LegalZoom.com, Inc. (NASDAQ:LZ) Q1 2024 Earnings Call Transcript May 8, 2024
LegalZoom.com, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day and thank you for standing by, and welcome to LegalZoom’s First Quarter 2024 Earnings Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Madeleine Crane, Head of Investor Relations. Please go ahead.
Madeleine Crane: Thank you, operator. Welcome to LegalZoom’s first quarter 2024 earnings conference call. Joining me today is Dan Wernikoff, our Chief Executive Officer; and Noel Watson, our Chief Financial Officer. As a reminder, we will be making forward-looking statements on this call. These forward-looking statements can be identified by the use of words such as believe, expect, plan, anticipate, will, intend and similar expressions and are not and should not be relied upon as a guarantee of future performance or results. Such forward-looking statements are based on management’s assumptions and expectations and information available to us as of today’s date. These forward-looking statements are also subject to risks and uncertainties that could cause actual results to differ materially from such statements.
These risks and uncertainties are referred to in the press release we issued today and in the Risk Factors section of our most recent annual report on Form 10-K filed with the Securities and Exchange Commission. Except as required by law, we do not plan to publicly update or revise any forward-looking statements, whether as a result of any new information, future events or otherwise. In addition, we will also discuss certain non-GAAP financial measures. We use non-GAAP measures in making decisions regarding our business, and we believe these measures provide helpful information to investors. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations of all non-GAAP measures to the most directly comparable GAAP measures are set forth in the Investor Relations section of our website at investors.legalzoom.com.
I will now turn the call over to Dan.
Dan Wernikoff: Good afternoon, everyone. Thanks for joining our call. I’ll start with a quick recap of our year-over-year financial performance in Q1. Revenue came in at $174 million, up 5%. Subscription revenue grew 10% and transaction revenue declined 3%. Adjusted EBITDA was $28 million, up 28% year-over-year or a 16% margin. LegalZoom formations were down 18% year-over-year, with formations as measured by Census EIN data down 2% year-over-year. As a result, our share for the quarter relative to Census EIN data fell 17%. As mentioned on our last call, a share decline was expected and reflects the partnership exit, continued commercialization testing and the rebuild of our sales organization. However, Secretary of State formations data pointed to a softer formations macro in Q1 than Census EIN data.
As a result, we believe our Q1 results overstate the market share loss. Despite the near-term trend, we continue to believe in the long-term health of the macro, which remains well above pre-pandemic levels. We’re also confident in our ability to reaccelerate our share growth throughout the year. We expect to exit the year with at least 10% growth in our market share relative to the first quarter. As we’ve now fully lapped our premium rollout, we’re focusing our efforts on other parts of our lineup that haven’t yet been optimized. One of the biggest levers to drive conversion is reducing the number of purchase decisions in the formation flow. We are simplifying the experience by focusing primarily on formations and compliance needs.
I’m encouraged by tests we ran at the end of the quarter geared towards better lineup optimization that will favor formation conversion improvements. Share growth should further be supported by our sales and marketing strategy. By early Q3, we expect to be back to our prior sales capability with a more efficient organization. We’re also reintroducing increased levels of brand spend, which should drive higher awareness and traffic while working in concert with our performance marketing to drive better conversion. While the macro has softened, compliance requirements have increased in complexity with the Corporate Transparency Act. We took advantage of this opportunity by launching a new product to assist with the filing mandates required by FinCEN.
The timing of this new requirement and our focus on monetizing customers post formation came together in Q1, and over the course of the quarter, we saw accelerated performance. We have had a well orchestrated strategy across all our channels to ensure our customers understand this new requirement. We continue to evolve the offering with a focus on leveraging the data we have today in our business profile so that our customers can comply with minimal effort. Overall, it was a strong quarter, with us meeting and beating guidance on revenue and adjusted EBITDA, respectively. Even with a weaker macro than anticipated, we’re also maintaining our full year guidance despite adjusting our expectations down for the macro, as we’ve been able to offset its impact with better performance than expected in compliance and BOIR.
