CS Disco, Inc. (LAW) Earnings Call Transcript

Ladies and gentlemen, thank you for standing by, and welcome to CS DISCO's Third Quarter of Fiscal Year 2026 Conference Call. [Operator Instructions] I would now like to hand the conference over to your first speaker today, Bill Roberts with DISCO Investor Relations. Please go ahead.

Good morning, and thank you for joining us on today's conference call to discuss the financial results for DISCO's Third Quarter of Fiscal year 2026. With me on today's call are Eric Friedrichsen, DISCO's Chief Executive Officer; Aaron Barfoot, DISCO's Chief Financial Officer; and Richard Crum, DISCO's Chief Product, Technology and Strategy 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 future capital expenditures, market opportunity, market position, product and go-to-market strategies and growth opportunities and the benefits of our product offerings 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 entitled Risk Factors in the company's annual report on Form 10-K for the year ended December 31, 2025, and the company's upcoming quarterly report on Form 10-Q for the quarter ended September 30, 2026. 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. Reconciliations between GAAP and non-GAAP financial measures and a discussion of the limitations of using non-GAAP measures versus their closest GAAP equivalent is available in our earnings release. And with that, I'd like to turn the call over to Eric.

Thanks, Bill. Good morning, everyone, and thank you for joining us. I just passed my 2.5-year anniversary at DISCO, and it's been a period of historic change for the legal industry. Just over the past few quarters, we've seen the legal industry go from a technology laggard to 1 that's rapidly being transformed by AI. DISCO has been an innovator in this space, and we're primed to capitalize on the large and growing appetite among law burns and corporations for the best legal AI capabilities. And we're doing so by forging our own path. While many legal tech companies are trying to be everything for everyone, DISCO is hyper focused on being the AI for litigators. We believe that we are uniquely positioned to win this category, thanks to our long-held advantages in data and evidence through our core eDISCOvery product and our latest innovations in building a unified AI solution tailored for the demands of modern litigation. In short, the legal world is rapidly evolving and DISCO is helping drive that change. Before I dive into the quarter, I am incredibly excited to welcome Mitch Razon as DISCO's new Chief Technology Officer; and Johan Reed as DISCO's new Chief Marketing Officer. As you saw from our press release this morning, the impressive resumes speak for themselves. Both Mitch and Johann are established leaders who are deeply experienced in growing and running large businesses in highly competitive industries. Given the high aspirations we have for DISCO, that perspective and experience will be enormously helpful. As we're building AI for litigators, I am thrilled that mission resonated so strongly with both Mitch and Johann. Now let's dive into some more detail. DISCO delivered a strong third quarter. We won more of the large and complex matters that sit at the center of our strategy. We grew with our largest customers and we saw AI become a bigger part of how litigators run their matters on DISCO every day. In Q3, total revenue was $45.3 million, up 15% year-over-year. Software revenue was $38.6 million, up 13% year-over-year. And services revenue was $6.7 million, up 21% year-over-year. All of these are adjusted for the contingent matter that we previously reported in Q3 of 2025. Adjusted EBITDA was $79,000, we reached positive adjusted EBITDA 1 quarter ahead of the Q4 target, and we expect to be adjusted EBITDA positive in Q4. In Q3, we saw a strong performance in the 3 areas that matter most to our near- and medium-term growth. First, continued growth in large matters. Second, expanding wallet share with our largest customers; and third, accelerating usage of AI across our platform. Let's start with large matters because they remained a thread that connects our strategy. We saw another quarter of strong double-digit growth in a number of large matters, which is an important focus because they generate more revenue, they expand as the case develops, and they stay on our platform longer. In short, large matters are worth significantly more to DISCO over time. They are also where DISCO delivers the most value to our customers, where our AI does is most valuable work and where our services teams continue to make the biggest difference. The rapid uptake of DISCO platform, our new commercial model has become a powerful engine to help drive large matters to DISCO. The number of large matters on DISCO platform tripled over the course of Q3 and Customers tell us that the inclusion of AI on every manner and the straightforward pricing make it easier to bring their biggest cases to DISCO. More importantly, DISCO platform is changing the way these firms approach their matters. Much Shells is a well-regarded full-service business law firm that is a long-time DISCO customer. They recently moved to the DISCO platform on an enterprise contract and put it to work on their largest construction matter where Cecilia AI has proven immediately useful compared to the general AI legal tools that they tried to use. The manager of eDiscovery noted, I anticipate Cecilia AI will really transform how we work, the more we use it, especially on our larger matters. Larger matters are also where services and software work hand-in-hand. The biggest, most complex cases demand nuanced, forensic collection, dedicated project management and review expertise and our global team of experts deliver all of it alongside the platform. Our services are important to our customers' success particularly in large matters where the additional