Docebo - Q2 2023
August 10, 2023
Transcript
Moderator (participant)
Thank you, operator. Before we begin, Docebo would like to remind listeners that certain information discussed today may be forward-looking in nature. Such forward-looking information reflects the company's current views with respect to future events. Any such information is subject to risks, uncertainties, and assumptions that could cause actual results to differ materially from those projected in the forward-looking statements. For more information on the risks, uncertainties, and assumptions relating to forward-looking statements, please refer to Docebo's public filings, which are available on SEDAR and EDGAR. During the call, we will reference certain non-IFRS financial measures. Although we believe these measures provide useful supplemental information about our financial performance, they are not recognized measures and do not have standardized meanings under IFRS. Please see our MD&A for additional information regarding our non-IFRS financial measures, including reconciliations to the nearest IFRS measures.
Please note that unless otherwise stated, all references to any financial figures are in US dollars. Now, I'd like to turn the call over to Docebo's Chief Executive Officer, Claudio Erba.
Claudio Erba (Founder and CEO)
Everybody, and thank you for joining us for our second quarter earnings call. With me today, Alessio Artuffo, our President and Chief Operating Officer, and Brandon Farber, our Senior Vice President of Finance. Brandon is filling in for Sukaran Mehta, our Chief Financial Officer, who is with his wife for the arrival of their first child. We wish Sukaran and his wife the very best. This morning, I will begin with a high-level summary of our results. We are pleased to report revenue growth of 25% in the June quarter that exceeded the upper end of our guidance range. Our profitability also exceeded our guidance, with an adjusted EBITDA margin of 7%. From a macro perspective, we saw trend consistent with the prior quarter. Enterprise segment spending is showing signs of stabilization, where our pipeline is healthy, while SMB customer took a more cautious approach due to macroeconomic impacts.
Geographically, we are seeing activities in U.S. beginning to pick up, while Europe remains flat. After successfully partnering with Amazon, Docebo is proud to announce that in Q3, we signed a major deal with another big five U.S.-based global technology leader as a customer. This partnership will support their multiple use cases, including a large external audience. Additionally, we will leverage their generative AI services to transform the delivery of personalized learning at scale and integrate cutting-edge features and functionalities into Docebo's learning platform. To further advance our leadership in AI, we acquired Edugo.AI. This acquisition enhanced our capability in large learning language model technology that also brings a team of expert AI engineers on board. We anticipate that this acquisition will contribute to our disruptive innovation engine, which has made Docebo a leading player in artificial intelligence and learning automation.
We look forward to providing more updates about our AI development roadmap at Docebo Inspire in September, our annual customer conference. In terms of channels, we are becoming increasingly excited about our expanding presence in the government vertical, also known as Fed and SLED. In Q2, we continued to demonstrate the viability of our platform through successful wins with municipal, provincial, and state-level customers. To further expand our customer base to include federal and state government customer, we are beginning the process of becoming FedRAMP compliant in the United States within the next two quarters. As previously discussed, we see this market as an excellent pillar for long-term growth. We have made strategic hires to form government-specific vertical team and are building a focused channel partner relationship with highly regarded firms such as Carahsoft and other large system integrators to expedite our access to the government space.
Our capital allocation strategy focuses on two areas: selective merger and acquisition, and efficient return of capital to shareholders. As valuation have become more favorable, we completed a two-tier acquisition this quarter. We will continue to evaluate opportunities based on their potential to address a broad spectrum of use cases that complement our platform. Before concluding my remarks this morning, I want to thank Martino Bagini, previously Chief Corporate Development Officer, a longtime partner and friend, for his service. As he decided to embark on a new chapter of his life, we wish him all the best on behalf of the entire company. Martino's corporate development responsibility will be reassigned to the finance organization, where we will leverage Sukaran's private equity expertise and give the team strong capabilities. They will work closely with me on future corporate development opportunities.
In conclusion, despite ongoing macroeconomic challenges that have become the new normal, our customer recognize that learning solution are a strategic necessity to drive top-line growth and core component of their tech stack. Docebo's strong financials, operational efficiency, and improving profitability position us for well sustainable, balanced, long-term growth. As we emerge from this economic cycle, the investment we make today will further strengthen our position and accelerate Docebo growth. Now, I would like to turn the call over to Alessio, who will give you an operational update.
Alessio Artuffo (President and COO)
Thank you, Claudio, and good morning, everyone. In quarter two, the company-wide average contract value increased over 8% to $48,100, from around $44,500 at the end of quarter two, 2022. ACV for new customers in the quarter was about $61,000, compared to $50,000 in quarter one. Growth in ACV is driven by increased penetration among enterprise customers, with deal values of $100,000 in ARR, accounting for approximately 50% of gross ARR generated in quarter two. 50% of these new customers have chosen Docebo for three or more use cases, which further highlights the strength of our platform and our ability to serve various complex audiences with one Docebo.