Now I’ll detail our performance across our strategic pillars in more detail. Beginning with our first strategic pillar, scale the business. We continue to focus on the opportunity to improve the LLC experience. The majority of our product sessions are mobile and they convert at less than 1/3 of the rate of desktop sessions. The conversion challenge has been one of both design and commercialization within a constrained form factor. At the end of Q1, we deployed a new mobile optimized experience and reduced the number of solutions cross-sold in the formations flow. While this new formation experience is designed for mobile, a simpler experience will benefit our desktop customers as well. We’re able to make these changes because of the combination of our new customer data platform, our post-formation experience in MyLZ, and a new sales organization.
We’re now unlocking a multi-channel, data driven approach to monetization after formation, the early results are promising. We are also making changes in the consumer side of our business. Estate planning is an important front door to our ecosystem, and many of the infrastructure investments we’ve made around our SMB experience and fulfillment infrastructure have been built in a way that allows us to leverage them across other offerings with relatively minimal investment. The estate planning product has not been refreshed for close to a decade and has created a revenue headwind over the last 3 years post pandemic. Despite that, we remain a leader in this space given our strong brand recognition and historical business model. While SMB continues to be our primary focus, estate planning is a highly relevant need for our SMB customers when it comes to tax planning, business partnerships and ownership succession.
We’ve taken the first couple of steps to update the product, and you should expect to see continual improvements throughout the year. Lastly, to support these product efforts, we’re beginning to reinvest in the brand. As we scale our brand spend, we’re taking a test-and-learn approach to find the right channels to reach key segments and increased awareness and product familiarity. In Q2, as part of our NBA partnership, we launched a new integrated campaign with a combination of TV, Social, CTV and Online Video, leveraging 2x NBA, MVP and NBA champion Giannis Antetokounmpo as our spokesperson. We expect Q2 to be the first quarter that we meaningfully increased CAM spend year-over-year since launching the premium lineup as we align our investment with the NBA playoffs to maximize reach and the relevancy of the campaign.
Now let me turn to our second strategic pillar, build the ecosystem. As we simplify the formation experience by eliminating unnecessary purchase choices, we continue to optimize the experience after the formation is complete. The recent changes to our formation flow may put some pressure on the performance of our subscription add-ons in the near-term, but we feel confident the changes we are making will benefit us in the long run. It’s still early in the transition, but we’re excited by the engagement we’re seeing on our platform. We had over 1 million MyLZ logins during March, double the volume we saw in December. During the quarter, we rolled out a new first use experience on the homepage, outlining all the tasks required during formation to ensure liability protection and government compliance.
Since the rollout, we have seen promising trends related to the conversion and utilization of our compliance offerings, while off of a relatively small base, post-formation sales more than doubled compared to the fourth quarter of 2023. We’ve also seen very strong post-formation engagement when it comes to BOIR. To refresh, FinCEN mandates that this report is filed within 90 days of forming, and for those customers that form prior to 2024, they have until the end of this year to make their initial filing. We have three objectives as it relates to BOIR: one, we want to educate all our customers about this new requirement; two, we want to make the experience simple, leveraging the business profile data we already have on the customers; and three, we’ll use it as an opportunity to introduce customers to our comprehensive compliance subscription.
We are now selling BOIR in MyLZ through email marketing and in our sales and care channels. The early results have been strong, but we expect further acceleration with additional testing. As we focus the formation funnel on conversion, we’ve shifted both tax and books from being a part of the initial purchase to instead being part of the post-formation marketing motion. For tax, the efficacy of attach is more seasonally-driven, so we don’t expect a significant impact. For books, we continue to drive-up activations and iterate on the core offering. We have big plans for books later in the year and are in a build mode with existing customers helping to inform the roadmap, which takes us to our third strategic pillar, Integrate Experts. There are two critical advisors that small businesses rely on to be successful, accountants and attorneys; and we’re focused on modernizing how solopreneurs can have affordable and easy access to both groups through a modern technology platform with a consistent experience across.
Since we just completed the initial filing deadline for tax season 2023, I’ll first recap our performance with LZ Tax. We have three clear learnings from the season: first, we have built the right premium filing experience; second, there is a clear advantage offering an integrated books to tax solution; and third, there remains a large portion of our customers we’re not yet serving when it comes to their early tax needs, which is still a large and unrealized opportunity. Exiting last year, we made the decision to recommercialize our tax offerings with the goal of driving higher customer consideration and retention. As we narrowed our audience to focus on the most relevant tax customers, we invested heavily in improving the experience, moving to an integrated filing experience all within our platform.
