CS Disco, Inc. (LAW) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. 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 Annual Report on Form 10-K. You should review the disclosure under the heading “Risk Factors” in this Annual Report on Form 10-K 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 cloud-native, artificial intelligence-powered legal product offerings that simplify legal hold, legal request, ediscovery, legal document review and case management for enterprises, law firms, legal services providers and governments. Our scalable, integrated product offerings enable 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 product offerings 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 product offerings. We provide legal departments with the ability to centralize legal data into a single platform, 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,
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time-consuming and error-prone parts of legal hold, legal request, 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’ actual usage of our product offerings. Customers generally do not commit to purchase a specific amount of usage on our product offerings 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% of our revenue in each of the years ended December 31, 2023 and 2022. 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 product offerings, our customers can increase usage of our product offerings to cover additional legal matters and adopt more of our offerings. As the amount of enterprise data in our product offerings increases, the strategic value and stickiness of our product offerings within an organization is enhanced.
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 product offerings 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. As of December 31, 2023, we had 1,441 customers, increasing from 1,327 customers as of December 31, 2022. We define a customer as an entity that we have a contract with and from whom we have recognized revenue during the preceding month. As of December 31, 2023 we had 289 large customers, defined as customers with revenue in excess of $100,000 over the previous 12-month period, increasing from 265 large customers as of December 31, 2022. Large customers accounted for approximately 75%, and 78% of our revenue for the years ended December 31, 2023 and 2022, respectively.
Our go-to-market strategy is focused on acquiring new customers and driving continued use and increased usage of our product offerings 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 primarily segmented into sales development representatives, field sales, inside sales and our customer success team. In addition, our platform is designed such that customers can grant access to third parties, including law firms and other legal service providers, to use our product offerings on the customers’ behalf. This access facilitates widespread adoption of our product offerings, as these law firms and other legal service providers often become customers on their own or recommend our product offerings to other legal industry participants after realizing the benefits of our product offerings. Likewise, if a law firm is our customer, the law firm may add users from its clients’ legal departments to our platform in order to collaborate with them. These users may then become champions and encourage the companies they work for to become customers.
As of December 31, 2023, we had $159.6 million of cash and cash equivalents. We generated revenue of $138.1 million and $135.2 million in the years ended December 31, 2023 and 2022, respectively, representing a period-over-period growth of 2%. Our net loss was $42.2 million and $70.8 million for the years ended December 31, 2023 and 2022, respectively. We generated Adjusted EBITDA of $(25.9) million and $(44.5) million for the years ended December 31, 2023 and 2022, 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.
Macroeconomic Considerations
Unfavorable conditions in the economy, both in the United States and abroad, may negatively affect the growth of our business and our results of operations. For example, negative conditions in the general economy both in the United States and abroad, including conditions resulting from inflation, rising interest rates, and the Russia-Ukraine and Israel-Hamas wars have led to economic uncertainty globally. Historically, during periods of economic uncertainty and downturns, businesses may slow spending on information technology, which may impact our business and our customers’ businesses.
The effect of macroeconomic conditions may not be fully reflected in our results of operations until future periods. If, however, economic uncertainty increases or the global economy worsens, our business, financial condition and results of operations may be harmed. For further discussion of the potential impacts of macroeconomic events on our business, financial condition, and operating results, see the section titled “Risk Factors.”
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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.
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 Hold, DISCO Request, DISCO Ediscovery, DISCO Review and DISCO Case Builder offerings, and have built a research and development process that reliably produces features for these product offerings. We intend to continue combining our deep legal domain expertise and commitment to world-class software engineering to continue delivering features and introducing new product offerings to address more areas of legal work, such as our ediscovery chatbot, Cecilia, which was released in the fourth quarter of 2023 in the U.S., and access to sources of primary law, which we acquired through our Fastcase license and intend to launch in 2024. Our future success is dependent on our ability to successfully develop, market and sell our product offerings to both new and existing customers.
Maintain and 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 current offerings to existing customers, and 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 platform 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 product offerings, competition, pricing and overall changes in our customers’ spending levels. Even if our customers expand their usage of our product offerings, we cannot guarantee that they will maintain those usage levels for any meaningful period of time or that they will renew their commitments.
