Docebo Inc
TSX:DCBO
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Docebo Inc
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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 U.S. dollars.
Now, I'd like to turn the call over to Docebo's CEO, Claudio Erba.
Hi, everybody, and thank you for joining us for our second quarter earnings call. With me today, Alessio Artuffo, our President and COO; and Brandon Farber, our Senior Vice President of Finance. Brandon is filling in for Sukaran Mehta, our CFO, 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 a trend consistent with the prior quarter. Enterprise segment spending is showing sign 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 5 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 the Docebo's learning platform.
As well to further advance our leadership in AI, we acquired Edugo. 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 [indiscernible]. 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 customers, we are beginning the process of becoming FedRAMP compliant in the United States within the next 2 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 2 areas: selective merger and acquisition, and efficient return of capital to shareholders. As valuation has become more favorable, we completed the 2 tuck-in acquisitions 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 long-time 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 his team's 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 customers recognize that learning solutions 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 investments we make today will further strengthen our position and accelerate the Docebo growth.
Now I would like to turn the call over to Alessio, who will give you an operational update.
Thank you, Claudio, and good morning, everyone. In quarter 2, the company-wide average contract value increased over 8% to $48,100 from around $44,500 at the end of quarter 2 2022. ACV for new customers in the quarter was about $61,000 compared to $50,000 in quarter 1. 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 2.
50% of these new customers have chosen Docebo for 3 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 in macro 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; and 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.
Also, 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 programs. 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, with 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 4 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 internal and external use cases that governments are bringing forward, giving local, state, and federal agencies the same ability to consolidate their [tax]. 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 this space. Additionally, we’re allowing with other key players, including distributors like Carahsoft, who can help us to simply 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 4 system integrator, which will white label 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 our 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 our presence in India, a young workforce with a large and fast-moving market from which the Docebo solution is ideally suited for.
Our OEM alliances are a core pathway into both the enterprise segment and new geos, and we’re pleased with how these new partners expand these pillars of growth. Both opportunities will be in the ramp-up mode over the next 12 months, and 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 the Docebo.
With that, I would like to hand the call over to Brandon.
Thank you, Alessio, and good morning, everyone. For those interested, a detailed breakdown of our financial results for the 3 and 6 months ended June 30, 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 to $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 8% 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 onetime costs related to severances, transaction costs and acquisition-related earnout 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 onetime 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 revenues. 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 onetime 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% to 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 a U.S. 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% and 81%. We expect adjusted EBITDA margin to range between 7.5% and 8%.
A few noteworthy points on the third quarter. We expect subscription revenue to be 2 to 3 percentage points higher than the overall company revenue, while professional services revenue to remain relatively flat quarter-over-quarter. The macro environment that we are operating in remains consistent with what we've experienced in the past several quarters.
In conclusion, I want to hit on 3 points. As we look forward to the next few quarters, we are seeing encouraging trends in the enterprise, government segment as well as our OEM channel. 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 can take questions from the analysts.
[Operator Instructions] Your first question will come from Suthan Sukumar at Stifel.
Congrats on another solid print here. Firstly, I just wanted to touch on your global tech customer win. I think that's sort of -- you had another key endorsement post your announcement with Amazon. Firstly, I just wanted to see if you can share some color in terms of what you're seeing in terms of changes over recent quarters with respect to the enterprise sales cycle. And on the big tech deal itself, any color you can share on sort of the size of the deal and what use cases are in focus? And from a competitive perspective, was this a displacement opportunity or was it, say, a broader sort of competitive win here?
Yes, Claudio speaking. The more we move upmarket, the more we discover that our enterprise customers are happy with Docebo because we provide sophisticated solutions to deal with sophisticated tech ecosystems. So the customers 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, if you have an internal training, your user provisioning is coming from HR platforms, but then the external can come from the CRM.
So the more we move up market, the more our customers 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. So 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? Brandon?
Suthan, super excited for this win. It's one that's been in the works for a while. You were asking about value. We can say it's a healthy 7-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.
And 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 great organization, then we have beating competition during the selection process. We found that our capabilities aligned exactly with what the company was looking for. And therefore, the selection process was relatively simple when compared to more the extensive contracting phase. Having said that, we're happy to announce this, and, yes, looking forward to more.
Yes. And I'll add a couple of points. First of all, this deal has been done in partnership with big 4 system integrators. I mean, we partnered with them because 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 love to work with technology customers because we can also leverage their own technology. And I'm very boring when I speak about AI, which is my main interest. And this is another opportunity to partner on AI.
