The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our unaudited condensed
consolidated financial statements and related notes appearing elsewhere in this
Quarterly Report on Form 10-Q and our audited consolidated financial statements
and related notes and the discussion under the heading "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the final
prospectus, or the Prospectus, for our initial public offering, or IPO, filed
with the Securities and Exchange Commission, or SEC, on July 22, 2021 pursuant
to Rule 424(b)(4), under the Securities Act of 1933, as amended, or the
Securities Act. This discussion, particularly information with respect to our
financial results of operations or financial condition, business strategy, plans
and objectives of management for future operations, includes forward-looking
statements that involve risks and uncertainties as described under the heading
"Special Note Regarding Forward-Looking Statements" in this Quarterly Report on
Form 10-Q. You should review the disclosure under the heading "Risk Factors" in
this Quarterly Report on Form 10-Q for a discussion of important factors that
could cause our actual results to differ materially from those anticipated in
these forward-looking statements.
Overview
DISCO provides a cloud-native, artificial intelligence-powered legal solution
that simplifies ediscovery, legal document review and case management for
enterprises, law firms, legal services providers and governments. Our scalable,
integrated solution enables legal departments to easily collect, process and
review enterprise data that is relevant or potentially relevant to legal
matters. We leverage a cloud-native architecture and powerful artificial
intelligence, or AI, models to automatically identify legally relevant documents
and improve the accuracy and speed of legal document review. Our AI models
continuously learn from legal work conducted on our solution and can be reused
across legal matters, which further strengthens our ability to help our
customers find evidence and resolve matters faster as they expand usage of our
solution. We provide legal departments with the ability to centralize legal data
into a single solution, improving security and privacy for our customers,
enabling transparent collaboration with other legal industry participants and
allowing customers to reuse data and lawyer work product across legal matters.
By automating the manual, time-consuming and error-prone parts of ediscovery,
legal document review and case management, we empower legal departments to focus
on delivering better legal outcomes.
We generate substantially all of our revenue from our customers' usage of our
solution. Customers generally do not commit to purchase a specific amount of
usage on our solution and their usage can fluctuate based on the number and
nature of legal matters they have at any particular time. As a result, our
revenue and other financial results can fluctuate from period to period given
the inherent unpredictability of the timing, duration and scope of legal
casework. We also offer our customers the option to enter into subscriptions
based on committed minimum usage on an annual or multi-year basis, which
represented 11% and 12% of our revenue for the three and six months ended
June 30, 2021, respectively. In addition, we generate revenue from a range of
professional services aimed at accelerating the time-to-value for our customers.
After using and realizing the benefits of our solution, our customers often
increase usage of our solution to cover additional legal matters and adopt more
of our offerings. As our customers use our solution over time, the amount of
enterprise data in our solution increases, enhancing the strategic value and
stickiness of our solution within an organization.
Our customers include a diverse set of enterprises across a broad set of
industries, as well as law firms, legal services providers of all sizes and
government organizations. While we serve customers across many different
industries, the way in which lawyers and legal professionals use our solution is
similar regardless of the specific industry in which each customer operates.
This commonality has created efficiencies in our sales and marketing and
research and development activities because we do not need to tailor our sales
and marketing activities to a wide range of different customer use cases.
Our go-to-market strategy is focused on acquiring new customers and driving
continued use and increased usage of our solution for existing customers. We
primarily sell through a direct sales force, which is organized based on the
stages of our sales motion. Our sales organization is segmented into sales
development representatives, field sales, inside sales, solution architects and
our customer success team. In addition, our solution is designed such that
customers can grant access to third parties, including law firms and other legal
service providers, to use our applications on the customers' behalf. This access
facilitates widespread adoption of our solution, as these law firms and other
legal service providers often become customers on their own or recommend our
solution to other legal industry participants after realizing the benefits of
working on our solution. Likewise, if a law firm is our customer, the law firm
may add users from its clients' legal departments to our solution in order to
collaborate with them. These users may then become champions and encourage the
companies they work for to become customers.
