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 Q3 earnings conference call. All lines I will now turn the call over to Chuck Glashing, Director of Investor Relations for HubSpot, you may begin your conference.
Thanks, operator. Good afternoon, and welcome to HubSpot third quarter 2018 earnings conference call. Today, we'll be discussing the results announced in the press release that was issued after the market closed. With me on the call this afternoon is Brian Halligan, our Chief Executive Officer and Chairman and Kate Bueker, our Chief Financial Officer. Before we start, I'd like to draw your attention to the Safe Harbor statement included in today's press release.
During this call, we'll make statements related to our business may be considered forward looking within the meaning of 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 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 4th fiscal quarter 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 August 1, 2018, for a discussion of the risks and uncertainties that could cause actual results to differ materially from expectations. During the course of today's call, or 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 each non GAAP financial measure and the comparable GAAP financial measure can be found within our third quarter 2018 earnings press release in the investor relations section of our website at hubspot.com. Now it's my pleasure to turn over the call to hubspot's CEO and chairman, Brian Halligan.
Thanks, Chuck, and good afternoon folks. Thank you for joining us today as we review HubSpot's third quarter 2018 earnings results Let's get right to it. Q3 was another strong quarter for HubSpot with 35% revenue growth, 4% non GAAP operating margins and over 52,000 customers, growing 40% from the prior year. These very strong numbers are the result of 2 big plays HubSpot began investing in a couple of years ago that are starting to pay off. 1st is our investment in growing HubSpot from a single app company to a full suite company dramatically increasing the value we deliver to a customer.
The second is our move from a funnel to a flywheel model to operate our business. The old funnel model views customers as an output, while the flywheel model recognizes the central role customers themselves play in driving your growth through upgrades and especially word-of-mouth. The flywheel mentality also puts a lot more emphasis on reducing friction in the customer experience, The great news is that our performance over the last few quarters gives me more confidence than ever their investments in suite and our move towards the flywheel are paying off already and will position us for continued growth in years to come. Let's dig into the sweet play, Back in the spring, we further expanded our offering of products with the introduction of Service Hub. This move into the Service segment was particularly exciting because it gave us an even better way to add value to our customers and help them to create their own remarkable customer experiences.
A typical customer often starts with just one of our hubs, usually marketing or sales, and then later adds a second and a third hub. A couple of years ago, about 20 percent of our revenue came from multiproduct customers. Since then, that percentage has doubled with over 40% of our revenue now coming from multi product with room to grow even much higher. By the way, we refer to this type of hub expansion at HubSpot as east west expansion, our first of 3 recent product expansion vectors. At our inbound event in September, we released several new and upgraded products that were a major part of our north in Southward expansion.
To the north, we made a massive upgrade to our Marketing Hub Enterprise. And also introduced enterprise additions of sales in service hubs. To the south, we made very important enhancements to our Marketing Hub starter product and also released a new starter edition for service up to complete the starter suite, really, really good stuff. Let's dig into the northern expansion of our suite with the introduction of the robust enterprise tier, we're better able to scale with customers as they grow. Now if you go back to 2015, HubSpot was a natural fit for customers in the, let's say, 20 to 200 employee range.
I'd give us an A for selling into and delighting a fifty person company back then. We nailed that segment. But things used to get a little bit tougher when customers grew and scaled up to a couple thousand employees for us. But now our new enterprise suite positions us well to delight customers with 200 employees all the way up to companies over ten times that size. As we highlighted in inbound, HubSpot with our 2594 employees in eight offices around the world has recently swapped out our existing CRM and now runs almost everything entirely on HubSpot.
We use our own CRM, Marketing Hub, Sales Hub, Service Hub in a wide range of integrations plugged in. We have a lot of headroom to grow in lockstep with all of our customers. In fact, this quarter, we landed our first multi year contract with a total contract value of over $1,000,000. Now I know some of you may be thinking Brian's finally going to the enterprise. He's moving up market into the enterprise.
I knew it, but I'm here to tell you That's not the case. This particular deal was struck with a customer with under 2000 employees, proving there's a whole lot of value to generate by serving the mid market. To me, this deal is a strong signal that our Northern expansion is working and as our midsize customers get their own flywheel spinning, our products can nicely scale alongside them. We're also expanding at the Southern end of the market at Inbound, we introduced a new starter version of Service Hub and made a key enhancement to Marketing Hub starter by adding email functionality. The market has responded particularly well to this new Marketing Hub starter product.
We've seen some really strong early demand. Now this starter tier is a big part of how we're implementing the flywheel. Friction is the enemy of any flywheel. So we're obsessively looking for ways to remove friction from the customer buying experience. Our starter products do just that.