Great. And the second question I had was on the public sector. And it sounds like you guys are seeing some pretty strong but early momentum here. Can you talk a little bit about what the opportunity you see overall? And from a public sector perspective, what's sort of the TAM potential here? And what is your go-to-market approach here? It looks like it's more direct. Could partners play a key role here? Any color there would be appreciated.
Yes. So Claudio speaking again, Suthan. The idea of the public sector, we discussed with Alessio probably 2 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 years 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. The -- 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 those vendors that can complement our offering.
Last point, we are exploring with the new company we have acquired Edugo and with its former CEO, Giuseppe. The possibility to build our own learning -- large learning language models to run AI inside a government cloud without going outside in nonfederal compliant environments. So -- and 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 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.
Yes, Claud, thank you. Suthan, again, great momentum here across federal and SLED or state and local education. Just for clarity, we've already been mildly successful on the SLED side without a whole lot of specialization in the past. So our incremental focus on SLED, we believe, will yield a higher win rates and better results. This is proven by recent success with closing state of Georgia working closely. And to do that, we have to work closely with large system integrator, and other success with the large provincial government agency in Ontario.
I think one of the things that we'd like to clarify is SLED is an opportunity that is shorter term for us. We're working very closely with distributors like Carahsoft to get better 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 USD 200 million. And so we believe that we have, thanks to technology like Claudio said, an enormous amount of right to win. And our process of FedRAMP is, if you will, the compliance step to reaffirm ourselves in a market that necessitates new technology, which we have. So 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. So we're very optimistic, and we see the great momentum.
Your next question will come from Robert Young at Canaccord Genuity.
I think you just said that the U.S. tech deal was 7 figures. So I guess that could be $250,000 in the Q3 guide. Are there any other onetime items? I think PeerBoard and Edugo, are those smaller? Should we think of those as a contribution? And when you look at the pipeline, are there other larger deals, 7-figure deals still out there to win? Are you still working on these types of deals? Or is this something that we should expect only once in a while?
Rob, Brandon here. I'll take the first part on the guidance. So with signing subsequent to quarter end, obviously, we're able to recognize more in-quarter revenue than our typical trend of signing a majority of our enterprise deals over the last 15 days of the quarter. So your color is correct. But it also speaks to 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 want 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, we did want to reiterate that we will exit Q4 with 10% EBITDA margin. So, as we absorb the Edugo and PeerBoard cost from an R&D perspective, we will still finish strong in Q4.
Brandon, I would only add that enterprise momentum continues. Rob, you were asking if we should expect more 7-figure deals. We certainly have incredible names in our pipeline of large deals. I would caution only the fact that this big 5 deal that we closed was 18 months in the making. 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. But in terms of pipeline being there and great companies and enterprise move up market, we're very, very excited.
Okay. Definitely nice to see the guide, not common to see people giving good guidance this quarter. The -- you said that the customers are seeing 3-plus use cases and then 30% coming from RFP. And 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 a competitive takeaway in the prepared comments. But you just talk about those 2 items and whether they're connected or whether there's the stack consolidation is something that's a big driver of the business, then I'll pass the line.
Yes. Robert, Claudio speaking. Short answer, Decebo 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.
Your next question will come from Josh Baer at Morgan Stanley.
Some of your prepared remarks pointed to signs of stabilization. I guess I'm just wondering if when you think about the growth potential of your company, is it fair to say that you'd hope to reaccelerate growth. Not looking for specific numbers or a time line, but when you think about your growth profile in a better macro, is it higher than current levels?
Yes, Claudio speaking. I'm -- I love profits because that means that we are running a healthy business that justify the fact that the business needs to exist because it makes profit. But on the other side, if you say the kind of CEO 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 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 be -- will become friendly again. On the other side, the business is incredibly healthy and we love a healthy business.
Great. That's really helpful. And 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?
Josh, I think I'd simply position is we view ourselves as a rule of 40. So 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 want to reaccelerate growth, we feel that we do have the necessary headcount at the moment, but to keep up with a lot of large numbers, we'll have to continually invest and invest to make sure that we're maintaining sufficient growth rates.
I was just going to add, Josh, that -- and one of our focuses really is to create continued more efficiency in our sales and marketing machine. We believe there is more value to extract and we're taking specific steps like value engineering and others to achieve better unit economics, both in pipeline and in funnel execution.
Your next question will come from Kevin Kumar at Goldman Sachs.