A significant majority of our revenue is directly correlated with our customers’ usage of our product offerings, which in turn is dependent on the timing of and activity driven by litigation, investigations and other legal matters for which our product offerings are used. As a result, our operating results have fluctuated significantly in the past in connection with the inception and conclusion of large legal matters, and we expect such fluctuations to continue for the foreseeable future.
An indication of the propensity of our customers to continue to work with and expand their relationship with us over time is our dollar-based net retention rate, which compares our revenue from the same set of customers in one period to the prior year period. As of December 31, 2023 and 2022, our dollar-based net retention rate was 92% and 106%, respectively. We calculate our dollar-based net retention rate as of the end of a period by using (a) the revenue from all customers during the twelve months ending one year prior to such period as the denominator and (b) the revenue from all customers during the twelve months ending as of the end of such period minus the revenue from all customers who are new customers during those twelve months as the numerator. Our dollar-based net retention rate could decrease over time as our customer base matures and the amount of revenue used in the denominator to calculate net retention grows.
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 an integrated, easy-to-use platform like DISCO to improve productivity and legal outcomes. We believe our market leadership and differentiated product offerings will enable us to efficiently acquire new customers across all channels. As of December 31, 2023, we had 1,441 customers, increasing from 1,327 customers as of December 31, 2022. 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 product offerings and expand, retain and motivate our sales and marketing personnel.
Expand Our Sales Coverage
We intend to continue to enhance our sales force headcount in strategic locations across the United States and globally. Our ability to achieve significant revenue growth will depend, in large part, on our success in recruiting, training and retaining
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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.
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 product offerings 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 lawyer productivity across more and more areas of legal work over time. We may expend significant resources in the development of additional offerings. For example, our ediscovery chatbot, Cecilia, which was released in the fourth quarter of 2023 in the U.S., and we intend to offer our customers access to sources of primary law, which we acquired through our Fastcase license and intend to launch in 2024. 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.
Expand Internationally
Our market is global and we believe there is a significant opportunity to expand internationally. In 2023, less than 10% of our revenue was generated by customers outside of the United States. We expect to continue to expand our global employee headcount in India. International expansion, including our global sales efforts, will add increased complexity and cost to our business.
Pursue Strategic Acquisitions and Strategic Investments
In February 2022, we acquired legal workflow products from Congruity360, LLC, or Congruity, in a purchase that expanded our offerings to provide a modern digital solution for legal hold obligations and legal request compliance. We intend to continue to selectively pursue acquisitions and strategic investments that we believe can expand the functionality and value of our product offerings and bring talent to our company. We believe that the combination of our market leadership, deep legal expertise and powerful end-to-end platform 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 product offerings within a single operating segment. We have two primary types of contractual arrangements: usage-based and subscription. Our usage-based revenue is derived from contracts under which customers are typically 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 each of the years ended December 31, 2023 and 2022, usage-based revenue represented 89% of total revenue and subscription revenue fees represented 11% of total revenue.
Cost of Revenue
Cost of revenue consists primarily of third-party cloud infrastructure expenses incurred in connection with our customers’ use of our product offerings. Cost of revenue also includes outsourced staffing costs, amortization of capitalized software development and personnel costs from employees involved in the delivery of our product offerings. 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 our product offerings and ensure that our customers are realizing the full benefit of our product offerings. The level, timing and relative investment in our cloud infrastructure could
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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 software development 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.
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 product offerings. In the near term, we expect that our research and development expenses will increase in absolute dollars but may fluctuate as a percentage of our revenue over time. In addition, research and development expenses that qualify as capitalized 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, 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 consist of travel-related expenses, software services dedicated for use by our sales and marketing organizations and outside services contracted for sales and marketing purposes. In the near term, we expect that our sales and marketing expenses will remain relatively consistent in absolute dollars but will continue to be our largest operating expense for the foreseeable future as we grow our business. Our sales and marketing expenses may fluctuate 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 and other corporate expenses. In the near term, we expect that our general and administrative expenses will increase in absolute dollars as our business grows but may fluctuate as a percentage of total revenue from period to period.
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.
