quarter financial results and our guidance for the fourth quarter and full year 2020. Third quarter revenue growth re-accelerated to 30% year-over-year in constant currency and 32% as reported. Q3 subscription revenue grew 32% year-over-year, while services revenue increased 12% year-over-year on an as-reported basis. Domestic revenue grew 20% in Q3, while international revenue growth was 39% year-over-year in constant currency and 40% as reported. International revenue represented 44% of total revenue in Q3, up 3 points year-over-year. Deferred revenue as of the end of September was $259 million, a 27% increase year-over-year. Calculated billings were $246 million in Q3, up 33% in constant currency and 38% year-over-year on an as-reported basis. Earlier in the year, we introduced proactive measures to provide customers and partners the flexibility needed to remain productive and engaged in parts of the HubSpot ecosystem. As I shared at the Analyst Day, we saw the vast majority of these COVID customer relief requests in the first half of the year. Overall, we continue to see a small number of new requests, and the retention of our customers at the end of the short-term plans remains strong. We continue to watch these trends carefully, particularly given the recent uptick in global COVID cases. We also saw continued strength in demand from new customers during the quarter. We ended Q3 with over 95,000 total customers, up 39% year-over-year. Net customer additions were nearly 9,000 and set another company record, driven by broad strength across the business, although we continue to see notable growth in our starter growth suite customers. Average subscription revenue per customer of roughly $9,700 was up a few points sequentially but down year-over-year, as a result of the strength that we've seen at the low end of the portfolio. Total revenue retention was greater than 100% in Q3. While retention benefited from the performance of customers upgrading at the end of short-term discounts, revenue retention would have remained above 100% without this benefit. The remainder of my comments will refer to non-GAAP measures. Third quarter gross margin was 82%, flat year-over-year. Subscription gross margin was 86%, while services gross margin was negative 20%. Third quarter operating margin was 7%, up 1.0 compared to the same period last year. Operating margin in the quarter exceeded our expectations, primarily as a result of strong revenue performance. At the end of the third quarter, we had nearly 4,000 employees, up 20% year-over-year. Net income in the third quarter was $40 million or $0.28 per diluted share. CapEx, including capitalized software development costs, was $30 million or 6% of revenue in the quarter. We expect CapEx, as a percentage of revenue, to be 6% to 7% in 2020. Free cash flow in the third quarter was $25 million, driven by strong business performance. As a result, we're increasing our expectations for full year 2020 free cash flow to approximately $60 million. HubSpot ended the quarter with $1.2 billion of cash and marketable securities. We remain confident that our strong balance sheet will provide us with the financial flexibility to invest for the long term. And with that, let's dive into guidance for the fourth quarter and full year of 2020. For the fourth quarter, total revenue is expected to be in the range of $235 million to $237 million, up 27% year-over-year at the midpoint. Non-GAAP operating income is expected to be between $13 million and $15 million. Non-GAAP diluted net income per share is expected to be between $1.13 and $1.15. This assumes 49.6 million fully diluted shares outstanding, and for the full year of 2020, total revenue is expected to be in the range of $866 million to $868 million, up 28% year-over-year. Non-GAAP operating income is expected to be in the range of $63.5 million and $65.5 million. Non-GAAP diluted net income per share is expected to be between $1.13 and $1.15. This assumes 48.7 million fully diluted shares outstanding. As you adjust your models, keep in mind the following. At current spot rates, we expect a 2-point FX tailwind to Q4 reported revenue and now expect a neutral FX impact to reported revenue for the full year of 2020. We have delivered modest operating margin leverage in 2020 as a result of our strong business performance, coupled with some cost savings from our shift to remote work. At our Analyst Day, I reiterated our commitment to investing for the long term and indicated that we expect to increase our R&D spending as a percentage of revenue. As a result of this increase, coupled with a return to a more normal level of employee spend over the next year, we do not expect to deliver operating margin leverage in 2021. We are still early in our planning process, so we will share a more detailed outlook for profitability when we report our Q4 results. The investments we're making in both our product and go-to-market teams are paying off and will position us well to grow in 2021 and beyond. And with that, I'll hand the call back over to Brian for his closing remarks.

Brian Halligan, CEO

I'd like to close by thanking my leadership team and all the HubSpotters out there who are listening tonight. It's been an exceptionally challenging year. You all have stepped up during these tough times with great execution and terrific resilience. I feel lucky to be on your team. Okay, operator, let's open it up to some questions.

