Ladies and gentlemen, thank you for standing by. And welcome to the to the CS Disco Third Quarter of Fiscal Year 2023 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 now hand the conference over to your first speaker today, Head of Investor Relations, Aleksey Lakchakov. Please go ahead, sir.

Good afternoon, and thank you for joining us on today's conference call to discuss the financial results for Disco’s second quarter of 2023. With me on today's call are Scott Hill, Disco's Chief Executive Officer and Michael Lafair, Chief Financial Officer. Today's call will include forward looking statements within the meaning of the Safe Harbor provisions of the private securities litigation Reform Act of 1995. Including but not limited to statements regarding our financial outlook and future performance, our use of capital expenditures, market opportunity, market position, product strategy, and growth opportunities and developments in the legal technology industry. 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, 2023, filed with the SEC on August 9, 2023 and the company's upcoming Form 10-Q for the year ended September 30, 2023. 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 Scott.

Thanks, Aleksey. Good afternoon, everyone, and thank you for joining us. For those of you who I have not yet met, I'm Scott Hill. I assumed the role of Chief Executive Officer about two months ago. Before we dive into the results, I would like to briefly introduce myself. I was the CFO of a company called Intercontinental Exchange, better known as ICE, from 2007 until 2021. I joined ICE not long after its IPO and helped lead a company that uses innovative technology to fundamentally transform commodity and financial markets and generate strong growth and investor returns. I met Disco just after I retired from ICE and saw a company similarly poised to use technology to transform the legal industry and generate strong growth and returns. I jumped at the chance to join Disco's Board of Directors in June of 2021, shortly before we went public. More recently, the Board asked me to step into the CEO role on an interim basis while we conduct the search for a permanent CEO. We are focused on finding a leader with demonstrated experience scaling businesses, leading high-functioning organization and building, enhancing and maintaining a strong cultural foundation. Once we find our new CEO, I look forward to remaining on Disco's Board of Directors. Until then, I will strive every day to make a meaningful and positive contribution to the company, its employees, its customers and its shareholders. There's a lot of work to be done. We've gone through a difficult couple of months, but we remain steadfast and focused on building the leading legal technology company. I'm here to enable that strategic vision by removing obstacles and making decisions that propel the business forward. I'm excited to be a bridge to Disco's next chapter. Although, I've been here only a short…

Thank you, Scott. In Q3 2023, revenue was $34.9 million, although year-over-year revenue was up only 1%, we are starting to see a pickup in eDiscovery usage. As Scott mentioned, we are seeing growth in both ECA and active data on our platform. Within review, revenue came in below where it was in Q2 due to $1 million review that ended offset somewhat by the growth of our eDiscovery business. In discussing the remainder of the income statement, please note that unless otherwise specified, all references to our gross margin, operating expenses and net loss are on a non-GAAP basis. Adjusted EBITDA is also a non-GAAP financial measure. Our gross margin in Q3 was 75%, as we mentioned before, our gross margins fluctuate from period to period based on the nature of our customers' usage, for example, email and types of data ingested and managed on our platform. Sales and marketing expense for Q3 was $15.4 million or 44% of revenue compared to 54% of revenue in Q3 of the prior year. This represents a decrease of over $3.1 million in the quarter year-on-year. The decrease was primarily driven by a decrease in sales and marketing personnel costs. Research and development expense for Q3 was $10.1 million or 29% of revenue compared to 40% of revenue in Q3 of the prior year. This represents a decrease of approximately $3.7 million in the quarter year-on-year. This decrease was primarily driven by a reduction in research and development personnel costs. General and administrative expense in Q3 was $6.6 million, or 19% of revenue compared to 23% of revenue in Q3 of the prior year. This represents a decrease of approximately $1.3 million in the quarter year-on-year. The majority of the decrease was driven by a reduction in general and administrative personnel costs.…

Thank you, sir. [Operator Instructions] Our first question comes from the line of Derrick Wood from TD Cowen. Please go ahead with your question.

Hey guys. This is Cole on for Derrick. Just want to get a better picture of kind of how sales rep productivity has been trending in the quarter. I know that last quarter, you talked enablement initiatives. But can you just give us an update on that.

Thanks for the question. So we're really pleased about the performance in Q3. It was a record quarter, the best quarter in the history of the company. And so in terms of rep productivity, we're pleased with the direction of the business. And as we mentioned in our prepared remarks, we're very, very pleased with the pace of where the business is going and how the usage on the platform, in particular, with respect to eDiscovery has picked up into October. So we're pleased with how things are going.

Great. Thanks. And then just one more, on the net new customer number, that was lower than it's been in the past couple of quarters, kind of impaired with the sales rep productivity, has that productivity shifted to more of a focus on existing customers and kind of selling into that more? Or what are you seeing on the new customer front?

