Cellebrite DI - Q3 2024

Transcript

Operator (participant)

Welcome to the Cellebrite Q3 2024 Financial Results Conference Call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star two. So others can hear your questions clearly, we ask that you pick up your handset for best sound quality. Lastly, if you should require operator assistance, please press star zero. I would now like to turn the call over to your first speaker today, Mr. Andrew Cramer. Mr. Cramer, the floor is yours.

Andrew Kramer (Head of Investor Relations)

Thank you, Todd, and welcome everybody to Cellebrite Q3 2024 Financial Results Call. I'm joined in New York City today by Yossi Carmil, Cellebrite CEO; Dana Gerner, Cellebrite CFO; and Tom Hogan, Cellebrite's Executive Chairman. There is a slide presentation that accompanies our prepared remarks. Please advance the slides in the webcast viewer to follow our commentary. We will call out the slide number we are referring to in our remarks. The call is being recorded, and a replay of the call will be made available on our website shortly after the call, along with a transcript of this event soon after.

Starting with Slide 2, a copy of today's press release and financial statements, including GAAP to non-GAAP reconciliations, the slide presentation, and the quarterly financial tables and supplemental historical information for the first three quarters of 2024 and each quarter of 2023 and 2022, are available on the Investor Relations website at investors.cellebrite.com. Unless stated otherwise, our discussion of our Q3 2024 financial metrics, as well as the financial metrics provided in our outlook, will be done on a non-GAAP basis only, and all historical comparisons are with the Q3 of 2023. In addition, please note that 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 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 March 21, 2024, and as amended on April 12, 2024. The Company does not undertake to update any forward-looking statements to reflect future events or circumstances. Slide 3 provides the agenda of topics we'll cover on today's call, and with that being said, I'll turn the call over to Yossi Carmil, Cellebrite CEO. Yossi?

Yossi Carmil (CEO)

Thank you, Andy, and thank you all for joining us this morning. So we delivered a strong Q1 performance that exceeded expectations thanks to increasing traction with our case-to-closure platform, what we call the C2C platform, the impact of our ongoing investment in market-leading innovation, and solid execution on all fronts. As illustrated on Slide 4, we produced notable ARR growth, surpassed $100 million in quarterly revenue for the first time in the company's history, and generated outstanding profitability. We are proud that we have consistently delivered a healthy mix of ARR growth and profitability, with recent results comfortably exceeding our baseline for the rule of 45 performance. So put it simply, Cellebrite's business momentum remained strong in the Q3, and we anticipate a positive finish to our year. Now, Dana will cover this in a few minutes.

Beyond the solid quarterly results, we took important strategic actions and accomplishments over the past several months, all of which are architected to drive long-term profitable growth and corresponding enterprise value. Cellebrite is uniquely positioned as a differentiated end-to-end platform provider with software offerings spanning the digital investigative lifecycle. Our AI-driven C2C platform enables customers to close more cases faster by elevating their productivity and efficiency for collecting, reviewing, sharing, and analyzing digital evidence. We have taken deliberate steps to anchor our C2C platform around three increasingly integrated flagship software solutions, and I want to give here a brief overview. So Insights is our family of digital forensic software that enables law enforcement to collect and review digital evidence from mobile phones, cloud applications, computers, and many other digital witnesses.

Guardian is our set of SaaS-based case and evidence management offerings for managing the examination process, securely sharing evidence, and enabling inter-agency and cross-agency collaboration. Our Pathfinder investigative suite includes AI-powered analytics and open-source intelligence tools for expediting investigations by surfacing leads, pinpointing connections, and identifying valuable evidence buried within mountains of structured and unstructured data across multiple digital witnesses. So we are mobilizing to capitalize on the extensive opportunities we see to expand our customer spending with us while also winning new logos. To that end, Cellebrite Federal Solutions was launched earlier this summer to expand our relationship with the U.S. federal government, and this unit is now fully operational. And I'm pleased to share that we delivered an excellent Q3 in the U.S. federal sector.

In addition, we have continued to augment our quota-carrying sales force in all major geographies to amplify our go-to-market motion for upgrades, upsells, and cross-sells. As we look forward towards 2025, this investment positions Cellebrite with the ramped sales capacity which is required for sustaining solid top-line expansion and extending to new buying centers within our installed customer base. Cellebrite's relationship with over 5,300 public sector customers typically begins by helping examiners and investigators to collect and review digital evidence across mobile phones, computers, cloud, and other digital witnesses. There is a long, broad growth runway ahead for Cellebrite Digital Forensic Solutions, and part of this expansion is expected to come from upgrading customers from our legacy digital forensic software to our new Insights suite. The value proposition for this upgrade is compelling.

Insights leverages a modern tech stack along with both proven and new digital forensic capabilities that enable customers to complete an examination as much as twice as fast while accessing more devices, extracting more data, and revealing more important information. In addition to the Insights upgrade, we believe our customers will want to expand the scope of their deployments, whether it is in a traditional technical lab environment or by extending our technology into the field. Just as important, we see substantial opportunity for customers to leverage our modular approach to Insights by adding high-value capabilities around advanced local access or unlocks and for automating and accelerating key examination processes. When we launched Insights earlier this year, our goal was to operate the vast majority of our installed base over the next three years with 10% adoption in 2024.