The majority of our starter products are now purchased touchlessly. This is great for customers who increasingly want to self serve. It's also great for HubSpot because the cost of acquiring a starter customer touchlessly is materially lower than our average customer acquisition costs, removing friction from the customer buying process is fueling our flywheel. Okay. So that was a quick overview of the slew of new products we announced in 2018, the biggest year of new product announcements in HubSpot history, or R and D investments they're really starting to pay off.
One of the things I still love about working in HubSpot is it still feels like the early innings of our business. We've made great progress over the last couple of years, but there's much work left to do to continue to further delight our customers and to reduce friction in our flywheel. We look forward to continuing to dig in on both these fronts in 2019. Another area of investment for us that's nascent but has high potential in 2019 and beyond is opening HubSpot up and letting our customers connect all of their other applications through us. Moving us from an all in one suite eventually to more of an all on one platform where customers use HubSpot to orchestrate their entire customer experience with our applications and other vendors as well.
Okay. Now I'll turn it over to Kate to take us through our financials and our guidance.
Thank you, Brian. Let's turn to our 3rd quarter financial results and our guidance for the fourth quarter. As Brian highlighted, Q3 was a very strong quarter for how spot. We delivered strong revenue growth over $3,000,000 of free cash flow and $5,900,000 of non GAAP operating profit. 3rd quarter revenue grew 35% year over year, driven by 35% subscription revenue growth and 39% services growth.
Constant currency revenue growth was 35 percent in the quarter, up one point over Q2 levels. The sequential increase in constant currency revenue growth is the result of the strong early traction from our 2018 product launches and the benefit of customers, which was up 40% year over year consistent with Q2 growth. Average subscription revenue per customer came in at $9959 which was down 4% year over year and roughly flat with Q2 levels. As I shared at our Investor Day in September, the largest driver product. Average subscription revenue per customer in our sales hub and our Marketing Hub X Starter continued to have positive growth year over year.
International performance also continued to be strong in Q3, with international revenue growth of 52% year over year, on both an as reported basis and in constant currency. International revenue represented 38% of total revenue in Q3 up nearly one point from last quarter. Deferred revenue as of the end of September was $162,600,000, a 35% increase year over year, while calculated billings defined as revenue, plus the change in deferred revenue, was $140,700,000, up 32% from Q3 of last year. Currency movements within the quarter resulted in a headwind in currency, flat to Q2 constant currency billings growth. The remainder of my comments will refer to non GAAP measures.
3rd quarter gross margin was 81.7 percent, up 1 point sequentially and up slightly year over year. Subscription gross margin was 86.5 percent, up 1 point sequentially and up slightly year over year, while services gross margin was negative 13%. Up 7 points year over year. 3rd quarter operating margin was 4.4%, down 1 point versus Q2, and up four points year over year. If you exclude the impact of inbound, operating margins would have increased by 2 points sequentially and 3 points year over year to 7.4%.
As Brian mentioned, we have been investing a lot in R&D and we expect to continue to make investments that we believe will drive long term growth for the business. At the end of the third quarter, we had 2594 employees, up 32% year over year. We had another solid quarter of hiring, and as we discussed in Q2, attrition continues to be favorable, which positions us well to execute on our growth plans. CapEx, including capitalized software, was $8,300,000 in the quarter. Moving on to earnings net income was 7 quarter of 2018.
Total revenue is expected to be in the range of $136,500,000 to $137,500,000. Non GAAP operating income is expected to be Non GAAP diluted net in fully diluted shares outstanding. And for the full year of 2018, total revenue is expected to be in the range of $505,500,000 to $506,500,000, up from our previous guidance of 496.8 to $498,800,000. Non GAAP operating profit is expected to be between $29,500,000 to $30,500,000 up from our previous guidance is expected to be between We expect full year free cash As you adjust your models, keep in mind the following. Currency movements created a 4 point positive impact on reported revenue growth in both Q1 and Q2 of 2018 and was roughly neutral in Q3.
At current spot rates, we expect a foreign exchange headwind
of
we saw a 3 point benefit to non GAAP operating margins from our adoption of the ASC 606 revenue recognition standard. While we anticipate a similar benefit to Q4 non GAAP operating margins, the benefit from capitalizing sales commissions over a longer period of time under ASC 606 will diminish thereafter. To 7% range, which is 1 to 2 points below our historic average. We expect CapEx will return to historical levels next year, primarily as a result of a couple of international facility projects. To close we delivered another strong quarter of operational and financial performance and believe we are well positioned for a strong finish to 2018.
With that, I'll hand the call back over to Brian for his closing remarks.
Thanks, Kate. One of the things that's critical to scaling a company in today's day and age is attracting and retaining great talent. This is an area we've invested tremendously in over time. We've won numerous front over the years, but I was particularly pleased to see last quarter, we were named the number one place to work for employee happiness in the U. S.