Operator, Operator

Your first question comes from Mark Murphy from JP Morgan. Please go ahead.

Mark Murphy, Analyst

Yes, thank you very much and congrats on a very special performance. Brian, I was thinking back to inbound; you had commented that this is the year that you started adding legitimate power to the platform and now we're hearing so much discussion of custom objects. Are you surprised at how quickly the enterprise functionality has resonated in this kind of environment? And do you see more activity at the upper bound of your target market in terms of company size?

Brian Halligan, CEO

Hey Mark, I read your report when it came out; I thought it was great. I'm not that surprised. There's been a lot of hard work that's gone into the platform level or custom object side of things, and it's been really going on for a long time. This was the year we really wanted to strengthen that enterprise tier of our products, the products that we sell into like 200 to 2000 level customers. We knew for customers of that size, a major objection from existing customers who were graduating and new potential customers was 'Gosh, we get this evolving business model, but we have to jam our business model into your relatively fixed object model.' It's sort of rigid the way we structured it, and what custom objects give the ability to do is wrap HubSpot in our object model around an evolving and more complicated business model. So this makes us a better fit, for example, for a university; there can be a student object. For a SaaS company, there can be a subscription object. For a manufacturing company, inventory could be an object. It just gives you a ton more flexibility if you're a scaling company. And so I'm not shocked that we're getting good adoption. It's a loud noise from our customers for us for a number of years, and so we undertook that project last year, and it came out great. The nice thing about Sales Hub Enterprise and about the custom object is they're part and parcel of HubSpot, so they inherit all the great automation and reporting. They're really powerful and easy to use, so I guess I'm not shocked.

Mark Murphy, Analyst

Okay, great. Kate, I have a mathematical question for you. At the Analyst Day, it was mentioned that Marketing Hub was over $600 million, growing at least 20%, and Sales Hub was over $160 million, growing 60%. Based on that, it looks like you're on track to book almost as much new business with Sales Hub as you are with Marketing Hub, which is becoming quite close, almost like a twin-engine situation. Is it reasonable to think of it that way at this point, or could we see a crossover in the next few years? I also considered that Brian mentioned October was the highest level you've achieved for Sales Hub Enterprise net new IRR, not September as I initially thought. I'm trying to connect all the dots and get your perspective on this.

Kate Bueker, CFO

I think you're going to see enhancing of the flows across the Marketing Hub and the Sales Hub over time. I think they're both great engines for the company and I think they're both going to be big growth drivers to come.

Operator, Operator

Your next question comes from Alex Zukin from RBC. Please go ahead.

Alex Zukin, Analyst

Hey guys, thanks for taking the question. Maybe the first one on what you're seeing with respect to sales cycles, the demand environment in the pipeline, how is that different from, call it, 90 days ago and even since inbound, what you saw come out of inbound? Because it does feel like some of the results are posting the billings numbers. It does feel like there is a bit of acceleration in terms of the priority set that you're solving for customers. So just any high-level comments, and then I've got a quick follow-up on everybody's favorite topic of billings.

Brian Halligan, CEO

Hey, Alex. It's an interesting year. If I think about this year, the year started really strong in January and February. We were very bullish about this year internally; we had done a lot of hard work last year to get ready. Starting with the kind of deal end of March to early June, we encountered huge headwinds, but starting at the end of June, that headwind turned into a tailwind, and that tailwind blew all through Q3 and into October too. I'm pretty happy with where we're sitting at the moment; things are going really well, and again, I think we're very well-positioned to help our customers through this and get some credit for that. I also want to give some credit to a lot of hard work from the team in execution over the last couple of years to put us in this position, so it's a little bit of both. It's hard to say what will happen with the election and the shutdown, and I'm not sure what's going to happen over the next six months. I'm pretty optimistic; the pipeline looks good, customers are quite happy, the value prop is quite strong, and our products are getting better. Customers need to move from an outbound model to an inbound model, from outside selling to inside selling, from offline to online. Our product is a really, really good fit for that type of need. So I'm feeling quite positive these days, actually.