resources and expertise make a difference on complex cases and are an accelerant to our software growth. Services helps us win larger matters and onboard them faster, which is reflected by our service performance this quarter. Services interwoven with our software is the core of our with you and every case value proposition, software and services that evolve alongside the customer and the case and continually add value across the life of the matter. Alongside large matters, we also made significant progress with large customers. The largest, most sophisticated firms and corporations not only have more large matters, they have consistent litigation needs and frequent spending, so we believe growing this segment gives us a more efficient path to a predictable and durable revenue base. The number of customers generating more than $100,000 over the last 12 months grew to 374 up from 326 a year ago and 354 just last quarter. These customers represent $133 million or 78% of our last 12 months of total revenue. We were also very pleased with the continued growth in AI usage across our platform. Revenue attributable to generate and Agentic AI capabilities grew over 200% year-over-year and engagement is deepening. Cecilia AI prompts increased approximately 40% during Q3, and the number of customers using Cecilia on multiple matters more than doubled. Advanced Research is another success story. As a reminder, Advanced Research is our next-generation genic tool that automates deep, complex interrogations of the facts to produce litigation quality work product at scale. This new feature is delivering measurable returns for our customers. A partner at Kutak Rock, an AmLaw 200 litigation leader called Advanced Research, his best associate and noted it stands out among legal AI solutions for the value it adds. He said that, -- now that AI is everywhere, ROI is what matters. We need solutions that are scalable and drive meaningful improvements in how we prepare and take a case to trial. Advanced Research has been a force multiplier on complex matters by handling difficult tasks across huge volumes of data to deliver real insights to our case teams. In Q3, we made advanced research generally available across our customer base. In that time, it has grown to account for 91% of all Cecilia Q&A usage and our largest matters are seeing the most use. Additionally, auto review has also continued to gain momentum, and we're seeing customers move from trying out a review to building it into how they work. One of our corporate customers recently directed all of its outside counsel teams to use auto review on every manner going forward, absent a compelling reason for an exception. That is a powerful signal of where eDiscovery review is headed. We are also investing directly in adoption. This quarter, we launched our AI adoption program which puts DISCO litigation engineers on site with customers to work hands on with case teams on advanced research and auto review in their live matters. Alongside it, our Pathways training program continues to expand. At 1 leading international law firm, we trained more than 200 people, most of them attorneys in a single quarter. The more confident litigators are with these tools, the more matters they bring to DISCO. Repeat usage is central to our strategy. And as I mentioned previously, our customers are really feeling the value these tools bring to the litigation teams. In the near to midterm, we see AI-driven first pass review becoming the default approach as the capabilities of this technology and overall readiness of the market continue to evolve. The quality of AI review has risen so dramatically that there is now more risk and human review and the massive speed advantages mean that our customers see significantly more value for their dollar. Being able to review in 48 hours, what it would take a team of 20 to do in 2 months and with higher quality completely reset the economics of eDiscovery review. This area of e-discovery is forever changing, and we are building auto review to lead that shift. Speaking of where the world of litigation is going, I also want to speak a bit about our unified litigation solution, which we announced going into pilot with key customers last quarter. The unified litigation solution is an incredible opportunity for DISCO to become the AI solution for litigators. While Richard will cover our progress in a bit, I want to share what we're learning from the litigators using it. The thing we hear most from our pilot customers, and these are some of the largest and most sophisticated firms in the world, is the need for purpose-built technology that can handle the speed and scale of modern litigation, manage their data natively and securely and provide deep contextual insight into both the facts of matter and the controlling law. One of our pilot customers and Amla top 50 firm with multiple matters in the pilot program, has used our solution in a large medical matter after recognizing that general legal AI tools had too many limitations. Two things brought them to our unified solution. First, our ability to easily manage the size and the complexity of the matter, and second, the ability to apply our advanced AI capabilities to both the facts and the law with any single secure environment. without relying on external data connectors or separate tools. All of this adds up to a very exciting story for DISCO. I believe now more than ever that our core business alone can drive DISCO to be a 20%-plus grower. Our core business is accelerating with larger matters larger customers and deeper AI usage. Our unified litigation solution offers enormous upside on top of that momentum as we broaden our capabilities to become AI for litigators and to serve even more needs for litigators across the full litigation life cycle. With that, I'll turn it over to Richard to dive into some impressive product updates.

