HubSpot, Inc. (HUBS) Earnings Call Transcript & Summary

Good afternoon. Thank you, everyone, for joining us to Morgan Stanley TMT Conference. My name is Elizabeth Porter, I'm an analyst on the U.S. Software Equity Research team, and I am very pleased to have with us today HubSpot's CEO, Yamini Rangan; and CFO, Kate Bueker. We are going to take Q&A at the end, so mics will go around. And before we begin, for important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. And with that, Yamini, Kate, thank you so much for joining us today.

Elizabeth, so fantastic to be here. Happy International Women's Day.

Happy International Women's Day. So just to start off, I'd love to get your view on the macro environment. In Q4, your net customer adds actually accelerated quarter-over-quarter, which was really impressive just despite kind of the overall macro environment. And while those were from kind of smaller ASP customers, investors were impressed nonetheless. So I wanted to get a sense for how demand has trended in recent months, like how are you guys are navigating the situation and what the outlook is for 2023.

Yes. I'll get started. And Kate, feel free to just jump in here. So Q4 for us was very, very consistent with what we saw in Q3. In Q3, we talked about lengthening of deal cycles, a lot of decision-makers that were involved in the deal cycles and a lot more scrutiny of the deal. That remained consistent within Q4. It did not get worse, it did not get better, and we think and we assume that we will continue to see those kinds of trends going into 2023. But if we step back in terms of what we are seeing across our customer base, 2 things. First off, small, medium businesses, that's the market that we serve, are really building their businesses on digital. At the beginning of the pandemic, they went towards digital solutions, digital marketing, digital sales, digital customer service solutions, and they've continued to build their business on digital and they're not going back. So that's like an overarching longer-term, maybe, trend that we are seeing. Now in the short term, we do see that the lower end of our customers velocity of decision-making is kind of doing well. We see this in short cycle deals within our pipeline, which is much more of deals that get started and closed in a given quarter. But the longer cycle deals are taking time, and that's because of all the trends that we just talked about. Having said that, customers care deeply about time to value. They really want to understand how quickly they can adopt and how quickly they can implement and how quickly they can get to value. They care deeply about sales and marketing alignment and they care deeply about platform consolidation and the potential cost savings there. And all of those are what we see reflected within our pipeline.

Great. And Kate, on the retention side, net retention has seen some softness in recent quarters similar to many other software companies, just as the upgrade motion has gotten more challenging, fewer seats as hiring moderates. But on the gross retention side, it's actually held in better despite some of the SMB fears. So what are your expectations on how net and gross retention can evolve through 2023? And what gives you the confidence that NRR can sustain above 100?

Yes, thanks for the question. You have all the stats, so exactly right. We had net revenue retention of 107; in Q4 just down a little bit, a couple of points. And what we're seeing is the same sort of trends. There's obviously 2 components of net revenue retention. There's the gross retention, which for us has really held nicely in that high 80s. And we feel really good about that as a representation of the value that HubSpot's platform really delivers. Between growth and net retention, there are all of the sort of net upgrade levers. The good news for HubSpot is that we have a diverse set of upgrade levers. What we have seen as our customers are facing the same economic challenges that everyone else is, is that they are very focused in making sure that they are very prudent in how they're spending their dollars. And so they're doing a lot of more intense kind of cleanup of contacts of seats. They are consolidating portals. And we think that, that pressure and those sort of actions will continue. And so we feel good about our ability to retain retention at or above 100 in the near term. Over the long term, as the economy recovers, we think that our net revenue retention will also recover as people go back to hiring more and they see their businesses grow. They will all grow their use of HubSpot.

Great. And when we think about some of the investments that you guys have been making, one thing that stands out is just movement and features into the larger enterprise space. And in Q4, you did see that success of moving into some of those larger deal sizes. So what features stood out the most to you in terms of being able to grab those larger deals? And how has the penetration into that upper end of your core customer segment evolved recently?