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We have experienced rapid growth in recent periods. Since inception and through
the filing date of this quarterly report, we have raised $401.1 million of
capital, of which $240.0 million was obtained through the proceeds of our
initial public offering (subsequent to June 30, 2021 and not reflected in the
financial statements) and $161.1 million through the sale of redeemable
convertible preferred stock. We had $47.0 million of cash and cash equivalents
as of June 30, 2021. We generated revenue of $29.5 million and $15.7 million in
the three months ended June 30, 2021 and 2020, respectively, representing a
period-over-period growth of 88%. We generated revenue of $50.7 million and
$31.4 million in the six months ended June 30, 2021 and 2020, respectively,
representing a period-over-period growth of 61%. Our net loss was $3.1 million
and $5.5 million for the three months ended June 30, 2021 and 2020,
respectively, and $6.0 million and $16.7 million for the six months ended
June 30, 2021 and 2020, respectively. We generated Adjusted EBITDA of $(1.6)
million, and $(4.4) million for the three months ended June 30, 2021 and 2020,
respectively, and $(3.5) million, and $(14.7) million for the six months ended
June 30, 2021 and 2020, respectively. See the section titled "-Non-GAAP
Financial Measure" for the definition of Adjusted EBITDA, as well as a
reconciliation of Adjusted EBITDA to net loss, the most directly comparable
financial measure stated in accordance with GAAP.
Impact of COVID-19 on Our Business
The COVID-19 pandemic has caused general business disruption worldwide beginning
in January 2020. The full extent to which the COVID-19 pandemic or COVID-19
variants will directly or indirectly impact our business, results of operations,
cash flows and financial condition will depend on future developments that are
highly uncertain and cannot be accurately predicted. As a result of the COVID-19
pandemic, governments in many of the jurisdictions in which we or our customers
operate instituted shelter-in-place orders in March and April 2020 to mitigate
the outbreak of COVID-19, forcing court closures and causing general delays in
litigation proceedings, as well as leading to delays in the collection of
enterprise data. Due to these factors, we experienced flat revenue growth in the
second quarter of 2020 from the first quarter of 2020, during which we generated
$15.7 million in each quarter. In addition, we executed a reduction in our
workforce in March 2020 in response to the COVID-19 pandemic. This reduction in
workforce resulted in a total impact of $0.7 million of charges related to
severance. As shelter-in-place orders expired and businesses and court systems
adjusted their operations to accommodate remote work policies, usage in our
solution increased and our revenue in the third quarter of 2020 returned to
pre-pandemic levels of growth.
We have also experienced, and may continue to experience, a modest positive
impact on other aspects of our business, including slower growth in certain
operating expenses due to reduced business travel, deferred hiring for some
positions and the virtualization or cancellation of customer and employee
events. While a reduction in operating expenses may have an immediate positive
impact on our results of operations, we do not yet have visibility into the full
impact this will have on our business.
We cannot predict how long we will continue to experience these impacts as
shelter-in-place orders and other related measures are expected to change over
time. However, as certain of our customers or partners experience downturns or
uncertainty in their own business operations or revenue resulting from the
spread of COVID-19 or COVID-19 variants, they may decrease or delay their legal
spending or request pricing discounts, any of which may result in decreased
revenue for us. In addition, we may experience customer losses, including due to
bankruptcy or our customers ceasing operations, which may result in an inability
to collect accounts receivable from these customers. In addition, in response to
the spread of COVID-19, we have required substantially all of our employees to
work remotely to minimize the risk of the virus to our employees and the
communities in which we operate and we may take further actions as may be
required by government authorities or that we determine are in the best
interests of our employees, customers and business partners.
