Ladies and gentlemen, thank you for standing by, and welcome to the CS Disco Third Quarter Fiscal Year 2021 Conference Call. At this time, all participants are in listen-only mode. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator instructions] I would now like to hand the conference over to your first speaker today, Lee Robinson, CS Disco Investor Relations. Please go ahead.

Good afternoon and thank you for joining us on today's conference call to discuss the financial results for Disco's third quarter and fiscal year 2021. With me on today's call are Kiwi Camara, Disco's Co-Founder and Chief Executive Officer; and Michael Lafair, Disco's Chief Financial Officer. During today's call, we will review our financial results for the third quarter of fiscal year 2021 and discuss our guidance for the fourth quarter and full fiscal year 2021. Today's call will include forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements regarding our financial outlook, including our guidance for the fourth quarter and full year of 2021, our market opportunity, market position, product strategy, and growth opportunities. In addition to our prepared remarks, our earnings press release, SEC filings and a replay of today's call can be found on our Investor Relations website at ir.csdisco.com. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results, performance, or achievements to be materially different from those expressed or implied by the forward-looking statements. Forward-looking statements represent our management's beliefs and assumptions only as of the date made. Information on factors that could affect the company's financial results is included in its filings with the 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 June 30, 2021, filed with the SEC on September 3rd, 2021. Additional information will be made available on the company's quarterly report on Form 10-Q for the quarter ended September 30, 2021. 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. And with that, I'd like to turn the call over to Kiwi.

Thanks Lee. Good afternoon and welcome to our Q3 earnings call. Before I jump in, I want to thank the entire team of Discovians for all their incredible effort, resulting in another stellar quarter. I also want to introduce our new Vice President of Investor Relations, Lee Robinson. Many of you will interact with her in the coming days and weeks and we will make sure there is time for all of you to become friends. With that, let's jump in. On our last earnings call, we spent a good amount of time discussing Disco, our history, and our strategy. For those joining our earnings for the first time, I would like to highlight a few key points. At Disco, we are well-positioned to take advantage of enduring trends in the $767 billion legal services market that is being transformed by software. These trends include the expanding variety of legal work, the ever-rising volume of enterprise data that can become evidence in legal matters, and the growth in regulation that companies are exposed to around the world. We leverage advances in artificial intelligence and cloud computing to build products that automate large categories of legal work, freeing lawyers to focus on those tasks that require human legal judgment. We do this by combining world-class software engineering and design with a deep understanding of the law and how lawyers work and think to create product experiences that feel magical to lawyers. Our first product, Disco ediscovery, helps lawyers quickly find evidence in large collections of millions, tens of millions, or even hundreds of millions of enterprise documents and data. Disco Review leverages Disco AI to automate the process of legal document review, using artificial intelligence models to automatically classify enterprise data into legal categories and identify potential evidence. Disco Case Builder…

Thank you, Kiwi. Before I discuss the results and guidance, I'll reiterate a few important aspects of Disco's business model. As we mentioned on our last earnings call, we primarily have a usage-based model that is driven by the number and nature of matters, volume of data, length of time on the platform, and other factors. Our customers appreciate the transparent pricing model and simple contracts that allow them to quickly adopt our solution and easily scale their usage. Now, let's discuss our results and guidance. As Kiwi mentioned, Q3 revenue was $29.9 million, up 67% year-over-year. We had strong performance with growth coming from new customer wins and the expansion of existing customers across all of our products, covering a broad spectrum of clients. 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 total gross margin was 74%, up from 69% in Q3 of the prior year. As a reminder, our gross margins fluctuate from period to period based, for example, on the amount and types of data ingested and managed on our platform. We expect gross margins to continue to be within the band we've historically seen. Sales and marketing expense was $12.9 million or 43% of revenue compared to 40% of revenue in Q3 of the prior year. This represents an increase of over $5.8 million in the quarter year-on-year as we continue to scale our go-to-market organization. Research and development expense was $9.4 million or 31% of revenue compared to 34% of revenue in Q3 of the prior year. This represents an increase of over $3.3 million in the quarter year-on-year as we continue to invest in innovation. General and administrative expense was $7.8 million…

[Operator instructions] And your first question comes from the line of Sterling Auty from JPMorgan. Your line is open.