Yes. It's Scott, and I'll take this. And it's interesting the way you phrased the question. It's not a focus on existing or a focus on new, it's a focus on both. And that's one of the things in the couple of months that I've been here that I think we need to do a better job of -- from a sales standpoint is it's not corporate or transactional, it's not corporate or a law, it's all of that. And so I was pleased to see the customer count up again 10% year-over-year. Pleased to see that it's trended up as we've moved through the year. And I think that's a great opportunity for us. It gives us a larger customer base to sell into. But it's also the case that we've got this great existing set of customers that I think we can do a better job of selling into as well. And so I'd like to see the customer count grow. We're clearly focused on continuing that trend. But we -- again, we want to do both. And I think in the quarter, we did a pretty good job of that. We saw some growth and existing customers, we saw growth in new customers, and that's a trend that I'm really working hard with Luke and the sales team to focus on it as we move forward and to take the steps that we can do to enable that team to be able to not do either or but to do both.

Great. Appreciate the color. Thanks.

Thank you. Our next question comes from the line of Scott Berg from Needham & Company. Please go ahead with your question.

This is Ron Morelli [ph] off from Scott Berg. Thanks for taking the question. Your 4Q revenue guidance is a touch life on the implied guide last quarter. Is this a difference based on less new customers signing 3Q or our existing customers, I guess, using -- is usage less than what was previously expected?

Yes. So we feel good about the usage and in particular, on ediscovery into October into the beginning of Q4. We -- in terms of the guidance, we have provided guidance based on what we believe the number will land based on all the information we have as of today, and we feel good about that number. Obviously, we would like to beat the guidance. But the number that we provided is the number based on all the facts we have today that we believe we're going to land based on where we are now.

Got it. And then with the addition of primary law, what does that do for the Disco platform competitively? And also how do the economics work for Disco? Thanks.

Yes. So I'll start, and then I'll let Michael walk you through the financial aspects of it. But I think the way that I would think about it is we've built an amazing platform that today helps lawyers understand all of the facts and the evidence in their case. And so whether it's in our ediscovery platform today or using Case Builder or we've been demoing Cecilia and basically interrogating Cecilia on all your facts and evidence, makes the workload of understanding your facts far more efficient than it has historically been. What the primary law does is allow us to go from what are my facts to what law is relevant to those facts? How do the facts and law intersect? And again, I think that's a really big step forward on our overall goal strategically to be an end-to-end platform, a place where lawyers can come in and work with their facts and evidence come in and understand the relevant laws and use all of that information to determine what the best path forward is with their clients. And so I think that's the great opportunity. Imagine so in a world where Cecelia becomes an expert on 100% of your documents and your facts. Imagine if that witness also knew 100% of the relevant law, how powerful that can be. And so I think for what's a relatively small investment, we have the opportunity to create an incredibly powerful offering for our customers. Mike, do you want to talk a little bit about the financial

Again, in terms of the financial impact of this, I mean, we spend -- it's a $14 million investment that gives us access to all of primary law, as we described in the release that went out yesterday for five years as well as regular updates of that law. So when I go back from almost six years ago when I joined the business, this has been a vision of the business from, I believe, the inception and especially from -- since when I joined. And as Scott mentioned, the concept that we have the evidence and we have our technology to help review that evidence and then we also have the law at the same time that we're going to build into the product. It's very, very powerful. And we also have an option to renew for another five years. And then we have additional options to renew beyond that. So it's a really exciting opportunity for not a large investment from a cash perspective to build it into our product and give our customers really the full spectrum from the eDiscovery piece to what is the law.

Got it. That's helpful. I guess with that option, is it another $14 million investment after five years? Or is there describes

We haven't disclosed what the option price is but it's -- we just haven't disclosed that.

Got it. Thanks for the color.

Thank you. Our next question comes from the line of Mark Schappel from Loop Capital Markets. Please go ahead with your question.

Hi. Thank you for my questions. Michael, I was wondering if you could just provide some additional details on your activity around your view product. For instance, are you expecting any additional legal matters to kind of wind down on the platform in the next quarter or two?

Yes, I mean, so all of our business, as you know, is usage-based or most of our business is usage-based. So matters will end when a case ends or when a case may settle or a judge may make a decision in one way or another that could cause the customer to actually have to load up a whole bunch of new data on the system or in the alternative if the case settles remove data from the system. So it's the review piece, and we mentioned this in the script, there was a large review that ended in the prior quarter in Q2 that was a significant amount of -- it was a $1 million-plus review. That review ended and had an impact on our Q3 numbers. And in terms of the guidance we've provided and we've provided some color on October, we feel really good about eDiscovery and the usage on eDiscovery that's kind of happened over the last couple of months and into October.