It's going well. But maybe to step back, there are kind of 2 bigger transformations here at play. And the first one is we are kind of transforming from a marketing automation company to a CRM platform, and you've seen that with the pace of innovation, as well as the product releases over the last couple of years in Sales Hub, Service Hub, Operations Hub. So we've expanded there. The second part of the transformation is that we are kind of going from the smaller portion of the SMB to the M, the mid-market and scaling companies within SMB. And for us, up market tends to be companies with 200 to 2,000 employees. And we think we can really win our fair share within that market, which is what you're seeing. And in terms of features, it's not one feature set. It's kind of the domino of multiple things that are happening at the same time. Our products has really gotten better. If you take Sales Hub, for example, starting with custom objects, but that was just the starting point of customization, and upmarket customers care deeply about governance, they care deeply about customization, extensibility reporting. And we've heavily invested and maintained the pace of innovation, all of that. I think the second part of the reason we are seeing the momentum is really our direct sales team, as well as the partner ecosystems, knowing how to have great conversations that really target the needs of our upmarket customers. So we're able to have great conversations on how to drive time to value and how to drive consolidation of their IT stack, and that resonates deeply within our upper end of the market. And then finally, the perception. I think there are scaling companies today, if they think about marketing automation, sales force automation, we're in the consideration and that perception has shifted. And the confluence of all of those factors is what you end up seeing as a result, which you rightly pointed in terms of Q4.

Great. And I want to go back to that consolidation point, and that's something that we've certainly been picking up in our checks. Just as IT budgets are constrained, looking for that opportunity to save costs and consolidate IT vendors, and in Q4, you actually highlighted that the mix of customers adopting 3 in 5 hubs improved. So what are the hubs that customers are incrementally going for and who are they replacing?

Yes, it's a great question, Elizabeth. I think you have to go back and think about what's happening within our customer base. Customers, as they think about their budgets in 2023, think about driving productivity and efficiency within marketing, sales and service. And historically, there's always been a handoff leakage between marketing and sales and between sales and service. And what I mean by that is marketing drives a lot of leads by the time it gets to sales. So they're like, well, the quality of leads is not that great, and I don't have visibility into the exact campaigns that are driving the pipeline for me. And customers care deeply about solving that problem. They care a lot about once you become a customer, what's that next step to transfer that to customers service and customer success. There's a leakage of information and context of that customer. So if we step back and think about what's happening within our customer base, they care deeply about visibility across their entire pipeline from leads to converted opportunities to conversion of customers. And that is the problem that HubSpot solves, and we solve it really efficiently. I think the second part of what customers care deeply about is looking at their IT stack and looking at places where they can eliminate point solutions or reduce the total cost of ownership by consolidating on a platform like HubSpot. Both of those are exceptionally important to our customers. And our value proposition resonates. We're all in one, we're easy to buy, we're easy to use, we're quick time to value, and our customers care deeply about that, which is why you're seeing that consolidation happening on HubSpot.

Great. And Kate, at the 2022 Analyst Day, you laid out a path for 20% to 25% operating margins longer term. What are the key assumptions to achieving this? And how far away are we from hitting that target?

