Docebo Inc. Q2 FY2023 Earnings Call

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, exceeding 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 signs of stabilization where our pipeline is healthy, while SMB customers took a more cautious approach due to macroeconomic impacts. Geographically, we see activities in the 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 Docebo's learning platform. To further advance our leadership in AI, we acquired Edugo. This acquisition enhances 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. 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 two quarters. As previously discussed, we see this market as an excellent pillar for long-term growth. We have made strategic hires to form a government-specific vertical team and are building focused channel partner relationships with highly regarded firms to expedite our access to the government space. Our capital allocation strategy focuses on two areas: selective mergers and acquisitions, and efficient return of capital to shareholders. As valuation has become more favorable, we completed two 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 components 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 Docebo's 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. Fifty percent 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 cautious spending in the 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, 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 VMware, 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 training efforts. 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 collaborating with other key players, including distributors 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 a global OEM alliance with a big 4 system integrator, which will white-label Docebo's 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. Our OEM alliances are a core pathway into both the enterprise segment and new geographies, and we’re pleased with how these new partners expand these pillars of growth. Both opportunities will be in 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 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 one-time costs related to severances, transaction costs, and acquisition-related earnouts that are 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 revenues. With the investments we made in the IT systems at the beginning of the year, we anticipate continuing 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% to 6.5% of revenue. We reported a net loss of $5.7 million for the second quarter of 2023 compared to a $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 an 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 remains 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 three points. As we look forward to the next few quarters, we are seeing encouraging trends in the enterprise and government segments 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.

Congratulations on another strong performance. I wanted to talk about your recent success with a global tech customer, especially following your announcement with Amazon. Could you provide some insights into the changes in the enterprise sales cycle over the last few quarters? Also, regarding the big tech deal, could you share details about its size and the key use cases? From a competitive standpoint, was this more of a displacement opportunity or a broader win?

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 internal training, your user provisioning is coming from HR platforms, but then the external can come from the CRM. So the more we move upmarket, 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, 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, than 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 a more 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 environments 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 passionate 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. 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 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 ten-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 the public sector because it's resilient in economic cycles. I mean, when there is a downturn, usually where the public sector spends more. And that's what we needed to make the business more resilient and less volatile. The 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 integrators. 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 of building our own large learning language models to run AI inside a government cloud without going outside in non-federal compliant environments. And this is a key differentiator. Not only are we a modern vendor, but we bring AI into a highly protected environment 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 the 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 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 integrators, 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 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, an enormous amount of right to win. 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 aggressively in it. So we're very optimistic, and we see the great momentum.

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 one-time 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 costs 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 when these deals will close exactly. But in terms of pipeline being there and great companies and enterprise moving up market, we're very, very excited.

Okay. Definitely nice to see the guide; it's not common to see people giving good guidance this quarter. You said that the customers are seeing 3-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 I think you said it was a competitive takeaway in the prepared comments. But you just talk about those two items and whether they're connected or whether 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, Docebo is now the best of breed out there. If you want to switch from legacy vendors, the RFP that will be issued, we will be the first vendor to be considered. That's it.

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 timeline, but when you think about your growth profile in a better macro, is it higher than current levels?

Yes, Claudio speaking. I love profits because that means that we are running a healthy business that justifies the fact that the business needs to exist because it makes profit. But on the other side, I'm the kind of CEO that is excited with 25% growth, no, absolutely not. I want to challenge myself, my team, and the entire company to be ambitious because we are in a moment where we are the best of breed. We are penetrating new markets and 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 becomes friendly again. On the other side, the business is incredibly healthy, and we love a healthy business.

Great. That's really helpful. Regarding the potential for acceleration in a better environment, should we expect to see a decline in margins when that time arrives? Will there be necessary investments for the reacceleration in growth, or do we already have the resources in place for that upcoming opportunity?

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 to make sure that we're maintaining sufficient growth rates.

I was just going to add, Josh, that one of our focuses is to create continued 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.

I wanted to just ask about the new OEM partnerships; it's 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. You need to know that Docebo has built an OEM technology that makes every vendor, from HCM vendors to payroll to ERP and many others, easy to integrate Docebo from two ways. One is we embed the Docebo white label, enabling or disabling features because we give the OEM partner full control over what part of the Docebo LMS they want to show and what they don't want to show. Different vendors have different training models. The second part is a very sophisticated solution that allows our partners to synchronize the release cycle with their release cycle. So we become a part of their technology stack. This allows OEM partners to easily embed and 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 two names that we've shared, there was actually one name. The other one was a big four firm. What I'd like to underscore regarding Darwinbox is that in terms of ramp-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 will reflect incremental revenues for us. Additionally, on the big four name, look, I'm particularly proud of the fact this is the product of investments in our channel organization and in general, maturity in managing system integrators. We believe our technology, as Claudio just described, aligns perfectly with the system integrators' goals. 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 are increased conversations around AI helping drive higher attachment rates there?

