David Gray/Getty Images News Introduction and investment thesis CS Disco, Inc. (NYSE:LAW) is a legal tech company trying to reshape the legal services industry with its cloud-based tech suite supported by AI. Disco went public in July 2021 after printing a few strong quarters but disappointed investors afterwards. The diminishing of a few large deals has negatively impacted the company’s revenue growth rate to a greater extent, which I believe wasn’t communicated properly. This resulted in a shareholder litigation against the company, which is still ongoing. This has been accompanied by the abrupt departure of Founder and former CEO Kiwi Camara in September last year, so there has been a lot to do around the house recently. The company spent recent quarters trying to stabilize the business, re-engineering its sales team, nurturing its corporate culture, and looking for a new CEO. On the 10th of April, Disco announced that they found a new CEO, who I believe will help restore the company’s reputation among investors. So, now everything is in place for the beginning of a turnaround, however, this wasn’t evident in the recently published Q1 2024 results. As I described in my previous article on the company, both customer count and revenue figures show stagnation, which continued into the Q1 quarter. This confirms to me that Disco remains a “show me” story, which combined with the current valuation leaves me sticking to my Sell rating. Q1 earnings: Not much to get excited about Disco reported revenues of $35.6 million for the recently closed Q1 quarter matching the midpoint of its previously set guidance. Although this has been an 8% growth yoy it meant stagnation compared to the Q4 2023 quarter, where revenues reached $35.7 million. Looking at the company’s guidance of $35.5 million for Q2 it seems that this could be the equilibrium for now: Created by author based on company data Although the company’s new AI-based product line and the arrival of the new CEO could indicate some optimism, I think it’s better to wait until the possible positive impacts show up in the income statement. Besides a stagnation in revenues, the total customer count of Disco stayed constant with 1,442 customers for the end of the quarter: Created by author based on company data This shows that since the abrupt departure of the former CEO and the following class action lawsuit against the company, Disco has likely had a hard time finding new customers. Luckily, the existing ones seem to stick around, as confirmed by former interim CEO and the incoming Chair of the Board of Directors, Scott Hill on the Q1 earnings call: And Mark, just a couple of data points to reinforce that point. Customer count was up year over year and up a little bit modestly from where it was the prior quarter. And DNR also ticked up slightly from where it was at the end of the year. So, each of those metrics, as Michael alluded to, suggest that along with the revenue performance in the quarter suggests that the churn was modest and not really a factor in the quarter. Looking at profitability metrics, the company’s bottom line keeps staying in the red. Adjusted EBITDA margin has been a negative 14.6% in the quarter, a significant deterioration compared to the previous quarter: Created by author based on company data The company informed investors previously that it intends to increase investments in sales and marketing to correct the former issues when they raced to profitability at all costs. This should help in reviving revenue growth, but also puts pressure on the company from the side of investors to show some evidence for this as soon as possible. Based on the Q1 earnings call management seems optimistic that this could be achieved already in the second half of the year, so the upcoming quarters should be of utmost importance. However, at the same time, management decided to trim the midpoint of its annual revenue guidance range by $2 million to $147 million, which signals further caution ahead. Besides increased spending on S&M, there are two factors in my opinion that could support a possible turnaround. On the one hand, after several months of uncertainty, the company hired a new CEO, Eric Friedrichsen, the former CEO of Emburse a travel and expense management company with ~1,000 co-workers. He has a proven track record of scaling businesses, which he did previously at SAP and Adobe as well. This could be an important plus, even if he arrived at Disco from outside the world of law, which could slow his transition to the company. On the other hand, Disco’s recently launched integrated large language model chatbot, Cecilia could be also an important contributor to a possible turnaround. Cecilia enables asking natural language questions and answers them based on Disco’s private eDiscovery library with citations supporting the evidence. Based on the recent earnings call it isn’t a significant revenue contributor yet but serves as an important tool to address customers. Disco announced a new feature for Cecilia recently, called doc summaries, which generates high-level takeaways of large documents potentially sparing several work hours for lawyers. This and similar solutions could make the company stand out from the fierce competition in the e-discovery space in the longer run. Finally, I want to share my quick thoughts on valuation, even if currently all eyes are focused on a possible topline growth turnaround. Trading at a market cap of $352 million with 2024 expected revenues of $147 million Disco’s shares trade at a forward P/S ratio of 2.2. The S&P500 trades at a forward P/S ratio of 2.8, so the shares of Disco, finally, trade at a discount compared to the market in general. Looking at the recent slide of shares since the publication of Q1 earnings that’s no wonder. I believe we are a step closer to those valuation levels, where we can say they are depressed enough to support the share price. However, until the stagnation in revenues continues accompanied by growing expenses, I wouldn’t rush to call the bottom. Conclusion There are some promising signs that Disco could finally stabilize its business after a few quarters of disruption. Currently, I believe investors should pursue a wait-and-see approach, looking for evidence of a topline growth turnaround. Until this happens, I think the share price could continue its gradual descent.