Cellebrite DI Ltd. Q1 FY2023 Earnings Call

Welcome to Cellebrite's First Quarter 2023 Financial Results Conference Call. All participants are currently in listen-only mode. We will open the floor for questions after the presentation. I would now like to turn the call over to your first speaker today, Mr. Andrew Kramer. Mr. Kramer, the floor is yours.

Thank you, Shelby. Good morning, everybody. Cellebrite's first quarter 2023 financial results conference call. Joining me today are Yossi Carmil, Cellebrite's CEO; and Dana Gerner, Cellebrite's CFO. There is a slide presentation that accompanies our prepared remarks and you can advance the slides in the webcast viewer to follow our commentary. We will be sure to call out the slide number we were referring to in our remarks. This call is being recorded and a replay of the recording will be made available on our website shortly after the call. Let's start with slide number 2. A copy of today's press release and financial statements including the GAAP to non-GAAP reconciliations and the slide presentation, all of that is available on the company's Investor Relations website at investors.cellebrite.com. Please note that the quarterly financial tables and supplemental data for the first quarter and each quarter for the past two years will be posted to our Investor Relations website after this call concludes. Also, unless stated otherwise, our first quarter 2023 financial metrics as well as the financial metrics provided in our outlook that will be discussed on today's conference call will be on a non-GAAP basis only, all historical comparisons over the first quarter of 2022 unless otherwise noted. In addition, please note that the statements made during this call that are not statements of historical facts constitute forward-looking statements. All forward-looking statements are subject to risks and 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 annual report on Form 20-F filed with the SEC on April 27, 2023. The company does not undertake to update any forward-looking statements to reflect future events or circumstances. Slide number 3 provides the agenda for today's call. As you will hear, we are pleased with our Q1 financial performance and strategic progress and we are focused on delivering on our full year 2023 targets. And with that said I'll now turn the call over to Yossi Carmil, Cellebrite's CEO.