Alex Zukin, Analyst

Brian, as you look ahead to next year, it's clear that you'll be investing to capitalize on growth opportunities. Many investors and companies are considering comparisons; some metrics are easing while others are becoming more challenging, depending on the type of software being sold. However, it seems that, given your current trajectory and the functioning sales cycles, everything is aligning well. Is there a chance that if stimulus arises, your growth could actually pick up as we move into next year? How should we approach that, and are there any connections with the variables around billings that we should be aware of for the upcoming quarter and beyond?

Brian Halligan, CEO

I honestly don't know if the stimulus will come or what its impact will be on HubSpot. What I focus on is what I can control and influence, which includes our employees, customers, and partners. I believe we are in a strong position. You have been tracking our company for a long time; I feel confident about where we are. Reflecting on when we first went public, it feels distant as we transitioned from a marketing app to a CRM platform, and we are making significant progress in that journey. We've invested heavily, and while it's still early, our vision for a modern CRM is substantial. We've accomplished a lot and there is much more to come. Overall, I feel quite optimistic these days.

Alex Zukin, Analyst

And then Kate, anything on billings that we should be aware of, given the different terms for some of your products now in the market?

Kate Bueker, CFO

I guess last time we talked about compression and the upfront duration of billings. I think we have a different conversation to have this quarter. I would start frankly with the reminder that the FX is different on billings than it is on revenue. So there was a 5 point benefit to billings in Q3. The number I would really focus on is that constant currency billings growth of 33%, and there are a couple of things I would point out. Strong business performance is going to drive strong revenue growth and strong billings growth. But quarter-over-quarter, we did see an improvement to the billing duration, and some of that is a mix where we saw some strengths in Marketing Hub and the Pro and Enterprise SKUs. We also saw a bit of a tailwind, just like we saw with retention, the return to normal billing or some of the customers that were under these short-term COVID discounts as they came out the other side. I would advise just long-term the great anchor point really still is constant currency revenue and constant currency billing tracking.

Brian Halligan, CEO

Alex, we're getting some feedback there so we had to mute your line. Thanks for the questions. Operator, if we could take the next one.

Operator, Operator

Your next question comes from Samad Samana from Jefferies. Please go ahead.

Samad Samana, Analyst

Hi, good evening. Thanks for taking my question. Let me echo, the very strong results; it was great to see. Kate, maybe first question for you. It was a really impressive performance, and net adds are up quite a bit quarter-over-quarter, but ASRPC also increased quarter-over-quarter. So is it fair to assume that the company either had more Pro and Enterprise signings as a percentage of the mix in Q3, or was that a function of something else?

Kate Bueker, CFO

Thanks for the question. We are obviously really happy with the new customer adds for the quarter. I would say that the starter growth suite was another quarter of really strong adds, and so that was a big driver of the customer count growth in Q3. But one of the things that I liked about the quarter was that we also had really strong adds in the Professional and Enterprise additions, frankly, both in Marketing and in Sales. I would caution us not to expect 8,000 or 9,000 new customers every quarter, but it was a great quarter for new customer adds. As far as ASRPC, some of the sequential uptick is going to be attributed exactly as you expected to a bit more in the Professional and Enterprise customer adds. I think there is also a little bit of help there from the customers coming off of the short-term discounts and going back to more normal pricing. I would just finish by saying we talked about how we expected the ASRPC was going to be under pressure for the next few quarters at least, as the customer mix shifts to that starter tier. I think that still holds true.

Samad Samana, Analyst

Okay, great. That's helpful for modeling. And then, Brian, maybe just a follow-up for you, if we may be zoom out, we've now been stuck at home for almost 7 to 8 months. But what we've seen for you guys is even excluding the upgrades off of discount or pricing, that a pretty strong net retention. So it seems like existing customers are buying again and adding additional products. Could you maybe help us just as stepping back, what are customers prioritizing as they adjust to our new reality particularly heading into 2021, and how that's translating into selling back into the base?

Brian Halligan, CEO

I believe many companies have realized that digitizing their go-to market strategies is essential, and very few people oppose this idea today. A decade ago, when we first began, many thought we were misguided with our focus on inbound marketing. Now, this approach is quite common, and I think the COVID pandemic accelerated these trends, particularly with people interacting with potential and existing customers from home. It's clear that many are embracing the digitization of their go-to market strategies, and HubSpot is in a strong position to facilitate this. We have developed a platform that aids in digitizing the entire go-to market process, establishing new modern operating models, and enhancing customer experiences. Therefore, it's not surprising that we've seen great success. I genuinely believe we are well-positioned moving forward; the progress we've made in our product and the enhancements to our go-to market strategies have been significant over the past year, and we are seeing positive outcomes from those efforts.