Yes, I think it's a good question. We've had a long-term model for the business that is non-GAAP operating profit margin of 20% to 25%. And we continue to believe that we are a 20% to 25% non-GAAP operating profit business. We are obviously not there yet, but based on the guidance that we shared at earnings, we're going to deliver 250 basis points of incremental leverage this year. And that's a step, important step toward that 20% to 25% goal, but we obviously have work to do. And so maybe I'll give a little bit more context around the actions that we've taken and how we think we -- where we think we continue to have opportunity to close the gap between where we are and where we want to get to. As we look at 2022, we had a great start to the year. As Yamini shared, we saw in Q2 some change in how our customers were buying, some slowness in deal flow. That actually took another step down in Q3 and remained challenging into Q4. And so as a business, what we did, we did 2 things. At the end of Q2, seeing what we did see, we pulled back on hiring pretty significantly in the back half of the year. We pulled back on a lot of our discretionary spending in the back half of the year. And as we went into Q3 and Q4, we saw that it was -- the challenge was sustaining as we started down the path of planning for 2023, and we aligned that we thought the market was going to continue to be challenging. We knew we needed to make a different step. And so we did a reduction of force at the end of January that accomplished a couple of things. Certainly, it did provide some leverage to the business in 2023. And but it also, and more importantly, allowed us to realign our resources around a set of very specific initiatives that will allow us to drive leverage over the longer term. And we talked about those on the earnings call. They were very much focused on internal systems, process automation, primarily focused on the go-to-market side that will allow us over time to realize efficiencies through increased direct sales rep productivity through better alignment and efficiency in our partner channel which you saw us start down the path with on the new commission structure, and finally, a continued investment in our product-led growth.

Great. And actually, going back to the partnership channel, you did make those changes to better align incentives with partners in the HubSpot goals. How much ARR is from the partner network today? And kind of what benefits can these changes make to the HubSpot model?

Yes. Partners are a pretty significant portion of how we think about going to market and winning within the market. They contribute about 40% of our ARR, and we have seen really good momentum. Stepping back, maybe 3 years ago, we went to our partners as we were going through the transformations that I talked about, which is going from marketing automation to CRM platform, going from the small portion of the SMB to kind of the larger upper end of SMB. We went to our partners, and we said our vision is to sell and service through export partners. And we've been really pleased with how our partners have stepped up. They've added technical capabilities, deep migration capabilities, integration capabilities so that they can help our customers, our joint customers, get the value from HubSpot's platform. So we're very happy with that. Now we did talk about a set of commissions, strategy changes and structure changes that we implemented in this quarter, and we just announced it with our partner ecosystem, and that stems from a couple of things. One, HubSpot's product portfolio has grown. We needed to relook at how we are incentivizing the partner channel to drive the value of that broader portfolio. So the change is really meant to incentivize partners to more deeply engage with customers and more deeply share the value of the multiple hubs in the suite that we have. And second, it is to incentivize the partners to be able to co-sell with our direct teams. And that's really the set of changes that we made. We've had a number of conversations with our elite partners, diamond plus partners. They understand it's a big change, but they also understand the rationale of what is driving the change. And I think we're going to see continued momentum within the partner ecosystem.

Great. And I want to hit on payments because that's been a focus for investors. And while it's still early days, you're going to first brought out the idea of payments at the 2021 Analyst Day and spoke to kind of the volume opportunity in the hundreds of millions over the next couple of years. And while this is going to take time to scale, and it is that longer-term initiative, how has the rollout of HubSpot Payments gone to date? And what's the type of penetration rates that you think that you could reach in your target market kind of longer term?

Yes, it's a great question. And you got everything right in terms of the fact. We did announce it at the Analyst Day in 2021. Now I talked about the 2 big transformations. The third bigger transformation is really how we become a single source of commerce and customer data over the longer horizon. And that is our bet in terms of payments and commerce. And here, we're willing to be very strategically patient. And we believe in putting the right seeds and making sure that we are continuing to kind of grow a business that will provide us the opportunity to really grow over the next few years. So we are strategically patient when it comes into the commerce and payments business. And again, it goes back into what problems we are solving for our customers. Our customers want to have commerce, as well as customer data in the same place. Why, because it allows for better marketing campaigns with the context of what has sold, what a customer is interested in. You can drive better marketing automation. You can have much better sales conversations knowing the purchases string, knowing what a customer is buying, using today drive much better conversations from a sales perspective. And it certainly allows services agents to be able to have much more personalized conversations. So the value of having commerce and customer data in a single place is just exceptionally important, and that's the problem that we're trying to solve for our customers. So in year 1, last year, our focus was validating that hypothesis was correct, and that's exactly what we saw. We saw merchants engage, we saw the value in terms of bringing commerce information and customer information to the same place. And so the validation of the hypothesis is there. Now the next stage is really to drive a much easier enrollment process, much more depth in terms of functionality and much more breadth in terms of how we take this to market. And that's the focus this year. And we'll be spending a lot of time on driving the pace of innovation to things like native payments processing, native invoice processing, flexibility in terms of how we drive all of that last mile -- the last mile of code to cash for our customers, and that's the focus this year. Again, this is a multiyear bet. And we think we are on the right track. We think the feedback that we've been getting from early customers is that we are solving the right problems for them. Now it's a question of how we broaden and deepen our product functionality.

