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 theSecurities and Exchange Commission , orSEC , onJuly 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 endedJune 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. 22 -------------------------------------------------------------------------------- Table of Contents 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 toJune 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 ofJune 30, 2021 . We generated revenue of$29.5 million and$15.7 million in the three months endedJune 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 endedJune 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 endedJune 30, 2021 and 2020, respectively, and$6.0 million and$16.7 million for the six months endedJune 30, 2021 and 2020, respectively. We generated Adjusted EBITDA of$(1.6) million , and$(4.4) million for the three months endedJune 30, 2021 and 2020, respectively, and$(3.5) million , and$(14.7) million for the six months endedJune 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 inJanuary 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 andApril 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 inMarch 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. 23 -------------------------------------------------------------------------------- Table of Contents 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 acrossthe 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 endedJune 30, 2021 , 12% and 9% of our revenue was generated by customers outside ofthe 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 24 -------------------------------------------------------------------------------- Table of Contents 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 endedJune 30, 2021 and 2020, usage-based revenue represented 89% and 86% of total revenue, respectively. In the six months endedJune 30, 2021 and 2020, usage-based revenue represented 88% and 87% of our total revenue, respectively. In the three months endedJune 30, 2021 and 2020, subscription revenue fees represented 11% and 14% of the total revenue, respectively. In the six months endedJune 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 endedJune 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 endedJune 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 25 -------------------------------------------------------------------------------- Table of Contents 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 endedJune 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 theU.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. 26 -------------------------------------------------------------------------------- Table of Contents 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
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(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 27
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