LegalZoom.com, Inc. (NASDAQ:LZ) Q1 2023 Earnings Call Transcript May 13, 2023

Operator: Good day, and thank you for standing by. Welcome to LegalZoom’s First Quarter 2023 Earnings Conference 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, Sarah Bland, Securities Counsel. Please go ahead.

Sarah Bland: Thank you, operator. Hello, and welcome to LegalZoom’s First Quarter 2023 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 results or otherwise. In addition, we will also discuss certain non-GAAP financial measures. Our CEO and CFO use these measures in making decisions regarding our business, and we believe these measures provide helpful information to investors. 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.

The non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. Now I’ll turn the call over to Dan.

Dan Wernikoff: Thanks, Sarah, and good afternoon, everyone. I’m excited to share our strong performance as we kick off 2023. I’ll start with a brief overview of Q1 results. Revenue came in at $166 million, up 7% year-over-year. Transaction revenue was down 5%, while subscription revenue was up 15%. LegalZoom business formations grew 32% year-over-year to 170,000 units. U.S. Census formation were up 4% to $1.5 million for the quarter. The resulting share gain was 27%, which is the largest gain we’ve seen since we began tracking it. Adjusted EBITDA was $22 million for the quarter or 13% margin. These results reflect the bulk of traffic going to a premium line of test over the full quarter, and then more specifically, all traffic being directed to the winning lineup at the beginning of March.

We tested this lineup for some time, and there were no surprises in the results once deployed. In March, we were able to better understand the implications of free messaging on traffic, and it exceeded our expectations. Coupled with a stronger-than-anticipated formations macro, we saw strength across the board. This is a significant business model shift and inflection point, providing a step function improvement towards realizing our strategy. Our first strategic pillar is to scale the core formations business. And in this quarter, we saw record formations growth, while improving service levels and reducing cost of revenue per unit on the formations business. Our second strategic pillar is to create an ecosystem of subscription services. With this new lineup, we will further leverage the ecosystem by shifting the purchase mix more aggressively towards recurring revenue.

And our third strategic pillar is to integrate experts. This new lineup includes a premium SKU that bundles a subscription with access to our network of independent attorneys. The freemium lineup is an accelerant to all of our strategic pillars. To be clear, it’s still early innings. And while we’re very happy with the initial launch, there are many opportunities to improve our performance across all investment areas. We’re excited to build on this new foundation and we have a backlog of improvements that we’ve already begun to test. Stepping back, our focus is to remove any barrier that stands in the way of someone wanting to launch a business. With this new lineup, we’ve materially reduced the price of forming a business, which is especially important in today’s economic environment.

In fact, the formation lineup pricing we have today is lower than it was at our founding in 2001. This focus on making our formations products more accessible, while expanding the type of services we offer beyond just legal and compliance has led us to revisit our mission. Our heritage as a legal disruptor is something we remain both proud of and dedicated to, but we continue to identify additional ways to remove barriers to block entrepreneurs when they form a business. As an early and often the first adviser to small businesses, our customers are looking for us to do much more. Democratizing law is one of many opportunities we have to make expertise more accessible and affordable. As such, 20 years into this journey, we’re updating our mission from Democratize law to unleash entrepreneurship.

We’ve already made progress against this new broader mission, and we’re excited to share additional product updates in support of it by the end of the year. With this new mission, our top priority is helping small businesses get off the ground. We mentioned last quarter that small businesses are resilient, determined, and their secular tailwinds point to a strong long-term macro. Many factors such as work from home, the emergence of gig economy platforms, lower capital requirements and increasingly sophisticated digital enablement tools make starting a small business easier and lower risk than it’s ever been before. Just as we feel good about the long-term prospects of the macro, we also anticipate growth opportunities as we begin to leverage generative AI.

The most exciting opportunity we see is eliminating inefficiencies in the contract drafting and review process. This was the key thesis of the Revv acquisition and the forms reinvestment we announced at the end of last year, where we see less opportunity, and therefore, we consider the product highly defensible is within our core filing solution. Let me go ahead and expand on both. There are 2 parts to our core formation process. The first is providing context and confidence around what’s required to form. We believe generative AI is a meaningful evolution to current search solutions when providing content and context and we’ll work to integrate those capabilities. Although it’s worth noting that much of this content has been widely available for some time through traditional search and there is a high bar around confidence in the source as well as regulations that advice to be delivered through a credentialed expert.