We saw healthy contributions from mid-market and large enterprise customers, both during the second quarter and within our sales pipeline as we look out through the end of this year. Our commercial segment, or SMB, has been more impacted by the cautious spending and market environment, resulting in some SMB churn that affected our net new customer adds in the June period. Regardless, gross retention held relatively flat quarter-over-quarter. Our focus remains on capturing optimal unit economics in our mid-market and enterprise pipeline. This is demonstrated through our strategy of, number one, supporting external and hybrid use cases, where almost 50% of our pipeline is external use case-facing and where we have the highest win rates. Number two, we continue to expand our partnership with large system integrators to penetrate both commercial and government enterprise contracts.
Number three, almost 30% of our wins this quarter came from RFPs, where customers are switching to Docebo and moving away from legacy competitors who are more focused on a roll-up strategy and only serve internal use cases. Now, I would like to highlight this with a few new customer wins, upsells, and cross-sells. In terms of new customer wins, in Germany, we were selected by Rolls-Royce Power Systems for our ability to address multiple use cases, including customer training, franchisee training, internal onboarding, and sales enablement. In North America, we signed a deal with Unity Health Toronto, a Catholic hospital network serving the greater metropolitan area of Toronto. This organization selected Docebo to address their onboarding and ongoing training initiatives for their physicians, nurses and staff, and medical university students.
In the healthcare vertical, the Royal College of Physicians and Surgeons of Canada chose Docebo as its future platform to provide its members with flexible access to continuing education, communities of practice, and its maintenance of certification program. HEI Hotels & Resorts, a hotel investment and management company with over 100 properties with brands that include Hyatt, Hilton, Marriott, Sheraton, and Westin, chose Docebo for our functionality, scalability, and content offerings to support their brands. Among the noteworthy upsells is in VMware, who is using Docebo for a variety of internal and external use cases, including customer training, channel training, and membership training. As Claudio called out earlier, we're making very good progress in the government vertical. In the second quarter, we were selected by a large provincial government agency in Ontario, Canada.
They chose Docebo for our AI-powered global search and content creation capabilities, including Shape, as well as for our track record service. We will be supporting their internal use case for onboarding and professional development. While in the U.S, working closely with a large Big Four system integrator, we won an external compliance use case for a major department with the state of Georgia. They selected Docebo for our robust functionality and ease of use for their targeted learners. We believe that Docebo can do very well within the government vertical for a number of reasons. Number one, elevating the performance of human capital is one of the largest focus areas at every level of government today. Number two, the first steps in this process will be to transition from outdated legacy platforms.
We have experienced this in the commercial segment and are now executing to repeat the success of swapping out outdated incumbents in the government sector. Number three, the ability to address the internal and external use cases that governments are bringing forward, giving local, state, and federal agencies the same ability to consolidate their tech stacks. Number four, initiating FedRAMP certification allows us to compete in more RFPs at the federal, but also state and local levels, in which StateRAMP certifications are more frequently required, opening up additional high-value growth opportunities. For now, I want to frame out our government vertical strategy by saying that we're working with our channel and select system integrators who have well-established government business units and are able to accelerate our right to win in the space.
Additionally, we're aligning with other key players, including distributors like Carahsoft, who can help us to swiftly and efficiently carry over Docebo's success from the private sector. As a reminder, this process takes time before FedRAMP certification is achieved. However, our initial investments are showing traction. During the quarter, we notably added to our roster of OEM partners. First, we entered into Global OEM Alliance with a Big Four system integrator, which will white label the Docebo Learn LMS technology as the underlying technology used to address their customers and workforce upskilling and reskilling requirements. We also added Darwinbox, a fast-growing HCM solution provider focused in India and Southeast Asia. With their intimate understanding of the working cultures of this region, we believe that this partnership can open up new geographical opportunities for us at an accelerated pace.
We're especially excited about their presence in India, a young workforce with a large and fast-moving market for which the Docebo solution is ideally suited for. Our OEM alliances are a core pathway into both the enterprise segment and new geos. We're pleased with how these new partners expand these pillars of growth. Both opportunities will be in a ramp-up mode over the next 12 months. We look forward to seeing their contributions add to our OEM and partnership results. Moving forward, we will continue to prioritize innovation, customer satisfaction, and enterprise segment growth. We're confident that our strategic planning, effective execution, and commitment to excellence will enable us to continue delivering the results that our customers have come to expect from Docebo. With that, I would like to hand the call over to Brandon.
Brandon Farber (SVP of Finance)
Thank you, Alessio, and good morning, everyone. For those interested, a detailed breakdown of our financial results for the three and six months ended June 30th, 2023, can be found in our press release, MD&A, and financial statements, which are now available on our website and are also filed on SEDAR and EDGAR. Total revenues for the second quarter grew to $43.6 million, an increase of 25% from the prior year, and exceeded our guided range of $42.9 million-$43.2 million. Subscription revenues were $40.8 million, representing 94% of total revenue for the quarter and an increase of 28% from the prior year. Annual Recurring Revenue was $172.9 million, an increase of 25%.
