Cellebrite DI Ltd. Q3 FY2021 Earnings Call

Good day, ladies and gentlemen, and welcome to the Cellebrite Q3, 2021 Earnings Call. As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Anat Earon Heilborn, VP, Investor Relations for Cellebrite. You may begin.

Thank you, Justin. Welcome to Cellebrite’s third quarter 2021 financial results webcast. Joining me today are Yossi Carmil, Cellebrite’s Chief Executive Officer, and Dana Gerner, Cellebrite’s Chief Financial Officer. This call is being recorded and a replay of this recording, as well as a copy of the presentation that accompanies this call, will be made available on our website shortly after the call. A copy of today's press release and financial statements, including GAAP to non-GAAP reconciliations, as well as supplemental financial information for the third quarter, are available on the Investor Relations website at investor.cellebrite.com. Statements made during this call that are not statements of historical facts constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties, and other factors that could cause matters expressed or implied by those forward-looking statements not to occur. They could also cause the actual results to differ materially from historical results and/or from forecasts. Some of these forward-looking statements are discussed under the heading Risk Factors and elsewhere in the company's registration statement on Form S1 declared effective by the SEC on October 6, 2021. The company does not undertake to update any forward-looking statement due to future events or circumstances. Please note that in the coming weeks, management will participate in a number of investor conferences, as detailed in today's press release. Please visit the events section of the Investor website to access webcasts of our presentations at these conferences, where applicable. With that, I'd like to turn the call over to Yossi Carmil, Cellebrite CEO. Yossi, please go ahead.