Samad Samana, Analyst

Great, thanks for that. It's good to see all the investments paying off. Have a great night.

Operator, Operator

Your next question comes from the line of Stan Zlotsky from Morgan Stanley. Please go ahead.

Stan Zlotsky, Analyst

Thank you very much. While reading the press release, one point that stood out to me is that some of the benefits you are experiencing right now are due to the ongoing digital transformation of the mid-market. Is this how you perceive your current position? You certainly have a strong solution for the SMB sector, and that is your primary focus in that area, but are you really concentrating on the mid-market and noticing the most growth in terms of incremental bookings and billings coming into the company?

Brian Halligan, CEO

That's a good question. We roughly break our segments down as 2 to 20-employee companies, which we call small; 20 to 200 employees, which is mid; 200 to 2000, which we call enterprise. We have perfect product market fit and perfect product go-to-market fit in that middle 20 to 200 employees, and we do extremely well there. I think what you're seeing this year is nice encouragement on product market fit and go-to-market fit a bit in the small to enterprise segment. On the small side, we did that repackaged starter suite at $50 per month; boy, that sounds really well. We're very happy with what's going on there. Customers are signing up; they have been retained nicely, they're upgrading. At the same time, we've seen a lot of improvements to our product lineup in that 200 to 2000 segment. So I see us at this time as being focused on start-up and scale-up. What I don't like to do is describe HubSpot as for a small business. I don't think that's really us. We're not aimed at little tiny companies; we want to be the number one CRM for scaling companies, so that's kind of where we fit in the market. It's similar to where NetSuite used to sit in the market. I think NetSuite's market is a lot smaller in the grand scheme of things than ours, but it's for that start-up and scale-up company between 2 and 2,000 employees.

Stan Zlotsky, Analyst

Perfect, thank you. And then if I could sneak in a quick follow-up. So, how are you guys thinking about Q4 guidance? On one hand, we're clearly seeing extremely strong results in Q3. And Brian, you talked about the tailwinds that you've been seeing through the summer and then all the way through October, but at the same time, we are seeing COVID cases spiking, and you mentioned in your prepared remarks that is a consideration. So, how did you guys reflect that in your Q4 guide? Maybe that's a question for Kate. Thank you.

Kate Bueker, CFO

Yes, I think we've been trying to take a very consistent approach for many years in terms of how we think about guidance. In the short term, our model is pretty predictable, and we're providing guidance now just for the next three months. We're a month in; so the next two months. To us, it's a bit of a balance of looking at business performance and then looking at potential outcomes. We're confident in the numbers that we put forward.

Operator, Operator

Your next question comes from the line of Walter Pritchard from Citigroup. Please go ahead.

Drew Foster, Analyst

Hi, this is Drew Foster, and thanks for taking the questions. I have two; at your Analyst Day, you highlighted that some customers were a key factor in deciding to go with HubSpot was that they were able to consolidate systems with you, so to what extent is the desire to consolidate front office technology going to reliably be a growth driver for you, Brian? And I'm wondering if you've noticed that trend in any specific demographics of customers in the common theme and whether you've drawn out any specific plays around addressing that opportunity across different combinations of your hubs, and I will follow up.

Brian Halligan, CEO

That's a really good question. There has been a lot of chatter about this, but there is an ad cut out of a 1998 newspaper. It’s an ad for Radio Shack, and in the ad, there are like 50 different devices, from an alarm clock to a compass, and next to it is an iPhone, and the iPhone does all that stuff now. I think that ad is spot on. That’s sort of like HubSpot. People have all these systems that they've kind of come together over time; they don't weave well together. We're seeing people streamlining their whole set back on HubSpot. Our integrations are very elegant; they're kind of like Apple's integrations, they're much tighter. So it's a little bit similar to that. We're seeing a fair amount of that here. Particularly, as we move from marketing to a full CRM platform, the platform can manage the entire customer journey from a complete stranger to a delighted customer. People have hundreds of applications managing that, and then they come to HubSpot with the mindset of managing that experience through HubSpot while plugging a few applications into it.