In the second quarter, we gained 85 net customers, bringing our total customer count to 3,591. This represents a 16% increase from the prior year. Average contract value for the second quarter was approximately $48,000, an increase from $47,000 from the first quarter of 2023, and an 80% year-over-year increase. Gross profit margin for the second quarter improved by 70 basis points year-over-year to 81% of revenue and was consistent with the prior quarter. Total operating expenses for the second quarter increased to $42.7 million from $25.9 million in the prior year. During the second quarter, we recorded $4.1 million in one-time costs related to severances, transaction costs, and acquisition-related earn-out that is excluded from our adjusted EBITDA calculation. We expect our restructuring activities to be completed during Q3 2023.
G&A, as a percentage of revenue, increased to 21.4% for the second quarter, compared to 18.2% for the first quarter of 2023. Adjusted for the one-time severances and acquisition-related costs, G&A represented 18.3% of revenue. Sales and marketing as a percentage of revenue increased to 41.4% for the second quarter, compared to 40.5% for the first quarter of 2023. Adjusting for the $1.5 million of restructuring costs, sales and marketing represented 37.8% of total revenue. With the investments we made in the IT systems at the beginning of the year, we anticipate to continue to gain operating leverage in sales and marketing over the next few quarters.
R&D investments in the second quarter were $8.8 million, or 20.2% of revenue, an increase from $7.4 million for the first quarter of 2023. Adjusting for the $1 million of previously mentioned one-time costs, R&D represented 17.9% of total revenue. We expect R&D to be closer to 19% of revenue in the next quarter as a result of our acquisition of PeerBoard and Edugo. Adjusted EBITDA performance was $3.1 million for the second quarter of 2023, or 7% of revenue, which is above our guided range of 5.5%-6.5% of revenue. We reported a net loss of $5.7 million for the second quarter of 2023, compared to $2.1 million net loss for the second quarter of 2022.
Adjusted net income for the second quarter of $7.9 million increased compared to adjusted net loss of $0.8 million for the first quarter of 2022. We generated positive free cash flow of $7 million and also earned $2.4 million in interest income. Given our strong cash flow generation since announcing our NCIB, we deployed $10.2 million towards repurchasing 279,676 common shares. Share-based compensation accounted for a modest 3% of second-quarter revenues, compared to 4.4% in the first quarter of 2022. Now for our Q3 2023 outlook. Due to the large deal we signed with the US Big 5 tech customer, we anticipate higher incremental revenue within the quarter.. We expect total revenues ranging between $45.9 million and $46.1 million.
We expect gross margin to range between 80%-81%. We expect adjusted EBITDA margin to range between 7.5%-8%. A few noteworthy points on the third quarter: We expect subscription revenue to be 2-3 percentage points higher than the overall company revenue, while professional service revenue to remain relatively flat quarter-over-quarter. The macro environment that we are operating in remains consistent with what we've experienced the past several quarters. In conclusion, I want to hit on three points. As we look forward to the next few quarters, we are seeing encouraging trends in the enterprise government segments, as well as our OEM channels.
We are successfully moving towards a balanced approach to growth and profitability as we continue to expand our adjusted EBITDA margins, even while investing in our AI roadmap, expanding our go-to-market teams in the government sector, and incurring costs to become FedRAMP compliant. Lastly, we reiterate our profitability guidance that Docebo will exit Q4 2023 with adjusted EBITDA margins of 10%. That concludes my prepared remarks. Operator, please open the line so that we could take questions from the analysts.
Operator (participant)
Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press star followed by the number one on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by the number two. If you are using a speakerphone, please lift your handset before pressing any keys. And as a reminder, we ask you to limit yourselves to two questions and return to the queue for any follow-ups. Please stand by for your first question. Your first question will come from Suthan Sukumar at Stifel. Please go ahead.
Suthan Sukumar (Managing Director)
Thank you. Good morning, gents. Congrats on another solid print here. Firstly, one just wanted to touch on your, your global tech customer win. You know, I think that serves as yet another key, key endorsement, you know, post your announcement with Amazon. You know, firstly, I just wanted to see if you can share some color on terms of what you're seeing in terms of changes, you know, over recent quarters with respect to the enterprise sales cycle. On the big tech deal itself, any color you can share on sort of the, the, the size of the deal and, and what use cases are, are in focus and, and from a competitive perspective, you know, was this a displacement opportunity or, or, what was it, say, a broader sort of competitive win here?
Claudio Erba (Founder and CEO)
Yeah, Claudio speaking. You know, the more we move upmarket, the more we discover that our enterprise customer are happy with Docebo because we provide sophisticated solution to deal with sophisticated tech ecosystems. The customer are happy when they buy a solution that can, for example, handle internal and external use cases, can synchronize the user database from different data sources. For example, you know, if you have an internal training, you, your user provisioning is coming from HR platforms, but then the external can come from CRM. The more we move upmarket, the more our customer are a fit for us because they deal with sophisticated environments, sophisticated subscription rules, sophisticated tracking, and this is becoming more and more our sweet spot.
If you are a very big company with very sophisticated use cases and scalability needs, and so on and so on, this is where Docebo thrives. Alessio, do you want to add something? Brendan?