I wanted to just ask about the new OEM partnerships, great to see. Maybe just how did the relationships develop? And anything you can add in terms of how impactful you expect them to be in terms of contribution over time?
Yes, Kevin. First of all, great to meet you. I believe it's your first question with us, correct?
Yes. Thanks for having me.
Welcome. So I would like to highlight how our OEM technology works, then you can enter into the execution part. But Kevin, you need to know that Docebo has built an OEM technology that makes every vendor, from HCM vendor to payroll to ERP and many others, easy to integrate Docebo from 2 ways. One is we embed the Docebo white label, enabling or disabling features because giving the OEM partner full control on the part of the Docebo LMS wants to show and what don't want to show because different vendor has deeper and training models.
The second part is a very sophisticated solution that allows our partner to synchronize the release cycle with their release cycle. So we become a part of their technology software stack. And this allows OEM partner to easily embed the user resell Docebo. So from a technology standpoint, we are ready to expand our OEM partnerships like this quarter happen. Ale, you can take.
Yes, amazing. Thank you, Claud. Yes. So in terms of the 2 names that we've shared, there were actually one name. The other one was a big 4 firm. What I'd like to underscore with regard to Darwinbox is that in terms of ramping up time frame, we should expect this to take about 3 to 4 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 were reflecting incremental revenues for us.
Additionally, on the big 4 name, look, this is -- I'm particularly proud of the fact this is the product of investments in our channel organization and in general, maturity in the way we continue to manage system integrators. We believe our technology, as Claudio just described, aligns perfectly with the system integrators' goals. And similarly, we expect these efforts to produce results over the next few quarters.
Great. And then it sounds like gross retention was fairly stable this quarter. Curious on maybe the cross-selling motion within the enterprise and maybe in particular Shape, how much is maybe increased conversations around AI helping maybe drive higher attachment rates there?
Sure. So look, we are extremely focused on growing our base, whether it is upselling or cross-selling and both are 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. Even in this quarter, we announced great results in expanding our relationship with VMware. So yes, we have a lot of focus on this, and we're executing very, very specifically.
And Ale, I want to chime in about Shape. Shape is my baby. Actually, Shape is already positioning in the large enterprise deals because we have been successful on solving one big problem with the AI. So I love the automation part that the bigger companies have. When you build – when you are a multinational company, and you build a content that needs to be deployed in 10 languages, your problem is not translation is what happened when you needed to modify this content and publish the version 1.1 or 2.0, where you need to retranslate everything.
So the advantage of using the Docebo Shape in this context allows customers to reduce from 40 days to like 20 minutes, the speed of deploying faster learning live in multiple languages. And this is what large enterprise needs from a productivity standpoint, reducing with sensibly in a manner where 40 days become 20 minutes, the effort to train their people and to distribute content. So this is where Docebo is already positioned in that market, and this is because our customers started asking those kind of sophisticated automations that you can achieve only with AI.
Your next question will come from Stephanie Price at CIBC.
I just want to follow up on the last question. Just curious to dig a little bit more deeper. When customers choose 3 or more services from Docebo, what are the biggest drivers there? Is it typically internal and external use cases? Or is it different modules and platform? And maybe related, are there other areas that customers are asking about that you're looking to add to the platform to complement the solution?
Stephanie, first of all, we love talking about the blend of use cases and what oftentimes we refer as hybrid, meaning the capability of solving for both internal and external use cases. In terms of the mix, 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 come to -- that we solve for are on the onboarding side and professional education side. But also there is an uptick on the sales enablement side, even with very large organization, which we are very excited about and 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. And the notable win that we have 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.
That's great color. And maybe related, just on, you mentioned Edugo there. Obviously, Docebo has been a bit more acquisitive than usual lately with Edugo 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.
Yes, absolutely. Before I'll pass M&A to Claudio, one thing that I forgot and want to make sure to address Stephanie is that one of the things that we consider more strategically about this blend of use cases, it's not only on the acquisition side, but it's also on the retention side. We see unit economics of excellence, top quartile when customers use the Shape for more than 3 use cases. And so we don't just think about it in the context of winning at a higher rate, but also retaining and increasing lifetime value. Claudio, Brandon I'll pass you the M&A question.
Yes, Stephanie, Claudio speaking. Rule number one in M&A, do not make mistakes. So we are very careful on analyzing the market on finding the best technologies that can be embedded inside the Docebo, if I’m referring to tuck-in M&As, and complement the Docebo offering. The 2 acquisition, Eudgo was an acquisition to inject more AI and faster inside the Docebo reusing their own proprietary large language data odelling. And with Edugo, I can promise that we are going to destroy the 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.