We increased last quarter our 2024 target to 15%, and we are on track to achieve this new target. Another area of strategic progress is the cloud. We continue to increase our product house investment to cloudify existing capabilities, enhance existing cloud offerings, and develop new cloud-native solutions across our Insights, Guardian, and Pathfinder product suites. And I'm happy to report that we are seeing some very positive returns on this investment. For example, during the past 12 months, Guardian grew more than 100% as more customers use this SaaS-based solution to transform how they manage and share digital evidence with investigators and prosecutors. Our investment in cloud infrastructure is also opening new doors for our Pathfinder analytics, which leverage AI technology to quickly surface leads and identify connections buried within mountains of structured and unstructured data across multiple digital devices.

In September, we announced Pathfinder in the cloud with AWS, allowing customers to access Pathfinder through the secure Amazon Virtual Private Cloud. Just as notable, as we look to expand further into investigative and intelligence units, we are building our SaaS-based capabilities and leveraging our ongoing investment in AI through an expanded suite of tools and capabilities that can help analysts and investigators analyze an even broader range of digital data sources, coordinate and collaborate better, and boost productivity by automating time-consuming, burdensome tasks. I would also like to briefly cover the recent capital market milestones which underscore our success in driving shareholder value. First, in mid-September, we completed our previously announced warrant redemption program, which produced 10.1 million net new ordinary shares.

Second, our strong stock price performance from mid-August through early November resulted in multiple triggering events totaling 21 million shares that have further increased our public stock float. At a high level, these milestones enable us to move forward with a significantly clear capital table, healthy trading liquidity, and simplified financial reporting. Now, Dana will provide more color about these developments in a few minutes. So let's turn to Slide 6 now, which highlights our four strategic priorities. I would like to illustrate how our success in each of these areas has enabled us to produce an NRR north of 120% for 23 consecutive quarters. Our first priority is to extend our leadership in the digital forensic units of our customers. Insights helps customers better address their caseload growth and makes it easier and more affordable for them to lawfully access the newest smartphones on the market.

Now, since Insights was launched in Q1 2024, we have seen healthy attachment rates for our unlock module when customers with no prior lawful access solutions upgrade to Insights. That trend has helped us nearly double the penetration of our advanced lawful access solutions within the installed base to the low 30% range during the past 12 months. The win on this slide is a great example of how an Insights upgrade with an unlock upsell can generate meaningful ARR growth. Our second priority is to accelerate our growth within the investigative and intelligence units, or what we call the I&I units, of our law enforcement customers. Now, early this year, we added dedicated sales specialists within our quota-carrying sales force, targeting the investigative and intelligence units, and we are already seeing this initiative help building a large pipeline of opportunities.

Our third priority is to expand our business in the private sector, where Cellebrite's data collection solution helps enterprises and service providers advance corporate investigation and e-discovery use cases. Our strategic partnership with Relativity, which we announced a few months ago, is off to a good start, highlighted by our participation at Relativity Fest last quarter. We continue to see Endpoint Inspector maintain good momentum with both enterprises and service providers as the remote data collection solution of choice for mobile devices, computers, and cloud workplace applications. Our fourth strategic priority is to help our customers harness the power of cloud. Earlier on the call, I detailed the investment we are making to expand our range of cloud-based solutions and enhance the infrastructure that supports them.

Now, while customers in the U.S. have been the primary early adopters of Guardian, we are starting to make inroads in certain international markets, which is highlighted by our first Guardian deal as part of a larger deployment of our full C2C portfolio by a regional police force in a key Western European country. I would like to conclude my prepared remarks on Slide 7. Cellebrite's market remains very healthy, with multiple tailwinds that are producing three major pains. First, today's crime involves more data and increasingly complex data. Second, operational inefficiencies make it harder for law enforcement to advance their investigations. And third, the need to build public confidence and trust around the ethics and accountability of law enforcement. So given the constrained law enforcement budgets, our customers cannot simply allocate more manpower to solve these challenges.

As a result, Cellebrite's customers are increasingly recognizing the need to invest in the type of disruptive technology that Cellebrite delivers. This is a major driver, or one of the major drivers, behind our plan to hold our first-ever Case-to-Closure, our C2C User Summit, at the leading event for digital investigation in late Q1 2025 in Washington, D.C. Now, as we look ahead, we are well positioned to close 2024 on a very positive note. Given our progress to date and the strength of our near-term pipeline, we have once again raised our 2024 targets for revenue and Adjusted EBITDA, while also increasing the low end of our ARR guidance. We look forward to 2025 with confidence in our ability to consistently deliver a balanced mix between ARR expansion with healthy profitability that will produce or exceed a baseline for Rule of 45.

The mission at Cellebrite is both inspirational and aspirational. It is focused on enabling our customers to deliver justice faster, smarter, and more defensively to help close the public safety gap and create a safer world. The team at Cellebrite is making good on the company's brand promise of justice accelerated by delivering an end-to-end set of digital investigative solutions for law enforcement agencies around the world. Cellebrite's workforce has performed admirably so far in 2024. Now, while the conflict in Israel escalated during the Q3, our business has not experienced any disruption. This is a tribute to the focus and resolve of our team, especially those based in Israel, and we appreciate their ongoing commitment and contributions. So that concludes my comments on our quarterly performance and accomplishments, and I will now turn the call over to Dana. Dana, please.