Thank you, Anat. And thank you for joining our call today. This is our first earnings call as a public company. Many of you have been following our progress since the beginning of the going public process back in April. Firstly, I would like to thank you for your interest and support. We are thrilled to start our journey as a public company by delivering progress on our strategy, along with strong financial results. Just to refresh, our strategy is to lead the digital transformation of our customers' investigative units, becoming a one-stop shop digital intelligence vendor. In Q3, we continued to see momentum with large and multi-solution deals, which we highlighted earlier in the year. We are pleased to report this quarter 25 deals larger than $0.5 million, compared with 15 such deals in Q3 last year, including our largest deal ever of approximately $10 million with a U.S. Federal account. In the first nine months of this year, we had 58 such deals reflecting a growth of 76% compared to the same period last year. These large deals reflect a successful upsell of additional licenses or new solutions to existing customers, as well as an increase in multiyear term-based deals. This momentum is a reflection of the success we have had within the public safety sector as part of the digital transformation process of strategic accounts. Furthermore, we are excited to see upsell driven this year by Premium, our high-end Collect & Review solutions with new license sales in Q3 to customers such as two federal agencies, and one state police force in the United States, a European Ministry of Interior Affairs and a municipal police force in the Near East. We successfully launched a Premium Enterprise solution and began deployments of the orders made even before solution availability, while receiving new orders from customers such as a county police force in the UK, two county sheriff's offices in the USA, Customs Authority and others. As a reminder, Premium is our advanced Collect & Review solution providing unlock and extract capabilities for leading iOS and Android devices. It is typically installed in a central location that can meet our strict security requirements. The new solution, the Premium Enterprise, is designed to decentralize our advanced capabilities while maintaining the security requirements found in Premium. The Premium Enterprise allows remote connectivity to UFEDs, the most widely adopted prime Collect & Review solution. This enables our special capabilities on every UFED, significantly improving customers' investigative processes. Let me share two win stories that provide some insight into demand drivers for our functions. A typical demand factor and growth driver for Cellebrite is a backlog of devices that need to be investigated. For example, one of the large wins in the quarter was with a National Correction Facilities Network in one of our large markets. Historically, this customer spent between $100,000 to $200,000 with us annually. These facilities were all working with one lab and a small team, which was unable to keep up with the number of mobile devices that were smuggled into prisons. Engaging with the senior government officer and conducting an extensive proof-of-concept, we secured a seven-digit order, which includes distributing responders, our simplified field solution in the production facilities and also using Commander, our license management solution to automate generating data and their usage. In addition, the deal includes services to bolster the customer's lab capabilities, train their teams, and implement best practices. Despite the fact that the customer booked this quarter approximately 10 times its previous year spend with us, we believe there is additional upsell potential within this customer in the future. The second example is a European country's national police force that purchased multiple solutions including UFED, Physical Analyzer, Pathfinder, Premium UFED Cloud Seeker Inspector, and Digital Collector, as well as training in a multimillion three-year deal. This police force will now be able to collect and review data for mobile, from computer, video, and the cloud, and analyze their findings across numerous investigation units throughout the country. The customer is adopting a highly progressive approach to investigations, aspiring to expand the adoption of digital intelligence in the police force to overcome bottlenecks and increase efficiency. We expect this approach to become more widespread as part of a global trend to digitize multiple aspects of law enforcement. These two examples illustrate how we constantly and successfully generate best-in-class net retention rates, which was 139% for the 12 months ending September 30, 2021. Furthermore, we believe the spending potential of our existing customer base is significant, and we are very focused on capturing this additional opportunity. Our vision of a comprehensive digital intelligence platform that allows users in agencies to collect, review, analyze, and manage digital data is a significant step forward from today's siloed manual backlog process. The discussions of this step forward are held at the executive level of agencies. In Q3, for example, we engaged with the most senior officers of police forces at three of the largest 20 cities in the United States to discuss our end-to-end digital intelligence platform. Such discussions attest to the quality of our salesforce. We invested in high caliber account executives, upgrading our ability to manage strategic accounts. We view these discussions as a positive sign of major law enforcement organizations' continued interest in adopting leading digital intelligence tools. Of course, such a step forward will take time due to the complex processes involved in digital transformation, requiring not only our solutions but also investments in infrastructure and personnel on the agency side. This complexity is one reason we expanded our service offering. The consulting services and training we offer assist customers in this transition. In the past months, we enhanced and expanded our digital intelligence platform to make the investigative process smarter, faster, and more efficient. Starting with organic development in Q3, we introduced a new version of Guardian, our Digital Evidence Management solution, and the industry's first remote mobile collection. Guardian is an important and strategic component of our digital intelligence platform. Public safety agencies face challenges managing an increasing amount of digital evidence while also maintaining the chain of evidence, ensuring compliance, protecting privacy, and meeting accountability requirements. Most agencies still manage data manually. Cellebrite Guardian is a digital evidence management solution that specializes in the investigative ecosystem, linked to actual investigative data generation through our collection review offering. This enables an analytical approach toward data, evidence workflow, and case management, streamlining the investigation process. Now all this is offered in a SaaS solution, enhancing efficiency and cost-effectiveness. This is our first SaaS solution, which is strategically important. We believe the public safety sector's readiness for SaaS solutions is on the rise, and we are committed to enhancing and expanding our offering in this space. Regarding remote mobile collection, it is an important capability for the private sector, where corporate investigations, e-discovery, and incident response often require collecting information from a distributed workforce. Continuous automated remote collections from both computers and mobile devices minimize disruption to the workforce. Cellebrite is the first to market with this capability due to our domain expertise on mobile collection. Let's discuss the inorganic portfolio expansion. We recently announced the acquisition of Digital Clues. We are excited about this acquisition as we see open source intelligence as an expansion of our digital intelligence offering, enhancing Cellebrite's competitive differentiation as an end-to-end digital intelligence platform provider. Open Source Intelligence is the collection and analysis of data from many publicly available sources, including the surface web, deep web, and dark web. Agencies engage in such activities manually, which can be as basic as checking a suspect's Facebook profile. The addition of this OSINT capability to our digital intelligence platform is a natural extension, enabling quick information gathering in the early stages of an investigation. This fits our value proposition of making investigations smarter, faster, and more efficient. Our extensive footprint and strong customer base provide significant cross-selling opportunities here. We expect to add almost another $1 billion to our term. Achieving this scale will require delivering strong Digital Clues cloud-based technology as an integrated solution, so that open source intelligence is fused into Pathfinder, our analytic solution, enriching Pathfinder's analytics capabilities. This will require some investment in R&D and time. We are excited about this new offering that expands our addressable market. We welcome the Digital Tools team, which will join us in the coming days after the acquisition's closing. In summary, we are very pleased with our performance in the third quarter and the continued success we have had in executing our strategy. We are also excited that our top customers remain committed to leveraging our suite of solutions to improve their efficiency and outcomes. We continue to innovate our portfolio by increasing the scope of our offerings as we help our customers apply their digital transformation initiatives in the investigative workflow. Combined with a healthy spending environment and budget availability of law enforcement organizations, we see tremendous market opportunities. We are confident in our ability to execute as more organizations recognize the vast potential of our digital intelligence platform. Above all, we remain committed to our mission to accelerate justice, protect and save lives, and preserve privacy. I am proud of our team's success in this quarter. Now with that, I will turn the call over to Dana to discuss the financials.