Thank you, Andy, and thank you all for joining us today. As reflected on slide 5, Cellebrite's first quarter results and KPIs demonstrate a strong start to 2023. The first quarter of 2023 was also marked by Cellebrite's continued progress with key strategic initiatives, aimed at advancing innovation and expanding our customers' relationship. It is really rewarding to see customers increasingly turn to Cellebrite for powerful digital intelligence software solutions that will help them modernize their investigative workflow. This is translating into higher usage for our Collect and Review solutions and increasing traction for additional growth engines like our Investigative Analytics and our Case and Evidence Management offerings, all of which is helping grow wallet share within our installed customer base and capture new logos. As a result, we move forward with a solid momentum in a healthy marketplace. Before I share some observations about our market positioning, highlights from the quarter, the market environment, and our outlook for the remainder of 2023, I will briefly review our first quarter results and other select metrics. The Q1 revenue of $71.2 million grew 14% over the prior year with subscription software revenue growing 27%. Our ARR grew 30% to $261 million. We delivered another quarter with dollar-based NRR greater than 120%. We closed 21 large deals each valued at greater than US$0.5 million. We reported Q1 adjusted EBITDA of $7.3 million for a margin of 10% and non-GAAP EPS of $0.03. And we generated more than $12 million in cash from operations and ended Q1 with cash and investments totaling just over $221 million and no outstanding debt. Turning to slide 6. Cellebrite is recognized by public and private sector customers, industry experts, and investors as a market leader in digital intelligence software solutions. The cornerstone of our business continues to be our Collect and Review offerings that are trusted by customers around the globe to lawfully extract, decode, and review digital evidence. Now these offerings, which represent more than 80% of Q1 2023 revenue, are augmented by our Investigative Analytics and Case and Evidence Management solutions that are still at the early stage of customer adoption. In addition to these offerings, we deliver high-value professional services including training, certification, and advanced services that customers use to reduce their backlog of devices by outsourcing digital evidence collection to our experts. During the first quarter, we executed well on our product road maps and go-to-market initiatives. In collect and review, the substantial investments we've made in recent years to expand our mobile research capabilities continue to pay off. Earlier this spring, we delivered an industry-first capability on our premium solution for the latest iPhone and iOS version. Our leadership in iPhone and iOS is complemented by our extensive coverage of Android-based smartphones, which command more than 70% of the global smartphone market. Looking ahead, we are also excited about our near-term plans to further elevate the value proposition of UFED, our basic collect and review offering used by tens of thousands of examiners around the globe. In terms of other notable development progress, we continue to enhance our Physical Analyzer and Pathfinder investigative analytics by leveraging our ongoing investment in artificial intelligence to further differentiate these offerings. These solutions enable law enforcement professionals to quickly leverage powerful, timely insights into digital evidence, automate time-consuming manual tasks, and advance investigations faster and more efficiently. We've also continued to advance Guardian, our SaaS-based platform for case management and evidence management. From a go-to-market perspective, we are gaining solid momentum. The actions we took last year to enhance our strategic accounts management in EMEA in the USA as well bring in new private sector sales leadership are making a tangible difference in closing new business and building a stronger high-quality pipeline of opportunities. This is reflected in several ways. Our first quarter NRR of 128% was the 17th consecutive quarter above 120%. Revenue in the Americas grew 20% while revenue in EMEA increased 14%, its best quarter of top-line expansion in the past year. Our flagship collect and review suite of solutions UFED Premium and Physical Analyzer were at the foundation of the vast majority of our Q1 large deals as expected. Two-thirds of these large deals included more of our mobile data forensic solutions such as Computer, Cloud Data Collection, Pathfinder, and Guardian, as well as training and advanced services. We're also pleased to note that our revenue growth rate within the private sector has accelerated into the high teens. And we are moving forward focused on driving further enterprise expansion through our direct sales, our service provider channels, and other high-value partnerships. Our ARR growth of 30% primarily reflects our success in expanding wallet share with existing customers. Geographically, we continue to produce significant ARR expansion in the Americas led by continued strength in our US state and local government sales group. We achieved this ARR growth even as we have stopped our new sales activities in dozens of countries as part of our ongoing commitment to operate our business with the highest ethical and professional standards. Dana will share additional insights on this topic in a moment. Moving to slide 7, I will highlight several Q1 deals that best demonstrate our R&D and go-to-market progress and success. In Latin America, we are helping a large national agency evolve and upgrade their mode of operation in the face of more crime that involves digital evidence including financial crimes. This customer is now benefiting from expanded premium licensing, as well as Guardian and Pathfinder. Just as noteworthy, this is the first customer in this region to use our digital intelligence offering that integrates cryptocurrency data and insights. With this deal, these customers' ARR increased substantially by 13 times to $1.6 million. In our USA state local government accounts, there were two notable Q1 wins that showcase our ongoing success in growing our wallet share with police departments serving midsized cities. Now in both cities, violent crime, especially homicides, have been on the rise. So to help law enforcement move faster, both customers not only added Premium, but they also began deploying Pathfinder to accelerate the investigations in Guardian to securely share digital evidence among examiners, investigators, and prosecutors. ARR for one of these customers increased by four times to nearly $600,000 and the other customer is also a great example of our success in harvesting smaller long-tail prime accounts. Now with this deal in place, ARR for this customer increased by over 10 times to just under $300,000. We were also pleased to see that a specialist intelligence agency in Western Europe expanded its use of our Premium solution nationwide, while also renewing the licenses for our other collect and review to accelerate their cyber investigation and safeguard their citizens. As a result, these customers' ARR increased by over 60% to $1.2 million. And last, in the private sector, there were two notable deals in Q1 with our service provider partners, who typically generate approximately half of our quarterly enterprise revenue. One service provider in a Central European country made its initial purchase of Mobile Elite, our on-prem enterprise solutions for collecting digital evidence from advanced smartphones. And another service provider's West Coast office made its first purchase of our Endpoint Inspector software for remote data collection. We believe that the breadth and depth of our product portfolio for the private sector leaves us well-positioned to continue expanding our service provider relationship going forward. So turning to slide 8. We moved into the second quarter with solid momentum in a healthy marketplace that is benefiting from multiple tailwinds. With 90% of criminal cases involving a digital element, law enforcement agencies are increasingly recognizing that they must modernize their investigative workflows and evolve their current mode of operation. Our own industry research masked late last year as for the support to this. And here are some additional facts. Most law enforcement professionals and prosecutors believe that digital evidence is more important than physical evidence and DNA to successfully prosecute cases. Approximately two-thirds of all phones entering the lab are locked. Nearly 75% of agency managers agree that there is a growing technology skill gap in policing making it even tougher for police forces to collect, manage, analyze, store, and use the digital evidence required to win conviction. And last, as it relates to digital transformation, almost half of the police chiefs and agency managers describe current strategies as poor to mediocre. Slide 9 addresses our outlook. More specifically, based on our performance to date and the opportunities we see going forward, we believe we are on track to deliver on our 2023 financial targets. I would like to close by reiterating that Cellebrite made important strategic progress during the first quarter and executed well against the top priorities that we outlined on our last quarter's call. Now these include bringing impactful innovation to the marketplace, extending our Collect & Review leadership, and broadening our reach into new buying centers that can benefit from our high-value investigative analytics and powerful case management solutions. Our team remains very enthusiastic about the company's prospects in 2023 and beyond, and we work together to deliver powerful digital intelligence solutions that will help our customers around the globe to protect and save lives, accelerate justice, and ensure data privacy. And with that said, I will ask Dana to begin her financial review. Dana, please?