Dana Gerner (CFO)

Thank you, Yossi.

It was a fantastic quarter for Cellebrite. We have delivered the Rule of 54 performance for Q3. It reflects great fundamental execution alongside the expected seasonality, but guys, to be clear, while we are excited about the Rule of X performance of this quarter, our long-term plans are to deliver a Rule of X range between 45 and 50. Now, let's start the review of the Q3 on Slide 9. Our ARR grew 26% year-on-year to $371 million at the end of September. As noted on the slide, our gross retention was approximately 91%, which is in line with the recent quarters. Consistent with our historical trends, much of ARR growth over the 12-month period came from higher spending by existing customers. From a product perspective, our Insights suite drove the majority of our ARR growth, which is complemented by the contribution from our Guardian and Pathfinder offering.

Geographically, the ARR mix for the 12 months ended September 30, 2024, was in line with the prior quarters and consistent with the year-to-date revenue mix. The Americas represented 54% of the total ARR, with EMEA at 34% and Asia-Pacific at 12%. In terms of growth rates by geography, the Americas grew 26% thanks to the solid demand in our U.S. federal and SLG customer segments. ARR in EMEA grew 24%, and it grew 31% in the Asia-Pacific region. Turning to Slide 10, we delivered third-quarter revenue of $106.8 million, our Q1 in the company history of revenue above $100 million. The 27% growth in the total revenue over the same period last year was primarily fueled by a 27% increase in subscription software. Our top-line performance benefited from some professional services revenue that was generated earlier than expected and the quarterly mix of an on-premise and cloud deployment.

Subscription revenue represented approximately 87% of the total revenue, which is in line with recent quarters. Now, let's move to Slide 11 for a view of our non-GAAP gross margins and non-GAAP operating expenses, which exclude share-based compensation, amortization of intangible assets, and acquisition-related expenses. Our Q3 gross margins of 86.1% was at the higher end of our full-year target. In terms of our operating expenses, Q3 operating costs were $62.5 million and 19% year-over-year increase. This primarily reflects higher personnel costs within our sales and marketing and research and development organizations and higher one-time project expenses within R&D. We ended September with 1,109 employees, a 3% increase from the Q2 and a 12% increase from the same quarter one year ago. Slide 12 covers our profitability and cash position.

We delivered Q3 Adjusted EBITDA of $31.3 million, or 29% on a margin basis, versus 25% in last year's Q3. Our profit performance reflects positively on our success in driving strong revenue growth, maintaining excellent gross profit margins, and effectively managing our cost structure. Our Q3 non-GAAP operating income was $29.5 million, with non-GAAP net income of $31.8 million, or $0.14 on a fully diluted basis. We ended September with $413.6 million in cash, cash equivalent, and investment, an increase of $47.6 million from the Q2 and an increase of $130.4 million from the same quarter last year. The sequential increase for the quarter primarily reflects the strong cash flow from operations.

Free cash flow for the Q3, which we defined as net cash provided by operating activities less capital expenditure and the purchase of intangible assets, was $39.8 million, up 42% from the same quarter last year, due primarily to the strong fundamental operating performance. I'd like now to move to Slide 13 to briefly cover the capital markets events that occurred during the Q3. On September 16, we successfully completed our warrant redemption with approximately 29.7 million public and private warrants being exercised and converted into 10.1 million net new ordinary shares. In addition, Cellebrite's stock price performance from July through the middle of September hit two separate price triggers, one at $12.5 and one at $15, and combined, they resulted in the commitment to issue a total of 10 million price adjustment shares and vest a total of 6 million restricted sponsor shares.

Our Q3 diluted weighted average shares outstanding as of September 30, 2024, increased 7% from Q2 levels, due primarily to the timing and magnitude of these events. Two days ago, we disclosed that our recent stock price performance hit the 17.5 price trigger, which resulted in issuing another 5 million price adjustment shares. Overall, these milestones support our long-standing goals of optimizing our capital structure, sustaining healthy trading liquidity, and simplifying our financial reporting. In terms of our financial reporting, since we fully retired all of the outstanding warrants and triggered 100% of our price adjustment shares and 80% of our restricted sponsor shares, the value of the remaining restricted sponsor shares and the remaining price adjustment shares as of September 30 are now represented on our balance sheet within shareholders' equity, rather than as liabilities, and we're no longer obligated to revalue them.

Let's move to Slide 14 for our updated 2024 Q4 and full FY financial expectations. Based on our results for the first three quarters of the year and our assessment of the near-term opportunities, we have again raised our outlook for the year. In terms of annual revenue, with a strong Q3, we increased our 2024 revenue range to be between $397 and $401 million, which implies Q4 revenue between $105 and $109 million. We also increased our 2024 Adjusted EBITDA target range to be between $96 and $100 million, or 24% to 25% on a margin basis. This implies Q4 Adjusted EBITDA in the range of $25 to $29 million, or 24% to 27% on a margin basis. This assumes a Q4 gross margins in the mid-80% range and Q4 operating costs between $64 to $66 million.

Finally, we increased the low end of our 2024 ARR target range to $390 million. In terms of modeling our diluted share count and factoring in all of the previously discussed capital markets events from Q3 and Q4, we expect our Q4 weighted average diluted share count to be around 241 million shares and our full-year weighted average diluted share count to be approximately 222 million. We expect to begin 2025 with approximately 255 million diluted shares outstanding, which is detailed on the table on Slide 25 in the appendix to this presentation. Overall, our Q3 was highlighted by robust financial results and meaningful tactical and strategic execution.