Sure. 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 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 passion. Actually, Shape is already positioned in the large enterprise deals because we have been successful in solving one big problem with AI. When you build for a multinational company, and you create content that needs to be deployed in 10 languages, your problem is not translation; it is what happens when you need to modify this content and publish version 1.1 or 2.0, where you need to re-translate everything. So the advantage of using Docebo Shape in this context allows customers to reduce from 40 days to like 20 minutes, the speed of deploying faster learning content in multiple languages. This is what large enterprises need from a productivity standpoint: reducing dramatically the effort to train their people and distribute content. This is where Docebo is already positioned in that market because our customers have started asking for those kinds of sophisticated automations that you can achieve only with AI.

I just want to follow up on the last question. I'm curious to dig a little bit 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 we oftentimes refer to 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 the competition tends to be more focused on the legacy side in solving for internal problems. The very frequent use cases 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 organizations, which we are very excited about. Acquisitions like Edugo will further strengthen our positioning in some of those capabilities. On the external side, similarly, the move of increasing our capabilities thanks to technology like PeerBoard is to strengthen our capabilities on the customer education side. The notable win that we mentioned shows that our ability to solve for sales enablement and external-facing capabilities has been one of the primary differentiators that led us to win 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 hand the M&A topic to Claudio, I want to ensure I address one point. It's that we see unit economics of excellence, top quartile, when customers use Shape 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 and increasing lifetime value. Claudio, Brandon, I'll pass you the M&A question.

Yes, Stephanie, Claudio speaking. Rule number one in M&A is do not make mistakes. So we are very careful in analyzing the market to find the best technologies that can be embedded inside Docebo and complement the Docebo offering. The acquisition of Edugo was aimed at injecting more AI and faster inside Docebo by utilizing their proprietary large language data modeling. With Edugo, I can promise that we are going to disrupt the learning content market that is 20 years old, made of passive videos because we are building something that will finally make the learner excited to learn. This is consistent with our roadmap and vision. Regarding 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 to interact and learn through social learning dynamics. This aligns perfectly with our fantastic roadmap that focuses on adding features for external training. We are continuously exploring the market from every angle, literally every 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 so on. We are not there to make acquisitions just to deploy capital, but we want to digest acquisitions and find the right opportunities.

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 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% to 19% as we make some incremental investments. But over time, that will stabilize. You should not expect that R&D will continue to decline as a percent of revenue. We see kind of 19% to 20% to be the high mark. And then over time, we'll gain leverage there as well. But even with those investments we are making, we're still very confident that we'll hit our adjusted EBITDA margin of 10% by Q4. One last point is that in Q3 and Q4, we have to make some significant investments in FedRAMP in order to become compliant, so some of those costs are impacting our R&D in the next couple of quarters.

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 are hard, but I will do my best here. We are super excited about our work with SIs. This is work that has been going on for a while. I would say I would characterize our work in two segments. Segment number one, the 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 had. 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 do we continue to develop relationships with this big SI that led to that win, but we also 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 is, as we have outlined before, 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 have been in those organizations for 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 but also an accelerated path and a longer-term view on pipeline opportunities that is very healthy for our ability to be predictable in the future in the government space. So our efforts are 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.

My next question is about the churn in the SMB space that you mentioned in your prepared remarks. Can you provide some insight on whether you expect this trend to continue, or if you believe the majority of the churn has already occurred in that sector given the current economic conditions?

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. 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 a success 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.

Martin, I'll take that. 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 a high switcher market, cost-conscious consumers always going for the lowest price. Given that our book of business continues to shift more to mid-market and enterprise, as SMB churn comes, we're still seeing gross retention remain relatively flat. 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 optimal unit economics and happy to see that gross retention is remaining flat.

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 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 a high switcher market, cost-conscious customers always going for the lowest price. Given that our book of business continues to shift more to mid-market and enterprise, as SMB churn occurs, we're still seeing gross retention remain relatively flat. And 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.

Absolutely. That's a market that, as you know, we continue to invest in with the most recent growth in setup for the DACH region. Winning Rolls-Royce in a relatively short time frame from launching our DACH operation was an incredibly encouraging sign. 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 entities and keeping our focus on these markets, but we also recognize that it takes time. 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's giving us access to a market that we are not in today.

I'll ask just one two-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 are working on in AI.

Yes. So about AI, now everyone is very focused on AI solutions. It's super easy to build something new using open APIs like OpenAI or others. There are a lot of experiments out there to create everything, including Shape-like products. That said, we started investing in AI four years ago. What we have learned is that the biggest problem of AI is not creating a nice product. But first of all, making it scalable. I mean, you need to build AI that serves thousands or millions of learners. This is more complicated than creating an appealing content generator. Second, you need to be compliant on how customers use data to train AI. There is an incredible level of complexity. Before startups can catch up, this level of complexity takes time. In this meantime, we have such a competitive advantage that Shape will become something else. I am confident that 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, AI is pervasive inside the technological ecosystems. We mainly see two main areas. One is automation. That means AI doing some routine tasks that are now done by humans, like content tagging, skill tagging, skill matching, semantic search, suggestion, etc. And then there is the part related to content where generative AI will disrupt an industry that has been relying on passive videos for the last 20 years, pretending that you learn something. 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.