DISCO (LAW) Q3 2026 earnings review
DISCO reaches operating breakeven early, but cash burn continues
DISCO, a maker of cloud software for trial lawyers, reached operating profit breakeven early while still burning cash. Third-quarter revenue rose 11%, or 15% excluding a one-off legal payout a year ago, and chief executive Eric Friedrichsen reported positive Adjusted EBITDA a quarter ahead of schedule. However, unpaid customer bills climbed and the business burned $5 million in free cash flow by our math.
| Total revenue (excluding Q3 2025 one-off) | +15% $45.3M, +11% headline from a year ago |
|---|---|
| Software revenue (excluding Q3 2025 one-off) | +13% $38.6M, +10% headline from a year ago |
| Adjusted EBITDA | $0.1M guided $(1.75)M to $(0.25)M |
| Full-year revenue outlook | Raised $1.6M middle of the range: 12.9% growth |
⚖️ Verdict: 🟢 Bullish
The story got better because the company added a record 20 large customers in the quarter and trimmed operating costs to hit its profit goal early. The caution is that this profit excludes stock pay and capitalised software costs, while rising customer receivables kept cash flowing out.
The question now is whether rapid adoption of the new pricing model and AI tools brings net new spending from existing clients or only relabels old revenue. If it brings extra spending, existing-customer sales will grow and collections will catch up; if it only relabels, software growth will stall near the current teen pace. The third-quarter filing's customer revenue breakdown and fourth-quarter cash collections will tell.
🐂 Bull Case
Operating Profit Reached Breakeven a Quarter Early
DISCO had promised to reach breakeven on Adjusted EBITDA, its profit measure excluding stock pay and one-offs, by the fourth quarter. "Importantly, we also reached break-even Adjusted EBITDA in Q3 - a full quarter ahead of schedule," chief executive Eric Friedrichsen said. The legal-software maker posted $79,000 in Adjusted EBITDA, beating its own outlook of a $0.25 million to $1.75 million loss.
- Adjusted EBITDA: $0.1 million, up from a $3.4 million loss last quarter
- Research and development, excluding stock pay: 27.5% of revenue, down 3.5 percentage points from last quarter by our math
- Sales and marketing, excluding stock pay: 33.6% of revenue, down 2.7 percentage points from last quarter by our math
- GAAP net loss: $5.0 million, narrowed from $13.7 million a year ago when stockholder lawsuits cost $7.0 million
The early profit matters because last quarter's losses had widened, raising doubts about the cost of new software development. Instead, research and sales costs fell in dollars from the second quarter while revenue rose. What to watch: fourth-quarter Adjusted EBITDA against the $0.0 million to $1.5 million plan. Staying near the top end would show the cost structure can hold.
Record Jump in Large Customers Supports Q4
DISCO tracks customers that spend more than $100,000 over twelve months because these law firms and corporate legal departments bring the largest cases. That group reached 374 customers at the end of September, up 15% from 326 a year ago. By our math, the Austin-based company added 20 net new large customers in the third quarter, up from 7 in the second quarter and 3 a year ago.
Large cases start with a smaller data load and expand over several quarters as lawyers add documents. Because this customer count accelerated from 10% annual growth last quarter to 15% now, it backs up the fourth-quarter software outlook. What to watch: whether large-customer additions stay in double digits in the fourth quarter, which would support growth into 2027.
Software Growth Held Up Through the Pricing Shift
In January DISCO launched the DISCO Platform, a commercial model that bundles its AI tools and charges customers by ongoing data size rather than upfront data loading. That shift carries a risk of lower upfront fees while customers switch over. Friedrichsen pointed to "rapid growth in our DISCO Platform, which has grown 10x since Q1 2026".
Third-quarter software sales rose 10% to $38.6 million, or 13% after stripping out $1.2 million from a contingent legal case that settled a year ago. The fourth-quarter software outlook of $39.4 million to $40.4 million points to 13.7% growth at the middle of the range, by our math. What to watch: fourth-quarter software revenue against that $39.9 million midpoint, which tests whether lower upfront fees slow year-end sales.
🐻 Bear Case
Cash Burn Continued as Unpaid Bills Grew
Reaching breakeven on Adjusted EBITDA did not stop cash from leaving the business. By our math, subtracting first-half cash flows from the nine-month figures shows DISCO burned $5.4 million of free cash flow in the third quarter, worse than the $2.0 million burn a year ago.
- Third-quarter operating cash outflow: $3.0 million by our math, against $1.0 million a year ago
- Third-quarter capital spending and software development: $2.4 million by our math, or 5.2% of revenue
- Accounts receivable (unpaid customer bills): $32.4 million, up 16.0% from June and 33.8% from a year ago by our math
- Cash and short-term investments: $96.8 million, down $4.6 million in the quarter
Revenue grew 11% from a year ago, so unpaid customer bills grew three times as fast as sales. Meanwhile, capitalised software and equipment spending doubled from a year ago. What to watch: fourth-quarter accounts receivable and operating cash flow, because true self-funding requires collecting cash on the new software contracts.