Alessio Artuffo (President and COO)
I'm super excited for this win. It's one that's been in the works for a while. You were asking about value. You know, we can say it's a healthy, healthy seven-figure project. Additionally, I can share, since you're asking, that the primary drivers of success were alongside what Claudio was saying, having a more modern, highly personalizable experience for various learners across multiple use cases, whether those are more on the enablement side or externally facing. You know, frankly, the idea here is that we are very proud to have spent a lot more time, if you will, on navigating the processes of purchasing of this a great organization than we have beating competition.
during the selection process, we, we found that our capabilities aligned exactly with what the company was looking for, and therefore, the, the selection process was relatively simple when compared to more the extensive contracting phase. Having said that, we're happy to, to announce this, and yeah, looking forward to more.
Claudio Erba (Founder and CEO)
Yeah, and that a couple of points. First of all, this deal has been done in partnership with the Big Four system integrator. I mean, we partner with them because-you know, it's not only a matter of technology. When you deal with complex, environment and complex needs, you need to partner with those guys. Point number two, I mean, we, we love to work with technology customers, so because we can also leverage their own technology. You know, I'm very boring when I speak about AI, which is my main interest, and this is another opportunity to partner on AI.
Suthan Sukumar (Managing Director)
Great, though. Thank you for that, thank you for that, that color. The second question I had was on, on the, on the public sector. It sounds like you guys are seeing some, some pretty strong but, but early momentum here. Can you talk a little, little bit about, you know, what the opportunity you see overall and, and from a public sector perspective? You know, what's the, the TAM, TAM potential here, and what is your go-to-market approach here? It looks like it's more direct, could, could partners play a, a key role here? Any color would be appreciated.
Claudio Erba (Founder and CEO)
Yeah. Claudio speaking again, Suthan. The idea of a public sector, we discussed with Alessio probably two years ago, was like, we need to cover the public sector because, first of all, the competition there is almost nonexistent or very legacy. Customers were locked in on a 10-year contract, and now there is this moment where they are renegotiating and changing the technology with some modern technology. Third point is you want to sell to public sector because it's resilient on economic cycles. I mean, when there is a downturn, usually is where public sector spend more, and that's what we needed to make the business more resilient and less volatile. Public sector is very big.
For me, it was an incredible learning opportunity to discover the size of the market, which is very different from federal to state, for example, and we are referring only to U.S., then there is Canada. Another couple of points, this is a business that you approach together with system integrator, and this is the most beautiful partnership we are doing now, is with the ven- with those vendors that can complement our offering. Last point, we are exploring with the new company we have acquired, going with the former Chief Executive Officer, Giuseppe, the possibility to build our own learning large language models to run AI inside a government cloud without going outside in non-federal compliant environments. This is a key differentiator.
I mean, not only we are a modern vendor, but we bring the AI in an environment which is highly protected, without, you know, going and connecting APIs outside the FedRAMP certified environment. Sorry if I'm going technical, but this is very important because I believe that government also needs a lot of innovation. Ale, you can take the rest.
Alessio Artuffo (President and COO)
Yeah, Claudio, thank you. Suthan, again, great momentum here across federal and SLED, or, you know, state, local education. Just for clarity, we've already been mildly successful on the SLED side without a whole lot of specialization in the past. Our, our incremental focus on SLED, we believe, will yield higher win rates and better results. This is proven by, you know, recent success with, with closing State of Georgia, working closely. To do that, we had to work closely with large system integrator and another success with the larger provincial government agency in Ontario. I think one of the things that we'd like to clarify is, you know, SLED is a, is an opportunity that is shorter term for us.
We're working very closely with distributors like Carahsoft to get better at the execution of it. When we think about federal, it's a little bit of a different path in the sense that it takes a little longer, we have less experience in it, but we're taking all the right steps. Just last year alone, I think, federal spend in LMS was close to $200 million. So we believe that we have, thanks to our technology, like Claudio said, an enormous amount of right to win. Our process of FedRAMP is, if you will, the compliance step to really affirm ourselves in a market that necessitates new technology, which we have.
If we close that gap, we'll be able to tap into it effectively, and we're already bidding and are very aggressive in it. We're very optimistic, and we see a great momentum.
Claudio Erba (Founder and CEO)
That's great. Thank you for for that color. I'll pass the line.
Operator (participant)
Your next question will come from Robert Young at Canaccord Genuity. Please go ahead.
Robert Young (Senior Equity Research Analyst)
Good morning. I think you just said that the U.S. tech deal was seven figures, so I guess that could be $250,000 in the in the Q3 guide. Are there any other one-time items? I think the PeerBoard and Edugo, are those smaller, or should we think of those as a contribution? When you look at the pipeline, are there other larger deals, seven-figure deals still out there to win? Are you still working on these type of deals, or is this, you know, something that we should expect only, you know, once in a while?
Brandon Farber (SVP of Finance)
Hey, Robert Young, Brandon Farber here. I'll take the first part on the guidance. You know, with signing subsequent to quarter end, obviously, we're able to recognize more in-quarter revenue than our typical trend of signing majority of our enterprise deals over the last 15 days of the quarter, so your, your color is correct. It also speaks to, you know, the visibility in our enterprise and mid-market pipeline, which gives us confidence as we look to the remaining half of the year. I also wanted to point out, if you look at the midpoint of our guidance, it roughly represents 25% growth, which is equal to our Q2 growth. On the EBITDA side, although we are making investments in Q3, you know, we did wanna reiterate that we will exit Q4 with 10% EBITDA margins.