Drew Foster, Analyst

Okay, got it. And as I'm thinking about ARR growth for your newer hubs and compare that to the growth curve of where Marketing was at this time. Obviously, the newer hubs have had the benefit of the cross-sell vector that marketing didn't have for some period of time. So if we do a qualitative exercise and exclude the benefit of cross-sells for those newer hubs and observe the success of those hubs on their own merits, what evidence or trend gives you confidence that you're shaking things up in those markets the same way that you did with marketing?

Brian Halligan, CEO

That's a good question. I think back when we released our Sales Hub products several years ago, we started with a product called Signal. It’s only gotten better, and it got a lot better a month ago with the Sales Hub Enterprise release. If I look at that product, most of the early sales were really cross-sell sales. Now, that product is as much a front door to HubSpot as it is the side door from Marketing Hub. So it's a lot – people come in on Sales Hub and then they buy Marketing Hub, or if there's an existing Marketing Hub, that's when they buy Sales Hub. That took a while to develop, but it's humming right now; it's a good-sized business, growing fast. I think we're going to see the same thing on Service Hub and the same thing on CMS Hub. A lot of it now is selling into existing customers, but those products are getting a lot better, and I think those will become front doors over time as well.

Operator, Operator

Your next question comes from the line of Arjun Bhatia from William Blair.

Arjun Bhatia, Analyst

Hi, guys, thanks. And I'll echo my congrats on the quarter. Kate, if I can start off, I know we've touched on this a little bit last quarter, but is there any update that you can give us on this COVID cohort of customers that are coming in on starter in terms of upgrade rates, churn, landing point, anything on that front would be helpful now that we're 90 days from when we last had this conversation.

Kate Bueker, CFO

Yes. I think the trends are very much the same as the ones we talked about in Analyst Day, and frankly, on the last earnings call. We continue to see those big starter cohorts. The vast majority of those starter cohorts are new to HubSpot versus customers that are downgrading or moving from another SKU. They are, on balance, similar in size to the customers that we saw signing up for our other starter SKUs before this package was introduced. They are upgrading at a rate that is similar, maybe a little bit lower than what we had seen historically, but at a rate that's healthy enough that we're excited about the opportunity there.

Arjun Bhatia, Analyst

Okay, that's very helpful. And Brian, maybe one for you – not to beat a dead horse on 2021, but just curious. Obviously, this has been a tough year for everyone. I'm curious about what you're hearing from your customers in terms of how they're thinking about marketing budgets and how those might change next year. Do you think there will be an elevated focus on digitizing marketing strategy as go-to-market continues? Or do you think we see that moderate a little bit going into next year?

Brian Halligan, CEO

It's hard to predict the future, and that is a very hard thing. I just say, connecting with my sales leaders and service leader over the last couple of days, people are feeling pretty good. Demand is strong, customers are buying more, and new accounts are coming in. I feel like our products are more and more competitive. It’s hard to know what happens if design lockdown or something really bad happens with this election, but feeling pretty good overall.

Operator, Operator

Your next question comes from the line of Ryan Macdonald from Needham. Please go ahead.

Ryan Macdonald, Analyst

Hi, thanks for taking my question and congrats on an excellent quarter. I guess, Brian, first one for you. Given that CMS Hub sort of fully launched in the midst of the pandemic, it feels like inbound was a bit of a coming-out party for the new product. But just curious to see sort of as you process the responses and feedback from inbound what you're hearing in terms of interest in adoption for CMS Hub and what sort of the mix you're seeing in terms of existing customers that may have been using the add-on functionality to Marketing Hub initially wanting to upgrade versus net new customers into the platform.

Brian Halligan, CEO

Hey Ryan. I’m hearing great things about CMS Hub. It’s an interesting industry; the content management system industry, and people probably—investor talk a lot about GoDaddy, but that really the dominant players in our part of the market even up from us are open-source projects that are not as well known to investors because there is no public company comp and they don’t really advertise much. We definitely compete; we are going to compete in the mid-market with the large open-source product called WordPress. I think when we really win over the long arc of this thing is there is tremendous power when you combine the content management system with a customer relationship management system. That's a one plus one equals three experience for your business. Those aspects are combined, and it’s going to be really, really cool. The adoption of CMS has been solid; the business is growing nicely, and partners, in particular, are really excited about it. Over the long haul, there is a collided scope of opportunities; that will be great for our customers and for us together.