Income Tax Provision
Income tax provision 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.
| Year Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | |||||
| Revenue | $ | 138,090 | $ | 135,190 | |||
| Cost of revenue(1) | 34,948 | 34,163 | |||||
| Gross profit | 103,142 | 101,027 | |||||
| Operating expenses: | |||||||
| Research and development(1)(2) | 51,623 | 59,258 | |||||
| Sales and marketing(1)(2) | 68,132 | 72,839 | |||||
| General and administrative(1)(2) | 33,232 | 40,738 | |||||
| Total operating expenses | 152,987 | 172,835 | |||||
| Loss from operations | (49,845) | (71,808) | |||||
| Other income (expense): | |||||||
| Interest and other income | 8,306 | 1,702 | |||||
| Interest and other expense | (168) | (473) | |||||
| Total other income (expense) | 8,138 | 1,229 | |||||
| Loss from operations before income taxes | (41,707) | (70,579) | |||||
| Income tax provision | (443) | (186) | |||||
| Net loss attributable to common stockholders | $ | (42,150) | $ | (70,765) |
______________
(1)Includes stock-based compensation expense as follows:
| Year Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | |||||
| Cost of revenue | $ | 1,036 | $ | 938 | |||
| Research and development | 7,767 | 8,068 | |||||
| Sales and marketing | 5,366 | 4,186 | |||||
| General and administrative | 1,989 | 8,545 | |||||
| Total | $ | 16,158 | $ | 21,737 |
(2)Includes restructuring charges as follows:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| (in thousands) | 2023 | 2022 | ||||
| Research and development | $ | 1,510 | $ | — | ||
| Sales and marketing | 648 | — | ||||
| General and administrative | 432 | — | ||||
| Total | $ | 2,590 | $ | — |
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| Year Ended December 31, | |||||
|---|---|---|---|---|---|
| 2023 | 2022 | ||||
| Consolidated Statement of Operations and Comprehensive Loss as a percentage of revenue:** | |||||
| Revenue | 100 | % | 100 | % | |
| Cost of revenue | 25 | 25 | |||
| Gross profit | 75 | 75 | |||
| Operating expenses: | |||||
| Research and development | 37 | 44 | |||
| Sales and marketing | 49 | 54 | |||
| General and administrative | 24 | 30 | |||
| Total operating expenses | 111 | 128 | |||
| Loss from operations | (36) | (53) | |||
| Other income (expense): | |||||
| Interest and other income | 6 | 1 | |||
| Interest and other expense | * | * | |||
| Total other income (expense) | 6 | 1 | |||
| Loss from operations before income taxes | (30) | (52) | |||
| Income tax provision | * | * | |||
| Net loss attributable to common stockholders | (31) | % | (52) | % |
______________
* Less than 0.5% of revenue.
** Columns may not add up to 100% due to rounding.
The following table summarizes our quarterly revenue by groups of similar offerings (in thousands):
| Three Months Ended | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| March 31, 2023 | June 30, 2023 | September 30, 2023 | December 31, 2023 | |||||||||||
| Software | $ | 27,560 | $ | 27,012 | $ | 28,413 | $ | 29,282 | ||||||
| Services | 5,569 | 7,264 | 6,530 | 6,460 | ||||||||||
| Total revenue | $ | 33,129 | $ | 34,276 | $ | 34,943 | $ | 35,742 |
Comparison of the Years Ended December 31, 2023 and 2022
Revenue
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| Revenue | $ | 138,090 | $ | 135,190 | $ | 2,900 | 2 | % |
Total revenue increased by $2.9 million, or 2%, for the year ended December 31, 2023 compared to the same period in 2022. Revenue related to new customers added since December 31, 2022 contributed $13.9 million, which was partially offset by an $11.0 million decrease in revenue from customers that existed as of December 31, 2022. The change in revenue from existing customers was driven by decreases in usage of our product offerings by several of our existing customers.
Revenue generated from our software product offerings increased by $3.0 million, or 3%, for the year ended December 31, 2023 compared to the same period in 2022 due to increases in usage of our software product offerings. Revenue generated from our services product offerings decreased $0.1 million, or 0.5%, for the year ended December 31, 2023 compared to the same period in 2022. This change was driven by decreases in usage of our services product offerings by several
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of our existing customers, particularly within DISCO Managed Review.
Cost of Revenue
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| Cost of revenue | $ | 34,948 | $ | 34,163 | $ | 785 | 2 | % | ||||||
| Percentage of revenue | 25 | % | 25 | % |
Total cost of revenue increased by $0.8 million, or 2%, for the year ended December 31, 2023 compared to the same period in 2022. This change was primarily driven by a $0.5 million increase in amortization of internally developed software and a $0.2 million increase in costs for cloud hosting as a result of increased usage of our product offerings.