Great. I'm going to ask 1 more question, and then we'll open up to the audience to see if there's anything. So Kate, on the revenue guidance piece, 19% growth for fiscal '23 was healthy considering kind of the overall kind of macro. And help us unpack what's included in terms of kind of the net renewal and the new business? And then second, outside of some of these macro headwinds, how should we think about the longer-term growth trajectory for the business?

Yes, again, good question. I would -- simply put, on the guidance front, we took a very similar approach to guidance this year that we have done since I arrived at HubSpot. Our baseline assumption is that the economy continues to be challenged throughout 2023, but it doesn't get materially better or materially worse than what we saw over the Q3, Q4 time period. Over the long term, I think -- I hope you heard that from Yamini throughout the comments, we feel great about the size of the opportunity that we are addressing and how early we are against that opportunity. And so we feel like we have room to grow this business for a long time.

Great. Are there any audience questions? Definitely have more to go through. So generative AI is a theme that's been on a lot of investors' minds just as people are trying to think through the ramifications of this new capability set for existing software vendors. So what are the implications for the markets that HubSpot is involved in? And how is the company positioned for the trend?

Yes. It's pretty exciting, isn't it? I think you have the macro situation, the way it is developing, you can't control. But at the same time, we're kind of having this iPhone moment within this industry, and there's just exciting developments that are happening. HubSpot has consistently invested in AI. It's been much more of predictive AI, but now generative AI is kind of like the big thing that has had a moment. And I think between ChatGPT, Stable Diffusion, a lot of things that have happened over the past few months, there are really exciting developments that are happening. I do think we're going to go through a little bit of buzzy and hype cycle phase, and then we're going to get to real differentiation. And real differentiation, all this starts with what's the value that you're adding for customers. We think about generative AI impact in kind of 3 large buckets. The first is content creation and ideation. It's just going to make the whole process of ideating, creating and publishing content much, much more productive. So think about the marketer who's writing a blog, think about a salesperson who's writing a sales sequence and reaching out to their customers, think about a service person writing a knowledge base. It's just going to make that much more productive. And the second area is it's actually going to make coding a lot more effective. There's a lot better natural language processing way to drive code. And I think we're going to see the impact in terms of software development. And then third, which is even more exciting, is that you're now going to have a very different kind of an interface to all software. Monday this week, we launched ChatSpot. It is in alpha stage. And what is interesting about that is we're bringing the power of ChatGPT connected to the APIs within HubSpot, connected to all of the APIs and things like Google to be able to interact using natural language with HubSpot. So if I'm wondering this morning what was the web traffic on our website last week and how did that trend compare to last month, how much has our pipeline grown by, I can just use natural language to be able to interact with HubSpot, and that's kind of what ChatSpot is that we announced on Monday. So there's just a lot that is happening. And ultimately, the differentiation is going to come from do we have the data that can fine-tune the models for our customers, which we do? And can we enable much more productivity at the point where work is happening which is where we are focused on and I think it's going to have a huge impact for especially SMBs. The SMBs are the classic can we do more with less, and this is going to drive a level of productivity as well as engagement with business applications. Early days.

Yes, I'm really looking forward to watching the trends. And with that, we're just about up on time. So thank you so much, Yamini and Kate, for joining us today and sharing your insights.

Thank you so much for having us.

Thank you.