The global impact of COVID-19 and COVID-19 variants continues to rapidly evolve
and we will continue to monitor the situation and the effects on our business
and operations closely. We do not yet know the full extent of potential impacts
on our business or operations or on the global economy as a whole, particularly
if the COVID-19 pandemic or COVID-19 variants continues and persists for an
extended period of time. Given the uncertainty, we cannot reasonably estimate
the impact on our future results of operations, cash flows or financial
condition. For additional details, see the section titled "Risk Factors"
Key Factors Affecting Our Performance
We believe that the growth and future success of our business depends on many
factors. While each of these factors present significant opportunities for our
business, they also pose important challenges that we must successfully address
in order to sustain our growth, improve our results of operations and establish
and maintain profitability.
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Maintain and Advance Our Innovation and Brand
Our success depends in part on our ability to maintain and advance our
innovation and brand. We have a strong history of innovation, demonstrated by
our DISCO Ediscovery, DISCO Review and DISCO Case Builder offerings, and have
built a research and development process that reliably produces applications and
features that lawyers love. We intend to continue combining our deep legal
domain expertise and commitment to world-class software engineering to continue
delivering features that lawyers love and introducing new applications to
address more areas of legal work. Our future success is dependent on our ability
to successfully develop, market and sell existing and new applications of our
solution to both new and existing customers.
Add New Customers
We believe we have a significant opportunity to continue to grow our customer
base. As enterprises continue their digital transformation journeys and the
demand for differentiation in the competitive market for legal services
continues to grow, we expect more and more companies will struggle with existing
legal solutions and ultimately will adopt integrated, easy-to-use solutions like
DISCO to improve productivity and legal outcomes. We believe our market
leadership and differentiated solution will enable us to efficiently acquire new
customers across all channels. Our ability to attract new customers will depend
on a number of factors, including the effectiveness and pricing of our products,
the offerings of our competitors and the effectiveness of our sales and
marketing efforts. We will need to dedicate significant resources to further
develop the market for our solution and expand, retain and motivate our sales
and marketing personnel.
Increase Usage and Penetration Within Our Existing Customer Base
Our large base of customers represents a significant opportunity for further
sales expansion. We believe that we will be able to continue expanding customer
relationships by increasing customers' usage of offerings that they already buy
from us, selling more of our existing offerings to existing customers, and, in
the future, introducing additional offerings to sell to existing customers. Our
long-term offerings strategy is aimed at building features and offerings that
address more and more types of legal work so that customers can continue to
centralize on our solution as the system of record and engagement for the legal
function. Our ability to increase sales to existing customers will depend on a
number of factors, including our customers' satisfaction with our solution,
competition, pricing and overall changes in our customers' spending levels. Even
if our customers expand their usage of our solution, we cannot guarantee that
they will maintain those usage levels for any meaningful period of time or that
they will renew their commitments.
Expand Our Sales Coverage and Establish a Digital Sales Channel
We intend to continue to increase our sales force headcount in strategic
locations across the United States and globally. Additionally, we plan to
develop a digital, self-service sales channel that can simplify the sales
process and enable customers to easily adopt our solution through our website
without the need to speak with a sales representative. Our ability to achieve
significant revenue growth will depend, in large part, on our success in
recruiting, training and retaining sufficient numbers of sales personnel to
support our growth. We will need to spend significant resources to expand,
retain and motivate our sales and marketing personnel.
Expand Internationally
Our market is global and we believe there is a significant opportunity to expand
internationally. In the three and six months ended June 30, 2021, 12% and 9% of
our revenue was generated by customers outside of the United States,
respectively. International expansion, including our global sales efforts, will
add increased complexity and cost to our business.
Extend and Strengthen Our Channel Partnerships and Integrations
Our partnerships, including with legal services providers and cloud
infrastructure providers, assist us in driving awareness and adoption of DISCO
and extending our reach. We intend to cultivate and leverage channel partners to
grow our market presence, enhance the virality of our solution and drive greater
sales efficiency. Our future success is dependent in part on our ability to
develop and maintain relations with these partners.