Thank you, Yossi. Hi, I am very pleased to present the analysis of our results for the third quarter of 2021. Going public may be a milestone quarter for the company; from a business perspective, we continue to deliver strong financial results that exceeded our expectations on many parameters, demonstrating strong execution on our go-to-market strategy and delivering growth primarily through expansion within our existing customer base. Let's start with revenue, where we enjoyed very strong performance in Q3, a clear trend since the beginning of 2021, which we expect to continue in Q4. Total revenue in Q3 was $65.9 million, up 24% from Q3 last year. Revenue for the first nine months of the year was $178 million, up 29% from the first nine months of 2020, well ahead of our expected growth rate for the full year, which was 21%. We are also pleased with our ability to deliver this outperform despite global supply chain challenges, as electronic components are required for the accessories accompanying some of our social responsibilities, and our operations team resourcefully secured their needs for Q3 as well as Q4. Looking at the different revenue streams, we are making progress to increase the proportion of subscriptions in our overall revenue mix, with subscription revenue being the main driver in Q3 at 46% year-over-year. We are particularly pleased with the year-over-year growth in terms of licensed revenue, which was 131% for Q3 and 135% for the first nine months of the year. As Yossi mentioned, we are seeing an increase in multiyear deals. Such deals have an upfront revenue recognition component, and the longer the deal, the higher it is. Therefore, this shift toward such deals contributed to the revenue growth of term licenses and strengthens the predictability of future revenue in ARR. As I mentioned in our previous call, we introduced UFED Ultimate and Pathfinder also in term-based models. This was expected to result in a steeper year-on-year decline in perpetual licenses in Q3 compared to previous quarters—indeed, perpetual licenses and other revenue of $6.7 million decreased 44% from Q3 last year. Much of our service revenue comes from instructor-led training classes, which were negatively affected last year by social distancing and travel limitations relating to COVID-19. With the opening of key markets, professional services revenue of $8 million grew 25% from Q3 last year. Moving to ARR, it grew 42% year-over-year to $171 million by the end of September 2021. The main drivers for ARR growth were excellent quarterly additional modules and solution-specific customer upgrades, tying into our high net retention rates of 139%. Out of 42% total ARR growth, 37% came from upsell and cross-sell. The majority of upsell and cross-sell was generated by our Premium solution, similar to what we experienced in the first half of the year. As mentioned in our previous call, we introduced the term license model for Premium in late 2019, enjoying strong acceptance within our customer base. The fundamental demand for Premium Advanced capabilities remains strong for the reasons Yossi described. We also believe that the term license model increased the attractiveness of the solution due to the simplified pricing structure. The dynamics for UFED in some more outcomes were different. UFED perpetual licenses have achieved significant market penetration, and customers need time to transition to a term-based model. Although, conceptually, the administrative and budgetary processes can be lengthy. The introduction of the Premium Enterprise solution described by Yossi, which is designed to decentralize the advanced capabilities by allowing remote connectivity to UFED, will support the willingness to transition to a term-based model. The transition to term licenses was always expected to be gradual over the coming two to three years, given public sector budget structures. Now that we have gained more insights into customer internal processes, we expect a transition pattern that is less linear and more weighted toward 2022 and 2023 budget years, allowing us to meet our ARR targets. Moving to operating expenses, I will discuss on a non-GAAP basis so that share-based compensation, amortization of intangible assets, acquisition-related expenses, and one-time expenses are all excluded. One-time expenses were particularly large this quarter, given costs related to the completion of the business combination and going public. The revaluation of financial instruments related to our destocking process is detailed on our balance sheet, resulting in finance income. These financial instruments will be reevaluated quarterly to the market fair value, and this revaluation will be presented in the financial income or expense line. But let's go back to non-GAAP OpEx. Non-GAAP operating expenses of $40.5 million increased 30% from Q3 last year, primarily due to headcount increases and travel and marketing-related expenses resulting from the market opening for face-to-face meetings. We increased headcount by 23 employees during the quarter, ending September with 843 employees. We continue to recruit mainly in R&D and sales, aiming to reach 900 employees by the end of March '22. Non-GAAP operating income and margin in Q3 2021 were $13.5 million and 20.4%, respectively. Adjusted EBITDA and margin were $15 million and 22.8%, respectively. Adjusted EBITDA expectation was for a 15% margin on an annual basis, reflecting operating leverage resulting from exceeding revenue expectations for Q3 and the nine-month period. Our 15% margin expectation was based on the exclusion of costs associated with becoming a public company, mainly board expenses and directors’ and officers’ insurance. We started incurring these costs in September and are pleased to have delivered higher than expected profitability. Q4 will be the first quarter reflecting those expenses fully. Q3 net income was $8.1 million, and fully diluted earnings per share were $0.05. Non-GAAP net income was $13.3 million, and non-GAAP fully diluted earnings per share were $0.08. However, these figures are not representative of ongoing performance, as they are based on the share count that is a weighted average between two months of historic ownership structure and one month of the new post-going public ownership structure. For modeling purposes, we recommend considering fully diluted shares outstanding if calculated at the end of Q3, which we estimate to be approximately $198.5 million. Operating cash outflow in Q3 2021 was $8 million, primarily impacted by going public-related expenses. In the 12 months ending September 30, 2021, there was an operating cash flow of approximately $38 million, and free cash flow of $30 million. We ended September with approximately $172 million of cash, cash equivalents, and short-term investments. In the coming days, we expect to spend approximately $20 million on the Digital Clues acquisition, as the acquisition will close in Q4; this will not significantly impact our 2021 financial results other than cash spent. In 2022, we expect Digital Clues to have a small positive impact on our ARR and subscription revenue, and to incur higher R&D expenses as we integrate open-source intelligence into our digital intelligence platform. We will provide an update on our 2022 outlook before Q4 2021 results. With that, I would turn to our updated 2021 outlook. We are pleased with our results for Q3 and the first nine months of the year, which have exceeded expectations in most parameters. We now increase our 2021 guidance; total revenue is expected to be between $241.5 million and $243.5 million, reflecting growth of 24% at the midpoint, up from a previous expectation of $236 million and 21% growth. We expect adjusted EBITDA to be between $45 million and $46.5 million, reflecting a margin of approximately 19% at the midpoint, up from a previous expectation of $36 million and 15% margin. Our ARR is expected to end the year with ARR growth of approximately 34%. This guidance reflects the mix between term licenses and perpetual revenues so far in 2021, as well as the administrative and budgetary processes required by our customers in transitioning our UFED install base to term licenses and adopting an end-to-end digital intelligence platform, as Yossi mentioned. At the same time, we see the quality of our ARR improving more than we had originally expected, given the higher proportion of multiyear deals. We are constantly evaluating additional avenues for investment in our top-line growth. Our expectation to end 2021 with higher earnings compared to the initial trend enables us to make such investments. We are glad to be in this position and will provide more color on that in our next call. With that, I will turn the call to the operators to open the Q&A session.