New AI Tools Still Lack Revenue Figures
DISCO is pitching itself as an AI company for trial lawyers, expanding beyond document review into case strategy. This quarter it opened general access to Advanced Research, "an agentic AI application that adds autonomous, multi-step reasoning and transparent decision-making logic". Its broader unified litigation product, which combines case facts with US case law, also "just added a second cohort to our pilot program", Friedrichsen said.
Advocates view these tools as a new growth driver, while sceptics worry that bundling AI into standard contracts just relabels existing revenue while development costs eat into GAAP profit. The release gave no dollar figures for AI sales or pilot pricing. What to watch: whether executives disclose standalone AI revenue or pricing for the unified litigation product on the call or in the quarterly filing.
Risks this quarter didn't answer
Four standing concerns could not be tested from the earnings release alone and await the quarterly filing or conference call.
- Existing-customer spending: last quarter's filing showed revenue from existing clients fell $0.9 million; the third-quarter filing's revenue bridge will show if retention improved after adjusting for last year's $1.3 million contingent fee.
- General-purpose AI rivals: whether broad legal AI tools are squeezing document-review pricing requires commentary from the call.
- Usage volatility: revenue still depends on the timing of large lawsuits, which only multi-quarter subscription mix disclosures in the filing can track.
- Compliance and legal costs: emerging-growth-company status ends December 31, 2026, and the $11.5 million legal settlement accrual still sits on the balance sheet awaiting final court clearance.
💲 Other KPIs
By our math, professional services revenue rose 17.9% from a year ago, or 15.8% excluding the $0.1 million contingent legal matter from the third quarter of 2025. That matches the 18% growth pace from the second quarter and follows a 25% rise in the first quarter, continuing the rebound from last year's declines.
Deferred revenue — cash customers have paid upfront for services not yet delivered — rose 10.1% from the second quarter and 8.0% from a year ago, by our math. However, it remains down 14.3% from $5.38 million at the end of December, showing that upfront multi-month billings remain a small fraction of total sales.
The weighted-average share count rose 5.1% from 62.09 million a year ago and 1.2% from the second quarter, by our math. The legal-technology provider recorded $4.74 million in stock-based compensation this quarter (10.5% of revenue) and does not buy back shares to offset employee stock grants.
🔮 Guidance
New. The plan calls for 13.7% growth from a year ago and 3.2% growth from the third quarter at the middle of the range, by our math. That replaces the $43.2 million to $48.2 million range implied by last quarter's full-year outlook. DISCO has beaten its quarterly revenue midpoint for eight straight quarters; if the 2.6% average beat over the last four quarters holds, fourth-quarter revenue would reach $48.0 million.
New. By our math, the middle of the range ($39.9 million) represents 13.7% growth from a year ago and 3.4% from the third quarter. That sits right on the $39.9 million midpoint implied by last quarter's annual plan, showing that the firm kept its fourth-quarter software target intact.
Unchanged. Management replaced its qualitative promise of positive fourth-quarter Adjusted EBITDA with a dollar range centered at $0.75 million. That compares with $0.08 million delivered in the third quarter and a $2.16 million loss in the fourth quarter of 2025.
Raised. The middle of the range moved up $1.6 million to $177.1 million, or 12.9% annual growth by our math. This is the third raise this year following increases of $2.0 million in the first quarter and $1.5 million in the second quarter.
Unchanged at the middle of the range ($150.0 million), which calls for 11.9% growth for the year by our math. The company raised the bottom of the range by $2.0 million and trimmed the top by $2.0 million after landing right on its third-quarter midpoint.
Raised. The middle of the range improved by $0.45 million to a $6.05 million loss after the third-quarter beat. Across the four quarters of 2026, the midpoint moved from $(6.5) million to $(6.0) million, back to $(6.5) million in the second quarter, and now to $(6.05) million.
❓ Key Questions
Did revenue from existing customers stop shrinking in Q3?
In the second-quarter filing, revenue from clients that existed a year earlier fell $0.9 million. Investors need the third-quarter filing's revenue bridge to see if existing clients spent more after adjusting for last year's $1.3 million one-off legal fee.
Why did accounts receivable jump 16% in one quarter?
Unpaid customer bills rose $4.5 million from June to $32.4 million, driving a $5.4 million free cash flow burn despite breakeven Adjusted EBITDA. Management did not explain whether slower collections or late-quarter billing caused the build.
How much revenue comes from standalone AI vs bundled contracts?
Advanced Research is now generally available and the DISCO Platform grew tenfold since the first quarter, but the release gives no dollar figure for AI sales. Without it, outsiders cannot tell new AI spending from relabelled document-review fees.
Why did quarterly capital and software spending double?
Purchases of equipment and capitalised software jumped to $2.35 million in the third quarter from $1.15 million in the second quarter, by our math. How much of the R&D drop on the income statement came from capitalising software costs instead?