Expand Our Offering Portfolio
We believe that our technology, and especially our approach to automation and
AI, is applicable to a wider range of legal processes outside of our current
core offerings. We intend to leverage our technology to introduce further
offerings that increase
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lawyer productivity across more and more areas of legal work over time. We may
expend significant resources in the development of additional offerings. Our
ability to successfully develop, market and sell new offerings will depend on a
number of factors, including the availability of capital to invest in
innovation, our customers' satisfaction with such offerings, competition,
pricing and overall changes in our customers' spending levels.
Pursue Strategic Acquisitions and Strategic Investments
We intend to selectively pursue acquisitions and strategic investments that we
believe can expand the functionality and value of our solution and bring talent
to our company. We believe that the combination of our market leadership, deep
legal expertise and powerful end-to-end solution provides an advantage in
pursuing select acquisitions. We may be required to expend significant resources
in connection with the pursuit of acquisitions and investments.
Key Components of Statement of Operations
Revenue
All of our revenue-generating activities directly relate to the sale and support
of our legal solution within a single operating segment. We have two primary
types of contractual arrangements: usage-based and subscription solutions. Our
usage-based revenue is derived from contracts under which customers are billed
monthly based on their usage of our offerings. Subscription revenue is derived
from contracts where customers are contractually committed to a minimum data
volume over a period of time. Revenue received from usage amounts above the
fixed data volume in our subscription contracts is considered usage-based
revenue.
In the three months ended June 30, 2021 and 2020, usage-based revenue
represented 89% and 86% of total revenue, respectively. In the six months ended
June 30, 2021 and 2020, usage-based revenue represented 88% and 87% of our total
revenue, respectively. In the three months ended June 30, 2021 and 2020,
subscription revenue fees represented 11% and 14% of the total revenue,
respectively. In the six months ended June 30, 2021 and 2020, subscription
revenue fees represented 12% and 13% of total revenue, respectively.
Cost of Revenue
Cost of revenue consists primarily of third-party cloud infrastructure expenses
incurred in connection with our customers' use of our solution. Cost of revenue
also includes outsourced staffing costs, amortization of internal-use software,
and personnel costs from employees involved in the delivery of our solution.
Personnel costs include salaries, benefits, bonuses, stock-based compensation
expenses and allocated overhead costs. We intend to continue to invest
additional resources in our infrastructure to expand the capability of solutions
and ensure that our customers are realizing the full benefit of our solutions.
The level, timing and relative investment in our cloud infrastructure could
affect our cost of revenue in the future. Additionally, cost of revenue in
future periods could be impacted by changes in outsourced staffing costs and
amortization associated with capitalized internal-use software costs.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing,
and general and administrative expenses. Personnel costs are the most
significant component of operating expenses and consist of salaries, benefits,
bonuses, stock-based compensation expenses and sales commissions. Operating
expenses also include overhead costs for facilities and shared IT related
expenses, including depreciation expense. During the six months ended June 30,
2021 and 2020, certain operating expenses decreased as a result of the COVID-19
pandemic and a related reduction in force. We expect certain expenses impacted
by COVID-19 to resume in the second half of 2021, although the timing and
magnitude of these expenses will depend on a number of factors including the
trend of the pandemic and potential lifting of stay-at-home orders.
Research and Development
Research and development expenses consist primarily of personnel-related costs
for our development team, including salaries, benefits, bonuses, stock-based
compensation expenses and allocated overhead costs. Research and development
expenses also include contractor or professional services fees and third-party
cloud infrastructure expenses incurred in developing our solution. During the
six months ended June 30, 2020, growth in research and development expenses was
offset by a one-time reduction in force in response to the COVID-19 pandemic. We
expect that our research and development expenses will increase in absolute
dollars as our business grows, particularly as we incur additional costs related
to continued investments in our solution. However, we expect that our research
and development expenses will decrease as a percentage of
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our revenue over time. In addition, research and development expenses that
qualify as internal-use software development costs are capitalized, the amount
of which may fluctuate significantly from period to period.