Operating Expenses
Research and Development
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| Research and development | $ | 51,623 | $ | 59,258 | $ | (7,635) | (13 | %) | ||||||
| Percentage of revenue | 37 | % | 44 | % |
Research and development expenses decreased by $7.6 million, or 13%, for the year ended December 31, 2023 compared to the same period in 2022. The change was primarily driven by a decrease of $6.9 million in personnel costs, including stock-based compensation, as a result of decreased headcount and the expansion of our operations to lower-cost international locations, and a $2.1 million increase in capitalized software development. This decrease was partially offset by $1.5 million in restructuring costs related to our reductions in force in January and May 2023.
Sales and Marketing
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| Sales and marketing | $ | 68,132 | $ | 72,839 | $ | (4,707) | (6 | %) | ||||||
| Percentage of revenue | 49 | % | 54 | % |
Sales and marketing expenses decreased by $4.7 million, or 6%, for the year ended December 31, 2023 compared to the same period in 2022. The change was primarily related to a decrease of $5.0 million in personnel costs, including stock-based compensation and variable compensation, for our sales personnel. Additionally, professional services and travel and entertainment expenses decreased $1.3 million and $0.5 million, respectively. These decreases were partially offset by a $1.8 million increase in marketing expenses as well as $0.8 million in restructuring costs related to our reductions in force in January and May 2023.
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General and Administrative
| Year Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | % Change | |||||||||||
| (dollars in thousands) | ||||||||||||||
| General and administrative | $ | 33,232 | $ | 40,738 | $ | (7,506) | (18 | %) | ||||||
| Percentage of revenue | 24 | % | 30 | % |
General and administrative expenses decreased by $7.5 million, or 18%, for the year ended December 31, 2023 compared to the same period in 2022. This change was primarily attributable to a $6.5 million decrease in personnel costs, including stock-based compensation. This decrease included a $7.7 million reversal of stock-based compensation costs related to the cancelled 10-year performance award previously granted to our former CEO (the “CEO Performance Award”). Had the CEO Performance Award not been cancelled, personnel costs would have increased $1.2 million. The decrease is also attributable to $1.3 million in unoccupied lease charges and moving expenses incurred in 2022 related to the opening of our new headquarters in Austin, Texas, as well as $0.4 million in issuance costs related to the CEO Performance Award granted in 2022. Further, corporate insurance costs decreased $0.7 million. These decreases were partially offset by $0.2 million in restructuring costs related to our reductions in force in January and May 2023.
Non-GAAP Financial Measure
We report our financial results in accordance with generally accepted accounting principles, or GAAP. However, management believes that Adjusted EBITDA, a non-GAAP financial measure, provides investors with additional useful information in evaluating our performance. We define Adjusted EBITDA as net loss, adjusted to exclude: depreciation and amortization expense; income tax provision; interest and other, net; stock-based compensation expense; payroll tax expense on employee stock transactions; CEO Performance Award issuance expense; unoccupied lease expense; restructuring charges; acquisition revaluation expense; expenses associated with stockholder litigation; and other one-time, non-recurring items, when applicable.
Adjusted EBITDA is a financial measure that is not required by or presented in accordance with GAAP. We believe that Adjusted EBITDA, when taken together with our financial results presented in accordance with GAAP, provides meaningful supplemental information regarding our operating performance and facilitates internal comparisons of our historical operating performance on a more consistent basis by excluding certain items that may not be indicative of our business, results of operations or outlook. In particular, we believe that the use of Adjusted EBITDA is helpful to our investors as it is a measure used by management in assessing the health of our business and evaluating our operating performance, as well as for internal planning and forecasting purposes.
Adjusted EBITDA is presented for supplemental informational purposes only, has limitations as an analytical tool and should not be considered in isolation or as a substitute for financial information presented in accordance with GAAP. Some of these limitations include that: (i) it does not properly reflect capital commitments to be paid in the future; (ii) although depreciation and amortization expense is a non-cash charge, the underlying assets may need to be replaced and Adjusted EBITDA does not reflect these capital expenditures; (iii) it does not consider the impact of stock-based compensation expense and payroll tax expense on employee stock transactions; (iv) it does not reflect other non-operating expenses, including interest expense; (v) it does not consider the impact of any contingent consideration liability valuation adjustments; and (vi) it does not reflect tax payments that may represent a reduction in cash available to us. In addition, our use of Adjusted EBITDA may not be comparable to similarly titled measures of other companies because they may not calculate Adjusted EBITDA in the same manner, limiting its usefulness as a comparative measure. Because of these limitations, when evaluating our performance, you should consider Adjusted EBITDA alongside other financial measures, including our net loss and other results stated in accordance with GAAP. We expect Adjusted EBITDA to improve over the long term as we achieve greater scale in our business and efficiencies in our operating expenses.