Thank you, Yossi. Let's begin a review on slide 11. Total revenue of $71.2 million for the first quarter was up 14%. This was driven primarily by 27% growth in subscription revenue. As detailed on this slide, 86% of our total quarterly revenue came from software subscriptions, up from 77% one year ago. Slide 12 details our ARR growth, which is an important forward-looking KPI for Cellebrite's sales momentum and the trajectory of future revenue. As Yossi noted, ARR grew 30% year-on-year, reaching $261 million at the end of Q1, primarily as a result of continued expansion with existing customers. Within this category, we produced strong ARR growth for our Collect & Review solutions mainly due to further penetration of Premium into our installed base. This expansion is augmented by faster growth from our Pathfinder investigative analytics and Guardian case management solutions albeit on a much smaller basis. And I'd like to briefly elaborate on churn, which reflects the impact of license reductions and cancellations. Churn was 10% in the first quarter, up approximately two percentage points, with that churn directly tied to erosion from customers in countries where we have discontinued new sales activities and are no longer pursuing license renewals. We anticipate that the impact from voluntary churn will likely remain at the current levels throughout 2023 and gradually lessen as we move into the latter part of 2024. Slide 13 details the historical trends for our non-GAAP gross margins and non-GAAP operating expenses, which exclude share-based compensation, amortization of intangible assets, and acquisition-related expenses. Our first quarter 2023 gross margin was 83.1%, which was up slightly from 82.8% in the same period one year ago. Our gross margin performance in Q1 reflects the positive impact from the sustained growth we have delivered in higher margin future sales. In terms of operating expenses, first quarter operating expenses were $53.5 million, which reflects disciplined spending, lower headcount on our personnel costs, and to a lesser extent favorable changes in foreign exchange rates. We ended March with 973 employees, down 3% from Q4 and up 6% from the same period last year. We expect headcount to return to year-end 2022 levels over the next quarter or two. Turning to slide 14. Our adjusted EBITDA in the quarter was $7.3 million or a 10.3% margin. This was due to the combination of a strong revenue performance and disciplined spending. Those same factors contributed to non-GAAP operating income of $5.7 million. Non-GAAP net income in Q1 was $6.9 million and non-GAAP fully diluted EPS was $0.03. I am pleased with our cash generation to start the year. We generated cash from operations in the first quarter of $12.5 million, due primarily to our strong operating results and excellent collection efforts. We finished the first quarter with $221.2 million of cash, cash equivalents, and investments, up $15.4 million from the end of 2022, despite meaningful cash outflows associated with annual bonus payments, fourth-quarter commissions, and $6 million for the final payment associated with the company's acquisition of BlackBag Technologies in early 2020. Let's move to slide 15. Based on our results thus far, and the opportunities ahead of us, we are on track to achieve our original financial outlook for 2023 and reiterate our full year 2023 guidance, which is displayed on this slide. In terms of ARR, we expect ongoing convergence between our subscription revenue and our ARR growth rate as we move through the rest of the year. On a related note, we expect that our total revenue growth rate will continue to leverage the subscription revenue growth rate, due to stronger growth in professional services, and the expected decline for other nonrecurring revenues as our perpetual license revenue has now reached relatively insignificant levels. In closing, Cellebrite is off to a strong start in 2023. We have continued to deliver compelling innovation to the marketplace, which has been critical for sustaining our commercial progress in expanding wallet share within existing accounts and winning new customers. We also demonstrated our commitment to convert solid revenue growth into improved profitability even as we made meaningful strategic investments to expand our business and deliver value to customers. While it is still early in the year, we move forward on track to achieve our 2023 financial targets. We are confident that executing on our plans over the coming quarters will drive value creation for shareholders, customers, partners, and employees. That concludes our prepared remarks, and I'll return the call back to our operator for Q&A.