Thank you, Eric. This quarter, we made great strides in our product road map for our core capabilities, our generative and agentic AI capabilities and our unified litigation solution. Let's start with DISCO platform because that is where customers are seeing the impact of our work today. From a product perspective, DISCO platform does something simple but important. It removes friction. With a straightforward commercial model and Cecilia AI included on every matter, case teams get the very best DISCO technology for a single price. Customers are responding so positively. They are buying DISCO platform at rates above our expectations, and they use it to gain a strategic advantage. . As of the end of the quarter, Cecilia was enabled on 96% of DISCO platform matters, which means AI is part of the entire workflow to give litigation teams the power to deeply understand their evidence and leverage that insight to best serve their clients. DISCO platform is also built for the large matters Eric described. Large matters bring more data and more complex data from the ever-growing list of collaboration and messaging tools and beyond. DISCO is built to handle it all and perform at scale. Our ability to ingest and structure massive data volumes and to do it with the speed and reliability our customers count on when their largest matters are on the line is a massive differentiator. The next area where DISCO is leading the market is advanced research. In Q3, we made advanced research generally available to all customers. Advanced Research is an agentic AI capability built deeply into our eDiscovery product. It goes well beyond simple question and answer by performing multistep reasoning across the matter's full evidentiary record. -- litigators need to understand what the evidence means for their case, and that is what Advanced Research is built to deliver. The adoption data tells the story. In October, advanced research accounted for 97% of Cecilia Q&A usage and its use is highest on our largest matters. That's exactly what we expected. The bigger and more complex the record, the more valuable it is to have a system that can reason with you across all of it. Turning to auto review. As Eric mentioned, we believe AI review will soon be the industry standard, and we are building for that moment. In Q2, we began rolling out an enhancement that simplifies and accelerates the process of creating the inputs needed for effective AI review. That capability is now in the hands of customers, and the results have been very positive. This enhancement reduces the learning curve for AI review, making AutoReview even more appealing. Now to our unified litigation solution. As a reminder, our unified litigation solution unites matters evidence and the law in a single pane of glass. with native access to the full eDiscovery record, metadata and work product included paired with DISCO's license to the full corpus of U.S. case law court rules, statutes and regulations. It is a powerful combination that puts the litigator in full command of the things that are most critical to winning their matter. We built our unified litigation solution because more than a decade of innovating in e-discovery has repeatedly shown us that litigation is simply different from other areas of law. It has a specific language, unique workflows at incredibly high stakes. As we've said before, we're not building software for lawyers. We're building solutions for litigators. Litigators need purpose-built technology to handle the scale and complexity of modern litigation. Simply put, litigation isn't a feature you add to your legal AI stack. It's an architecture you build from the ground up and expertise you gained from years of working directly with top litigators on their most critical matters. Last quarter, we announced our initial pilot for our unified litigation solution to learn quickly on real cases with leading firms, including 4 [ AML ] 50 firms. Fast forward 3 months, and those pilot customers are now actively working on the product on live matters and providing exactly the kind of detailed feedback we'd hope for. One pilot firm has already successfully used the solution on a matter requiring the scale of the evidence collected, something they told us many of the general purpose legal AI simply cannot do today. In less than a week, they were able to perform a thorough risk assessment and advise their clients on the best legal path forward. Work that would have taken an entire team of associates weeks to accomplish. The firm now has multiple live matters in our pilot demonstrating the value the solution adds. That is exactly the sort of insights the pilot is designed to provide and we're using it to further refine our road map. We've expanded the pilot with a second cohort of customers and expect to onboard a third cohort before the end of the year. We will share more on broader availability as our plans evolve. One theme that stands out in what we're hearing from our pilot customers is the value of deep context and a true native mastery of the facts because fax is where most cases are on or lost. Much of the industry is reaching a portion of the evidence and the law through connectors such as an API call to a research service and MCP integration into someone else's platform or more often and potentially more risky, a copy of the documents stripped out of the context that lives in the source system. At their core, many of these connections are a workaround for capabilities a platform can access or build itself. And for customers, it means having to license and maintain multiple solutions to do their work. DISCO doesn't have that problem. We hold both the evidence and the law natively and our unified litigation solution reasons across them together. That is what gives case teams confidence in the output, and it's what our customers tell us they really want a unified litigation solution that was built specifically for their unique and complex needs rather than a solution cobbled together across MCP connections. To be clear, we will always partner where it makes sense for our customers. But when it comes to the evidence and the law native integration is what substantive case work requires. We don't believe that shallow connections, the void of context and that expose sensitive data to multiple systems are the right things for our customers. More importantly, as we've learned from our pilot, it is not what our customers want. Taken together, -- we believe DISCO platform, advanced research, auto review and our unified litigation solution shows clear evidence that our AI native stack is compounding. The platform our customers rely on the AI they increasingly built into their work and the data that flows through DISCO every day are what gives us confidence today and in the future. With that, I'll hand it over to Aaron.