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The following table presents a reconciliation of Adjusted EBITDA to net loss, the most directly comparable financial measure stated in accordance with GAAP, for the periods presented:
| Year Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||
| (in thousands) | ||||||
| Net loss | $ | (42,150) | $ | (70,765) | ||
| Depreciation and amortization expense | 4,159 | 2,974 | ||||
| Income tax provision | 443 | 186 | ||||
| Interest and other, net | (8,138) | (1,229) | ||||
| Stock-based compensation expense | 16,158 | 21,737 | ||||
| Payroll tax expense on employee stock transactions | 470 | 520 | ||||
| CEO Performance Award issuance expense | — | 386 | ||||
| Unoccupied lease expense | — | 1,127 | ||||
| Restructuring charges | 2,590 | — | ||||
| Acquisition revaluation expense | 500 | 540 | ||||
| Expenses associated with stockholder litigation | 74 | — | ||||
| Adjusted EBITDA | $ | (25,894) | $ | (44,524) |
Liquidity and Capital Resources
We have financed operations primarily through customer payments and net proceeds from sales of equity securities, including our IPO in July 2021. As of December 31, 2023 and 2022, our principal sources of liquidity were cash and cash equivalents, totaling $159.6 million and $203.2 million, respectively. Cash equivalents include highly liquid investments that are readily convertible to known amounts of cash and have original maturities of three months or less. We believe our existing cash and cash equivalents will be sufficient to fund anticipated cash requirements for the next 12 months. We believe we will meet our longer-term expected future cash requirements primarily from a combination of cash flow from operating activities and available cash and cash equivalents. We may also engage in equity or debt financings to secure additional funds.
The following table presents our material cash requirements for future periods as of December 31, 2023:
| Payments Due by Period | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Less than 1 Year | 2-3 Years | 4-5 Years | Thereafter | Total | ||||||||||||||
| (in thousands) | ||||||||||||||||||
| Operating lease commitments(a) | $ | 2,231 | $ | 4,260 | $ | 3,562 | $ | — | $ | 10,053 | ||||||||
| Finance lease commitments(b) | 47 | 94 | 75 | — | 216 | |||||||||||||
| Cloud platform purchase commitments(c) | 18,000 | 18,000 | — | — | 36,000 | |||||||||||||
| Other purchase commitments(d) | 868 | 385 | — | — | 1,253 | |||||||||||||
| Total | $ | 21,146 | $ | 22,739 | $ | 3,637 | $ | — | $ | 47,522 |
a.We occupy certain facilities under non-cancelable lease arrangements. Our New York lease agreement is set to expire in May 2024 and our Austin lease agreement is set to expire in July 2028. We may lease or purchase additional space as needed to accommodate our needs.
b.We lease certain furniture and fixtures classified as a finance lease. The leased furniture is depreciated on a straight-line basis over the shorter of the life of the lease or 5 years and is included in depreciation expense.
c.Cloud platform purchase commitments encompass non-cancellable agreements to support our software. These expenses are incurred as services are performed and are in the normal course of business.
d.Other purchase commitments primarily encompass non-cancellable software agreements to support our internal functions. These expenses are incurred as services are performed and are in the normal course of business.
Our future capital requirements will depend on many factors, including our revenue growth rate, usage of our product offerings, billing frequency, the timing and extent of spending to support further sales and marketing and research and development efforts, and the continuing market acceptance of our product offerings. Although fluctuations in general macroeconomic conditions, such as the current inflationary environment and rising interest rates, the Russia-Ukraine and Israel-
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Hamas wars, have not materially impacted our liquidity to date, we plan to continue to evaluate aspects of our spending, including capital expenditures, discretionary spending, and strategic investments throughout 2024. We have considered the impacts of these factors on our liquidity and capital resources to date, and we do not currently expect them to impact our ability to meet future liquidity needs.