Operator instructions. Our first question comes from Shaul Eyal from Cowen.

Thank you. Good morning or good afternoon, guys. Congrats on results and guidance. Yossi, as we think about the overall healthy trends you're seeing, when we apply that to your product offering, your end-to-end platform, is there one product that is standing out rather than the entire portfolio, or is the strength you're seeing quite broad-based right now?

Shaul, thank you first of all for the congratulations; highly appreciated. To your question, I would say that we are performing very well on all fronts, but particularly in the Collection and Review piece, with Premium and Premium Enterprise. We are about to launch the management solution, Commander, our license management suite, and the investigative analytics. We are growing, but nothing compares to the success we have had with Premium and Premium Enterprise. This is largely due to the fact that there are approximately 28,000 UFEDs well-entrenched as the primary tool for Collection and Review. Premium contains specific capabilities related to high models of Android and iOS, coupled with strict security environments. Premium and based on the changes made last year, have seen much larger distribution now. The introduction of Premium Enterprise has significantly improved the mode of operation and has resulted in improved efficiencies.

Understood, thank you for that. As my follow-up, one of the main discussion points within the technology and non-technology sectors over the past few months has obviously been supply chain constraints. It would appear from your performance and guidance that you're not supposed to be seeing an impact. But Yossi, I want to hear how you guys are thinking about it internally.

Dana, would you like to take it?

Yes, thank you, Shaul. We've seen those trends for over a year now, and we started injecting our supply chain methodologies to purchase upfront for much longer lead time components. We have successfully concluded Q3, and we will also be able to conclude Q4, providing for all of our sales needs. Entering 2022, we feel we are in a very strong position. While uncertainty exists, we have a solid contingency plan and hope to continue our performance accordingly.

Our next question comes from Jonathan Ho from William Blair.

Hi, good morning. Let me echo my congratulations as well. I just wanted to start by asking about the customer spending environment. How are budgets looking these days? And can you help us understand how to think about potential stimulus from the budget administration?