You know, as we absorb the Edugo and PeerBoard cost, from an R&D perspective, you know, we will still, like, you know, finish strong in Q4.
Alessio Artuffo (President and COO)
Brandon, I would only add that enterprise momentum continues, Rob. You were asking if we should expect more seven-figure deals. We certainly have a incredible names in our pipeline of large deals. I would, I would caution, you know, only the fact that this Big five deal that we closed was 18 months in the making. It, it elongated beyond our initial views, and so deals remain elongated, and it's hard for us to say on these deals when they will close exactly. In terms of pipeline being there, and great companies, and enterprise move-up market, we're very, very excited.
Robert Young (Senior Equity Research Analyst)
Okay, thanks for that. Definitely nice to see the guide, not common to see people giving good guidance this quarter. You said that their customers are seeing three-plus use cases, and then 30% coming from RFP. I just wanted to dig into that a little bit. Is that consolidation of existing customers, or is it... I think you said it was competitive takeaway in the, in, in the prepared comments. If you just talk about those two items and whether they're connected or whether there's, you know, this, this stack consolidation is something that's a big driver of the business, I'll pass it on.
Claudio Erba (Founder and CEO)
Yeah, Rob, Claudio speaking. Short answer, the table is now the best of breed out there, and if you want to switch from legacy vendors, the RFP that will be issued, we will be the first vendor to get on our desk. That's it.
Operator (participant)
Your next question will come from Josh Baer at Morgan Stanley. Please go ahead.
Josh Baer (Executive Director and Equity Research Analyst)
Great, thank you for the question. Some of your prepared remarks pointed to signs of stabilization. I guess, just wondering if when you think about the growth potential of your company, is it fair to say that, that you'd hope to reaccelerate growth? Not looking for specific numbers or a timeline, but when you you think about, you know, your growth profile in a better macro, is it, is it higher than current levels?
Claudio Erba (Founder and CEO)
Yeah, Claudio speaking. I'm, I'm, you know, I, I love profits because that means that we are running an healthy business that justify the fact that the business need to exist because makes profit. On the other side, if you, if you say me that I'm a Chief Executive Officer that is excited with 25% growth, no, absolutely. I want to challenge myself, my team, and all the company to be ambitious because we are in a, in a moment where we are the best of breed. We are penetrating new markets, new geographies. The total addressable market is pretty high. I think that strategically, we are opportunistic. We are positioning ourselves to reaccelerate growth if and when the macro environment will become friendly again. On the other side, the business is incredibly healthy, and we love a healthy business.
Josh Baer (Executive Director and Equity Research Analyst)
Great, that, that's really helpful. Then sort of with that positioning for acceleration in a better environment, second part of the question: Should we expect to see a step back in margins when that time comes to Like, are there investments needed for that reacceleration in growth, or are the resources in position for that opportunity ahead? Thank you.
Claudio Erba (Founder and CEO)
I think that Brandon-
Brandon Farber (SVP of Finance)
Yeah, Josh-
Claudio Erba (Founder and CEO)
Brandon would say. Yeah. Okay, go on.
Brandon Farber (SVP of Finance)
Yeah. Hey, Josh. I think I'd simply position it as, you know, we, we review ourselves as a Rule of 40. you know, as we see, growth reaccelerate, we'll adjust our EBITDA margins and make sure that we're making the investments that are necessary to continue to operate in growth. Obviously, if we, if we want to reaccelerate growth, we feel that we do have the necessary headcount at the moment, but to keep up with large of, law of large numbers, you know, we'll have to continually invest and invest to, to make sure that we're maintaining, sufficient growth rates.
Claudio Erba (Founder and CEO)
Josh, Oh, sorry.
Brandon Farber (SVP of Finance)
Oh, go, go ahead.
Claudio Erba (Founder and CEO)
Apologies, Josh. I was just gonna add, Josh, that one of our focuses really is to create continued more efficiency in our sales and marketing machine. We believe that there is more value to extract, that as, you know, we're taking specific steps, like value engineering and others, to achieve better unit economics, both in pipeline and in funnel execution.
Josh Baer (Executive Director and Equity Research Analyst)
Okay, great. Thank you.
Operator (participant)
Your next question will come from Kevin Kumar at Goldman Sachs. Please go ahead.
Kevin Kumar (VP and Equity Research)
Hi, thanks for taking my question. I wanted to just ask about the new OEM partnerships. Great to see, maybe just how, how did the relationships develop? Anything you can add in terms of how impactful you expect them to be in terms of contribution over time?
Claudio Erba (Founder and CEO)
Kevin, first of all, great to meet you. I, I believe it's your first question with us, correct?
Kevin Kumar (VP and Equity Research)
Yeah. Thanks for having me.