But once a customer has the necessary context, the formation process is a complex workflow. This requires data collection, mapping the data set to proprietary unstructured forms and the last mile connection to over 3,000 counties, 50 states and several federal agencies. These agencies do not have APIs. Instead our IP here is the combination of the scale workflow, numerous RPA bots to automate filing and last mile capabilities that sometimes require human intervention. In many ways, we act as an API on top of all government agencies and likely have an opportunity to be a plug-in through ChatGPT. We do, however, believe generative AI will revolutionize the legal document space and therefore is an untapped growth opportunity. You can already see large investments being made in national consulting and legal practices to build internal tools that serve enterprise clients.

What isn’t addressed by that investment is smaller, independent firms that can’t afford to make similar investments. These are the firms that typically serve small businesses. According to the ABA roughly half of practicing lawyers are in firms of 1 to 10 attorneys. One of our strategic pillars is to integrate experts. As part of that strategy, we’re building an expert platform that enables smaller firms within our ecosystem to compete by driving new business, managing administrative burdens, enabling efficiencies and leveraging new technologies. We’ve hinted multiple times that you should expect new product releases in the back half of this year that will provide clarity on our strategy with attorneys. And the foundation for this is a new contract and forms platform that will leverage AI.

It’s worth noting that while technology will continue to make attorneys more efficient due to regulations related to unauthorized practice of law, attorneys will still play a prominent role in the delivery of legal services and this is yet another area where we differentiate ourselves from most of our online competition with a large network of independent attorneys already operating in our ecosystem and ready to consume these services. Beyond generative AI, there are many growth opportunities across all our strategic pillars. With the new line of rolled out and parallel progress on tech investments to streamline fulfillment, we continue to improve efficiencies as we scale volume. We’re about halfway through our automation investment and have opportunities to drive higher margin for multiple years.

These investments will also serve to improve the customer experience by lowering the error rate and increasing our speed to file. In addition to efficiency gains, we’re focused on improvements in how we commercialize our service through the formation of workflow. Right after we deployed our winning test, we were in market testing ongoing improvements to the new lineup. And in the coming months, we have additional tests queued up on our attached products and services. Similar to virtual mail, we moved quickly to integrate forms and e-signature through MyLZ. This is the third ecosystem subscription launched within the last 2 years. We aim to be the simplest and e-signature, provider offering a low-cost service tailored specifically to small businesses needs.

We’re currently working to reimagine the entire end-to-end experience starting with form and contract creation through the collaboration with an attorney and culminating with a process to get a digital signature and securely store your documents. In addition to deploying a lineup that included an attorney subscription bundle, we continue to make progress on our third strategic pillar, integrating experts. While tax season is extended this year with grace periods for filing in California, we’re far enough along through the year to understand our performance and begin applying learnings towards next season. For the year, we expect to double the total number of returns filed compared to 2022, benefiting from the product investments we made before the tax season.

We’re still just a couple of years into creating this service and believe there are opportunities to drive stronger growth through a better return experience, which will then translate to better retention rates. In our first tax season, we were largely an off-line provider. That changed this year as we built onboarding, intake, document upload and accountant scheduling into MyLZ. In turn, those investments drove significant improvements. But with any new product experience, we continue to receive valuable feedback that will be incorporated into postseason releases. Outside of the filing experience, we are still constructively dissatisfied with active usage and retention rates. While we expected lower retention for those seeking pure advisory as their needs may be more episodic, especially right after they form and pre-revenue.

We have not seen the level of ongoing active engagement expected for those entitled to a tax return. We have many insights in this area. And as was the case last year, we’re building and we’ll be testing improvements in anticipation of next tax season. On the whole, this was a big quarter at LegalZoom, and I want to thank the legal Zoom employees for all their hard work and dedication. We made considerable progress against our new mission of unleashing entrepreneurship, and as a result, we’re raising both top and bottom line guidance for the year, which Noel will detail in a few moments. I’m very encouraged by the progress we’ve seen in the market, demonstrating significant share gains, while accelerating our shift to recurring subscription revenue.

What gets me even more excited, though, is what I see in our product pipeline and the advances we continue to make in building out a new and novel SMB ecosystem. With that, I’ll turn it over to Noel.

Noel Watson: Thanks, Dan, and good afternoon, everyone. I’ll begin by echoing Dan’s excitement with regards to our start to the year. The combination of our new lineup, alongside refresh marketing messaging, drove impressive market share growth in business formation, a key focus of ours as we look to drive more customers into our subscription ecosystem. Importantly, this combination has also led to improved traffic trends and marketing efficiencies as we’ve been able to significantly reduce our marketing spend year-over-year, while driving the higher volumes. We continue to see increasing benefits from automation within our operations where improving productivity levels allowed us to fulfill orders faster than anticipated in the quarter.