As a result, we are well positioned to deliver a 2024 performance in excess of 45 for the second consecutive year, thanks to increased profitability that benefited stronger-than-planned gross margins and disciplined spending, even as we invested meaningfully in our product house and go-to-market organizations. As we look ahead, we believe we remain well positioned to deliver solid ARR expansion and profitability that will enable us to deliver or exceed our target baseline of 45 while funding initiatives critical to our long-term success, such as enhancing customer success, accelerating our efforts around the cloud, fueling innovation, and incrementally expanding our quota-carrying salesforce and marketing team. That concludes my commentary. I'll ask you to go to Slide 15 so that I can now turn the call back to Yossi.

Yossi Carmil (CEO)

Thank you, Dana. The last 20 years, 19 as CEO, have been an amazing journey for me with many successes along the way. When I began as CEO, there were just 18 of us working out of a small office. And at the end of this year, 2024, I will finish my tenure as CEO, having established Cellebrite as a market and technology leader with 1,100 employees and a global footprint that includes dozens of offices worldwide and 7,000 customers in over 100 countries. We are now, Cellebrite is now, a publicly traded company that is taking major strides over the past three years to earn the trust of shareholders and drive meaningful value creation. This level of success would not have been possible without the support of our customers, partners, and investors, and the commitment and contribution of our talented employees.

It has been very rewarding to have led Cellebrite over the past three decades, but I believe that it is now the right time for me to step aside as CEO and pass the baton to a new leader who will take Cellebrite to the next level. At some point down the road, I will focus on different types of roles that will enable me to contribute my knowledge and experience to the high-tech industry. But before that can happen, we plan to close out 2024 on a successful note, as reflected in our updated outlook, and complete all the work necessary to position the company to sustain its business momentum next year and beyond. Cellebrite moves forward with a strong leadership team, an exciting technological roadmap, and a compelling strategic plan that is aimed at driving value creation for all key stakeholders.

As the search for my successor progresses, I'd like to personally thank Tom Hogan for his support since he joined as an Executive Chairman 15 months ago. In a very short time, we developed a strong partnership, and he has made a major impact in many areas such as strategic planning, sales, marketing, and investor communication, to name a few. His imprint on Cellebrite has been and will continue to be critical to our success. I know Tom will help lead a very thoughtful and efficient search for a new CEO and provide our company with great leadership as interim CEO. In closing, I'm confident in Cellebrite's strategic direction and in our company's ability to capitalize on the opportunities that lie ahead. As proud as I am about what we have achieved in the past 20 years, I know the best for Cellebrite is yet to come.

And I remain a loyal and supportive shareholder, and I look forward to seeing all that Cellebrite will accomplish over the coming years. And before we take questions, Tom Hogan would like to close out our prepared remarks. Tom, please.

Thomas Hogan (Executive Chairman)

Thanks, Yossi. I'll be brief, but I want to start by sharing my heartfelt compliments to you. As many of you know, I've been at this for a long time. I've seen leaders who excel at scale, and there are others that excel as entrepreneurs, but it's the rare exception that a leader gracefully navigates a company from early-stage revenue up to and through the $100 million mark. The few that successfully cross that chasm, even more rarely, then succeed in guiding a company from $100 million all the way to $400 million.

In a world that's increasingly focused on short-term performance with equally shortened CEO tenure, Yossi's stayed the course, as he shared, for over 19 years as CEO of Cellebrite and leaves a legacy he should forever be proud of. So on behalf of all of our employees, our customers, our shareholders, and the full Cellebrite board, I want to express our gratitude for his service and wish him nothing but continued health and success. Now, as the exec chair, Yossi's decision brings mixed emotions. On the one hand, I couldn't be more pleased for him personally. He's earned this break and the time to figure out what comes next while reconnecting with all the personal priorities that are often collateral damage as a CEO. On the flip side, his passion and his history with this company, excuse me, certainly leaves some big shoes to fill.

As for the future, our search efforts have already kicked into high gear. It's my belief that this company is a unique, the proverbial one-in-a-million company. I'm not sure where you find a company that's both AI-driven and cloud-centric, a company that's the undisputed platform leader in a large-growing and still highly fragmented market, while at the same time delivering high levels of ARR growth with outstanding customer loyalty and retention and strong free cash flow that Dana just talked about, all while truly making the world a better, safer place. Based on that profile, we fully expect a rich list of qualified candidates to quickly surface and compete for this job. Cellebrite deserves nothing short of an exceptional new CEO, and this board is completely committed to protecting that standard as we evaluate candidates.

It's obviously impossible to predict or to commit to a specific date or timeline, but we do not expect a protracted process. We will move with purpose and pace, and to the extent there's any gap between Yossi's departure at the end of 2024 and the arrival of a new world-class leader, I will step in as the interim CEO. With that said, we'll now ask the operator to open the floor for comments and questions.

Operator (participant)

The floor is now open for questions. At this time, if you have a question or comment, please press star one on your telephone keypad. If at any point your question is answered, you may remove yourself from the queue by pressing star two. Again, we ask that you pick up your handset when posing your question to provide optimal sound quality. Thank you. Our first question will come from Shaul Eyal with TD Cowen. Please go ahead.