Claudio Erba (Founder and CEO)
Welcome. Ale, I would like to highlight how our OEM technology works, then you can enter into the execution part. Kevin, you need to know that the Duetto have built an OEM technology that makes every vendor, from HCM vendor, to payroll, to ERP, and many others, easy to integrate Duetto from two ways. one is we embed the Duetto white label, enabling or disabling features, because giving the OEM partner full control on the part of the Duetto LMS wants to show and what don't want to show, because different vendors have different training models. The second part is a very sophisticated solution that allows our partner to synchronize the release cycle with their release cycle.
We become part of their technology software stack, and this allows OEM partner to easily embed the user excel Duetto. From a technology standpoint, we are ready to e-expand our OEM partnership like these, these quarter happen. Ale, you can, you can take it.
Alessio Artuffo (President and COO)
Yeah, amazing. Thank you, Claudio. In terms of the, the two names that we've shared, well, actually one name, the other one was a Big Four firm. What I'd like to underscore with regards to Darwinbox is that in terms of ramping up timeframe, we should expect this to take about three to four quarters that will essentially allow the company to fully operationalize our technology and their commercial offering, enabling their field team and effectively starting to produce results that will reflect in incremental revenues for us. Additionally, on the Big Four name, look, this is... I'm particularly proud of that. This is the product of investments in our channel organization, and in general, maturity in the way we continue to manage our system integrators.
We believe our, our technology, as Claude just described, aligns perfectly with the system integrators goals. Similarly, we expect these efforts to produce results over the next few quarters.
Kevin Kumar (VP and Equity Research)
Great. Thanks for the color there. It sound like growth retention was fairly stable this quarter. Curious on maybe the cross-selling motion within the enterprise and maybe in particular Shape, you know, how much is maybe increased conversations around AI helping maybe drive higher attachment rates there? Thanks for the question.
Alessio Artuffo (President and COO)
Sure. Look, we, we are extremely focused on, on growing our base, whether it is upselling or, or cross-selling, and both are incredibly, incredibly high priorities in our listing execution. You are accurate and correct in saying that the cross-selling opportunity is higher on the enterprise side, and we pay special attention to this. You know, even in this quarter, we announced great results in expanding our relationship with VMware. Yeah, we have a lot of focus on this, and we're executing very, very specifically.
Kevin Kumar (VP and Equity Research)
Thanks for taking my call.
Claudio Erba (Founder and CEO)
Yeah, and Ale, I, I want to chime in about Shape. Shape is my baby. Actually, Shape is already positioning in the large enterprise needs, because we, we have been successful on solving one big problem with the AI. I love the, the automation part that big companies have. You know, when you build-- when you are a multinational company and you build a content that need to be deployed in 10 languages, your problem is not translation. Is what happens when you need to modify this content and publish the version number 1.1 or 2.0, where you need to retranslate everything.
The advantage of using Docebo Shape in this context allows customers to reduce from 40 work man days to like 20 minutes, the speed of deploying fast learning live in multiple languages. This is what large enterprise needs from a productivity standpoint, reducing sensibly in a manner where 40 days become 20 minutes, the effort to train their people and to distribute content. This is where Docebo is already positioning that market. This is because our customers started asking those kind of sophisticated automations that you can achieve only with AI.
Operator (participant)
Your next question will come from Stephanie Price at CIBC. Please go ahead.
Stephanie Price (Executive Director and Senior Equity Research Analyst)
Good morning. I, I just want to follow up on the, on the last question. Just curious, to dig a little bit more deeper. You know, when customers choose three or more services from Docebo, what are the biggest drivers there? Is it typically internal and external use cases, or is it different modules in the platform? Maybe related, are there other areas that customers are asking about that you're looking to add to the platform to complement the solution?
Alessio Artuffo (President and COO)
Stephanie, good morning. First of all, we love talking about the, the blend of use cases in what oftentimes we refer as hybrid, meaning the capability of solving for both internal and external use cases. In terms of the mix, we, we know we like the external business as we've shared multiple times because it's very differentiated and yields better unit economics, and we win at a higher rate in that space, where competition tends to be more focused on the legacy side on solving for internal problems. Let's say that the very frequent use cases that we solve for are on the onboarding side and professional education side, but also there is a uptick in, on the sales enablement side, even with very large organization, which we are very excited about.
Acquisitions like the one of Edugo, will further strengthen our positioning in some of those capabilities. On the external side, similarly, the move of increasing our capabilities also thanks to technology like PeerBoard, is to really strengthen our capabilities on the customer education side. The notable win that we've mentioned, I would say that this ability to solve for sales enablement and external facing capabilities has been probably, from a differentiated standpoint, the one element that has led us to winning this very large deal.
Stephanie Price (Executive Director and Senior Equity Research Analyst)
That's great color. Thanks. And maybe related, just on, you mentioned Edugo there. Obviously, Docebo has been a bit more acquisitive than, than usual lately with Edugo and, and PeerBoard. Just curious if you could talk a little bit about the M&A environment and, what you're seeing in the market here?
Alessio Artuffo (President and COO)
Yeah, absolutely. Before I, I pass M&A to Claudio, one thing that I, that I forgot and want to make sure to address, Stephanie, is that one of the things that we consider most strategically about this blend of use cases is not only on the acquisition side, but it's also on the retention side. We, we see unit economics of excellence, top quartile, when customers use Docebo for more than three use cases. So we don't just think about it in the context of winning at a higher rate, but also retaining, you know, and increasing lifetime value. Claudio, Brandon, I'll pass you the M&A question.