Yes, thanks. Hi, guys. So, one question and one follow-up. And these are two popular ones that I've gotten from investors, so I think it's helpful just to level set people. Can you give us a sense, when you look at the percentage of users or when you look at the user base in total, what percentage of those that are on the platform are actually sitting in corporate legal departments versus the outside law firms that they're actually using?

Sure. So, all of the spend for Disco obviously comes from the legal department budget of litigants, generally large corporations. In terms of users, it depends on the corporation's kind of in-sourcing versus outsourcing strategy. So, a typical approach would be that the corporate has a couple of in-house counsel and maybe an internal sort of paralegal-style team that does the initial assessment of corporate data that may be relevant to a new legal matter like an investigation or a lawsuit. For example, if there is an internal whistleblower complaint, the users may be entirely internal to the corporate legal department where they'll use our platform to collect enterprise data, do their investigation and then decide whether or not they need to take action. Similarly, in the litigation context, internal users in the legal department might conduct that initial review and then decide that it's appropriate to negotiate a settlement, so that the case never actually winds up in court. Now, if a legal matter progresses beyond that point, most corporate legal departments will engage outside counsel at a law firm to represent them in the legal matter and once that happens, the preponderance of the users shifts from the legal department to lawyers at outside counsel. And these are often large teams of lawyers who are conducting a legal document review, providing advice to the client, and ultimately, taking other action like filing lawsuits or filing motions, taking depositions, doing all the other kinds of things that happen in big legal disputes. So, the exact split of users varies company-by-company based on how much the company in-sources relative to using law firms and it also shifts over the lifetime of a legal matter.

That makes sense. And that's a good bridge over to the follow-up is, when you look at the decisions to -- on ediscovery solutions, any qualitative description of what percentage of those are just corporate legal departments deciding on their own on the pathway that they want to go versus those that are either partially or maybe even heavily influenced by the outside legal firm? So, in other words, investors are trying to understand how important are the outside legal firms to the decision process on ediscovery tools.

So, each customer falls somewhere on a spectrum from entirely in-housing the decision about ediscovery to entirely outsourcing it to the law firms they work with. At a high level, Sterling, a good way to think about it is roughly 50-50. 50% of the time, the principal decision-maker will be someone sitting in the legal department. 50% of the time, the principal decision-maker will be someone sitting at the law firm. But when I say principal decision-maker, I don't mean sole decision-maker, right? Generally, there's a consultation process. There are many stakeholders involved in each of these sales. So, if you think of a typical large corporate legal department, maybe they frequently use four or five different law firms to represent them. And they may also have sold risk to a variety of insurers, who will weigh in, in connection with their ediscovery decisions. So, that's kind of a network of decision-makers who all work together. Now, this is why when we've talked in the past about the importance of our partnership strategy with law firms, that's why that strategy is both so important and so effective, right? If you're a lawyer at a law firm, you represent multiple clients, some of those clients will be using Disco and some of them will be using one of our competitors. The lawyer at the law firm gets to have both experiences, and our belief is that very frequently, those layers develop a strong preference for Disco. So, what happens then is that they go to their other corporate clients and either influence the decision or if the decision is outsourced to them, they simply make the decision to switch to Disco, and that's how we spread from corporate to law firm to corporate to law firm.

Understood, that's very clear. Thank you, Kiwi.

Thanks Sterling.

And your next question comes from Koji Ikeda from Bank of America. Your line is open.

Hey, guys. Thanks for taking my question. Really nice quarter here. Just a couple from me. So, looking at the fourth quarter guidance, nearly 50% growth here. So really great growth, but it is down a bit sequentially. However, that sequential decline is less than when we saw in the Q3 guide that you gave during the second quarter results. So, how should we be thinking about that? Is there any large cases that you are anticipating coming off the platform or maybe already have in the fourth quarter or is this just another element of conservatism here?