By comparably thrilled about that. Another area of continued investment and focus is making HubSpot as diverse and inclusive of workplaces possible. I was happy to see that Fortune Magazine just rated us as the 18th best place to work in the U. S. For women.
We have more work to do on diversity inclusion, but I was pleased to see some recognition on that front. With that in mind, I want to close by thanking all the hub bottters as well as all our customers, partners and investors. Operator, can we please open the call for some questions?
Your first question comes from Brad Sills from Bank of America Merrill Lynch.
Great. Thanks guys for taking my question. Congratulations on a nice quarter. I wanted to ask about just early traction with the enterprise addition, particularly for marketing. I know it's early, but any color you can provide on how just general pipeline and interest has been trending there?
Hey, Brad. It's Brian. I'll take this one. It's going really well. The marketing enterprise in particular, the big upgrade actually happened on November first where we, we released a whole slew of new really compelling functionality.
What I think this does for us is it positions us very well with the company between, let's say, 202,000 employees to win a deal. It also positions us well as customers signed up maybe when they had 50 employees as they scale, they will be able to keep them longer and scale along with them. So Early, early returns are good. The demand is good. As you know, we're raising the price of that product I haven't really heard any pushback on it.
It seems like that was a good move. So feeling great about the early traction on marking enterprise.
Great. Thanks. And one more, if I may please, Brian. Any color on the addition of sales into the marketing base I know in the past, you've made comments that sales, customers are adding marketing, but the other way around Is an area where you've been focusing on potentially improving? Any commentary there would be helpful, please.
Thank you.
Yes, it's actually going really well. Also. We're seeing lots of customers come in starting with marketing and buying sales and lots of customers come in starting with sales and buying marketing. I guess if there was a surprise, it's the number of customers who have come in and bought the whole suite upfront. That's ticked up that's exceeded my expectation.
I've been really happy with that. So going well on that front.
Great. Thanks, Brian.
Your next question comes from Samad Samana from Jefferies.
Quarter. Thanks for taking my questions. Maybe one to start with on the $1,000,000 TCV deal, I'm sure that's going to send out to a lot of people Bryan, can you delve into maybe some more characteristics about that customer? Maybe what products did they did they take? Was the duration of that deal different than a typical HubSpot deal with a customer of that size?
And what convinced them maybe to commit that much to the company by borrowing index? You're going to have a couple of folks.
I was very happy about that. I kind of put it in the it's a kind of neat thing that happened, but I'm not going to start having sort of a checklist on my desk of the number $1,000,000 deals. So we're not gonna reporting the number of $1,000,000 deals, it's not going to be a focus of ours. I thought it was just an interesting proof point to show Yeah, these new enterprise products we came out with are really good and they deliver a ton of value. The company that made the purchase purchase marketing enterprise.
That actually wasn't a full suite deal. There's been lots of nice, full suite deals. So that was a marketing enterprise deal. I don't think we would have won that deal had we not come out with all that new functionality that inbound that we're about to release. So the new features are really working for us.
The company itself is only about 400 employees. So I think this deal is a nice time that even in the mid market, we are delivering a tremendous amount of value for these customers. And they'll likely be a more of these in the future, but we're sticking with our SMB focus. We're not moving into the enterprise. I don't think that would really really overfocused on the number of $1,000,000 deals at HubSpot.
But the product work, the new features are working. People are getting value from it. The sales cycle on that deal is relatively short. And what was interesting about that sale, I was actually involved with that sale was a lot of it was self-service, kind of like what I talked about on stage in inbound. They, they gave the product a good try on their own they, they used our API quite a bit in the trial and really got quite comfortable with it.
And then our sales sales org kicked in and did a fantastic job. Now one note I would give you on that, Sumad, is it's a $1,000,000 deal, but it's a 4 year deal. This isn't a 1 year deal. I want to make sure we don't get over our skis. On $1,000,000 deals at HubSpot.
Great. And maybe just one follow-up on customer hub. We're now about 6 months to that release. Maybe just how does the ramp comparing to sales hub? And is it maybe help us understand how that sales motion and the receptivity to the product with all the bundled fleet prices and etcetera.
And that's it for me. Thanks again.
Just to make sure everyone's got the vernacular, it's called ServiceHub, not Customer Hub. And just for refresh folks, we came out with ServiceHub Pro Edition back in the spring. And then in inbound, we came out with the starter and the enterprise edition. So far, it's gone really, really well. It's ramping faster whatever we are 5 months in.
We're having a lot faster than the sales product did 4 or 5 months in. The product's improving a lot. A lot of people are buying it. I mean, it's still early, kind of like the sales product. It's mostly, if I think of SMB Small, medium sized businesses, it's more S than M right now.