The floor is now open for questions. We'll take our first question from Jonathan Ho with William Blair.

Hi, good morning, and congratulations on the strong results. Just wanted to I guess get a little bit more color on the decision to voluntarily stop selling in some regions. Could you maybe give us a sense of how large the customer base is in these areas? And maybe what changed to cause you to stop selling in these areas now?

Shall I take it, Dana?

Please.

First of all, I want to emphasize that nothing has changed in our foundation. Ensuring that technology that is intended for good is used properly and reaches the right places has been integral to our business for years. Human rights, data security, and data privacy are crucial priorities for us. To provide some background, in 2021 we established an Ethics and Integrity Committee to guide the Board on this policy, which has only strengthened our compliance and ethical practices. In line with our efforts over the past years, where we ceased sales activities in several countries, we have now decided to cease operations in additional countries. This ongoing effort is focused on ensuring that our operations are in the right areas, where we can guarantee that our products are used appropriately. Jonathan, we have always approached this cautiously and we are improving over time. Based on our commitment to ethical compliance, we are enhancing our activities in this regard by blocking or exiting more countries. Does that address your question?

It does. I mean the first part of the question was sort of the size of the customer bases in these countries that you're exiting?

Maybe I'll take...

Yeah. Go ahead, Dana.

So in principle, we are really looking at a very, very long tail of a customer base. In these regions we've done very insignificant business. So this will not have a substantial impact on our revenue growth or ARR growth as I alluded to in my part and we expect it to be almost negligible.

Got it. Got it. And then, you mentioned AI as part of the enhancements that you're putting into your products. Can you give us a little bit more detail in terms of what that opportunity looks like longer term? And can that maybe change either the competitive sort of win rates or drive additional upsell opportunities? I just want to get a little bit more detail around that AI opportunity.

Yes, with pleasure, and really exciting in that context. First of all, we invest in AI as you probably remember and use it as part of the technological assets that we put into our investigative analytics Pathfinder and also in the PA. Look, we continue to invest here because we see AI capabilities, I would say on Physical Analyzer and Pathfinder as something that enables our customers to use it and quickly leverage insights which is, by the way, classically helpful for digital evidence and especially in the investigative world. Because as we move forward with AI, we will see that it will play a bigger role and an important role. And you can think about it like that in the investigative world, what we can help and offer is basically to add technology improvements to the mode of operation for the investigators around creating investigative scenarios and helping with classifications of media, location, images, etc. As a result, as you probably understand, that will be a differentiator, creates obviously increased business opportunities into the future. And especially in those two areas that I've mentioned, one Collect and Review with Physical Analyzer; and second, the ongoing interest which is related to Pathfinder investigative analytics. So, definitely a technological benefit with an ongoing business opportunity for us.

Fantastic. Thank you.

And we'll take our next question from Shaul Eyal with TD Cowen.

