Q2 2022 CS Disco Inc Earnings Call
SEC from time to time, including the section titled Risk factors in the company's quarterly report on Form 10-Q for the quarter ended March 31, 2022 filed with the SEC on May 13th 2022, and the company's upcoming Form 10-Q for the quarter ended June 30th.
'twenty two.
In addition, during today's call, we will discuss non-GAAP financial measures.
These non-GAAP financial measures are in addition to and not a substitute for or superior to measures of financial performance prepared in accordance with GAAP.
A reconciliation between GAAP and non-GAAP financial measures and a discussion of the limitations of using non-GAAP measures versus their closest GAAP equivalents is available in our earnings release.
I'd like to turn the call over to Kelly.
Welcome and thank you for joining our Q2 2022 earnings call. We have just marked a big milestone the completion of our first 12 months as a public company.
Q2, we brought on some amazing new hires as mentioned in our last earnings call. We added a new chief Human Resources Officer, Jack nausea groups.
We also brought on a new Chief marketing Officer, Tom <unk>, who joined US from Mongo DB and will help drive just goes brand awareness.
We also welcomed a new vice president of product strategy, Katy Dubord, who formerly served as global Chief Innovation Officer of the law firm Bryan Cave Kati brings deep domain expertise and insight into what lawyers want and need.
In June our inaugural class of associates and entrance joined Discos emerging leaders rotation program.
We brought in 39 top graduates 10 in turns from 17 different universities across the United States. Following an intensive Onboarding program that included learning our industry, our business and many law school experience and the legal Tech Hackathon. These emerging leaders who've joined to every.
Part of our company, including sales marketing product.
And HR.
We are excited to develop this next generation of talent during their three year Associate program MTV impact that each of them will make at disco.
Now I'll talk about our Q2 results.
Revenue for Q2 was $33 7 million above the midpoint of our guidance range. Our Q2 revenue grew 14%. Despite a very challenging comparison in Q2 2021, <unk> revenue grew 88% and benefited from a small number of large reviews.
In each of our earnings calls we have explained how the usage based nature of our business can result in revenue volatility as a result of changes in the timing and nature of usage on our platform.
Activity or lack of activity in particular cases, especially in large cases can drive increased volatility in our revenue.
This is especially true for our review product <unk>.
While we continued to see strong performance in the Ediscovery in Q2, we experienced this volatility in our review of business. As a reminder, this is one of the considerations that informs our guidance philosophy.
We continued to add new customers at a steady pace growing our customer count to 1255 as of June 30, an increase of 27% year on year.
Our steady growth in customer count reflects the growing adoption of cloud computing and software based solutions in the market.
We believe our future growth will come both from continuing to add new customers and from expanding these customers by growing the percentage of their legal work that happens on our platform across all our products.
We have talked extensively about scaling our go to market organization.
I'd like to give you an update on how that is progressing.
We are on track with hiring across quota carrying salespeople sales development representatives and customers success.
We continued to invest behind the success, we are seeing with our sales development representatives and customer success teams each of which has shown increasing productivity both in aggregate and on a per person basis.
One of our learnings as we have scaled our go to market organization is that we can benefit from a higher ratio of lead generation to quota carrying sales capacity, especially now with more than half of our sellers have been at disco for less than one year.
We are achieving this increase in lead generation capacity by investing in sales development representatives customer success and marketing programs.
Historically marketing programs have accounted for a relatively small percentage of our leads with the addition of our new CFO <unk> <unk> and with the early success, we have seen in Q1 and Q2 for marketing programs, albeit at a limited scale, we are preparing to accelerate our investment in.
Marketing programs in the second half of the year.
Across all our go to market investments, we continue to closely monitor performance both in the aggregate and on a unit basis, we will continue to adjust the pace and direction of our investments as needed as we scale out our go to market team.
We remain committed to and excited about capturing the unique opportunity in front of us to build the technology system of record and engagement for the legal function.
This quarter, we won a three year ediscovery subscription deal with a large well known technology advisory firm we.
We were up against a number of vendors in the RFP and successfully unseeded the incumbent provider the.
The customer needed self service ability and was impressed with <unk> AI capabilities and how our platform under <unk> concepts and context improves time to evidence and reduces review time.
They liked disco university with its user friendly content and the ability to easily learned through the use of on demand training modules.