I suspect 6, 9, 12 months from now. It'll be a lot more M, but right now it's more S, but really good reception so far with selling quite well. People seem to like what we're up to. And I feel like we got another hit product there on hand. Yes, feeling really good about it.
And your next question comes from Mark Murphy from JP Morgan.
Yes, thank you. And I'll add my congrats. Kate, I wanted to ask you regarding the calculated billings growth. Where you said it's I think it came in at 34% in constant currency, very consistent, very healthy. But is there any adjustment to be made there for the increasing mix of HubSpot sales bookings which I think pulls through a shorter duration of a couple of months versus only 6 or 7 months for marketing.
So is there any even if it's something subtle there any upward adjustment to be made in that number?
Yes, sure. I think billings is I would characterize as relatively misunderstood metric in our business. I think if you look at the composition of the calculated billings, 90% of calculated billings is revenue. And so it's going to take a big swing in the months upfront or what we sell in order to move that away from revenue growth over time when you're looking at it on a constant currency basis. So, yes, we do see a slightly smaller duration for deals on the sales hub, but that's really not moving the needle tremendously in calculated billings growth.
Okay. And then a quick follow-up, maybe for Brian, was there any actual impact from the pricing changes? I think, as you had mentioned, price of Marketing Enterprise went to 3200 a month starting, just a few days ago. Did that have any tangible impact on the Tono business either in Q3 or in the month of October?
Minimal
pull forward. But like Kate said, in a SaaS business, the way we're set up, it's not a big swing in the numbers you're going to see, but it helped a little bit, but it's not life changing.
Your next question comes from Bhavan Suri from William Blair.
Hey guys, actually Arjun Bhatia on for Bhavan. Thanks for taking my questions. Just wanted to touch on the growth suite a little bit. I know it's been introduced relatively recently here, but What can you share on the initial traction you're seeing from the growth suite and how much of a role that play in the quarter. And then just wanted to get an understanding of, are customers actually landing at with the growth suite or are you still seeing a single hub customer maybe transition over time into the multi product and all three products, product suite?
Good question, Arjun. I'll take that. I guess my reaction to that is we come out with the growth suite offering an inbound. So 1st week in September. So in terms of the impact on the quarter itself, very, very minimal.
Having said that, we got a nice uptick on it. People were quite interested in it. And I think what's going on in the world is more and more companies are going to kind of pick a platform and buy applications that platform vendor and Glenn glue other applications in around it. And I kind of think it's like the way you would buy either G Suite or Outlook or you're an Apple per or an Android person. And it's a bit of an all in one play.
And we want to incent people to buy that way. We think that's the right way to buy. If you buy it all together from HubSpot and then you glue all these other third party applications in that works so well with HubSpot, boy, it's really, really nice platform to enable our customers to create a very nice end to end experience for their customers. So I guess at a high level, it's going pretty well. It's had a nice uptick on it.
And I think that will continue to go well. I think that's the way over the long haul people end up buying this type of software.
Great. That's helpful. And then maybe just a follow-up on the customer count. It looks like Customer account went up about 4500 net new customers sequentially, which is generally higher than we're seeing. Just wanted to see if there's any impact from inbound there or if there's anything else that's driving that change to be higher than it's been over the past few quarters here?
Yes. I think that the largest contributor there is the uptake in the new marketing starter product.
Okay, great. That's helpful. Thanks for taking my questions.
Your next question comes from Stan Slotsky from Morgan Stanley.
Wanted to excuse me, wanted to keen on the U. S. Versus international growth. International is certainly growing very, very, very rapid clip. When you're thinking about the investments in international versus driving growth in U.
S, are you thinking of balancing those 2 priorities? And then I have a quick follow-up.
Yes, why don't you start and I'll add in.
Sure. I'm feeling good about the growth on both sides. International is growing very, very fast. And I think that's just a result of the investments we've made. We got going into international a few years ago.
We made big, big investments in opening offices and hiring people as well as big investments in translating the product, translating offering the product and the sales and the service in different languages. And I think those investments have largely worked and we're getting a nice return on those investments. So We expect to invest in both where we get better returns. We invest a little faster in international, but we're investing in both. We feel like it's still early days for HubSpot lots and lots opportunity, both domestically and international.
Got it. And then a quick question for Kate. I'm not sure I'm jumping between calls, but did I miss the net revenue retention rate and where, how trends are in the quarter?
You did not miss it, but you want to start and all that on?
Well, we had a little argument about this actually, Stan, because we had our best revenue retention quarter ever. But Kate reminded me that this metric would bounce around a little bit and with all the product and packaging changes that can go up and down over time. But we had a very, very solid, revenue retention, quarter, best quarter ever. And, really I'm personally very excited about that.