Thank you. Good afternoon, Yossi, Dana, Andy, congrats, good to see the ongoing stability in the business, great progress also on the governance front. My first question Yossi is actually on the pipeline. How would you characterize the pipeline? Is it close to record levels? Also, did most of the slippage from the past probably year, did that already come back?

I would say the following. First of all, it's a healthy market, Shaul. This is one. Second, the pipeline is healthy, especially as we look forward even beyond Q2 to Q3 and Q4. And I would even say that in the perspective of 2023 and beyond, we feel very confident right now in something that I can say is scalable, can grow as we expected and relying among others on a very stable pipeline. When it comes to what we were facing in the past, I said all the time the market is healthy and we had to upgrade and correct some elements which are related to our go-to-market. We did in the USA, in EMEA and we feel I would say also very comfortable in the combination between the existing pipeline, the pipeline health, and our ability to execute with our go-to-market organization.

Understood. Understood. Thank you for this color. And my second question. So, Magnet Forensics, as we all know, I was merged with Grayshift, and Thoma Bravo pursued both these transactions. I know it could be early days you'll see, but have you witnessed any change within the competitive landscape?

No major change in the competitive landscape, specifically to Magnet and Grayshift as spoken last quarter. One, that merger anticipated actually right now practical happening is good for the market. It shows the attractiveness of the market. It was not a surprise for us. Those entities were as standalone collaborating with each other in the past. I also say that the merger reflects actually the value of Cellebrite because it was among others based on the importance of the mobile, as part of the entire scheme. Back to the question about the changes. So no changes not there and not in general. We continue to see smaller competitors from time to time that attempt to match elements of our product strategy. Our investment in innovation, I would say, the strong customer relationships that we have and our ability to scale our position. We need to continue with our plan. And we believe that 2023 will be an important progress in that respect with our competition. We need to do our thing.

Understood. Thank you for that, congrats.

Thank you.

Next question operator.

And we'll take our next question from Tal Liani with Bank of America.

Hi. Good morning. Private sector, you mentioned new sales initiative and growth in the private sector. Can you give us a little bit more details first of all on your efforts to drive growth and opportunities, etc.?

Private sector revenue at Cellebrite was and still is slightly below 10% of our total quarterly revenue. We believe the current growth rate is significant and has strong potential. We also have the capability to accelerate this growth based on our current offerings, specifically in collection and remote collection. Additionally, we are taking steps to collaborate with more partners in the industry. Regarding deal sizes, in the public sector, similar to the private sector, deal sizes for private sector customers depend on the required products and the number of licenses needed. Larger corporate customers typically need far fewer licenses for their IT and legal teams involved in investigations compared to smaller to midsized public sector customers. Consequently, we expect continued growth in the private sector, although it may not match the pace observed in the public sector. We are pleased with what we see so far. I should also note that we have upgraded our sales team and leadership, giving us a team that can effectively scale our efforts. While we expect private sector revenue to remain around 10% of our activities moving forward, it's positive as the entire market grows, contributing to our growth in the private sector.

I have a second question. In the last two quarters, you mentioned deal slippage, and this quarter appears to be very strong. Are you still experiencing slippage with deals? Additionally, can you discuss how macroeconomic conditions are affecting projects and the scrutiny surrounding them?

I'll start with the second part. We do not see any macroeconomic factors currently affecting the business. In fact, we previously discussed concerns regarding funding cuts. Now the discussion is shifting from funding to refocusing on police resources. Last year, we talked about challenges in completing large deals in a timely manner. However, I believe we are in a much stronger position now. To emphasize, our reliance on any single large deal or project is reasonable and well-managed. We are seeing an increase in large deals, although these are not so substantial that they dictate our entire quarterly performance. Our ability to grow alongside these transactions from a multitude of smaller long-tail customers in the state and local government sector has improved. This leads to reduced variability and a more diversified environment, ensuring we are not overly dependent on any major deals to achieve our targets. We are in good shape.

Great. Thank you.

And we'll take our next question from Doug Bruehl with JPMorgan.

Hey good morning and thanks for taking my question. So looking at your ARR slide and seeing that growth over the past year really driven almost entirely by expansion of revenue. What products and services are you seeing the most strength in for that expansion component?