As expected, our subscriber count in tax was down year-over-year, but utilization improved with approximately 20% more filers per active subscription. The combination of simplified customer intake, matching to a dedicated tax expert, and utilization of MyLZ for document sharing and expert collaboration drove a net promoter score of 59 for the overall tax filing experience and a net promoter score of 87 for interactions with our experts during the season. While the channel strategy is a headwind to subscription revenue in 2024, we believe the superior experience of this season will drive retention improvements moving forward into next year. This was our first tax season where a customer could utilize LZ Books, despite only having launched books in the formations flow with 3 months left in fiscal 2023, 17% of our 1040 filers imported data from LZ Books this season.
We also saw clear trends in the data, including strong upgrades from customers with over $10,000 in annual profit. We feel very good about the future upsell opportunities given that one-third of the 1040 filers that imported data chose a book solution distributed through LegalZoom, whether LZ Books or QuickBooks. And over 50% of all filers used manual methods, which demonstrates the distribution opportunity for LZ Books post filing. Despite having high customer satisfaction when it comes to our current tax offering, there is a large population of customers who are not ready to file so soon after forming. For many, the price is prohibitive as we only offer an assisted filing solution. Approximately 40% have not yet started operations at the time of formation and over 35% generate less than $10,000 in their first year in operations.
We continue to believe books is the right gateway to tax services. We’re working to expand the potential audience of books customers along with addressing the accessibility of our tax offerings. Moving on to the legal side of expertise, on our last call, I hinted that our newly designed expert platform could support not only tax experts, but could also be the foundation for attorney offerings as well. This investment in our platform, combined with our Arizona law firm, has created a unique opportunity for us to expand beyond providing general legal advice. I’m excited to announce that through our law firm, we will be partnering with our network of attorneys to participate directly in legal matters. The first legal matter we have launched is prenuptial agreements.
This matter was selected intentionally, given its quick time to value, low jurisdictional complexity and forms-based engagement. We’re still very early in our journey, but to be clear, our expectation is that we begin to launch additional legal matters on this platform within the consumer and SMB space. This will be a platform play in a space that currently has no established players and certainly no one with the brand name recognition, technology capabilities and attorney reach. In closing, I’d like to thank the entire LegalZoom organization for their hard work during the quarter. We remain focused on putting the customer first from formation and compliance to financial and legal needs. And our progress this quarter reflects our dedication towards our customer, and our overall mission to unleash entrepreneurship.
With that, I’ll turn it over to Noel to go deeper into the financials.
Noel Watson: Thanks, Dan, and good afternoon, everyone. I’ll now discuss our first quarter performance in more detail. Please note all comparisons will be on a year-over-year basis unless otherwise stated. Total revenue was $174 million for the quarter, or up 5%. We completed 139,000 business formations in Q1, down 18%. Our market share of business formations was 9.3%, which represented a 17% year-over-year decline. Looking at these results in more detail, beginning with business formations. In Q1, business formation growth was impacted by a partnership exit, which occurred in Q3 of 2023. This will continue to remain a headwind in Q2 of this year, however, will be fully lapped by the end of Q3. Looking at our LLC direct channel, our formations were down 12% year-over-year.
We experienced softness due to a combination of testing changes as we worked to fully optimize our lineup and a lower contribution from our sales efforts as we work to rebuild our team. Lastly, the macro underperformed our expectations, declining 2% year-over-year in Q1 versus our expectation of low single-digit growth. Turning to market share performance. The combination of our partnership exits, commercialization testing and Salesforce transition pressured our market share in the first quarter. However, as Dan noted, we believe Q1 Census data understates our formations market share relative to EIN applications during the quarter. We expect to exit the year with at least 10% share growth relative to Q1, as we lap some of the factors I just discussed and look to drive higher conversion through the product.