Is it fair to say that it was above 100%?
Yes, yes,
it was over 100%.
Okay.
It was over 100%. And I would just add that when you look at the drivers of sort of the slight uptick in revenue retention over Q2, it's really the upgrade from the new enterprise products that we're seeing drive that up a little bit.
Your next question comes from Richard Davis from Canaccord. Hey, thanks
very much.
Maybe kind of on that topic, because I mean, we always ask for more, but I was thinking about on the churn side, And if you think about some good inbound programs, they take consistency. And the question I have is really I have to imagine that if I adopt inbound, There's this moment in time. I don't know if that 6 months or 12 months where I'm kind of like, darn it. It's not, I don't feel like I see a lot of traction yet. And that moment is when you would get churn and stuff like that.
Is there a way, are there tools or strategies or actions that you could take to get people through that dark moment. And I don't know if it's, again, if it's 3 months or 12 months, but you must see that to some degree, I would think, at least that's what we've heard from talking to people.
Yeah. I mean, there's a whole slew of things we've worked on to improve the value we deliver to our customers over time. First is just investing in the product to make it better and more relevant. 2nd is just trying to stay very modern. So as social media networks change, as search engine optimization change, as sales techniques changes, keeping up of those and pulling our customers into it, pulling them into enabling them to create a better customer experience end to end for them.
And then we've moved our packaging around a little bit. We what we try to do on packaging is for a while, we thought, well, let's just do much longer payment terms on these folks, but we don't necessarily want to lock people in for a long time. We want to make it easy for them to buy. And then offer a lot of value to them. So we do all kinds of things, I would say, and are very, very focused as a company on delighting these customers and making sure they're getting as much value as possible.
And if I think about it like over the course of HubSpot, when we first started the company, Richard, we really just help people get more visitors to their site. And then we help them get more leads to their, database. And then we help them sell more leads. And then we're helping them to like those, those customers, like the value problem and the value we deliver to customers has dramatically expanded over time. And And as a result of that, you've seen that retention rate come up over time.
Your next question comes from Alex Zukin from Piper Jaffray.
Hi, this is Taylor Reiners on for Alex. I wanted to double click on the growth suite bundle. When we think about that being about a 25% discount relative to list price, for purchasing the products individually. How does that compare to kind of typical discounts for individual products? And then do you see that driving up subscription revenue per customer over time as multi product adoption starts to continue to trend higher?
Thanks.
Yes. I mean, I'll take the pieces. I think that the idea in designing the growth suite packaging was to give some benefit for our buying the whole thing. And so that is typically a bit more of a discount than you would get on a regular product. I think there are other ways that you can get discounts including sort of signing up for longer commitments, etcetera.
As it relates to ASRPC, yes, certainly adoption of the enterprise product in growth suite should be a positive impact on that. But as we've talked about historically, over the last couple of quarters here, we have a bunch of competing factors that are going to move that number around And we talked about in my, recorded remarks that or my written remarks that the biggest driver of ASRPC in this quarter was actually at the low end of the product SKU with the impact of the big customer additions from Marketing Starter.
Got it. Thanks and congrats on a good quarter.
Your next question comes from Jennifer Lowe from
UBS. Great. Thank you. I wanted to ask about the enterprise products and sort of the early demand you've seen there. And in particular, on the net new retention, the net revenue retention metric you mentioned that you're seeing a lot of strong upgrade activity within the existing base.
I'm curious at this point how much of the demand you're seeing is that, that it's existing customers looking to get more functionality for HubSpot with HubSpot and and really interested in the enterprise offering as a built in demand versus bringing new customers into the fold with enterprise where that is today and then where you think your aspiration to see that go over the next year or 2 is?
Jennifer, I'll take that. Thank you for the question. I gave you kind of a mix. We're definitely seeing with the new marketing enterprise functionality that people that marketing professional are upgrading. And with the new sales enterprise SKU, people are upgrading there.
The service business is so new. There's not a lot of upgrading there. We're all starting to see some net new demand from companies between call it 202,000 employees like our first $1,000,000 deal. That was a net new customer at the enterprise level. So I kind of call it a wash about the same of each so far.
I think over the long, long haul, probably more from the outside as we work through the installed base of pro customers. I think that demand will shift a bit to the outside. I also just think we'll keep customers longer. One of the things that's always bothered me about HubSpot is when customers get to a certain size, they'll churn office and go to another platform and Frankly, that's kind of irritating. And then I don't think we'll see much of that happening in the future.