Sales and Marketing
Sales and marketing expenses consist primarily of personnel-related costs
directly associated with our sales and marketing staff, including salaries,
benefits, bonuses, commissions and stock-based compensation, and allocated
overhead costs. Sales and marketing expenses also include advertising costs and
other expenses associated with our marketing and business development programs.
In addition, sales and marketing expenses are comprised of travel-related
expenses, software services dedicated for use by our sales and marketing
organizations and outside services contracted for sales and marketing purposes.
Travel-related expenses, decreased in the six months ended June 30, 2021 and
2020 due to the COVID-19 pandemic. We currently expect travel-related expenses
to resume in the second half of 2021, although the timing is uncertain and
related to the trend of the pandemic. We expect that our sales and marketing
expenses will increase in absolute dollars and continue to be our largest
operating expense for the foreseeable future as we grow our business. However,
we expect that our sales and marketing expenses will decrease as a percentage of
our revenue over time.
General and Administrative
General and administrative expenses consist of personnel-related costs
associated with our finance, legal, human resources and administrative
personnel, including salaries, benefits, bonuses, stock-based compensation and
allocated overhead costs. General and administrative expenses also include
external legal, accounting and other professional services fees, software
services dedicated for use by our general and administrative functions,
insurance, allowance for credit losses, and other corporate expenses.
We expect to incur additional expenses as a result of operating as a public
company, including costs to comply with the rules and regulations applicable to
companies listed on a national securities exchange, costs related to compliance
and reporting obligations, and increased expenses for insurance, investor
relations and professional services. We expect that our general and
administrative expenses will increase in absolute dollars as our business grows.
However, we expect that our general and administrative expenses will decrease as
a percentage of our revenue as our revenue grows over the longer term.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income, income
related to non-operating activities, interest expense and gains and losses from
foreign currency transactions and remeasurements of foreign currency-denominated
monetary assets and liabilities to the U.S. Dollar.
Provision for Income Taxes
Provision for income taxes consists primarily of income taxes related to foreign
and state jurisdictions in which we conduct business. We maintain a valuation
allowance on our federal and state deferred tax assets as we have concluded that
it is not more likely than not that the deferred assets will be utilized.
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Results of Operations
The following tables set forth our results of operations and such data as a
percentage of our revenue for each of the periods presented.
                                                     Three Months Ended                     Six Months Ended
                                                          June 30,                              June 30,
(in thousands)                                    2021                2020               2021               2020
Revenue                                       $   29,547          $  15,727          $  50,678          $  31,395
Cost of revenue(1)                                 8,695              4,509             14,483              9,580
Gross profit                                      20,852             11,218             36,195             21,815
Operating expenses:
Research and development(1)                        7,861              6,215             14,123             14,418
Sales and marketing(1)                            10,832              7,170             18,708             16,492
General and administrative(1)                      5,128              3,143              9,182              7,403
Total operating expenses                          23,821             16,528             42,013             38,313
Loss from operations                              (2,969)            (5,310)            (5,818)           (16,498)
Other income (expense):
Interest and other income                             21                 15                 34                 79
Interest and other expense                           (92)              (161)              (148)              (249)
Total other income (expense)                         (71)              (146)              (114)              (170)
Loss before income taxes                          (3,040)            (5,456)            (5,932)           (16,668)
Provision for income taxes                           (43)               (20)               (79)               (45)
Net loss                                      $   (3,083)         $  (5,476)         $  (6,011)         $ (16,713)
Accretion of redeemable convertible preferred
stock                                                (25)               (22)               (51)               (45)

Net loss attributed to common stockholders $ (3,108) $ (5,498) $ (6,062) $ (16,758)

_______________

(1)Includes stock-based compensation expense as follows:


                                   Three Months Ended                Six Months Ended
                                        June 30,                         June 30,
(in thousands)                       2021             2020            2021           2020
Cost of revenue              $       10              $   7      $       18          $  13
Research and development            285                217             486            439
Sales and marketing                 235                 88             318            158
General and administrative          436                192             632            382
Total                        $      966              $ 504      $    1,454          $ 992


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