HubSpot, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are with the same 2017 periods unless noted. Financial amounts are in U.S. dollars. HubSpot provides a cloud-based marketing, sales, and customer service software platform. It reported 52,505 customers at quarter-end, up from 37,450 a year earlier.
Financial performance
| Metric | Q3 2018 | Q3 2017 | First 9 months 2018 | First 9 months 2017 |
|---|---|---|---|---|
| Revenue | $131.8m | $97.7m | $369.0m | $269.1m |
| Gross profit / margin | $106.1m / 80% | $78.7m / 81% | $296.0m / 80% | $214.4m / 80% |
| Operating loss | $(15.1)m | $(12.1)m | $(40.4)m | $(30.7)m |
| Net loss | $(18.7)m | $(10.6)m | $(52.3)m | $(28.2)m |
| Net loss per diluted share | $(0.48) | $(0.29) | $(1.37) | $(0.77) |
Subscription revenue was 95% of total revenue in both years. Operating expenses increased 33% to $121.1m in Q3 and 37% to $336.4m for the nine months, including substantial investment in research and development, sales and marketing, and staffing. Stock-based compensation was $19.6m for Q3 and $55.3m year to date.
For the first nine months, operating cash flow was $51.7m, compared with $35.6m. Investing activities used $51.7m, while financing activities provided $10.2m. Cash, cash equivalents, and restricted cash totaled $101.7m at September 30, up from $92.8m at year-end 2017.
At quarter-end, cash and cash equivalents were $96.1m; short- and long-term investments totaled $478.4m. Working capital was $455.2m. Convertible senior notes had a $400m principal balance and $313.6m net carrying value. Total liabilities were $556.2m and stockholders’ equity was $229.4m.
Material changes and operating drivers
- Revenue grew 35% in Q3 and 37% year to date, primarily reflecting customer growth. Average subscription revenue per customer declined: Q3 was $9,959 versus $10,332; nine-month average was $9,913 versus $10,309. Management attributed the decrease chiefly to the freemium model and lower-priced products.
- Q3 gross margin slipped to 80% from 81%; the nine-month margin remained 80%. Management cited improved hosting-cost leverage relative to subscription growth, alongside higher hosting, employee, software-development, and infrastructure costs.
- Net losses widened. In the nine-month comparison, interest expense rose to $15.9m from $7.9m, largely reflecting the 2022 Notes and related discount amortization; the 2017 period also included a deferred tax benefit.
Outlook, accounting, and risks
- No numerical financial guidance is provided in the supplied filing text. Management expects continued spending on sales and marketing, research and development, customer support, international operations, and infrastructure; it does not expect near-term profitability. It expects operating leverage and improved margins over the long term if revenue growth supports the investment.
- Management said working capital was sufficient for at least the next 12 months. It expects approximately 94% of the $89.4m of disclosed remaining performance obligations for contracts originally exceeding one year to be recognized over the next 24 months.
- Adoption of the new revenue standard changed the timing and capitalization of commissions and certain revenue. Versus prior guidance, it reduced nine-month total revenue by $0.2m and operating expenses by $11.5m, improving reported operating and net loss by $11.3m. Operating cash flow was unchanged. This accounting effect is material when assessing year-over-year expense and loss trends.
- The $400m 0.25% convertible notes due 2022 became convertible at holders’ option during Q4 2018 after the conversion condition was met. As of November 6, 2018, no holders had converted or indicated intent to convert. Cash settlement of conversions could affect liquidity; the notes’ disclosed fair value was approximately $658m.
- Commitments include $355.7m of future operating lease payments and a three-year web-hosting agreement carrying approximately $48m of obligations. The company plans to adopt lease-accounting guidance in 2019; it expected recognition of operating-lease assets and liabilities but could not quantify the impact.
- Key risks include ongoing losses, customer renewals and retention, competition and pricing, execution of growth and product development, reliance on third-party hosting and integrations, privacy and security regulation (including GDPR), currency fluctuations, and the notes’ conversion and repayment requirements. The filing states there was no material pending litigation. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether customer growth and retention can offset falling average subscription revenue per customer, and how customer and dollar-retention metrics trend.
- How much reported expense and loss trends reflect the new revenue standard’s commission capitalization and amortization treatment.
- Cash settlement, conversion, or reclassification implications of the 2022 Notes, including the $400m principal obligation.
- Whether investment in personnel, R&D, hosting, and leases yields improving margins without impairing liquidity.
- Exposure to privacy-law changes, third-party service interruptions, competition, and foreign-exchange movements.