I think people will be very happy with it. One of the things I think is interesting about HubSpot is we, ourselves, have moved pretty much our whole business on the HubSpot or whole front office application front office operation. And we have lots of employees, 2500 employees, aid offices, relatively complicated organization. And we've got plenty of headroom to grow with the product. So we think our customers will scale right alongside us with the new enterprise skews.
Great. And as you think about opportunities to acquire new customers in this slightly larger bucket than where you've played historically. How are you thinking about the sales investment behind that? Is it taking the existing team you have and just giving them a broader scope of leads to pursue or is it a little bit more of a dedicated effort given that the price points are significantly higher than what you've sold traditionally?
We might add, so we break our sales organ our direct sales organization into 3 segments small business, which is, I think, 2 to 25 employees, medium 25 to 200, in enterprises 200 to 2000. We might see a little bit of an increase in the size of the sales organization into that 200 to 2000. We've put some things in place on the security side to help our customers understand how secure their data is with HubSpot. Enable them to get out that information more easily. We put some things in place on the legal side for contract review to make that more easy to do.
We're working on some cool stuff on the implementation side to enable that. And so there's been some investment on our side. There'll be some continued investment to ensure that we're ready when they call on us. I think the reality of what happens is we're on pretty much everyone's radar these days if they're looking at a net new CRM system. Just think we're going to win a lot more of those deals when they dig in and really evaluate it.
Your next question comes from Kirk Materney from Evercore ISI. Great.
Thanks for taking my question. This is Peter Levine in for Kirk. So for question here is when you look at the adoption of the broader suite, is there any real difference in terms of what you're seeing in the U. S. Versus international markets?
No, it's generally similar. Okay.
Fair enough. And then, I know it's still kind of in the early innings, but you talked about a new kind of channel initiative targeting targeting more IT implementation focused partners. Can you kind of tell us about where you are today in your expectations from these newer partners over the next 12, 24 months?
Sure. Let's talk about partners a little bit. We didn't talk about them in the prepared remarks. I'll give you my perspective on it. 1st 8 years of HubSpot, we sold marketing software and we built a marketing agency channel that has worked, it's still working incredibly well.
Now when I look at those agencies, there's several 1000 of them. Some of them are really excited from just helping companies with their marketing and their website lead generation to helping them create a full flywheel and grow their business. But not all of them are, and we're not going to force them to do it. Many of them come from website design businesses and they're just not that interested in doing it. So overall, that marketing agency channel is performing well.
Many of them are selling the full suite somewhere. At the same time, we have a new initiative underway, that is going pretty well. It's still pretty new, but I'm bullish on it where we've got new agencies coming in. Sales agencies, CRM agencies, IT agencies. And it's still pretty early.
It's going to get some nice investment next year. And I think that will grow nice fleet. And those agencies, I think, will be much more likely to sell either CRM or sell that full suite of products. So I think think what you'll see over time is our agency program will diversify much more in the future. One of the things I love about HubSpot is we actually have 2 channels that work very well.
We have a direct channel. The unit economics are really good and our direct channel is growing very fast. And we have this agency channel growing very fast unit economics work. That agency channel, I think we have a chance to innovate and really do some cool stuff with over the next year or 2.
Great. Thanks guys. Appreciate it.
Your next question comes from Terry Tillman from SunTrust.
Yeah. Hey, thanks for taking my questions. Brian, maybe the first question just relates to one of your comments earlier around ServiceHub. In seeing faster ramp than you saw 5 months plus with the sales products. I guess could we just delve into that bit more in terms of some of the drivers of the faster rate of success there.
And also what I'm curious about is competition wise, what are you seeing in terms of, is it replacing something? Because you've had months in the market now, is it replacing something or is it greenfield?
Yes, couple of thoughts. When we first came out with the sales product and I think you probably remember this it was very light. It was we actually called it signals. We didn't call it Sales Hub, and it was a it was a couple of very light features for a sales rep really. And it did well.
It was priced very low. Over time, we grew that thing into a full on Salesforce automation product that we call sales hub. What I would say about Service Hub is a little it started off far more robust than that sales product. In fact, we came out initially with that product in the spring at the professional offering because it was pretty robust. One of the you've all seen us increase our R and D investment over time.
One of the use of proceeds on that R and D investment was a big investment in what we call the HubSpot framework, which is underlying platform underneath HubSpot, where you can imagine there's workflows, there's email, there's social, there's web pages And then the hubs themselves, we combine those different things and we add interesting functionality to it to bring it to life. So what we were able to do when we build the service hub, leverage that framework to build something relatively robust rate out of the gate. That's the big difference. The second big difference obviously is we have much larger installed base the sell to than we have in the sales organization. So those two reasons I think are combining for faster growth and a bigger business more quickly with the the service hubs and the sales hub.