Shaul Eyal (Equity Research Analyst)

Thank you. Good afternoon. Good morning, everybody. Yossi, congrats on the quarter, congrats on the past few decades, and congrats on the road ahead. Tom, Yossi, as you think about the search process, will the new CEO be based in Israel or in the U.S.? And also my follow-up question, Dana, any little Cytech acquisition contribution this quarter? Thank you.

Yossi Carmil (CEO)

Don't let you take the easy one.

Dana Gerner (CFO)

I'll take the easy one. As we said when we acquired Cytech, the contribution is very minimal. This quarter was slightly below $500,000 to the total revenue.

Yossi Carmil (CEO)

Yep. And on your first point, look, the answer is we're casting the widest net possible given the unique asset this company represents and our desire to secure the best CEO on the planet. And so we are not restricting that aperture search to any geography, whether it be Israel or the U.S. So it will be driven by finding the best leader.

Shaul Eyal (Equity Research Analyst)

Thank you.

Andrew Kramer (Head of Investor Relations)

Next question, operator? Operator?

Operator (participant)

We'll go next now to Mike Cikos of Needham.

Mike Cikos (Equity Research Analyst)

Hey, thanks for taking the question, guys. And Yossi, it's been a pleasure working with you over the last couple of years. I'll let go of Shaul's comments. The first question I have for you was relating to the CEO succession plan here and just wanted to get a better sense of when Cellebrite retained the executive firm. I know we're talking about our expectations for surfacing new candidates quickly, but how have the candidates been that you guys have assessed so far? And then the second piece, investors hear CEO succession plan, and sometimes their antenna starts to go up. I know that the firm just had its first-ever investor day in March of this year with the announcement that Yossi will be departing the firm. Is there any reason to think that the longer-term models through calendar 2028 that we received in March of this year are changing, or no? Are you guys willing to reiterate that long-term target from where we sit today? Thank you.

Thomas Hogan (Executive Chairman)

Yes, Tom, I'll take that. So first, there's no fundamental change with respect to the business plan or strategy. That's something that Yossi and I worked closely on starting last summer, establishing the framework, the narrative, the platform for an end-to-end solution in the industry, using that to guide us from an asset and an IP perspective that will fuel growth.

Our focus is still, we believe this is very much a growth company with a huge amount of headroom, but we continue to do it with balance and an eye on cash flow and profitability. So that positioning and framing we did in our inaugural investor day still holds. On your question on the search, we started to have the conversation with Yossi actually just a few weeks ago. And so we then reached out to some of the Tier 1 search firms. They're now fast at work building that slate. And as I shared with you, they are very bullish about if you just think about this company, we continue to scale.

And in spite of that, we continue to deliver strong Rule of X performance, which any potential smart CEO loves to see: a growth company that's not trying to figure out how to generate cash or vice versa, and a company that you go to bed at night and not only are you driving value creation, you literally can go to sleep at night knowing that you're playing a key role in making the world a better, safer place. So they are very bullish about that candidate pool. And as I said earlier, we're going to move with pace, but also maintain the highest standard to get the best person on the planet.

Yossi Carmil (CEO)

And Mike, first of all, thank you for the kind words. Just adding that, especially at that point, after reflecting with the management the strategy for the coming three to five years, which we have done recently, and also reviewing the market trends and ingredients and all the market factors, I'm also glad to say that everything plays in Cellebrite's favor in terms of strategic growth, budgets, and market conditions. So on top of that, also the market plays in our favor. And I'm obviously concurring with what Tom said about no reason to change anything and, on the contrary, clear growth path.

Great. Appreciate the thorough answer there, Tom and Yossi. Thank you.

Yep. Next question, operator?

Operator (participant)

Our next question will come from Jeff Van Rhee with Craig-Hallum. Please go ahead.

Jeff Van Rhee (Equity Research Analyst)

Great. Thanks for taking my questions, guys. And I'll add my congrats, Yossi. Just what an exceptional run and exceptional performance. It's been great working with you.

A couple of questions for me on the quarter and kind of the outlook. The C2C platform and the vision obviously seems to be playing out. Specific to insights, any updates on adoption expectations for 2025? Just an early look on what might be a target in terms of conversions, and then secondarily, just curious in terms of the unlocks. You gave an example or two in the prepared remarks of people upgrading and driving significant to ARPU uplift, but just trends you're seeing in the unlocks, the pace of unlocks, the magnitude of usage, any color there would be great.

Yossi Carmil (CEO)

So maybe I will start with basic, I would say the C2C and the adoption. The good news, the case-to-closure platform resonates very well when it comes to the way law enforcement decision-makers are looking at it.

And the better news is that we are still in a very early stage and very early days, meaning when one thinks about the 5,300 public sector customers, the percentage of customers who have deployed Insights in Guardian and Pathfinder or end-to-end is still quite small. So the growth potential is tremendous. And 300 customers, by the way, which is even good news if we think about part of it, had adopted so far two out of the three flagship products, so Insights and Pathfinder and/or Guardian. So there is a significant growth potential, and you and we should be very optimistic about the broader adoption.