Claudio Erba (Founder and CEO)
Yeah, Stephanie, Claudio speaking. Rule number one in M&A, do not make mistakes. We are very careful on analyzing the market, on finding the best technologies that can be embedded inside Docebo, if I'm referring to talking M&As, and complement the Docebo offering. The two acquisition, Edugo was an acquisition to inject more AI and faster inside Docebo, reusing their own proprietary large, large language data modeling. With Edugo, I can promise that we are gonna destroy the e-learning content market that is, 20 years old, made of passive videos, because we are building something that finally will make the learner excited to learn. This is consistent with our roadmap and vision.
Brandon Farber (SVP of Finance)
About PeerBoard, we have acquired a community system that works very well with our thesis of external training. When you have a customer academy or a partner academy, you don't want only to train those partners with content, but you want those customer and partners interact and learn through social learning dynamics. This is incredibly consistent on Fabio's roadmap, that is focusing on adding features for the external training. We are continuously exploring the market from any angle, literally any angle, but we are extremely careful. We want to pay a fair price, and we, we have to digest those acquisition, you know, onboard people, embed the technologies and stuff like that. We are not there to make acquisition just to deploy to deploy the capital, but we want to digest acquisition and find the right opportunities.
Stephanie Price (Executive Director and Senior Equity Research Analyst)
Thank you for the color.
Operator (participant)
Your next question will come from Richard Tse at National Bank Financial. Please go ahead.
Speaker 13
Yes. Hi, it's James sitting in for Richard right now. Good job in the quarter, and I was just wondering, should we expect R&D as a percentage of revenue to continue moving up as you guys continue to invest in AI? Or do you see the partnership with that big tech company kind of offsetting those incremental investments?
Brandon Farber (SVP of Finance)
Hey, it's Brandon speaking. You should expect in Q3, R&D will tick up as a percentage of revenue, roughly to 19% as we make some incremental investments, but over time, that will stabilize, so you should not expect that R&D will continue to climb as a percentage of revenue. We see kind of 19%-20% to be the high mark, and then over time, we'll gain leverage there as well. You know, even with those investments that we're making, you know, we're still very confident that we'll hit our adjusted EBITDA margins of 10% by Q4.
Speaker 13
Okay, great.
Brandon Farber (SVP of Finance)
Also, sorry, one last point is, even in R&D as well, in Q3 and Q4, we have to make some significant investments in FedRAMP in order to become compliant. Some of those costs as well are impacting our R&D in the next two quarters.
Speaker 13
Okay, great. Thanks, Brandon.
Operator (participant)
Your next question will come from Andrew Charles at TD Securities. Please go ahead.
Andrew Charles (Managing Director and Senior Research Analyst)
Hi there. My question was on the system integrators pipeline. Just wondering if you could share any details on that, on whether we can expect any more big partnerships, or even any more Big Fours?
Alessio Artuffo (President and COO)
All right. Well, details perhaps is hard, but I will do my best here about that. We are super excited about our work on SIs. This is a work that has been going on for a while. I would say, I would characterize our work in two, in two segments. Segment one, commercial space. We recognize that working with the top enterprises in the world requires a deeper relation in the form of alliances or teaming agreements with the biggest firms and system integrators in the world. The great news is, we are developing those relationships to a deeper level than we ever have. I would say, with a high degree of confidence, that had we not done that, the Big five win that we, that we announced, would have probably been very hard to accomplish.
Not only we continue to develop relationship with this big SI that led to that win, but also we continue to work with the peer group of greater size, not only the Big Four, there are more, tap into the enterprise market because they are very present. The second comment is on the government space. The government space, as we have outlined before, is a partners world. This means not only local partners that play very favorably in the jurisdiction, in the states, in the cities, in the counties, but more broadly, there are certain size, there are practices that are very government-focused, and they are already in those organizations for since a long time.
They have a view, they understand how the federal agencies buy, and our ability to work closely with them gives us not only more credibility, not only an accelerated path, but what we love is it gives us a longer-term view on pipeline of opportunities, that is very healthy for our ability to be predictable in the future in the government space. Our efforts are being coordinated under our renewed alliance organization. We've made some investments in terms of people, and we're extremely excited about it, and more news to come.
Andrew Charles (Managing Director and Senior Research Analyst)
Okay, great. Thanks for that answer. My next question is on... In your prepared remarks, you mentioned some churn in the SMB space. I was wondering if you could comment on that, whether you see it continuing or maybe you've seen the bulk of the churn happen in that space, given the macro?
Alessio Artuffo (President and COO)
We believe that this is very consistent with our strategy and go-to-market over the past years. We recognize that the SMB logos have less maturity, and they tend to to churn at a higher rate than enterprise customers. Listen, it, you know, we, we are focused on building a system that really succeeds in the mid-enterprise space. Now, with that said, with the right level of automation, training, and skill, and upskilling, we can make successful also SMB customers. You know, we believe that this churn in the lower part of of the, the, the sec- the customer base is really by design. I don't know if Claudio or Brendan, you want to add something on this topic?