We have been pleased with the excitement around feedback on the expansion of our product portfolio with a hold at request products that we acquired in Q1 of 2022.
In Q2, we had existing holder request customers renew and we're excited to see the interest from new and existing customers during the period.
These are large enterprises, including a notable company in the consumer Tech space.
We are very excited to see hold and request that discount in the door of enterprises early on in the legal value chain.
Complement the other disco products and accelerating our company's legal work.
Part of our value proposition is our laser focus on providing the most intuitive and effective user experience for our customers. A direct result of combining our deep domain expertise with a commitment to world class engineering.
In Q2, we continued to rollout new features that help lawyers get to evidenced faster while also investing in platform performance and capabilities.
While there is a highly anticipated innovations we are proud to announce and have our customers use is topic clustering with automatic indexing.
This feature capitalizes on our proprietary AI to allow users to quickly gain insight into groups of documents with an AI generated outline that works like a table of contents for the entire document universe.
<unk> generated from the documents themselves before any human lawyer review.
Topic clustering with automatic indexing labels groups of documents with phrases extractive directly from the records to help lawyers quickly find relevant content.
This helps lawyers quickly learn the language of the case and use that language to inform further searching and exploration of large datasets youth.
Users are able to quickly identify the topical content of documents drill down to explore subtopics cluster similar subject matter together and the organized topic clusters into an easily navigable list.
We are always making incremental improvements to our platform that ultimately help lawyers get too evidenced faster and improve their quality of life.
We understand there is great interest in understanding how macroeconomic factors like inflation and the risk of a slowing economy may impact our business.
As these questions are frequently raised in investor conversations we thought it would make sense to share with you. What we are seeing as well as how we plan to manage through this environment.
While we didn't exist during the global financial crisis over a decade ago, but youll find if you analyze the historical market data is that the ediscovery market was relatively resilient.
As a matter of fact, according to an industry report the discovery market experienced healthy growth between 2008 and 2011, while many categories of software experienced much more tepid growth.
We believe that E discovery will continue to be a demand during periods of economic contraction as our customers deal with a less cyclical parts of the law, primarily litigation disputes as compared to areas of law, such as corporate transactions or capital markets.
It will always be disputes and investigations, regardless of the macroeconomic environment.
While we have all seen reports of potentially moderated growth in it spending our customers' budgets are not only it budgets, but legal ones. We provide critical technology to lawyers that is required in all kinds of complex disputes and investigations.
We will continue to tout the benefits of using technology like disco to make legal work more efficient for both the time and cost perspective for legal departments and law firms.
We have heard from customers that are focused on delivering a more efficient way of handling large volumes of legal work is of particular interest in the current climate.
I'd like to conclude undisclosed overall outlook and investment philosophy before Michael gets into the numbers, we see a large market for disco and intend to continue to go after the opportunity ahead of us while we are moderating guidance for the fiscal year, primarily on account of the <unk>.
<unk> review that I previously discussed we remain committed to investing in our products and the scaling of our go to market organization.
Using technology to transform the way legal departments of lawyers work is a long term vision to which we are deeply committed.
We are as excited as ever about the opportunity in front of us and we are resolute in our belief that the products and team we have built position us well to build a large and enduring business software transforms the legal industry.
I'll now turn it over to Michael to discuss our financial results and guidance.
Thank you <unk> I will now discuss the details of our recent quarter results and provide guidance for Q3 of 2022 and an update on our outlook for fiscal year 2022.
I'd like to reiterate that our business is primarily a usage based model that is driven by the number of matters nature of usage on the platform volume of data length of time on the platform and other factors that may impact revenue in any given quarter.
As Kieran mentioned in Q2 revenue was $33 7 million above the midpoint of our guidance range, while Ediscovery had strong performance and we're seeing traction with our newest hold and request products year on year revenue was impacted by volatility in usage by some of our customers.
<unk> and review.
In discussing the remainder of the income statement. Please note that unless otherwise specified.
All references to our expenses operating results and share count are on a non-GAAP basis.
Our gross margin in Q2 was 76% up from 71% in Q2 of the prior year.
As a reminder, our gross margin fluctuate from period to period based on for example, the amount and types of data ingested and managed on our platform. We expect gross margin to continue to be within the band we have historically seen.