Thank you, Richard. Q3 results reflect continued progress in the areas Eric and Richard just walked through. When excluding the contingent matter from Q3 2025, total revenue was $45.3 million, up 15% year-over-year at the high end of our guidance range. Software revenue was $38.6 million, up 13% year-over-year and services revenue was $6.7 million, up 21% year-over-year. When including the contingent matter, those year-over-year growth rates were 13%, 11% and 18%, respectively. This contingent matter was initially reported in our Q3 2025 earnings. It was revenue associated with the matter that has been on our platform for more than 5 years and was contingent on the successful outcome of the case. At the time, we recognized $1.3 million of total revenue from the case $1.2 million of which was related to software. I want to touch on the quarter in more detail. First, DISCO platform was again our biggest driver of software revenue growth. DISCO platform revenue has grown more than 10x compared to Q1 of 2026. We've already exceeded our full year internal target for DISCO platform and as of October 1, DISCO platform is the default commercial model for all new and renewal contracts. Second, AutoReview continued to scale with total AutoReview revenue growing more than 4x year-over-year. Third, services. Services growth was driven primarily by professional services tied to our largest matters. We view services as an accelerant to software. And in many instances, our services offerings are an important reason customers brought those cases to DISCO. I also want to revisit a dynamic I've mentioned the past 2 quarters. As DISCO platform adoption grows and now that it is our default commercial model, we may see some short-term revenue impact from lower onetime ingest fees. To date, it continues to have an immaterial impact on the business. We expect that to be more than offset over time by DISCO platform's ongoing fees and by the larger, longer and more complex matters that come with it. In addition to larger matters, DISCO platform is also driving improved consideration and better unit pricing. We believe this is a positive trade-off for the long-term revenue profile of our business and far outweighs onetime ingest fees. Turning to profitability metrics. As a reminder, unless otherwise specified, references to gross margin operating expenses and net loss are on a non-GAAP basis, and adjusted EBITDA is also a non-GAAP financial measure. Gross margin in Q3 was 77%, consistent with the prior year. Sales and marketing expense was $15.2 million or 34% of revenue compared to 33% in the prior year. Research and development expense was $12.5 million or 27% of revenue compared to 28% in the prior year. The dollar increase reflects continued investment in our unified litigation solution advanced research and auto Review to capitalize on the legal industries AI transformation. General and administrative expense was $7.9 million or 17% of revenue compared to 19% in the prior year. We are also pleased to announce that we were adjusted EBITDA positive a quarter earlier than expected. Adjusted EBITDA was $0.1 million in Q3, representing an adjusted EBITDA margin just above breakeven compared to negative 1% in Q3 of the prior year and negative 8% last quarter. Net loss in Q3 was $0.3 million or negative 1% of revenue compared to a net loss of $0.6 million or negative 1% of revenue in Q3 of the prior year. Net loss per share was breakeven compared to negative $0.01 in Q3 of the prior year. Turning to the balance sheet and cash flow statement. We ended Q3 with $96.8 million in cash and short-term investments and no debt, maintaining our strong financial position. Operating cash flow year-to-date through Q3 was negative $15.8 million compared to negative $15.7 million in the same period last year. Turning to guidance. For the fourth quarter of fiscal year 2026, we are providing total revenue guidance in the range of $45.8 million to $47.8 million and software revenue guidance in the range of $39.4 million to $40.4 million. We expect adjusted EBITDA to be in the range of breakeven to $1.5 million. For fiscal year 2026, we are raising our total revenue guidance to a range of $176.1 million to $178.1 million, reflecting the Q3 beat with software revenue guidance in the range of $149.5 million to $150.5 million. I want to point out that the midpoint of this revenue range is above the high end of the range we provided at the start of the year. We are updating full year adjusted EBITDA guidance to the range of negative $6.8 million to negative $5.3 million. We continue to expect to be adjusted EBITDA positive in Q4 of this year. Now I'd like to open the call up for Q&A. Operator?