Hey, Koji, thanks for your -- thanks for the question. So, as a new public company, and this is our second quarterly call, we want to be prudent in our guidance. Q2 was an outsized performance. We were really, really excited about the growth of 88% in that quarter and we're equally excited with the growth of 67% in Q3. We want to be conservative. I've said that before. And we want to be prudent in our guidance. We feel really good about the quarter and the numbers and the momentum in the business. And so, we feel good about it.

Got it, got it. And then just one follow-up for me here. On net revenue retention, I know you guys aren't giving that out, but maybe if you could help us understand from a directional perspective. I know you, in the perspective, the original IPO perspective, it was 122% for the first quarter. Could you help us out maybe directionally? Was it--

We're still pleased with that number. It's north of what we published in the S-1. And we're really pleased with where it is.

Got it. Thanks, guys. Thanks for taking my questions. Really appreciate it.

And your next question comes from the line of Tyler Radke from Citi. Your line is open.

Hey, good evening guys. Thanks for taking my question. I wanted to just help -- see if you could help us understand just kind of the moving thesis between Q2 and Q3. Obviously, as you called out, Michael, there was a kind of unusually large impact from a large customer in Q2. So, maybe just help us understand like how much did that large customer revenue kind of go down sequentially? And where you made that up, was that primarily new customers or expansions?

So, the shift is not due to any particular customer as opposed to our business as a whole. If you look at Q2, the way I described that on our last earnings call was a tsunami of goodness. It's literally everything going right that could go right in our business. If you think about every customer at Disco or each of our businesses or each of our geographies, each of them have fluctuations because of the usage-based nature of our business. And what you saw in Q2 was all of those usage-based streams having their positive variance stack up. And so, in some sense, Q2 with 88% growth is an example of how good, good can be when everything in our business goes right. Now, coming off of that amazing quarter, we couldn't expect that all of those fluctuating trends would again stack up magically in Q3, and so we gave you a conservative guidance. But, of course, as Q3 actually turned out, it was another stellar quarter and we beat that guidance by 16%. So, that's how to think about it. There's not a particular customer that's driving ups or downs. It's more appropriate to think that our whole business is usage-based and has these kinds of fluctuations, which informs our guidance philosophy.

Okay, that makes sense. And I know there was quite a few job postings you guys have had on Disco Review and kind of some of the services stuff. I'm just curious how the progress of that organization is going? What you're seeing both from a hiring perspective, given the labor shortages, as well as a demand perspective from customers? Thank you.

Yes, we've had great progress, less so in Services than in Review. Our Review business we've been making big investments in scaling up the leadership team. So, I think it's public now. We added a leader of that team, Umair Muhajir, who joins us from EY Law. And we added a Director, Saida Joseph, who joins us from Morgan Lewis. Those are two examples of really high-caliber folks who we've added as we're scaling out the Review operation. Our services side, as you know, is a much smaller portion of our business, and we've made sort of ordinary hiring there to keep up with our growth, but we're much more focused on the three core lines; ediscovery, Case Builder, and Review.

And your next question comes from Brent Thill from Jefferies. Your line is open.

Hi. This is Luv Sodha on for Brent Thill. Congrats on a great quarter, guys. Maybe the first question for Kiwi. Kiwi, great quarter. I wanted to ask about -- we were looking at this data from federal case data and we see this massive backlog in terms of pending cases. Is that something that benefits you guys? And then how do you see the sustainability of that backlog as you head into 2022 and 2023?

Yes, I've read this in your report and I certainly can see the thinking behind it. But I can tell you, on the ground, this is not something that we've been talking with customers a lot about. It does make sense that if there is such a backlog, that that backlog could create a tailwind for Disco, but it just hasn't been our experience on the ground. What we hear from customers is much more of the usual, that sort of the timing of legal matters can't really be controlled, and it just is what it is, right? If you think about usage of our platform, it's driven by when a regulator opens an investigation or when a lawsuit is filed or when a whistleblower complaint comes up. I think earlier in COVID, so the quarter right after COVID hit, there was more of an impact because you literally had courthouses shut down. And that cut both ways, right? It lengthened the kind of usage of our product for matters that began before the shutdown, but it also delayed the addition of new data for matters that were delayed due to the shutdown of the courts. But we're just not seeing that as much right now.