And this is consistent with our roadmap and vision. 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 customers and partners interact and learn through social learning dynamics. And this is incredibly consistent on fabulous 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 have to digest those acquisitions, onboard people, embed technologies and stuff like that. So we are not there to make acquisitions just to deploy the capital, but we want to digest acquisition and find the right opportunities.
Your next question will come from Richard Tse at National Bank Financial.
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?
It's Brandon speaking. You should expect in Q3, R&D will tick up as a percentage of revenue, roughly 18%, 19% as we make some incremental investments. But over time, that will stabilize. So you should not expect that R&D will continue to decline as a percent of revenue. We see kind of 19%, 20% to be the high mark. And then over time, we'll gain leverage there as well. But even with those investments that we're making, we're still very confident that we'll hit our adjusted EBITDA margin of 10% by Q4.
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, so some of those costs as well are impacting our R&D in the next couple of quarters.
Your next question will come from Evan Chow at TD Securities.
My question was on the system integrators pipeline. I'm just wondering if you could share any details on that on whether we can expect any more big partnerships or even any more big 4s?
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 working in 2 segments.
Segment number 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. And the great news is we are developing those relationships to a deeper level than we ever had. And I would say with a high degree of confidence that had we not done that, the big 5 win that we announced would have probably been very hard to accomplish. So 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 4, there are more to 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 partner's world. This means not only local partners that play very favorably in the jurisdiction, in the states, in the cities and the counties, but more broadly, there are certain SIs, there are practices that are very government-focused and they are already in those organizations 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.
So 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.
Okay. Great. 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 on whether you see it continuing or maybe you've seen the bulk of the churn happen in that space given the macro.
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 churn at a higher rate than enterprise customers. And listen, 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 of SMB customers. But we believe that this churn in the lower part of the customer base is really by design. I don't know if Claudio or Brandon you want to add something on this topic.
No.
No. Nothing to mention.
Your next question will come from Martin Toner at ATB Capital Markets.
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 percentage of that ARR looks like those customers that are currently churning?
Martin, I'll take that. So one thing that I should mention is that our gross retention did remain flat quarter-over-quarter. So although we see some churn in the SMB market, which is high switcher market, cost conscious always going for the lowest price. Given that our book of business continues to shift more to mid-market and enterprise and SME churn comes, we're still seeing gross retention remain relatively flat.
And also, 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. So we'll continue to just focus on customers with our optical unit economics and happy to see that gross retention is remaining flat.
Great. Congrats on the Whale and also congrats on Rolls-Royce announcement. Can you talk a little bit about the European opportunity? How is that coming along? And how much could it contribute to growth going forward?
Absolutely. That's a market that, as you know, we continue to invest in with the most recent growth and setup for the DACH region. Winning Rolls-Royce in a relatively short time frame 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, but we also recognize that it takes time. And we're hoping to continue to announce great logos like Rolls-Royce in the quarters to come.
Just one other point as well with our OEM win with Darwinbox, we’re also adding the Indian market, which we’re not in today. So with that OEM play that gives us an access to a market that we’re not in today.
Your next question will come from Christian Sgro at Eight Capital.
I'll ask just one 2-part question. On a topic Claudio is very passionate about, and that's artificial intelligence. So part 1, more from a financial perspective, would you say that Shape is the only product that's commercialized in market and upsold separately right now? And then part 2 and a little bit more open ended, 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 what you're working on in AI.
Sorry, I got the first question, not the second. Can you repeat the second one, please?
Yes, Claudio. It'd be -- there are some references to AI in the release and prepared remarks, but what are you selling to customers? What are you going to customers with to show the power of those AI integrations?
Yes. So about AI, now everyone is – I mean, now it’s super easy to build something new, using open APIs like OpenAI or others. So there are a lot of experiments out there to build everything, including Shape like products that can be interesting products. That said, we started investing on AI 4 years ago. And what we have learned is that the biggest problem of AI is not creating a nice product. But first of all, make it scalable. I mean, you needed to build AI that can serve a million of learners. And this is more complicated than creating an appealing content generator.
And second, you need to be compliant on how the customer uses data to train the AI. So 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 Shape will become something else. So I have the confidence that the Shape integrated with the Docebo ecosystem will be something that large enterprises will love to use. But 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 2 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. And 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.
There are no further questions. So at this time, I will turn the conference back to Claudio for any closing remarks.
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. And don’t forget to come to Inspire.
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.