And obviously, what I would like to add here before handing over either to Tom or to Dana, that we believe that the cloud enablement of the solutions, and I reiterated the investment that we are doing in the cloud. Basically that should accelerate the adoption of the C2C. Think cloud, think AI, and you can anticipate further progress in terms of adoption based on a very successful and strong roadmap. Dana, would you like to add?

Dana Gerner (CFO)

I think we said from the very early beginning that this is a journey of three years. So while we are expecting to finish the year at around 15%, we still have a very healthy growth in the future for the coming two, three years ahead of us. I would mention what you said about the analogs. We said in the script that around 30% of our customer base has adopted.

That means that we have a potential first to penetrate the rest of the 70% and continue upselling additional add-on packages to the existing customer base. So it's not only the Insights-based packaging, but it's also the add-ons that generate a great potential for the future.

Yossi Carmil (CEO)

One add-on in terms of the Insights is the fact that we are extremely satisfied with the comments and the perception and the reaction of customers about the Insights in the market. Again, we brought here a revolutionary solution for the digital forensic unit for examiners and investigators that completes the examination twice faster, accesses more devices, and brings more abilities which were basically broken down into several separate modules.

So, based on that for positive feedback, I can also say that there is high acceptance, higher acceptance for higher price, appreciating the value, and definitely a strong belief and confidence in our ability to meet the 2025 and 2026 conversion rates.

Jeff Van Rhee (Equity Research Analyst)

Got it. Very helpful. One last question for me then. With respect to Pathfinder, maybe just talk for a few minutes about Pathfinder. Obviously, the AWS deployment, kind of curious what you expect that to do to Pathfinder adoption and then also current adoption of Pathfinder. What's the make and model, so to speak, of those that are choosing to buy and use it? Is this tending to fall within large agencies? Just kind of the distribution of adoption and what we can learn from it so far.

Yossi Carmil (CEO)

So maybe I will start, and Dana, we'll hand over to you. We can do it together. Basically, just a reminder, we are aiming two targeted major subsegments within the public sector: the digital forensic unit, what we call the DSU, and IU, the investigative unit, and also the intelligence unit, and over there, Pathfinder is basically a suite of, I would say, powered by AI analytical capabilities and also open-source intelligence tools that basically can help customers to surface the golden evidence very quickly out of a huge amount of either structured or unstructured data which has been ingested from many, many sources, our sources and other sources.

So basically, the Pathfinder is, and we said it several times, while the Insights or what we call the collective review area is planned to grow 15%-20% every year, the Pathfinder as investigative analytics is something that we expect it will continue to grow in a pace of, let's say, 35%-50% year over year. And everything that we do right now in terms of cloudifying that part while maintaining the on-prem, announcing the VPC implementation with AWS, building on existing SaaS-based capabilities with expanded AI-driven tools and all that, that should promise to celebrate a very solid growth. And I'm glad also to report that we are growing exactly in the pace that we originally planned with Pathfinder. Dana?

Dana Gerner (CFO)

And maybe double-click on one note in your questions. Yes, indeed. Currently, because the Pathfinder, whether it's on-prem or VPC deployment, actually serves a larger customer base, the 1,200 large strategic customers. The journey to the cloud with the C2C platform, as we discussed before, is actually democratizing our solutions, and we believe that the future would allow us also to bring a lot of the goodies that the Pathfinder brings currently on-prem into the Case-to-Closure platform and be available to a broadened customer base with SaaS capabilities, so again, we see great future to this offering in the coming years.

Yossi Carmil (CEO)

Last but not least, and we've got no time here for an educational session, but at the end of the day, one in a C2C context cannot separate and should not separate the Pathfinder from the Guardian, which is a cloud SaaS-based solution which basically creates the best connection between what is produced with examiners, with the Insights, and then analyzed, ingested, and analyzed. So the Guardian as a bridge is a critical component. And I'm glad to report that actually we have seen since the beginning of the year an amazing traction and also doubling the size and the achievements in terms of ARR related to Guardian. And that means that it works. It works.

It takes basically in the C2C concept, in a C2C perception, the combination of Insights, investigative analytics, Pathfinder, and the Guardian means that the company delivers on the promise to the customers, and customers are adopting.

Operator (participant)

Thank you. Our next question will come from Brian Essex with J.P. Morgan. Please go ahead.

Brian Essex (Equity Research Analyst)

Good morning. Thank you for taking my question. And Yossi, congratulations. It's an amazing accomplishment that you've made with Cellebrite. So hats off to you. Thank you. Maybe the first question I have is around the federal sector. Would love to get an understanding of what percentage of your business does federal within, specifically within the public sector, what percentage does federal account for, and how are you managing the evolution of Cellebrite's federal solutions, particularly with respect to how it impacts your existing federal relationships?

Yossi Carmil (CEO)

I'll take it for a start. First of all, just to remind us all, we have a very strong position in the federal space as part of our public sector activity for years by now. End of 2023, the federal space was around 20% of the entire total Cellebrite activity, meaning was, is, and obviously should remain meaningful, and forming the Cellebrite Federal Solutions business unit or company that we have declared last quarter basically enabled us to expand, and that's the logic of it. The main logic of it is basically expanding the TAM in the federal space.

That structure will help us to accelerate the growth in a very strong segment for us, as I said, and basically deploy, I would say, a broader range of solutions and be exposed to programs and opportunities in a context of growing sales opportunities that we will not be able to be exposed in the former operation mode that we delivered so far. I'm glad to report that now the CFS is running and ready, and we are pretty much very positive about that. As for the impact for the future, I would say still anticipate the initial financial benefits of the CFS. I would say that you will see the company will see an impact in 2025, but a very meaningful impact when it comes to 2026 and 2027.