Got it. Great. And maybe a quick follow-up. You mentioned some great hiring on the go-to-market side. I guess, could you talk to us a little bit about how you are tracking relative to your goals? I know during the IPO process, you were talking about 10 reps a month. Is that still a good benchmark going forward in terms of, you know, your go-to-market investments that you're making?

We're continuing to invest aggressively in go-to-market. And it's not just quota-carrying sales reps, although they're the tip of the spear. It's also the roles that are to the left and right of them. So, we've been increasing our investment in marketing programs, things like digital and field marketing. In my prepared remarks, I talked about the 30-plus events that we attended in Q3, which is a notable change as the world is coming out of COVID. We've also invested in scaling headcount across our SDR team. Those are folks focused on lead generation and scaling headcount across our customer success organization, which is very focused, obviously, on customer success but also on identifying upsell and cross-sell opportunities. So, if we look at what's going on in the business, what I'll tell you is that our pace for investing in go-to-market, both in terms of programs and headcount, is only accelerating. And we expect to continue that, not just through the end of this year but into 2022 and beyond.

Got it, great. Thank you.

And your next question comes from DJ Hynes from Canaccord. Your line is open.

Hey, guys, nice work here and great set of numbers. Kiwi, what are you seeing the legal service providers do to slow the adoption of AI-driven review solutions? I mean, the value prop just seems so obvious to me that I'm curious how they sell against it.

Well, look, I think we're winning. I think the numbers bear that out and so does what we're hearing on the ground. I think what you're seeing is the fact that it's a really large market, right? And so, there is so much room for software-based solutions to grow while these services companies, in some sense, hang on. I think many of the owners and management teams at the services companies are pursuing the sort of consolidation, drive margins kind of a classic private equity style strategy to continue milking the market before this transformation happens. I'm obviously a bit biased, but for my seat, I really haven't seen an effective answer to the underlying trend, which is driving Disco's growth, which is the move away from services to software.

Yes, okay. And then I don't know if this is better for Michael or you, Kiwi, but I want to ask about R&D spend. I mean, we've seen a pretty significant jump, right? It's up more than 50% since Q1 of this year. Any way to put a finer point on kind of where that investment is going? And is it being allocated toward kind of existing product enhancement? Is it being put toward working on new stuff? Just any qualitative color there would be helpful.

It's principally being allocated to our existing three products, so ediscovery, Review, and Case Builder. One thing that is, I think, unique and special about Disco is our focus on investing in platform, as well as features. So, in my prepared remarks today, we talked about both, right? We talked about an example of innovation on the feature functionality side, which is Disco ECA, but we also talked about -- and I think it's equally or even more important about the kinds of investments we're making on the platform side, which manifests to customers in things like performance in the accuracy and capability of our AI models and so forth. So, we continue to invest aggressively in R&D. I'll tell you one thing about our R&D spend that I think is important to understand. When you look at kind of early stage tech companies, there's two types of R&D, right? There's the R&D that lets go build a product and kind of hope the market is there and iterate until we figure out product-market fit. And then there's the kind of R&D that we're doing at Disco now, which is everything we build has a huge waiting list of existing customers ready to pony up money for those capabilities. So, our number one focus is scaling out go-to-market and S&M next year, but you will see us continue to invest in R&D because ultimately, we think the way you build great companies is product.

Yes, very, very helpful color. Thank you.

And your next question comes from Derrick Wood from Cowen. Your line is open.

All right. Thanks for taking my questions. Congrats on another strong quarter. Kiwi, I wanted to ask what kind of impact you've seen in brand awareness since the IPO? And I know you mentioned attending more events this quarter, but any way to gauge how the IPO, if any, has given you more market awareness or how it may be helping with lead gen or win rates?