Ryan Macdonald, Analyst

Got it, thanks. And then the follow-up; obviously, the environment is evolving quickly, but any sense? Are you hearing anything recently internationally with sort of over the past few weeks with Europe seemingly going back into a lockdown, or any impact to the business at all?

Brian Halligan, CEO

Yes, we're asking the same thing. I checked with my European leaders, and right now it seems okay. It's hard to say what happens two, three, or four weeks from now, but the demand seems pretty solid over there. The execution has been really strong again. I think our value prop is super strong, so it's hard to predict what happens in the future, but feeling pretty good right now.

Operator, Operator

Your next question comes from Ken Wong from Guggenheim Securities.

Unidentified Analyst, Analyst

Hi, this is Nancy for Ken. Thanks for taking the question. Just two questions. First on retention; do you see a risk for that to track back down after if lockdowns start again? Or have your customers been able to figure out how to kind of work through the new normal? Or I guess on the flip side, is there more headroom to this number to improve as we get further from the short-term discount?

Kate Bueker, CFO

Yes. I mean Q3 was a very strong retention quarter for us. I said in the prepared remarks that retention was comfortably north of 100%. I also said that absent the tailwinds we see from customers coming off of those short-term discounts, we still would have been comfortably above 100%. We are through the majority of those, and so I think retention is strong; we're certainly excited about that. I would particularly note that we are seeing really strong retention on a customer dollar retention basis, which is that gross retention number. More of our customers are sticking around with HubSpot.

Unidentified Analyst, Analyst

Great, that's helpful. And just hang on to that. So have customers who previously might have contracted seats or downgraded SKUs expanded back up yet?

Kate Bueker, CFO

Yes. It's hard to say; I think when you look at the overall net upgrade rates that we're seeing in Q3, they are dramatically larger than what we saw in Q2, which would lead you to believe that, as a whole population, our customers are on net upgrading more.

Operator, Operator

Your next question comes from the line of Kirk Materne from Evercore ISI.

Kirk Materne, Analyst

Thanks very much, Brian. What do you think about the opportunity with the Sales Hub, the Enterprise Sales Hub? I would expect that the easier land is to continue to grow with your customers that might have historically grown out of your technology versus going after new customers, but that might be wrong. So just kind of thinking about when you talk to your sales leaders—is it about trying to go and rip and replace? Is it about expanding with existing customers already with you? I guess how are you thinking about the balance because I imagine the sales cycles are very different with those two conversations?

Brian Halligan, CEO

Yes, there are a few layers to it. I think that the lowest layer is retaining those customers longer. We have customers that outgrow us, and the reason they outgrow us is partly due to things like custom projects. The big reason why somebody would grow out is retention. We want to retain them as they go from 200 to 2000 employees—that's a good one. Then just winning more deals. People hesitate to buy HubSpot if they're going to scale up. We are very much HubSpot for scaling companies, and I think the answer is yes now. Between what we're doing on the functionality side and what we're doing in the business model side, we’ve got a market that is much more attractive. The third layer is ripping and replacing, and that's a harder thing to do. It's certainly happening, and I hear about them when it does happen—it's exciting when that occurs. But it's probably the third layer on the cake. Overall, it's going well; people are really excited about our customers, our partners, and sales reps. It’s getting us in a lot more conversations.

Kirk Materne, Analyst

That's helpful. And then one sort of more maybe higher-level question for you. When you talk to others in the broader CRM space and maybe at the enterprise level, this concept of a customer data platform continues to come up, and we've seen M&A around this. Do you think that the CMS combined with your marketing technology solves the customer data-centricity discussion for you all, meaning, and know why a small company would want a customer just as well as a big company? Is that conversation coming up, and do you think you’re able to get at that with your existing technology now, or is that something that you're willing to partner with others on?

Brian Halligan, CEO

People do think of HubSpot as their central store for all their data. Over time, we want to expand that; it's possible to integrate all your systems in HubSpot, take them back and forth. That's one of the reasons we acquired a company; we want them to report on all that. HubSpot is positioned over the very long haul if you want to use the term ‘customer data platform,’ I want HubSpot to be their center of gravity, which enables us to create personalized experiences, whether it's on our tool or other tools that they use, integrating everything from Zoom to Google AdWords and building on that.

Kirk Materne, Analyst

That's helpful. Thanks and congrats on the quarter.

Brian Halligan, CEO

Thank you.