Dana, would you like to start?

Yes, especially in the U.S. market regarding the stimulus funds, we see the opposite of what we feared—budget cuts. Instead, we see enough budgets being approved for customers. The challenge remains with customers to allocate those funds for digital intelligence, especially since many of those stimulus funds have been appropriated for crime fighting due to the increased crime rate currently experienced in the U.S. Our salesforce is working with those customers to allocate funds for their digital intelligence needs. We do not observe budgetary constraints substantially among our customers.

I would like to add, there are ongoing discussions about police funding, which have shifted from defunding to pro-funding. Particularly in the state and local segment in the U.S., where 50% of our strategic accounts are North American accounts. State and local governments show a positive funding environment. The U.S. Federal Government has created rescue funds for use at the state level. While there is some uncertainty on the usage of these funds, the trend indicates optimism from our perspective.

Got it. As a follow up, can you provide additional color on the large deal activity you're witnessing? This has picked up significantly. Can you help us understand how much is coming from upselling to Premium versus new product areas? And how sustainable is your ability to capture more wallet share from existing customers? Thank you.

First, it's important to note that Premium Enterprise is an upsell; it's a new solution. Premium Enterprise is not merely a new version of Premium but a new solution with a completely different distribution system. The growth plan is based on our strong presence in the public safety sector, where we sit with 5,000 agencies. Our penetration level in these accounts was around 20%, so growth potential is significant. We anticipate a one to four ratio from every dollar we see now in the lab and field. In areas where we implement fully integrated digital intelligence, that ratio could increase to one to ten or more. We are confident we can achieve meaningful growth. We have a strong position in the lab and outside with collection and review, and we can expand with more collection and review solutions along with investigative analytics.

And our next question comes from Mike Cikos from Needham and Co.

Thanks for getting me on here, guys. I appreciate the questions. I wanted to come back to an earlier point. There was quite a bit of scratching of papers, and the call actually went quiet at one point—for most of Dana's comments—talking about your share count at the end of Q3 being around 198.5 million shares. Just wanted you to be aware since you're trying to provide new disclosures. Can you hash it out again?

I appreciate that very much. To clarify, our current count of shares on a fully diluted basis is 198.5 million, comprised of 100 million shares plus 18.5 million shares related to employee options. Additional earnout shares and warrants exist, but they shouldn't be included in the count for modeling purposes. We recommend taking fully diluted shares outstanding at the end of Q3 for more accurate calculations.

Thank you for the clarification. I was hoping to get a couple more questions regarding the Digital Clues acquisition. Can you walk us through the criteria that led Cellebrite to make a build versus buy decision? What feedback have you received from customers regarding OSINT?

Regarding our process, OSINT is an emerging discipline we anticipated would grow within law enforcement. It was always an element of 'buy' rather than 'make' for us. Our inorganic growth criteria emphasize increasing the span of digital intelligence, technical capabilities, and customer needs. The relevance of OSINT to our offering is clear as it allows agencies to gather quick information at an early stage of investigations.

It sounds like a checkbox for expanding your TAM through that acquisition. I also wanted to ask about your go-to-market approach in targeting customers for cross-sell or upsell opportunities. Is it just about having subject matter experts working with them?

In the public sector, we target two accounts: strategic accounts and mid-sized prime accounts. Our strategic accounts have considerable growth potential, with a focus on the digitization of investigative flows. Dedicated account executives manage these accounts, along with technical account managers, and customer success teams nurture solution implementation. We aim to invest heavily in these accounts to maximize upsell and cross-sell and nurture digital intelligence solutions throughout.

Great. Yossi, Dana, and Anat, good afternoon, and congrats on closing the true end merger. Upselling to Premium appears to be one of your main near-term revenue growth drivers. Can you provide an estimate for what percent of your UFED base is on UFED Premium—less than 20%? How many years do you estimate it will take for most of your UFED base to be using UFED Premium?

We have signed around 20 Premium Enterprise deals just before the end of the quarter, with only two installed so far. So currently, around 7% to 10% of the UFEDs are contracted under Premium, many of which are still in the implementation phase. This is a very early stage of introducing our Premium Enterprise.

We need to clarify the position regarding UFED Premium and Premium Enterprise. Premium Enterprise is a new solution and the opportunity to connect UFEDs to the Premium capabilities is just starting now; there will be a strong potential for growth here. Before we conclude today, I want to thank you all for joining us, and for your support. Wishing you all a nice day.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.