The number one change in our business we've seen is a title wave of inbound RFPs. And it's hard to -- I mean, we get so many of these RFPs now that we actually struggle to answer them, which is, of course, a wonderful problem to have and one that we'll address through hiring. But that, I would say, is kind of the single biggest change. Across our business, right, we are seeing great engagement at the field marketing events that we go to. And we're also -- you'll remember last quarter, I talked about an increase in our win rates. More recently, we've seen that increased win rate be sustained in Q3, and so whether that's Disco's maturity or some lift from the IPO process. I think what's going through customers' minds is, look, Disco is a well-capitalized public company, is somebody I can partner with as I think about my journey to adopt legal technology over the next three, five, 10 years and beyond.

Makes sense. And, Michael, one for you on the gross margin side. I mean, we've seen it bump around 73% to 71%, now 74%. Just remind us the mechanics behind what changes those? And then maybe what you're thinking about how to model Q4 and what's kind of baked into your guidance?

Yes. So, Derrick, good question and as I've mentioned before, the margin does move around. It's kind of similar to the fact that we've got this usage-based model and the type of data that's ingested, the mix of the data can potentially impact the margin. I wouldn't read too much into the margins in Q3. It was an awesome quarter. I'll take 74% blended margin any day of the week. The margins in Q2 were a little bit lower, that was an outsized performance quarter, but still 67% year-over-year growth is also outsized and exceeded our expectations. So, we're really pleased with the 16% beat.

And just any help in terms of directional comments around how to think about Q4?

So, Q4, I really would look at our guidance, both the revenue and the adjusted EBITDA margin. We're not guiding at the gross margin level, but I would say that you should basically look at the historical bands that we've seen over the last couple of quarters, and that's really the guide you should go by.

Got it. Thank you.

And your next question comes from Scott Berg from Needham. Your line is open.

Hi Kiwi and Michael. Congrats on the great quarter, and thanks for taking my questions. I guess I have two. Kiwi, in your pre-scripted remarks, you talked about seeing customers use more than one product a little bit more. It sounded like Review was the specific module that had a pickup there, but I assume most of your net dollar retention today is still just expanded usage on the ediscovery side of the platform. But as a customer adds those additional products, how should we think about their spend with Disco? If they're adding Review or Case Builder, does the $1 go to another $1 goes to $3, maybe in all three solutions? Or what does that ratio look like? Thank you.

$1 goes to $3. So, this obviously varies a bit customer-by-customer. But if you look at mature customers who are adopting all solutions, their total spend is two to three times their ediscovery only spend. And that's why we're so excited about this multiproduct, right? It creates an enormous tailwind for growth as we go into 2022 and 2023 and continue to drive higher multiproduct attach rates. And it also demonstrates one of the key pieces of leverage in our business, which is, over time, as we add more and more products portfolio, we're able to capture a bigger percentage of the legal budgets of our clients with very little incremental S&M spend, providing a pathway to long-term operating leverage.

Very good. Helpful there. Thank you. And then from a follow-up perspective, I know you talked about one of your legal firm partners referring to a large customer in the quarter that added $200,000 worth of revenue in the quarter. But how should we think about kind of that partner traction overall in terms of the leads or referral business that you're seeing from them today versus maybe six or nine months ago?

Well, I can give you color that our -- I mean, our relationships with law firms are absolutely core to our strategy. You'll remember that's my own background, right? The origin story of Disco is a bunch of lawyers at a law firm being so frustrated with existing solutions that we actually built our own. And back in the day, we had no intent to It was not our intent to start a company. We were just so frustrated, we wanted better tooling for ourselves. And then we said, wow, there's a lot of demand for this and we spun it out, and that's the story of Disco. But it's woven throughout our organization. The phrase we use is to build product experiences that feel magical for lawyers, and that's just -- that's who we are. It's in our DNA. And the lawyers at these law firms, they see it and then they become champions and advocates. And it works two ways. It works both in that kind of partnership model where they introduce us to their clients, to corporate legal departments, but it also works in a second-order way because most in-house counsel started out as associates or partners at law firms. So, a lawyer will start and get to know Disco using it at a law firm for one of our corporate clients, and then that lawyer as they become more senior in their career, will take an in-house job, and they'll bring Disco with them. And then over time, they'll move across multiple companies, and they'll take Disco with them. That kind of network effect and investing behind the absolute delight of individual users is just key to our strategy.