We may, in the future, enter into arrangements to acquire or invest in complementary businesses, products and technologies. We may be required to seek additional equity or debt financing. In the event that we require additional financing, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital or generate cash flows necessary to expand our operations and invest in continued innovation, we may not be able to compete successfully, which would harm our business, operations and financial condition.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
| Year Ended December 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | Change | % Change | ||||||||||||
| (dollars in thousands) | |||||||||||||||
| Cash used in operating activities | $ | (25,531) | $ | (46,014) | $ | 20,483 | (45) | % | |||||||
| Cash used in investing activities | (20,035) | (9,688) | (10,347) | 107 | % | ||||||||||
| Cash provided by financing activities | 1,873 | 3,469 | (1,596) | (46) | % | ||||||||||
| Net decrease in cash and cash equivalents | $ | (43,693) | $ | (52,233) | $ | 8,540 | (16) | % |
Operating Activities
Our largest source of operating cash is payments received from our customers. Our primary uses of cash from operating activities are for personnel-related expenses, marketing expenses, hosting expenses and overhead expenses. We have historically generated negative cash flows and have supplemented working capital requirements primarily through net proceeds from the sale of equity securities.
Net cash used in operating activities for the year ended December 31, 2023 was $25.5 million, a decrease of $20.5 million from net cash used in operating activities of $46.0 million for the year ended December 31, 2022. The change in cash flow used in operations was primarily due to a decrease in net loss of $28.6 million. Fluctuations in net loss are further explained in the Comparison of Years Ended December 31, 2023 and 2022 section included elsewhere in Management’s Discussion and Analysis. The decrease in cash used in operating activities was also due to a $1.2 million increase in depreciation and amortization expense due to additional fixed assets and capitalized software development, an increase in accounts payable and accrued expenses of $1.1 million related to the growth of our operations, and an increase in other current assets of $0.7 million related to various prepaid expenses. These decreases in cash used in operating activities were partially offset by a decrease in stock-based compensation of $5.6 million primarily related to the cancellation of the CEO Performance Award, a $3.4 million increase in accounts receivable related to lower collections of outstanding balances, as well as a $1.4 million decrease in deferred revenue as performance obligations are satisfied.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2023 was $20.0 million, an increase of $10.3 million from net cash used in investing activities of $9.7 million for the year ended December 31, 2022. The increase in cash used in investing activities was primarily related to the purchase of the primary law intangible asset from Fastcase, Inc. of $14.0 million to support new features in our product offerings. This increase was partially offset by a $4.1 million decrease in cash paid for the acquisition of legal workflow products from Congruity.
Financing Activities
Net cash provided by financing activities for the year ended December 31, 2023 was $1.9 million, a decrease of $1.6 million from net cash provided by financing activities of $3.5 million for the year ended December 31, 2022. The change in cash flows was primarily related to a decrease in proceeds from exercises of stock options of $3.5 million due to an decrease in
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option exercise activity. This decrease was partially offset by net proceeds received from the issuance of common stock under the ESPP of $1.5 million.
Critical Accounting Estimates
Our consolidated financial statements have been prepared in accordance with GAAP. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. We evaluate our estimates and assumptions on an ongoing basis using historical experience and other factors and adjust those estimates and assumptions when facts and circumstances dictate. Actual results could differ materially from those estimates and assumptions.
While our significant accounting policies are more fully described in Note 2, “Summary of Significant Accounting Policies,” in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the accounting policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.
Capitalized Software Development
We capitalize certain costs related to the development of our product offerings and other software applications for internal use. In accordance with authoritative guidance, we begin to capitalize our costs to develop software during the application development stage. Capitalization of costs begins when two criteria are met: (i) the preliminary development efforts are successfully completed, and (ii) it is probable that the project will be completed and the software will be used as intended. We stop capitalizing these costs when the software is substantially complete and ready for its intended use, including the completion of all significant testing. These costs are amortized on a straight-line basis over the estimated useful life of the related asset, generally estimated to be four years. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditure will result in additional functionality and expense costs incurred for maintenance and minor upgrades and enhancements. Costs incurred prior to meeting these criteria together with costs incurred for training and maintenance are expensed as incurred and recorded within product development expenses in our consolidated statements of operations and comprehensive loss. The capitalization of software development contains uncertainties because it requires management to exercise judgment in determining the point at which various projects may be capitalized, in assessing the ongoing value of the capitalized costs and in determining the estimated useful lives over which the costs are amortized. To the extent that we change the manner in which we develop and test new features and functionalities related to our product offerings, assess the ongoing value of capitalized assets or determine the estimated useful lives over which the costs are amortized, the amount of software development costs we capitalize and amortize could change in future periods.