Okay. Thanks. And then, Michael, with respect to your prepared remarks around needing to make some additional investments next year. I was wondering if you could just elaborate a little bit more on that?

Yes, it's Scott. Let me take that one. So I think from my standpoint, two months into the role, there are a couple of areas that I think are important for us, as I said in my prepared remarks, to strike a balance between food and investment and not losing sight of the opportunity to grow. I look at an amazing group of people inside the company and an amazing set of products that have been developed and are being developed. And again, that's just not my opinion. That's for me spending probably three or four dust meetings with customers. But I think it's important that we really enhance the ability of our sales team to get out and sell those great products to our customers. As I said earlier, the growing number of customers gives us a growing amount of opportunity. There are a couple of places where, for example, we really have dialed back significantly in our investment, in our sales operations function. We largely disinvested in our customer success function. And all of those are necessary to support the sales team to be successful with customers. And so we're going to make some investments to improve those areas and enhance those areas. So our sales team can focus on what they do best, which is sell. The other thing, I think the company has done a really good job this year of focusing on performance management with regards to the field sales but I think it's left us a little under capacity in the field right now. And so we're going to make some investments to make sure we've got the right capacity in the field. So those investments are about further enabling the sales team about supplementing the sales team to give us the team on the field that has the opportunity to go out and consistently win. Because ultimately, as we move along the path towards profitability, I think a path that is a combination of prudent investment and top line growth is really the only sustainable way to get there.

Great. Thank you. That's helpful.

Thank you. Our next question comes from the line of David Hynes from Canaccord. Please go ahead with your question.

Hey, good evening, guys. Scott, maybe I could stay on that Fred I hear your comments in the prepared remarks that pendulum has swung kind of too far towards cost optimization. Is that at Hampton any way that you guys are backing away from the Q3 2024 EBITDA breakeven target?

Yes. I'm two months into the job, I'm not backing away from anything nor am I leaping ahead. All I'm saying is I think there are areas that – as I move from kind of 30,000 seats at the Board level down to 10 feet at the CEO level, I think some rebalancing needs to occur. I'll give you another example. Our team has worked incredibly hard as we move through this year to deliver on the product. I mentioned the pace of productivity out of our engineering team is better than it's ever been. The products that we're developing, the skills that we're developing for Cecilia are remarkable. And I'm not convinced that the rewards have kept up with that for the team. And so I think there's an investment in our people. I said it in my prepared remarks, I think the most important asset we have is our people. And so I think there's an investment that needs to be made there. So I'm in no way today suggesting that it's a significant investment in terms of dollars but it is significant in terms of what I believe it will result in. And that is an even more motivated employee population and even more motivated and enabled sales team. And I think that will help us get back to the growth company that we were and help enable, as I said, a more sustainable profitability as we move forward as a company.

Yes. Understood. Thank you. Michael, a follow-up for you. So increased revenue sequentially now for three quarters in a row. It sounds like you're pretty constructive on the trends that you're seeing through October. Is there anything you're seeing in the business today that would lead you to think that – that trend of sequential growth doesn't persist into Q4?

Look, Vijay, it's a really good question. I mean we feel good about the recent trends in the business over the last few months and in particular with respect to eDiscovery and additional data on the platform and then into October. And so we feel good about all those trends. We are usage-based. And so cases will end and cases will get added back to the platform. So I'm cautiously optimistic about the trends in the business, and I'm really pleased in terms of where they've been going in the last few months.

Okay. One last quick clarification for me. I believe I heard you say that, that large client review ended in Q2. Is that correct? So there was no bleed of revenue from that into Q3?

I don't actually know exactly offhand if it -- there may have been a little bit of a tail into Q3. I'm not sure off hand, but the $1 million plus was all in Q2, and there could have been a little bit of a tail, but if it was, it wasn't material.

Okay. Thank you guys. I appreciate the color.

Thank you. [Operator Instructions] Our next question comes from the line of Koji Ikeda from Bank of America Securities. Please go ahead with your question.

Hey, Scott, hey, Michael. Thanks for taking the questions. Michael, I just wanted to circle back into some of your prepared remarks about 2024, realizing you're not guiding on the revenue side, but you did make a comment on operating expenses. I think I heard you right where you said you're trying to hold operating expenses flat for next year. Does that mean like on a 4Q guidance run rate basis? Or just trying to understand exactly what you meant by that holding expenses flat.

I think what I said was no significant increase from where we are now is what I said. And we're going to have more to come back to you with more color and detail in Q1 when we report Q4.