Sales and marketing expense in Q2 was $17 6 million or 52% of revenue compared to 36% of revenue in Q2 of the prior year.
This represents an increase of approximately $7 million in the quarter year on year as we've previously mentioned we've been focused on investing in our go to market organization. We continue to feel that now is the right time to invest and scale our business in order to capture the opportunity ahead, while there is ramp time for new hires.
We are measuring and closely monitoring the returns on the investments, we're making in our people.
Research and development expense in Q2 was $13 1 million or 39% of revenue compared to 26% of revenue in Q2 of the prior year. This.
This represents an increase of over $5 5 million in the quarter and year on year as we continued to invest in personnel, who are focused on innovation of our product and platform in order to provide a magical customer experience.
General and administrative expense in Q2 was $8 million or 24% of revenue compared to 16% of revenue in Q2 of the prior year.
This represents an increase of over $3 3 million in the quarter year on year, we have strategically added to our G&A organization following our IPO to support the increasing scale of our business.
Particularly in our finance and accounting organization and HR teams.
Operating loss in Q2 was $13 3 million, representing a margin of negative 39% compared to negative 7% in Q2 of the prior year.
Adjusted EBITDA was negative $12 4 million in Q2.
A negative 37% compared to a margin of negative 5% in Q2 of the prior year.
Overall, our EBITDA was better than guidance due to strong gross margin and lower than expected expenses in the quarter.
Net loss in Q2 of $13 5 million or negative <unk>, 40% of revenue compared to a net loss of $2 1 million or negative 7% of revenue in Q2 of the prior year.
Net loss per share in Q2 was 23.
Compared to a net loss per share of <unk> 16.
In Q2 of the prior year.
Turning to the balance sheet and cash flow statement, we ended Q2 with $228 2 million in cash and cash equivalents.
Operating cash flow in Q2 was negative $22 2 million compared to negative $10 2 million in Q2 of the prior year.
Now turning to the outlook for Q3 of 2022, we are providing revenue guidance in the range of 32 million to $34 million, representing 11% year over year growth at the midpoint for.
For Q3 of 2022, we are providing adjusted EBITDA guidance in the range of negative $19 5 million to.
The negative $17 $5 million, representing adjusted EBITDA margin of negative 56% at the midpoint.
As previously mentioned, we will continue to invest in building out our go to market team and adding additional product capabilities, we want to be prudent in our investment decisions, while continuing to position <unk> to grow our share of the significant long term market opportunity that we believe we are well positioned.
And to capture.
For the full fiscal year 2022, we are lowering our revenue guidance to the range of $132 million $236 million, representing 17% growth at the midpoint of our revised 2022 revenue guidance is primarily attributed to the volatility in our review business and conservatively incorporates with.
Potential for an incremental headwind that may materialize in the back half of the year.
We anticipate that our original product Ediscovery will have over $100 million in revenue in 2022, with an annual growth rate of more than 30%.
For the full fiscal year 2022, we expect an adjusted EBITDA margin of negative 43% at the midpoint, representing a range of negative <unk> 60 million to negative $56 million.
We're continuing to invest in our business and scale the organization to capture the opportunity in front of us.
We are focused on providing the best products on the market to our customers.
Providing innovation to the practice of law and transforming the way legal work is performed we are delighted to continue to hear positive feedback from our most important stakeholders our customers.
We see a huge opportunity for <unk> in the market and we are investing in our people and organization to reach the kind of growth and scale, we want to achieve.
We acknowledge that these investments take time to reach fruition, we will continue to pursue market share in an industry ripe for technological disruption and we will drive this goes leadership and its transformation I would like to now turn the call over to the operator to open up the line for Q&A operator.
Thank you Mr repair, ladies and gentlemen at this time given the question simply press Star one and we do ask that you. Please limit yourself to one question again star one for questions.
First to Koji Ikea with bank of America.
Hey, guys. Thanks for taking my questions I wanted to kind of dig in on the guide. This is clearly going to be very topical for you guys here come in coming out of the quarter. So yes.
Totally understand kind of the commentary there on the review product, but I'm wondering if you could get a bit more granular on why is there. So much volatility in the review why is it causing that guide down is there anything else to call out or was considered with the revenue guidance.