Stock-Based Compensation
We account for stock-based compensation in accordance with the authoritative guidance on stock compensation. Under the fair value recognition provisions of this guidance, stock-based compensation is measured at the grant date based on the fair value of the award and is recognized as expense, over the requisite service period, which is generally the vesting period of the respective award.
On May 20, 2022, the Compensation Committee approved the CEO Performance Award to Kiwi Camara, the Company’s Co-Founder and who was then serving as the Chief Executive Officer, subject to approval of our stockholders at the 2022 Annual Meeting of Stockholders. The CEO Performance Award is a 10-year nonstatutory stock option, the vesting of which is tied solely to achieving stock price milestones. The milestone price requirement is considered a market condition under ASC Topic 718 Compensation - Stock Compensation. The grant date fair value of the CEO Performance Award was estimated using Monte Carlo simulations based on the following key assumptions:
•Fair value of the common stock. The fair value of our underlying common stock is determined by the closing price of our common stock on the date of grant, as reported by the NYSE.
•Expected volatility. The expected volatility is derived from a weighted average of DISCO’s volatility and the historical volatilities of the common stock of several entities with characteristics similar to ours, such as the size and operational and economic similarities to our principle business operations.
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•Risk-free interest rate. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to the expected term of the CEO Performance Award.
•Expected dividend. The expected dividend is assumed to be zero as we have never paid dividends and have no current plans to pay any dividends on our common stock.
•Exercise behavior. The exercise behavior is assumed to be the midpoint of (i) the later of the time-based vest date and performance hurdle achievement date, and (ii) the expiration date.
If any assumptions used in the Monte Carlo simulations changed significantly, stock-based compensation expense may differ. On September 10, 2023, Mr. Camara resigned from his position as Chief Executive Officer and member of the Board of Directors, effective immediately. As no Milestone Prices were achieved as of September 10, 2023, the termination resulted in the cancellation of the CEO Performance Award, and all stock-based compensation expense incurred to date was reversed in the period in which the termination and cancellation occurred.
Acquisitions
When we acquire a business, the purchase consideration is allocated to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated respective fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require us to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, useful lives and discount rates. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to operating expense in the consolidated statements of operations and comprehensive loss.
Recent Accounting Pronouncements
See Recently Adopted Accounting Pronouncements in Note 2, “Summary of Significant Accounting Policies,” in our consolidated financial statements of this Annual Report on Form 10-K for more information.
JOBS Act Accounting Election
We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012, or JOBS Act, and, for so long as we continue to be an emerging growth company, we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. In addition, pursuant to Section 107 of the JOBS Act, an emerging growth company may elect to take advantage of the extended transition period for complying with new or revised accounting standards until those standards would otherwise apply to private companies. However, we have irrevocably opted not to use the extended transition period for complying with any new or revised financial accounting standards, and as such, we are required to adopt new or revised standards at the same time as other public companies.
7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is principally the result of fluctuations in interest rates and foreign currency exchange rates.
Interest Rate Risk
We had cash and cash equivalents of $159.6 million and $203.2 million as of December 31, 2023 and 2022, respectively, which consisted of bank deposits and money market funds. The cash and cash equivalents are held for working capital purposes. The primary objective of our investment activities is to preserve principal while generating income without
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significantly increasing risk. We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. Due to the short-term nature of our investments, we have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in interest rates.
Foreign Currency Exchange Risk
Our revenue and expenses are primarily denominated in U.S. dollars. For our foreign operations, the majority of our revenue and expenses are denominated in other currencies, namely, British pound, Canadian dollar and India rupee. Our subsidiaries remeasure monetary assets and liabilities at period-end exchange rates, while non-monetary items are remeasured at historical rates. Revenue and expense accounts are remeasured at the average exchange rate in effect during the period. If there is a change in foreign currency exchange rates, the conversion of our foreign subsidiary’s financial statements into U.S. dollars would result in a realized gain or loss which is recorded in our consolidated statements of operations and comprehensive loss. We do not currently engage in any hedging activity to reduce our potential exposure to currency fluctuations, although we may choose to do so in the future. A hypothetical 10% change in foreign exchange rates during the periods presented would not have had a material impact on our consolidated financial statements.
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