Okay. Okay. Got it. And then just thinking about that and some of Scott's comments on potential revenue growth drivers from here. I guess you guys are doing a good job of trying to control what you can, which is investing in the growth levers that you are. And when we're looking at the model, is it safe to say or safe to assume that the primary function here to drive growth given the revenue recognition, usage-based model of your revenue, it's customers, right? It's trying to land as many customers as you can. And customer growth is going to be the best indication of future growth for this business?

Yes. Look, it's Scott and Michael will know the numbers better than I do. But clearly, our ability to continue to grow customers is a net positive from a revenue standpoint. But as I said to the earlier question, I don't think it can be only that, right? I think we have to continue to drive new customers, but then we also need to continue to build the relationships with existing customers to sell them more. If they're an eDiscovery customer, that's fantastic. But if they have a review coming up in front of them, we need to be selling them on our review team. We have an outstanding review team and we need to make sure our customers -- our existing customers know about that review team. Again, an eDiscovery flag planet in the ground is fantastic, but have we shown them Case Builder and all of the skills that we have in Case Builder, the ability today on a subscription basis to have Case Builder and use Cecelia skills to develop a timeline, to do witness management? Are they aware of that offering? With our corporate clients, we made an acquisition a couple of years ago of a hold product. And having lived in the corporate world within the last couple of years and been in a company where on occasion, you got those hold notices showing the GCs of those companies, that opportunity, our existing customers, that opportunity, I think, is a great way for us to establish a foothold from which we can grow. And so my mantra with the sales team has been, it's not -- do we do transaction or subscription. If not, do we sell eDiscovery or Review? It's -- we should do it all. And we should use the portfolio of products that we have and that we're developing to attract new customers without question, but we should certainly take advantage of the 1,449 customers that we have to sell them more. As I look at this company, I don't, in any way, see us having an issue of a lack of opportunity to gain new customers to sell more into existing customers, I think the field is open. I think the products we have are there. I think we have a terrific sales team, and we're going to make investments to enable them more. And so it's both. It's -- yes, you should expect us to continue to grow customers. But you should also expect us as we move forward to talk about what we're doing to sell our existing customers more.

Got it. Thanks Scott. Thanks Mike for taking the questions. Really appreciate it.

Thank you. Our final question comes from the line of Brent Thill from Jefferies. Please go ahead with your question.

This is Luv Sodha on for Brent Thill. Thank you, Scott, and thank you, Michael, for taking my questions. Over the past few quarters, you've highlighted maybe continued optimization in some of your larger customers as they're renegotiating some of their spend, is it fair to assume that the comments you made in terms of eDiscovery usage improving, does that apply to those larger customers as well?

Yeah. The improvement we're seeing, again, this is my theme for the call, I guess, is across all of our customers. So we are seeing improvements with the existing customers and again, some of what you're talking about with the existing customers, where we're negotiating, that's the exact opportunity I'm talking about where we can go to those customers and say, hey, it's more than eDiscovery. Let me talk to you about the opportunity to buy case builder to buy review to -- when it's available in the fourth quarter to buy Cecelia. And so it is absolutely the case that we are seeing some growth in our existing customers, particularly as we work through the wave of some of the larger cases that had come off earlier in the year. But I definitely see an opportunity in those customer conversations to really sell the breadth of the company and the breadth of the products and allow us to see the usage go up related to that.

Got it. And just a quick follow-up, on -- thank you for the net new adds commentary. But wanted to dig in, I guess, on an absolute basis, it was only 18 customers added versus, let's say, the six quarter average has been around 50%. So I guess it is somewhat of a step down. So was there anything different in terms of churn? Or any additional color you can add there? Thank you.

Yeah. I'm not considered -- I don't think I'd say, 18, up as a step down. It's a smaller step up, but it's a step up. And it's -- I don't have the numbers right in front of me, but I'm pretty confident in saying that it's been a step-up each quarter for the last eight to 12 quarters. And that's the trend you want -- would I have liked 18 to be in one shot. Are we focused on continuing to drive more customers? Absolutely. But I don't want to apologize for another sequential improvement in our customer count. Because again, that's 18 more customers that can buy the breadth of the products we have to offer.

Got it. Thank you.

There are no further questions at this time. Scott Hill, CEO. I'll turn the call back over to you.

Thank you, Bhavesh. This has been a challenging year for our company. I want to thank our employees for their resilience and maintaining a remarkable focus on continuing to innovate and serve our customers. I also want to reiterate my commitment to working with all of you to make Disco a great place to work. And importantly, I want to thank our customers, for their continued confidence and business. We're committed to continuing to help you be more efficient, by delivering innovative technology solutions. Thank you for joining us today. And thank you for your interest in Disco.

Thank you. This concludes today's conference call. We thank you for participating. And you may now disconnect.