Okay. Awesome. And then my follow-up question just relates to the touchless sales motion. I know that's still evolving, but like any kind of quantification on how much of the business that is actually more of that approach and And could that be a byproduct of this increase kind of touchless sales up a big faster leverage on sales and marketing? I mean, you're seeing leverage some not complaining, but maybe talk a little bit more about the touchless sales motion.
Thank you.
Sure. I can touch on Kate can add. That is nascent going well. What's interesting about it, what are the most interesting things going? We talked a bunch about that enterprise layer of products.
Just as interesting, if not more, is that marketing hub starter product is going very, very well. We came out with kind of version 2.0 of that product in the end of July and the uptake has been excellent on that product. And over half of that is is touchless. And I really like that motion. And what we expect over time is that to be a very large pool of customers and that they over time we'll buy sales starter and service starter.
Some of them will move from marketing starter to marketing pro. So we're investing in that. We're making good progress that'll be a big initiative for next year. I think you'll continue to see us move on that path. One of the people who really inspires us is the guy named Jay Simons.
He's the president over at Lansing is on and he is on our board. And the reason we put him on our board is we really liked the way atlassian does business and goes to market. I don't know if we'll ever get all the way to where they are, but we're kind of headed in that direction. And I really like that direction we're headed.
Your next question comes from Scott Berg from Needham.
Hi, this is Ryan McDonald on for Scott Berg. I guess just starting out, with the sales hub, that's it seems it appears to be have been accretive to subscription gross margins. When we're looking at Service Hub, what sort of impact would you expect to have there on the margin?
I think that the subscription gross margin numbers have trended sort of up a couple points over the last few years. It all runs on the same infrastructure. And so teasing apart the margins of the individual project product in hubs is frankly not something that is a very easy endeavor.
Yes. Scott, one of the things that we talked about last quarter that moderated, to a large extent this quarter was, we had some incremental COGS associated with GDPR through the first half of the year. That largely went away in the third quarter that
gave us some sequential benefit as well.
Got it. And then just a quick follow-up. In regards to professional services, that line item continues to grow faster than software. Is there anything that's changed there in terms of the services you're providing or are customers consuming more for any particular reason?
Yes, a couple of things on the services business. I the first thing I would just remind you is that it's a very small part of the overall revenue for the company. And so sort of small changes in that revenue stream generate big changes in the growth rates and profitability profile there. So just I would first just keep that in mind. That said, I think there are a couple of positive things that we've seen in the services revenue stream this quarter.
One is just a benefit from the mix of subscription products that we're selling. So as we sell more pro and enterprise products, as we sell more marketing products that has a benefit, flow through benefit to services revenue, The other thing is with the adoption of 606, there's a small amount of revenue that gets attributed over to the services business that was not there in 2017. And so that's going to show a little bit of benefit in terms of growth rates.
I'd add, there's no strategy change there. One of the things I've always liked about HubSpot is we give our customers 2 choices of implementation. Choice number 1 is they can do it themselves and we teach them how to do it. Choice number 2 is they can outsource a lot of it to an agency partner. We're sticking with that model.
We really like that model. So there's little tweaks, little tiny changes in here, but there's no big strategy shift going on.
Your next question comes from the line of Koji Akita from Oppenheimer.
Great. Thanks for taking my
questions and congratulations on the quarter. I'm going to throw this question out there for either Brian or Kate. Back at the Analyst Day, you gave a ton of great insight on ARR metrics for marketing, sales and service. And I know this is not something that you want to give out numerically on a quarterly basis, but I was wondering if you could just give some some qualitative commentary on how ARR trended for the 3 segments here?
That's sort of the backwards way into trying to get us to, to tell you on a quarterly basis. I think the trends that we outlined at the Analyst Day, we're continuing to see in terms of the relative growth rates of this segment.
And I wanted to go back to that $1,000,000 TCB deal. I mean, that's an awesome, awesome win for you guys. Congratulations. Just thinking about the installed base is whole. I mean, is that really that big of an anomaly in deal size?
Or are there other customers in the wheelhouse that are already somewhat near that zip code or even trending to sort of that level? I mean, any sort of commentary there would be great.
Yes. Just a reminder, a 4 year deal. So let's just say, and I don't even know if this case, let's say it's $2.50 per year. We have other customers in that range at this point. I think you'll see customers that the largest customer we have in per year revenue, I think we'll see that drift up over time.
As we get more enterprise deals and we get more of these suite deals because really there's 2 growth vectors going on. 1 is the North Spector and the other is the east west vector. So there's room to move there. I think there'll be more. But we're not moving the enterprise One of the reasons we don't move to the enterprise is, there's a lot of competition in the enterprise, salesforce.com, Adobe, IBM, Oracle, lots of interesting companies that are executing well.