Maybe anything with some big cases might be falling off and just kind of thinking about the guidance. Michael appreciate the ediscovery percentage contribution for the total 22 guidance it looks like about 75% of revenue, but thinking about review how much was that as a percentage of revenue maybe over the past several quarters. Thanks guys.
Thanks, Koji So our review business enables much larger ticket sizes, we've talked in the past that customers, who adopt multiple disco products principally E discovery and review their total spend can wind up being two to three times.
Spend on E discovery alone. So that's driven by Big ticket reviews. In addition, the review business as a whole is relatively earlier in revenue scale, then the ediscovery business and as a consequence, there is more volatility in the review business caused by the timing of activity in large review.
To put this a bit in perspective, if you focus on reviews that bill more than $1 billion in a quarter two or three of those reviews make the quarter, a great quarter, two or three more make it a complete home run and so the kind of volatility that we're talking about is driven by the presence.
Or absence of a low single digit number of March reviews.
Yeah.
Thank you we'll go next now to Tyler Radke Citi.
Yes, thanks for taking the question so.
Obviously, that's a pretty significant cut to revenue guidance, but it looks like youre largely maintaining your investment posture, maybe just give us a sense like on.
On a normalized basis understanding that the macro environment is difficult.
Today, but how do you kind of expect longer long term growth.
To trend I mean, obviously, you're you're making investments.
Still at a pretty healthy pace, so presumably youre seeing no change in the long term market opportunity, but I.
I guess as we think about growth beyond this year just help us frame.
What levels, you're achieving four and investing for thank you.
Yes, we've been pleased with the continued steady growth in customer count we disclosed in our prepared remarks that customer account is now at 1255, representing growth of 27% year on year, so focusing on customer count.
So a little bit from the volatility that is created by changes in the volume and nature of usage on our platform by particular customers in any particular quarter. In addition to that steady growth in customer account I talked a bit about the unit productivity in aggregate productivity across.
<unk> our go to market team now that we're four quarters into the six quarter go to market build out that I talked about at time of IPO. So all those fundamentals of our business seem to be tracking well and give us an appetite to continue our level of investment although of course, we adjust the level and direction of our <unk>.
<unk> from time to time based on market conditions and the performance we've seen in the business.
In terms of long term growth Michael mentioned in his remarks that our original E discovery product, we anticipate we'll do more than $100 million of revenue this year growing more than 30% year on year.
That product has gotten to a level of revenue scale that decreases the amount of volatility that is created by particular customers or particular matters and so I think you can think of that as a base on top of which we have invested in layering. These newer products things like disco review.
<unk> case builder disco hold and disc of requests and we've talked about how those products unlock materially larger ticket sizes customers, who are using multiple products can wind up spending two to three X what they would spend on E discovery alone.
This gives us.
<unk> believes that over time, there will be an opportunity to accelerate growth both by continuing to add new customers at a steady pace as we have demonstrated and by continuing to expand those customers and encouraging to move more legal workloads and more kinds of legal work onto the <unk> platform.
Thanks, and so just to.
Okay.
Okay.
Thank you. We'll go next now to Derrick Wood at Cowen and company.
Yeah.
Thank you.
I guess kiwi.
In your prepared remarks, you talked about how your market is you know what stands the macro headwinds and in fact, often leads to more disputes and litigation activity.
Why do you think you are seeing this kind of change in demand behavior play out, especially considering your review technology has a strong ROI I guess.
Just trying to get a sense for what has changed so dramatically over the last three months.
Is it perhaps due to some lost customers from using review or can you just shed a little bit more color on why the customer behavior is doing what it's doing.
Sure, it's less about lost customers and more about changes in customers' usage on the platform again to put this in perspective, the presence of two to three large reviews reviews that build more than $1 billion in a quarter.
What caused this to be a great quarter and two to three more reviews would cause it to be an absolute home run quarter. So the volatility that we're talking about the review business has to do with the presence or absence of a low single digit number of big ticket refuse we're not seeing anything fundamentally different.
In win rates or in the demand environment or in sales cycle times or anything like that and I think you can see that demonstrated in the steady growth we've shown in customer count, which to some extent abstracts away from this volatility and usage.
Thank you and ladies and gentlemen, just a reminder, please limit yourself to one question and the next now to argument Romani at Piper Sandler.
Hi, Thanks for taking my question.