Excellent. Congrats again on the strong quarter.

[Operator instructions] Your next question comes from Parker Lane from Stifel. Your line is open.

Hi, gentlemen. Thanks for taking my question. I wanted to ask about the international opportunity. Kiwi, you just referenced you've had a tidal wave of inbound RFPs. Just wondering how many of those have come from internationally domiciled organizations and how that's informing your investments in either a physical presence or a much stronger go-to-market investments to address these areas in 2022?

I don't have that stat close to hand on what percentage of RFPs come from internationally headquartered companies, but I can give you two pieces of color there. One is that these RFPs generally come from large multinationals. And so, sort of regardless of where they're headquartered, the scope of the RFP tends to be global legal matters or at least more than one country. Sometimes, it's a particular geography. So, that's kind of data point number one. Data point number two is that we continue to see strong momentum outside the United States and importantly, a big chunk -- I mean, the vast majority of that momentum is being driven by local business, not by U.S. multinational. So, it's not like we opened the London office solely to service American-headquartered clients. We both have American-headquartered clients, and we've had success at developing local business with European-headquartered multinationals. So, over the next few years, you'll see us accelerate our investment in international, expanding to more geographies elsewhere in the world, both to capture that local business and so that we can service our existing clients everywhere they operate.

Yes, makes a lot of sense. And then thinking about your commentary on ingestion and production speed improvements, how much of that has come from your own internal development efforts versus those of some of the third parties like Amazon Web Services that you're actually building the platform on top of?

Yes. So, look, we think that taking advantage of cloud computing and the network of technologies that folks like Amazon and Elastic have built on top of the cloud is really table stakes for how you should build a modern product, but yet it's not universal than legal, right? It still remains one of our huge differentiators that we didn't forklift a code base written to run on some service providers kind of server under their desk and just run it in a cloud environment and call it cloud. Instead, we built a cloud-native product that aggressively leverages things that make cloud unique like Elastic Compute. We're a really big user of Amazon Lambda, which lets us rapidly scale out compute to deal with the searches of data. We're able to get fleets of GPUs for very small increments of time, which lets us apply the latest deeply compute-intensive approaches to machine learning and AI. So, those things are sort of core to what we do. And while you would think they would be broadly adopted in legal tech, in our view, they still have not been. Now, on top of that, about half of our R&D budget is dedicated to investing in platform. And you can think of those as the things that Disco has built on top of those cloud-native technologies where even if you did the cloud-native part, you haven't done the Disco proprietary part, and that's all kinds of things throughout their platform. They tell me that I sometimes bore people with their technical details, so I'll spare you. But one example is when you think about any given document, that document will be related to many other documents. For example, it could be an email that's in a conversation with other emails or it might be a document that has similar documents that might be earlier drafts contract that SMD is looking at. It could have dozens of these other kinds of relationships. And one of our big investments was building a system that allows us to update documents even though the document contains all of these other relationships, which might make it basically very expensive to update from a compute and time point of view. That's one example of the kind of technical investment that is perhaps a boring to our customer but translates into things that our customers care deeply about, which are the performance apps that I included in my prepared remarks.

Yes, appreciate all the color and congrats on the quarter.

And that concludes our question-and-answer session. I will turn the call over back to CS Disco's Co-Founder and CEO, Kiwi Camara, for closing remarks.

Thank you for joining us today. I'm very excited about the momentum we are building and our third quarter results are a fantastic representation of this. We have firm belief in our ability to scale our business, attract new customers, and accelerate adoption of our solutions with both new and existing customers. We strive every day to innovate and create a magical experience for our customers. They are our focus. We will continue to aggressively invest behind each of our growth opportunities and are confident that we can drive long-term durable growth and redefine how law is practiced. We thank you for your interest in Disco and for joining our Q3 2021 earnings call.

This concludes today's conference call. Thank you for participating. You may now disconnect.