So maybe I'll take it Yossi. Predominantly from a volume and dollar perspective, the Collect and Review being our major installed base is driving most of the growth with further penetration of our advanced collection capabilities in the shape of premium solutions. We do see faster ARR growth with our investigative analytics and the Guardian solutions. But as they are coming from a smaller basis, the impact of the total dollar amount and the mix and the average ARR growth is marginal currently.

Great. That's all for me. Thank you.

Welcome.

And we'll take our next question from Jamie Shelton with Deutsche Bank.

Good morning and thanks for taking my question and congrats on the solid execution. It's great to see the launch of Pathfinder X. And you've touched on it briefly, but if you could talk to recent Pathfinder momentum as well as any additional color around contribution and growth today? And I guess, more importantly, where you think this could go over the next few years? And I've got a quick follow-up. Thank you.

Thank you for the question. Dana will start off. Although Pathfinder has been available for several years, it has only achieved significant functionality and gained traction with customers in the last two years. We have closed dozens of Pathfinder deals in the past year as we cross-sell and upsell this offering to our existing customer base. In Q1, we highlighted three customers that included Pathfinder. Pathfinder positions Cellebrite very strongly as a key offering in the investigative world. It serves as a business intelligence tool tailored to how investigators work. It also presents a great opportunity to leverage the unique way data is collected with our Collect and Review feature and analyze that large volume of data to quickly find evidence. We anticipate positive growth for Pathfinder in the future, though it involves longer sales cycles and sometimes requires changes to the customer's operations. Overall, we see it as a significant growth opportunity for the investigative segment and a clear competitive advantage for us.

And just a quick follow-up. Can you provide us what percent of your UFED base is now connected to premium enterprise?

I would say that we are seeing an average of connected usage with senior enterprise in the mid-teens.

Thank you. Understood.

Welcome.

We'll take our next question from Louie DiPalma with William Blair.

Yossi, Dana, and Andy, good morning.

Good morning.

Good morning.

Following on my colleague Jonathan's question, is there a potential for you to forge commercial partnerships with some of the generative AI vendors like OpenAI or Google to integrate those systems with your Physical Analyzer and perhaps upsell that AI capability to your current installed base?

Look, in general, collaborations are always possible, but one needs to remember that we are dealing with investigators, and we are dealing with investigative data. And it is important for us also to, let's say, to keep the knowledge in out and make sure that we are giving something that is reliable, closed, contained and stable enough. The investment that we do in AI has been primarily focused on developing our machine learning models, including those for, I would say, media and topic classification. And obviously, we'll continue to explore ways that I would say open source-based AI models can complement our own capabilities and let's say further enhance and support the solution. So, yes, for the auction but we'll see into the future.

Great. That makes total sense. And another question. Many vendors in public safety have implemented price increases over the past year in this inflationary environment. Did you increase the pricing on any of your key products, or is there the potential for you to do so in the future to add to the existing core growth?

So first of all, yes, there is an option for an ongoing price increase. In addition, we actually just now increased the prices in the public sector for our Collect and Review and investigative analytics at the beginning of Q2. So the activity in Q1 didn't basically was not affected by that. The statement is, by the way, valid mainly for the US or the Americas because in the beginning of the year we did some modifications in the pricing to Europe based on the currency exchange rates. Into the future, and since you are talking to a company which is facing its growth mainly on growing within existing accounts, existing logos, and focusing on strategic mid-high and the large federals, we intend or we think that we can see continuous price increases for the value that we bring into our solutions. So it is also part of the strategy for the future to come. And to sum it up. So yes and yes.

Thanks, Yossi. Thanks everyone.

This concludes the Q&A portion of today's call. I would now like to turn the floor over to Cellebrite CEO, Yossi Carmil for additional or closing remarks.

Okay. So thank you again everyone for joining us. Thank you for the questions. And thank you, especially, for the Cellebrite employees for a great Q1 and good luck to us in the rest for the rest of the year. Thank you. Have a great day.

Thank you. This concludes today's Cellebrite first quarter 2023 financial results conference call. Please disconnect your line at this time and have a wonderful day.