Operator, Operator

Your next question comes from the line of Koji Ikeda from Oppenheimer. Please go ahead.

Koji Ikeda, Analyst

Great, thanks for taking my questions. Congratulations on a really great quarter. First off, I wanted to thank Brian for bringing up that Radio Shack ad picture; that just popped in my head right now, so that was just methodology. Thank you for bringing that up. I wanted to ask you about the Sales Enterprise version, especially with custom objects—could you talk a little about what custom objects mean from a customer lens? Does it enable them to possibly replace any existing applications, or does it allow the customer to potentially stay longer within the HubSpot ecosystem as the business scales before having to look outside the HubSpot box for additional features?

Brian Halligan, CEO

The way I would describe it is, let's just say you are a university and you're using HubSpot. You just want to call your prospective student leads and when you call your students that are paying, you call them customers. This is unnatural! You're jamming your business model into HubSpot's rigid object model. What you want to do is to match the way your entire front office system or CRM system works with the way your business works. That means you've got a student and a student is an unusual model; it's different than a typical customer because the student convenes and lasts four years. So custom objects inside of HubSpot allow you to report on that and create workflows around it in certain ways, enabling you to do a whole lot more. When a company comes in, they buy HubSpot Sales product, Marketing product, and they're super happy with it. As the firm scales up to 500 to 600 employees, their business model gets complicated, and they get irritated because they have to jam it back into HubSpot. As their business model evolves, HubSpot will evolve with them and scale with them. That makes sense?

Koji Ikeda, Analyst

Yes, totally makes sense. Thank you for that. I wanted to just ask you one more follow-up here on the CMS Hub. You mentioned open source and WordPress, but what about Drupal? Can you compete with Drupal right now, and what’s the longer-term vision for the CMS Hub to be competitive against Drupal deployments?

Brian Halligan, CEO

No problem; we're pressing against Drupal, both like the big open-source projects. They've been around for a while, and they're powerful products, but they kind of lie at the upper end of the market. We took a very different approach with HubSpot where we’re purely out-of-the-box—a very modern approach to building it. Overall, I'm not trying to downplay the value of Drupal. I see a lot of large enterprises using it. If you watch the trajectory of CMS, we're moving up-scale. Our key competitive advantage will be the power and benefits seen from combining the CMS with our marketing and sales technology.

Koji Ikeda, Analyst

Got it. Thanks for taking my questions.

Operator, Operator

Your next question comes from Siti Panigrahi from Mizuho.

Unidentified Analyst, Analyst

Hey, this is Michael on for Siti Panigrahi. Congrats on a great quarter once again. I want to dive in quickly on International. You saw a nice acceleration in the quarter. Can you point to anything in particular that is driving success abroad? Moving forward, can we expect that to maintain the type of strength even with the ongoing shutdown?

Kate Bueker, CFO

Thanks so much for the question. It's interesting that you called that out. I think that the performance is pretty broad-based. Yes, we saw some acceleration or re-acceleration in international growth, and we also saw a re-acceleration in domestic growth. So I think it was across hubs and geographies that we saw really strong performance.

Operator, Operator

Your next question comes from the line of Brent Bracelin from Piper Sandler. Please go ahead.

Unidentified Analyst, Analyst

This is from Jefferies on for Brent. I was wondering in terms of the traction in the enterprise and professional customers this quarter on the higher-end sort of customer; how long were they in the funnel? I'm wondering whether these customers were looking at digital engagement products more even since the early pandemic and kind of finally converted in Q3, or are these new customers that you're engaging with in the quarter and converting in Q3 alone? Just trying to understand that there are customers out there that are enduring the pain of a traditional go-to-market and then they have to make changes in the back half of the year.

Brian Halligan, CEO

Honestly, it's a little bit of both. A lot of people have been looking for a long time and finally bought. There are some shorter cycle MRR increases that probably came in within the month of that purchase. It’s not up a lot. I think it's a little bit more broad-based than people thought. I also think part of our momentum is all the stuff going on in the world has people really thinking about digitizing their go-to-market, but even if this is a normal year where nothing happens, I think we would be having a good year. We are set up well, so I think it’s a little bit of both.

Operator, Operator

That was our last question. At this time, I will turn the call over to Brian Halligan, CEO and Chairman for closing comments.

Brian Halligan, CEO

Thanks to all of you for joining us today. I look forward to talking to you soon.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.