CS Disco, Inc. Q3 FY2023 earnings

CS Disco reported third quarter fiscal 2023 revenue of $34.9 million, up 1% from the prior-year quarter. Gross profit was $26.0 million, up 0.6%, while gross margin slipped to 74.4%, down 0.5 percentage points. The operating loss narrowed to $2.9 million from $20.1 million a year earlier. Net loss narrowed to $1.0 million from $20.1 million. Diluted EPS was negative $0.02, up from negative $0.34. Operating margin was negative 8.3%, up 49.9 percentage points. On a non-GAAP basis, Adjusted EBITDA was negative $4.5 million, compared with negative $13.1 million in the third quarter of 2022. For the first nine months of fiscal 2023, revenue was $102.3 million, flat compared with $102.7 million. Year-to-date net loss narrowed to $36.3 million from $52.1 million, and year-to-date diluted EPS was negative $0.61, up from negative $0.89.

Operational momentum centered on customer growth and product expansion. DISCO grew to 1,449 customers as of September 30, 2023, a 10% increase compared with the third quarter of 2022. The company announced a licensing agreement with Fastcase, Inc. for comprehensive United States primary law data, including all federal and state laws, regulations and court rulings. Management anticipates integrating primary law into its solution to automate drafting of legal documents and research memos, and to assist lawyers in identifying potential legal claims and defenses. New product features released in the quarter included self-service capabilities for Slack, DISCO Ediscovery Annotations, and the Witness Management module for Case Builder. Usage-based revenue represented 89% of total revenue in the three months ended September 30, 2023 and 2022, while subscription revenue represented 11%. For the nine months ended September 30, 2023 and 2022, usage-based revenue was 88% and 89% of total revenue, respectively, and subscription revenue was 12% and 11%, respectively. Customers outside the United States generated 8% of revenue in the three and nine months ended September 30, 2023.

Cash flow and backlog metrics showed mixed signals. Operating cash flow was negative $6.9 million in the third quarter, up from negative $14.5 million in the prior-year quarter. Year-to-date operating cash flow was negative $28.7 million, up from negative $36.7 million. Capital expenditures were $1.1 million in the third quarter, down from $1.9 million a year earlier. Year-to-date capital expenditures were $3.6 million, down from $3.7 million. Deferred revenue was $2.97 million, up 8.2% compared with the prior-year quarter. Remaining performance obligations were $17.5 million, down 10.7% compared with the prior-year quarter. Revenue growth came from new customers, partially offset by lower usage from existing customers.

Guidance points to a softer fourth quarter. For the fourth quarter of 2023, DISCO expects revenue between $34.0 million and $36.0 million and Adjusted EBITDA between negative $7.0 million and negative $5.0 million. For the full fiscal year 2023, the company expects revenue between $136.3 million and $138.3 million and Adjusted EBITDA between negative $31.9 million and negative $29.9 million. The outlook is based on assumptions that are subject to change, and there can be no assurance that DISCO will achieve these results. Reconciliation of Adjusted EBITDA on a forward-looking basis to net loss, the most directly comparable GAAP measure, is not available without unreasonable efforts due to high variability and complexity and low visibility with respect to charges excluded from the non-GAAP measure, particularly stock-based compensation expense. Management also noted that its ediscovery chatbot, Cecilia, is in beta testing and is anticipated for release in the fourth quarter of 2023 in the United States, while access to sources of primary law is intended to launch in 2024.

Risks remain substantial. DISCO has a history of operating losses and a limited operating history. The company depends on its ability to maintain and advance innovation and brand, add new customers, increase usage and penetration within its existing customer base, expand sales coverage, establish a digital sales channel, expand internationally, extend channel partnerships and integrations, and expand its offering portfolio. A significant majority of revenue is directly correlated with customer usage, which depends on the timing and activity of litigation, investigations and other legal matters. Revenue can fluctuate with the inception and conclusion of large legal matters. Macroeconomic conditions, including inflation, rising interest rates, disruptions in access to bank deposits or lending commitments due to bank failures, the COVID-19 pandemic, the Russia-Ukraine war and the Israel-Hamas war, could harm the business. The company also faces competition, pricing pressure, and the need to manage spending and strategic investments.