CS Disco, Inc. (NYSE: LAW) — Q3 2021 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2021. DISCO provides cloud-based, AI-powered software for e-discovery, legal document review and case management. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $29.9m | $17.9m | $80.5m | $49.3m |
| Revenue growth | 67% | — | 63% | — |
| Gross profit / margin | $22.0m / 74% | $12.3m / 69% | $58.2m / 72% | $34.2m / 69% |
| Operating loss / margin | $(9.1)m / (30%) | $(3.0)m / (17%) | $(14.9)m / (18%) | $(19.5)m / (40%) |
| Net loss | $(9.2)m | $(3.2)m | $(15.2)m | $(19.9)m |
| Adjusted EBITDA (non-GAAP) | $(7.6)m | $(3.2)m | $(11.1)m | $(17.9)m |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $(18.8)m | $(17.7)m |
Q3 revenue growth reflected new customers (71% of the increase) and greater usage by existing customers (29%); for the nine-month period, the split was 65% and 35%, respectively. Usage-based arrangements supplied 89% of Q3 revenue and 88% of nine-month revenue. Q3 operating expenses rose 102% year over year to $31.1m, outpacing revenue growth; sales and marketing and general and administrative costs increased notably. Nine-month operating loss improved from the prior year, which included a $1.1m sales-tax refund and pandemic-related effects.
Financial position and liquidity
- At September 30, cash and cash equivalents were $258.5m, versus $58.6m at December 31, 2020. Current assets were $288.2m and current liabilities $20.7m.
- Total liabilities were $20.8m. There was no debt outstanding at quarter-end; the company had a $40m revolving facility available, secured by substantially all assets.
- Nine-month investing cash outflow was $2.3m, principally property, equipment and capitalized internal-use software. Financing provided $221.0m, primarily from the IPO.
- Management said existing cash and borrowing capacity were expected to fund anticipated cash requirements for at least the next 12 months.
- Remaining performance obligations were approximately $17.0m; the company expected to recognize about $9.2m over the next 12 months. RPO excludes certain time-and-materials contracts and is not necessarily indicative of future revenue.
Material changes, outlook and risks
- The July 2021 IPO issued 7.5m company shares at $32 per share. The filing reports approximately $219.8m of net proceeds after underwriting discounts and offering costs in its cash-flow/MD&A discussion; the notes cite approximately $223.2m after underwriting discounts, before offering expenses. Preferred shares converted into common stock at the IPO. A September secondary offering was by selling stockholders; DISCO received no proceeds.
- No specific revenue or earnings guidance was provided. Management expected continued investment in research and development, sales and marketing, infrastructure and public-company costs; it anticipated near-term Adjusted EBITDA fluctuations and long-term improvement with scale. The filing warns that usage and revenue can fluctuate with the timing, scope and resolution of customers’ legal matters.
- COVID-19 had delayed some customer data collection and legal work in 2020. Management said the full future effects remained uncertain; renewed disruption, weaker customer spending, delayed usage or collection difficulties could affect results.
- Key risks include reliance on usage revenue, customer concentration, competition, dependence on AWS and other third parties, cybersecurity and privacy exposure, hiring and scaling demands, and international and regulatory complexity. The company reported no litigation it believed would have a material adverse effect.
- Management concluded disclosure controls were effective at a reasonable assurance level, but remediation of a previously identified material weakness in controls over employee secondary-stock-sale transactions remained ongoing.
- Subsequent events: In November 2021, DISCO terminated its $40m Comerica revolving credit agreement without an early termination fee. It also reported October warrant exercises and 0.5m RSUs granted in October and November, with expected compensation cost of $24.3m over a weighted-average 3.8 years.
Important facts for investors to verify
- Whether rapid revenue growth and improving gross margin can be sustained while operating expenses rise and the company remains loss-making.
- How much revenue and cash generation depend on variable customer usage, and whether customer concentration or receivables collection presents a material exposure.
- The company’s liquidity and financing plans after termination of the revolving credit facility, including the use of IPO proceeds.
- The status and effectiveness of remediation for the material weakness, and the potential effect of subsequent RSU grants and other equity awards on dilution and stock-based compensation.
- How COVID-19, cloud-provider dependence, cybersecurity/privacy obligations and legal-industry competition affect customer demand, service continuity and costs.