Andrew Charles (Managing Director and Senior Research Analyst)
Perfect.
Brandon Farber (SVP of Finance)
No. Nothing to add.
Operator (participant)
Your next question will come from Martin Toner at ATB Capital Markets. Please go ahead.
Martin Toner (Managing Director of Institutional Equity Research)
Thanks very much for taking my question. You guys mentioned churn. Can you talk a little bit about what the customers that are churning look like, and look into your ARR, and tell us what % of that ARR looks like those customers that are currently churning?
Brandon Farber (SVP of Finance)
Hey, Martin, I'll take that. You know, one thing we should mention is that our gross retention did remain flat quarter-over-quarter. You know, although we see some churn in the SMB market, which is, you know, high switcher market, cost-conscious, always going for the lowest price, given that our, you know, our book of business continues to shift more to mid-market and enterprise, as SMB churn comes, you know, we're still seeing gross retention remain relatively flat. Also, you know, when we look at SMB from gross retention and also expansion opportunities, SMB is a bit suboptimal. We see most of our expansion opportunity in the mid-market and enterprise space as well. We'll continue to just, you know, focus on customers with our optimal unit economics and, you know, happy to see that gross retention has remained flat.
Martin Toner (Managing Director of Institutional Equity Research)
Great, thanks. Congrats on the Whale, and also congrats on Rolls-Royce announcement. Can you talk a little bit about the European opportunity? How's that coming along, and how much could it contribute to growth going forward?
Alessio Artuffo (President and COO)
Absolutely. That's a market that, as you know, we continue to invest in with the most recent growth and set up for the DACH region. Winning Rolls-Royce in a relatively short timeframe from launching our DACH operation was an incredibly encouraging sign, and we continue to see remarkable pipeline growth in Europe, particularly in the U.K, France, and Benelux, as well as good momentum in pipeline in the APAC region, not just in Europe. We remain focused on launching these new, if you will, entities and focusing on these markets. You know, we also recognize that it takes time, and we're, we're, you know, hoping to continue to announce great logos like Rolls-Royce in the quarters to come.
Brandon Farber (SVP of Finance)
Just one other point as well, you know, with, with our OEM win with Darwinbox, we're also adding the Indian market, which we're not in today. With that OEM play, that gives us an access to a market that we're not in today.
Martin Toner (Managing Director of Institutional Equity Research)
That's great. Thank you very much. That's all for me.
Operator (participant)
Your next question will come from Christian Sgro at Eight Capital. Please go ahead.
Christian Sgro (Equity Research Analyst)
Hi, good morning. I'll ask just one, two-part question on a topic Claudio is very passionate about, and that's artificial intelligence. Part one, more from a financial perspective, would you say that Shape is the only product, you know, that's commercialized in market and upsold separately right now? Part two, and a little bit more open-ended, you know, what across the entire portfolio are customers most excited about? What are you showing them in demos? Give us a little bit of color on, on what you're working on in AI.
Claudio Erba (Founder and CEO)
Sorry, I got the first question, not the second. Can you repeat the second one, please?
Christian Sgro (Equity Research Analyst)
Yes, Claudio. It'd be. There are some references to AI in the release and prepared remarks. You know, what are you selling to customers? What are you going to customers with to show the power of those AI integrations?
Claudio Erba (Founder and CEO)
About AI, you know, now everyone is.. I mean, now it's super easy to build something new using OpenAPI, like OpenAI or others. There are a lot of experiments out there to build everything, including Shape-like products that, you know, can be interesting products.
Let's say that we, we started investing on AI four-years ago, and what we have learned is that the, the biggest problem of AI is not creating a nice product. First of all, make it scalable. I mean, you need it to build AI that can serve millions of learners, and this is more complicated than creating an appealing content generator. Second, you need it to be compliant with, on how the customer uses data to train the AI. There is an incredible level of complexity, and before startups can catch up, this level of complexity takes time, and in this meantime, we have such a competitive advantage that Docebo Shape will become something else.
I have the confidence that the Shape integrated with the Docebo ecosystem will be something that large enterprises will love to use. By the way, we are demoing some new Shape features at Docebo Inspire in Nashville in September. To answer your second question, I mean, AI is pervasive inside the technological ecosystems. We do see mainly two main areas. One is automation. That means AI doing some routinary works that now are done by humans, like content tagging, skill tagging, skill matching, semantic search, suggestion, you name it. Then there is the part related to the content, where the generative AI will disrupt an industry that is 20 years old legacy, because it's still tied to passive videos to watch, pretending that you learn something.
Christian Sgro (Equity Research Analyst)
Perfect. Thank you very much for taking my question.
Claudio Erba (Founder and CEO)
Thank you.
Operator (participant)
There are no further questions, so at this time, I will turn the conference back to Claudio for any closing remarks.
Claudio Erba (Founder and CEO)
Perfect. Thank you everyone for joining this earnings call. I think it's my 13th one, if I'm not wrong. Happy to see you in November. Speak soon. Thank you. Don't forget to come to Inspire.
Operator (participant)
Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask you to please disconnect your lines.