[Operator Instructions] Your first question comes from the line of Scott Berg from Needham.

Nice quarter. Eric, I want to start on the demand growth side. Your -- the company's revenue growth has been really stable in the 12% to 14% range the last couple of quarters now. A lot of new products. But how do you think about the pushes and pulls to get to that 20-plus percent level that you all are targeting now that you've seen this kind of higher, more stable level of growth? .

Scott. Look, I am more confident than ever that the core business at DISCO can be a 20%-plus grower, if you look at the total revenue growth this quarter, we accelerated from 13% in Q2 to 15% in Q3. It was the best growth quarter that we've had in 4 years. And that's double-digit growth over double-digit growth from a year ago. So obviously, those are top line numbers, which I'm really, really pleased with, but it's not actually the top line numbers that give me the confidence, Scott. It's how we got there. It's the fact that we set our strategy, our core strategy really around wallet share expansion in our largest customers, winning larger matters and driving AI adoption. And then you layer on top of that, the progress that we made with DISCO platform that is far outperformed our expectations for this year. And when you think about the fact that there's some short-term trade-off with DISCO platform, in terms of short-term revenue. But as that data expands, that means that our revenue grows, which gives us even more downstream opportunities. So the combination of those pieces alone give me a lot of confidence in predictable and durable accelerated revenue growth. Just software alone grew $1.8 million from Q2 to Q3, which is almost 5% sequential growth quarter-over-quarter. So look, I think all the leading indicators give us a lot of confidence that we will get to be a 20%-plus grower in our core business. I'm not ready to call any kind of a specific quarter at this point where we'll get there. But my confidence that the core business will be the 20%-plus grower is higher than it ever has been. And then the early returns on the unified litigation solution give me confidence that we've got a path to even faster growth beyond that.

Excellent. Helpful. And then, Aaron, you achieved adjusted EBITDA positive here for the first quarter, as you all mentioned the quarter ahead. I have to notice that your PA expense capitalized take down pretty meaningfully in the quarter relative to kind of every historical period. Was you were reporting of adjusted EBITDA Direct result of change in any sort of capitalization versus expensing R&D. Is there kind of -- or is that just related to something else? .

Yes. I mean let me kind of unpack the adjusted EBITDA performance for the quarter, right? And I think what you just said, we were very pleased to have come in positive -- and I think, as Eric actually alluded to a second ago, really, it's how we did it in some ways, right? We kind of grew our way into -- we talked about from the beginning, we want to orient towards growth. And so the 15% growth adjusted for the contingent matter is the main driver, right? And then you see the kind of gross margins with our product profitability have kind of stayed in line with historical norms, and we've been disciplined in our operating expenses. And those are really the elements that have driven the profitability you are correct that our R&D has picked up, the capitalization, if you will. It's not from an accounting policy change or from anything else that really is us investing in the unified litigation solution. So we've been investing, if you think about it all year, we've been investing in advanced research in auto review and really what you saw is in Q3, the investment in the unified litigation pickup. And that's a new product. And so that's something that you would capitalize.

Your next question comes from the line of B.J. Heim from Canaccord Genuity.