Brian Essex (Equity Research Analyst)

Got it. That's helpful. And maybe for Tom, on the CEO transition, I think you noted that you're focused on bringing in the best leader possible. Is there a set of criteria that you have? I think Michelle mentioned location is one point of question, but in terms of technological expertise, sales expertise, customer focus, what is your shopping list or wish list as you go to the search firms and look for the most suitable candidate possible?

Thomas Hogan (Executive Chairman)

Well, as the search people shared with us when we talked about this, they just grinned and said, "So it's basically the God spec." And I said, "Yep, that's right.That's what this company deserves." I know this maybe sounds like I'm dodging the question, but we didn't want to get laser-focused as the question you raised, in a lot of cases, is a really good, fair question, which is, "Hey, given where the company's at, given the strength of the executive team, is the company in bigger need today of a go-to-market CEO or a product CEO?" And you can apply multiple vectors to that. Public sector experience would be an example, the geography question. And so we, by design, didn't want to over-index on specifics. Again, we're shooting high.

So our goal is to punch above our weight and announce a new CEO that the marketplace just kind of takes the breath away and says, "Wow." And that's the priority to help guide this to the billion-plus ARR mark and what we expect will be an aggressive strategic agenda over the next four or five years. So I'm not trying to dodge your question, but we wanted to give them a shot first with a pretty wide-open aperture, and then we'll tune and prioritize from that list.

Brian Essex (Equity Research Analyst)

Okay. That's very helpful context, well, thank you very much.

Thomas Hogan (Executive Chairman)

Yep. Next question, operator?

Operator (participant)

Yes. Our next question will come from Jonathan Ho with William Blair. Please go ahead.

Jonathan Ho (Equity Research Analyst)

Hi. Good morning, and congratulations, Yossi. It's been great to work with you as well. When we look at sort of the net retention, can you give us a little bit of additional detail, just given how strong it's been? How much of this is driven maybe by new seat expansion versus upsell? I just want to get a sense of maybe the sustainability or durability of net retention. Thank you.

Dana Gerner (CFO)

Yes. I think I mentioned as part of the ARR growth, the vast majority of the contribution to the ARR growth and to the net retention is the expansion within the Insights offering, both by upgrading the current offering, but also by selling more, not necessarily seats, but more volume. So if you think about the add-ons and growing it from the almost doubling into last year, this is actually to the same seats that are sitting on an Insights-based solution, just giving them more capabilities, and this is a combination of the two.

And then some of it is really coming from the great performance of the Guardian that has more than doubled its ARR in the past 12 months, growing very fast from a small base, and continuous implementation of the Pathfinder. So that is, in a way, what we were trying to convey to our customers, that they need to move to the next generation of the C2C platform. They need to enjoy the benefits of those new solutions. And we are seeing great adoption.

Yossi Carmil (CEO)

Excellent. And then just in terms of your commentary around AI, can you give us a little bit of additional detail on how customers can leverage AI within your solutions and how this could maybe expand your opportunity as well? Thank you.

So first of all, one need to understand, and we said it several times. Customers, and especially our customers, I'm talking about investigators and examiners in DSU and IU, they place a very high value on the AI capabilities that we brought to the market so far. Again, in the context of AI and machine learning, Cellebrite is delivering capabilities in the Insights suite of solutions in the collect and review for a decade by now. But then, obviously, the question is about the future. Customers basically report that leveraging AI capabilities enables them to achieve step function increase in investigative speed and efficiency, and also in effectiveness. I would like also to add that we see significant opportunity going forward with advanced AI capabilities.

Let's not forget that as we look at our C2C platform, then we need to remember that it's pretty much AI-driven in the elements of insights and in the elements or in the, I would say, the flagship part of the Pathfinder and Guardian as well. Concretely, when I look at what the company is about to offer, we support our customers or intend to support our customers with media analysis capabilities into the future and also text analysis. I can say also high usage when we look at investigations today is around crypto. In the case of cryptocurrency analysis, AI-driven capabilities can be very meaningful as well. Very meaningful as part of the drive of the C2C platform. I'll stop there.

Thomas Hogan (Executive Chairman)

Let's go to the next question, operator.

Operator (participant)

Our next question will come from Brad Zelnick with Deutsche Bank. Please go ahead.

Great. This is Bhavin on for Onshore. Brad, thanks for taking our questions, and congrats on all the success, Yossi. Just two on our end first. Just as you look at your historical performance and kind of have discussions with your customers, any high-level thoughts on how a change in U.S. administration and what that could mean for Cellebrite, both in U.S. federal and state and local?

Yossi Carmil (CEO)

I'll take it. I'm glad to say and reiterate what we said in the past. We are in this business for 16 years. Administration change. There was never any impact whatsoever on our business. I think that the trends that we are talking about, which are coming mainly for our customers, law enforcement agencies, are reflecting an increasing need in digital transformation, increasing need to improve the mode of operation.