Transaction revenue was $66 million, down 3%, driven by a 10% decline in average order value, partially offset by a 9% increase in transaction units. We recorded 336,000 transaction units in the quarter. This 9% increase was primarily due to an increase in non-formation business-related transaction products such as annual reports, as well as the introduction of our BOIR offering. Average order value was $198 for the quarter, down 10% due to the aforementioned mix shift toward non-formation transactions, which are generally lower, priced as well as a decline in partner revenue. We expect AOV to be relatively flat year-over-year in Q2 and continue to expect a mid single-digit decline in AOV for the full year, compared to the full year 2023. Subscription revenue was $108 million, up 10% due to increases in both subscription units and ARPU.
We remain dedicated to continuing to shift our revenue towards subscriptions over the long-term. We ended the quarter with over 1.6 million subscription units, up 7% year-over-year as we experienced strength in forms and e-signature subscriptions, due to the bundling of these products into certain business formation offerings and growth in virtual mail subscriptions. This growth was partially offset by the impact from the exit of legacy partner relationships. ARPU came in at $272 for the quarter, up 5%, driven by a mix shift toward our high value subscription offerings. ARPU was also impacted by the exit of certain channel partner relationships and the introduction of forms and e-signature subscription offerings, which carry lower price points.
Turning to expenses and margins, where all of the following metrics are on a non-GAAP basis, first quarter gross margin was 64% compared to 66% in Q1, 2023. The year-over-year decrease was driven by higher filing fees as a percentage of revenue as California reinstated filing fees in the third quarter of last year, following a 12-month pause. As a reminder, we generally experience lower gross margins in the first half of the year due to the seasonality associated with tax season and business formation. Sales and marketing costs were $51 million or 29% of revenue and decreased 10% from last year. Customer acquisition marketing costs were up sequentially due to seasonality, but remained flat year-over-year. In Q2, we expect CAM expenses to increase approximately $5 million compared to the first quarter of 2024 due to higher brand spend, some of which was deferred from Q1 in order to better time our investments with a few changes to our lineup, continued build out of our sales team, and the alignment of our NBA sponsorship with the peak season.
Our investments in CAM in 2024 will largely be offset by the savings we are experiencing from our sales reorganization. Non-CAM sales and marketing expense was down $6 million or 35% due to the impact from the sales reorganization as well as ongoing efficiencies in our marketing strategy. Technology and development costs were $17 million, up $2 million or 16% as we remain invested in driving product-led growth. General and Administrative Expenses were $16 million or up 3%. Our performance drove adjusted EBITDA of $28 million or 16% margin. Adjusted EBITDA increased 28% year-over-year compared to adjusted EBITDA of $22 million and a margin of 13% to same time last year. Deferred revenue increased by $20 million in the quarter. Free cash flow was $25 million compared to $22 million for the same period in 2023.
Our free cash flow in the first quarter reflects cash tax payments of approximately $4 million, following the full utilization of our existing tax credits. We expect Q2 free cash flow to be slightly down sequentially due to higher estimated tax payments and full year free cash flow to be in the range of $85 million to $95 million. We ended the quarter with cash and equivalents of $228 million. We remain debt free with no outstanding borrowings under our $150 million revolving credit facility. During the first quarter, we repurchased 1.2 million shares of our common stock at an average price of $10.91 for a total of $13 million. We plan to continue to opportunistically repurchase shares of our common stock as part of our balanced approach to capital allocation.
In terms of capital allocation, we continue to prioritize organic investments in the business, followed by strategic acquisitions; and lastly, stockholder returns via repurchases of our common stock. We maintain the ability to execute against all 3 priorities simultaneously, given our strong cash position. Turning to our outlook. For the full year, we continue to expect revenue of $700 million to $720 million or 7% year-over-year growth at the midpoint, and adjusted EBITDA of $135 million to $145 million or 20% margin at the midpoint. We are reiterating our full year outlook based on 2 key factors. Our expectations reflect a higher full year contribution from BOIR, based on our first quarter performance, largely offset by a softer macro expectation.
Based on the trends we are seeing today, we now expect a mid-single-digit decline in the formations macro for the full year 2024 versus our original expectations of flat to low-single-digit growth. As a reminder, the macro showed a strong acceleration in the back half of 2023, creating a more challenging comparison. Based on this, for the second quarter of 2024, we expect total revenue of $172 million to $176 million or 3% year-over-year growth at the midpoint, and we expect second quarter adjusted EBITDA from $25 million to $27 million or 15% margin at the midpoint. And with that, let’s please open the call for questions.
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