We like SMB. We like that the internet kind of disproportionately benefits SMB versus the enterprise Our genetic code is there. Our go to market is there. And so we're likely very, very likely to stay kind of in our swim lane of between a few employees up to a couple 1000 employees.
Great. Thank you for the color. Congrats on a great quarter.
Your next question comes from Tom Roderick from Stifel.
It's actually Parker Lane in for Tom. Thanks for taking my question. Brian, if I look at HubSpot Connect, it's obviously a big priority for the company to land customers and then, integrate with other enterprise and SMB apps out there. But when I look at the page, I see a lot of players like Salesforce and Zendesk that are sort of involved with businesses they be involved in your east west expansion strategy. I'm just wondering how much disruption you're seeing in the HubSpot Connect ecosystem from the launch of your products, if any?
And what kind of customer would be using sales force alongside of HubSpot?
Really good questions. Let me give a little color on that. We've been investing over the last couple of years, but we've rest a little more this year in moving HubSpot to be more of a platform. We invested a lot in increase in the number of API endpoints we have invested a lot in increasing the quality of those endpoints. We invested a lot in building integrations ourselves and enabling third parties to build integrations to HubSpot.
We built integrations to really cool products like Shopify, Stripe, Slack and others that are really, really going And what we want to do over the long, long haul is just say, Hey, pick up spot as a partner. And we're not just all in 1, we're all on 1. And if you want to use HubSpot service hub, that's great. If you want to use intercom or do you want to use Zendesk, that's great. Come out with service hub and we still have lots and lots of happy customers that are using Zendesk for service and intercom for service.
Intercom recently improved their integration with HubSpot around that. And so we have to grow up and we have to be a platform player just like all the other platform players and give them a choice and make sure they get a great customer experience. That's kind of how that's our philosophy around it.
Your next question comes from Brian Peterson from Raymond James
So, Brian, maybe as we can we talk about this move north a little bit as you guys have phrased it, but the dynamics like they're now versus maybe when you went public back in 2013. We've seen some M and A in the space. And you mentioned, as customers had grown in the past. They migrated to different platforms. What are we seeing in that kind of upmarket movement now?
I mean, it's super early. No huge changes. I mean, we of course see salesforce.com. They're a very good partner and competitor in deals. And we win our fair share.
The Adobe deal is interesting. We've always seen Marketo up in that space. And I think we'll see Marketo up in that space in the future. But so far, we're keeping an eye on it, but no, no huge changes so far in our competitive landscape. I think we're just going to win more deals in that 200 to 2000 segment.
And I think we're going to be able to hold on to more customers as we move on. 200 to 2000. What I'd like to see happening is let's just say you're using HubSpot for marketing and sales and service. And maybe for whatever reason, our service hub is doing answering mail for you and say, oh, I want to continue to use HubSpot, but I'm going to use Zendesk instead of Service Hub, for whatever reason, there's functionality in there that's more enterprisey what I'd like to see happen over the long haul. A hub spot sort of as your as your hub and build around it.
Got it. Thanks, Brian.
Your next question comes from Ross MacMillan from RBC Capital Markets.
Well, thanks a lot and congrats for me as well. Brian, in our field work, when we when we think about sales adoption, I think it at least my perspective is that it's more skewed to net new customers as opposed to base customers. And I'd love your perspective on that and whether you think over time, there's mechanisms to get the base to adopt faster as well?
I think that that research is pretty good. We have done remarkably well in getting net new accounts who don't use our marketing product to buy that sales product. I've been delighted with that. And I think we're pretty good at cross selling our marketing product to those sales customers. And I think we're pretty good at selling our sales product to the marketing customers.
I think that's an area where we're going to continue to improve in and we'll there's leverage in as we go forward. But you're right that we have a lot of folks coming into HubSpot as net new customers buying sales starter and sales pro. And I'm actually delighted about it. I think that's filling up our all base that we can cross sell to over time. That sales business, Ross, is really humming, really, really well, very, very happy with the way that thing's growing.
That's great. And then just one for Kate. I know you don't guide to billing calculated billings and I know you say it's a misunderstood metric, but I I did just want to make sure that we were thinking about Q4 because I think the comp is very hard. I think there were five points of was there was five points of FX tailwind inbound timing is different, that I know it wasn't big, but there was maybe a little bit of the price change impact in through Q3. So maybe, I don't know, what are the things that we should think about as we set up our models here for Q4?
Yes, I think for Q4, what you we've said on the call is that there's a couple of 1 to 2 points of headwind on the revenue side. There's probably another one to two points of headwind on the deferred revenue side. So calculated billings will have more of a headwind than revenue.
Okay. Thanks everybody for joining the call. Look forward to talking to you soon.
This concludes today's conference call. You may now disconnect.