So I just want to ask this question a little bit differently on on guidance and kind of the impact that.
A couple of clients may have on overall review.
So given.
Just to.
Clarified like you may have just Tuesday clients.
The difference between a quarter a.
Good quarter, a good quarter excellent part of wood.
Should we expect this type of volatility.
As basically part of the business and is this type of.
What does it agility repeatable.
And then if thats the case should we really look at expanding the range of.
All.
The guidance, you'll provide to more than $4 million to $5 million.
So on every quarterly.
Paul we have emphasized that our business can demonstrate the volatility and revenue from quarter to quarter driven by changes in the nature and volume of usage on our platform and as a reminder, those changes in usage are driven less by customers' decisions about.
What kind of legal technology, they want to adopt and more by exogenous factors that are often outside the control of the particular customer for example, the timing of a new lawsuit or investigation ruling lawsuits investigations.
That increase or decrease the scope of data and review involved or the timing of an adjudication or negotiated settlement in terms of the volatility going forward. We think there are two big contributors to the volatility of our review business first is that the ticket sizes for review can.
And be materially larger than the ticket sizes for E. Discovery, you've heard me mentioned several times the two <unk> to three <unk> total spend of customers adopting multiple products as compared to their ediscovery spend alone.
Those larger ticket sizes are coupled with review being earlier in its product life and as a consequence, having a smaller revenue base.
Think there's some wisdom, we can take from how we saw the E discovery product go through its journey early in its life. When it had earlier revenue scale. The discovery product two exhibited more volatility because any particular matter or customers usage represented a larger percentage.
Of the overall E discovery revenue, but now the E discovery product, we anticipate we'll do more than $100 million of revenue this year with a growth rate of 30% or more.
That kind of revenue scale, we have seen materially decreased volatility for the discovery business. We believe that as the review business reaches similar revenue scale, we'll see similar declines in the volatility of that business.
Yes.
That's really helpful. Thank you very much.
Thank you we'll go next now to Brent Brent Thill at Jefferies.
Hi, This is love soda on for Brent. So thank you again for taking my question.
I wanted to ask about a pretty big.
DSO in margin guidance for the year.
Could you just.
From the marketing investment what are the investments a plan on the product or the sales side in terms of head count and could you maybe give us how you're tracking the productivity of these reps maybe give us some additional color there. Thank you.
The EBITDA guidance is principally a function of the moderation, we're doing to our revenue guidance and again that is us reflected in Q2, and then adhering to our guidance philosophy of providing prudent guidance for the forward quarter in terms of our investments in go to market.
We look at a variety of things and I talked about some of them in my prepared remarks today one of the things. We're most excited about are increases in productivity both in the aggregate and on a unit basis from our sales development representatives, who generate new opportunities and our.
<unk> success team, which generates upsell and cross sell opportunities in the existing customer base. Both of those teams for the past couple of quarters have set new records for productivity in the aggregate and on a per person basis, one of our learnings as we continue the build out of the <unk>.
To market organization is that right now when so many of our sellers have relatively short tenure of disco more than half of them have been here less than a year. There is an opportunity to increase the level of investment in lead generation relative to quota carrying sales capacity and so we will be sure.
Shifting the direction of our investment in the back half of the year Accordingly, increasing our investment in <unk> and CSM and also scaling out marketing programs with the addition of our new CMO.
Thank you we'll go next to Scott Berg Needham.
Thank you and Michael Thanks for taking my question today.
Keith Let me ask this a different way I know, we're all kind of asked in roughly the same question plus or minus but your new guidance calls for a second half revenues to be down 21, 5% at the midpoint.
With that $17 million reduction thats, the big number annualized it's $34 million I guess, what I'm trying to understand is in this review product 17 million, even if I break that up between two quarters sounds like it's more than just a couple of customers. How can the I guess, how can the magnitude be that big of a swing factor.
Be that big.
In this one area because it's not a couple gigabytes of data usage not a few million Bucks, one way or the other necessarily that's a big enough number to big enough percentage that it's outside of I think our standard deviation or two of what we would think volatility of this model would look like thank you.
Yeah.
I think the magnitude we're talking about in the review business and specifically, what we saw a shortage in the second quarter or a couple one two or three large reviews billing north of $1 million per quarter, the presence or absence of 1% to 6%.