And I'm glad to say that at any point of time in recent years, and ever since we started 15 to 16 years ago, there was any impact whatsoever on that, neither administration, elections, or anything like that. We crossed even areas, or I would say eras of crises, the financial crisis of 2011, or even COVID with the wrong anticipation about the funding police, which has proven to be wrong as well. So you can be very confident that, or we are very confident that there would be no impact also this time about the way we go forward with our customers and the budgets.

Super thoughtful and insightful. Just as a follow-up, you spoke about kind of continuing to add headcount, especially on the sales side. Any insight on where kind of you will be deploying salespeople, whether it's on Guardian, Pathfinder, specific geos, public sector, private sector, etc.?

Absolutely. First of all, I'm glad to say that we have a rich people's problem. Again, as we look at the opportunity pipeline, we actually need more quota carriers in order basically to serve the needs of the customer. And this is rich people's problem and a good place to be as a company. If we think about our focus, we mentioned several times, while expanding our growth in the DFU as a clearly proven growth engine, we need to expand in the INI investigative units and intel. And as I mentioned in my opening, you will see more investment from our side in quota carriers, which are specialists to the elements and the needs of customers and personas in the investigative units.

And side by side to that, customer success and the ability basically to enable cross-sell and upsell while understanding the mode of operation of the customer and tie it to a value leads to the fact that you will see from Cellebrite also side by side with classic quota carriers and additional investment in customer success. And these are good news for us and for the customers.

Thomas Hogan (Executive Chairman)

Next question, operator.

Operator (participant)

Yes. Our next question will come from Tomer Zilberman with Bank of America. Please go ahead.

Tomer Zilberman (Equity Research Analyst)

Hey, guys. Yossi, congratulations on the 20-year mark, and I hope you get to enjoy your much-deserved time off. So maybe looking at this quarter, just wanted to talk more higher level about the performance of government budgets in relation to your outperformance versus your expectations and the street.Maybe can you talk about how the federal budget ended, especially as this was the closing budget for them, as well as when you look at the state and local level, how that performed this quarter?

Yossi Carmil (CEO)

First of all, I want to say you mentioned the Fed, and I mentioned that in my opening. The federal year came to an end, end of Q3 in the U.S. That's what makes basically the Q3 from Cellebrite very meaningful in the context and in the impact of our ability to deliver on the Fed side. And it was a very strong performing quarter in terms of Fed. That reflects basically the fact that our anticipation regarding budgets and about the ability of our customers to finance the deals, including C2C and growth and everything which is related to digital transformation, met expectations. So that was a good one.

And as I said, we do not see any anticipation of change in that respect. So much for the Fed, but the good news is that also on the state and local government, we see the same trends. We always said, especially as we started the year, that we intend to do a double down with a very strong focus on the state and local government. And over there, we also see no change, meaning no news, good news. I always emphasize the facts, and by that, I will finish that part, that we have a huge advantage. One, our highs, as much as the highs are never too high, the lows are never too low in law enforcement. There is a need. There are predictable budgets.

And as a company who is pretty much sticky and tied to the deep conversations with our customers about plan related to C2C, and we're having a strong and closed conversation with them, we have pretty much visibility about the budgets and about what is expected. So confidence on both sides, basically no change. And these are good news as we look and anticipate what's going to happen in 2025 and beyond.

Operator (participant)

Thank you. Our next question will come from Max Michaelis with Lake Street Capital. Please go ahead.

Max Michaelis (Equity Research Analyst)

Hey, guys. Just one from me, and congratulations, Yossi. Just looking forward to 2025 on a high level, I know you mentioned in your script you're talking about your consistent or meaningful ARR expansion and then healthy profitability supports a baseline for Rule 45. When we think about that, I mean, are you anticipating any meaningful expansion in just a dividend, or should we think pretty stable from what you're performing at in 2024 on a margin basis? Thank you.

Dana Gerner (CFO)

Maybe I'll start. So our long-term model that we provided earlier this year spoke about CAGR around 24% on the ARR and a very healthy EBITDA range of 20%-25%. When we are finishing the year and performing better than that, we do not have yet provided formal guidance for 2025. But I do think that looking at the constant performance also towards the coming years, we've seen the range that I spoke about is the right way to look at our business growth.

Max Michaelis (Equity Research Analyst)

Then I don't know if I missed it in the call or not, but what was the reason for the $3 million tick-up quarter-over-quarter increase in pro services? Was that related to federal, or help me out with that?

Yossi Carmil (CEO)

That was an APAC customer that we have contracted specific services a year ago. We completed it earlier in the year. It was supposed to be next quarter, a one-time event.

Operator (participant)

Thank you. This does conclude 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.

Yossi Carmil (CEO)

So first of all, I would like to thank you all for participating in this call. But I would like to use the opportunity also to, in a wider sense, to thank you, probably for the last time in this uniform, for the trust in Cellebrite, the long-term trust so far, and I'm also sure into the future. Above all, I would like to use the opportunity and thank the Cellebrite employees, as always, for an excellent Q3. And obviously, good luck.

We're still over a year to close, so I wish all of us good luck by closing successfully this year. And on a personal note, I would like to use the opportunity and thank all Cellebrite employees, all those and the managers who have been part of my journey throughout these years and were part of my personal journey and personal success. Good luck to the company and good luck to us all. Thank you.

Operator (participant)

Thank you.his does conclude the Cellebrite Q3 2024 Financial Results Conference Call. Please disconnect your line at this time and have a wonderful day.