Of those reviews can take a quarter from good to great to a complete home run and again that is volatility that's created by the big ticket sizes and review as well as the relatively small size of the review revenue base today in terms of our go forward guidance, we have sought to DRAM.
Risk the guidance as much as possible and to adhere to the guidance philosophy that we've articulated on each of our prior earnings calls, where we expect to be prudent in our forward guidance now that will result in some quarters that have outsized beats as you've seen in the past and some quarters that have.
More modest beats like the quarter, we just reported.
Great. Thank you.
Thank you Leo next <unk> Parker Lane at Stifel.
Hi, it's Max on for Parker. Thanks for taking my question can you just kind of if we think about expenses going into 2000 2300 and on guidance for 'twenty three but as the second half is going to be kind of the trough for margins as we look at the out year or will that those levels of spending kind of continue.
Okay.
Okay.
When we went public I announced a six quarter plan to ramp up our go to market capacity by about three X. So we're now through four quarters of that six quarter plan and as I discussed in my prepared remarks, we're now fully on track with the hiring that's implied by that plan.
Our anticipation is that after this year you should see incremental leverage in the business as we begin to move toward the long term margin profile.
Got it thanks.
Thank you. We'll go next now to David Hynes of Canaccord Genuity.
Hey, this is Luke on for DJ Thanks for taking the question.
So we're curious how are you thinking about cumulative accumulative cash burn and timeline to breakeven given the revised near term growth outlook, but consistent investment agenda going forward. Thanks.
Sure I think if you compare our historical cash burn through the strength of our balance sheet. I believe we ended the quarter with north of $200 million of cash on the balance sheet.
There is no expectation that we will need to return to the market to raise additional capital for organic purposes, we anticipate being able to get to profitability based on the strength of our current balance sheet and as I said in response to the last question. Our anticipation is that beginning in 2008.
23, you will start to see increasing leverage in the business now that we've gone through this three asking of our go to market capacity this year.
Thank you and just a reminder, ladies and gentlemen star one piece for any further questions. We'll go next 90, Mark Schappell at loop capital.
Yes.
Hi, This is Tim grieve golf or Mark.
I wanted to talk with respect to Congruity 360 has the user interface for our holders request 360.
Been updated to match.
<unk> you there.
So that work is in flight, we did a handful of kind of a simpler user interface updates things like the logo and navigator show them, an oct integrations and things like that shortly after the acquisition closed we do anticipate a broader sort of version.
Two of the user interface of those products, including deeper integration into the rest of the <unk> product suite to unfold over the course of <unk>.
23 and of course like all our products when we build a product we think it's always important to maintain R&D capacity on that product. So that we're making continuous improvements inspired both by our vision for the future of the product, but also by the feedback we're receiving from existing customer.
And prospects in the market.
Okay.
Okay.
Thank you we go back now to Tyler Radke Citi.
Hey, Thanks for taking the follow up.
So can we maybe you could help us understand why.
Why these review deals arent happening is it.
Simply because maybe these.
Use cases, where for a legal case that got pushed out that was maybe more cyclical and then just help US understand are you are you not anticipating.
Any more of these larger view cases to fall in the second half just help us understand how much you've kind of de risked the guide from a disk.
<unk> review perspective, thank you.
Sure. So typically and again, we're talking about a small handful of reviews that build more than $1 million in a quarter.
Those tend to be a big ticket litigations, if this or you would read about in the paper and the timing of them is again somewhat exogenous it depends on when such a litigation is initiated when a big new investigation initiated it depends on rulings by the court or other decisions.
Gross a regulator about the scope of discovery and the investigation it depends on the progress or lack thereof in settlement negotiations and the timing of rulings on incremental motions and on the final disposition of the case. So it's a lot dependent on what's going on in the specific legal.
Process in terms of our guidance what we have sought to do is to derisk. The guidance from the point of view of these kinds of large reviews.
Thank you and it appears we have no further questions. This afternoon I'd like to turn the conference back over to key camera co founder and CEO for any closing comments Mr camera.
Thank you for joining us today at <unk>, we will continue our march to be the legal technology leader and make the everyday lives of lawyers easier smarter and more efficient. We thank you for your interest in disco and for joining our Q2 2022 earnings call.
And again, ladies and gentlemen conclude today's conference call. We thank you for joining.