We also saw reductions in the number of customer care contacts per order and in the related cost per contact. We believe there is still a significant opportunity to improve the efficiency and effectiveness of our operations and are maintaining the investments needed to realize these gains. Cost discipline remains focus. As we look to balance our goals of reaccelerating revenue growth and improving margins. We remain confident in our ability to drive significant margin improvement year-over-year and see our Q1 results as an important indication of our progress. One of the key factors in our performance this quarter was the macro where its performance exceeded our forecast and was the first quarter of formation growth reported by the Census in over a year.

As a result, we’re increasing our formations macro expectation for the second quarter. Despite this strength and aligned with our focus on controlling expenses, at this time, we are not adjusting our macro assumptions for the back half of the year. We will continue to manage to the expectation of a recession with the one exception being the continued acceleration of our investment in product and technology. I’ll now provide you with a review of our performance in the first quarter and end with our outlook for Q2 and the full year 2023. Total GAAP revenue in the period came in at $166 million, up 7% year-over-year and above the top end of our guidance range. Transaction revenue was down 5% year-over-year at $62 million. Average order value declined 18% year-over-year, while total transaction units were up 15% year-over-year.

Reduction in average order value was driven by the full rollout of our new lineup. We completed 170,000 business formations in Q1, up 32% compared to the same period last year. Our formations growth well outperformed the market, which was up 4% during the period as measured by U.S. Census data, enabling us to grow our market share by 27% versus the same period last year. The successful share gain can largely be attributed to our new lineup, and we, therefore, expect the year-over-year growth in share gains to moderate in the second half of this year as we start to lap the initial testing and expanding rollout of our free products. Transaction units were 308,000 in Q1, up 15% year-over-year and increasing business formation transaction was offset by a decline in intellectual property and consumer transactions.

Average order value came in at $202 in the first quarter, down sequentially from the fourth quarter and down 18% year-over-year, again, driven by the rollout of our new lower-priced lineup. As mentioned earlier, we did see increasing benefits from automation within our fulfillment operations and improving productivity levels allowed us to fulfill orders faster and recognize more revenue than anticipated in the quarter. Subscription revenue was $97 million in the quarter, up 15% year-over-year due to a 10% increase in the number of subscriptions and continued improvement in ARPU. We saw revenue growth in the quarter across our core compliance, LZ Tax and virtual mail subscription products. I remind you that Q1 is a stronger quarter for revenue recognition in LZ Tax, given the higher tax preparation volumes and unutilized tax preparation entitlements.

ARPU came in at $259, up 6% year-over-year and flat sequentially from the fourth quarter. The increase was primarily due to the increased mix of higher-priced LZ Tax subscriptions within our total subscription base. We expect year-over-year ARPU growth to moderate through the remainder of the year. Partnership revenue was up 11% year-over-year in the first quarter at $6 million. Now turning to expenses and margins, where all of the following metrics are on a non-GAAP basis. Gross margin came in at approximately 66% of revenue in the first quarter, up from 65% in Q1 of last year. The improvement was driven by efficiency gains from cost reduction initiatives implemented in the second half of last year. We expect gross margin to slightly decline in 2023 as a result of higher filing fees as a percentage of revenue due to higher business formation volumes.

Sales and marketing costs were $57 million in the quarter with 35% of revenue, down 11 points from Q1 of last year. Customer acquisition marketing came in at $41 million, down 24% year-over-year. In Q2, we continue to expect a significant year-over-year decline in customer acquisition marketing, although to a lesser extent than our Q1 results. Technology and development expenses were $14 million in Q1, up $1 million year-over-year as our primary hiring focus remains in product and engineering. General and administrative expenses were $15 million in Q1, up $1 million year-over-year. Adjusted EBITDA was above our guidance range at $22 million for the quarter compared to $2 million in the first quarter of 2022 and our base of deferred revenue increased $17 million in the period.

In the first quarter, we continued to execute on our $150 million share repurchase authorization. We repurchased a total of 771,000 shares of our common stock at an average price of $8.78 per share for a total repurchase of $7 million. Since inception, we have completed $102 million in buyback with a total of 10 million shares repurchased. As of March 31, 2023, we had cash and cash equivalents of $204 million and no debt outstanding. I’ll now provide guidance for the second quarter and full year 2023. For the second quarter of 2023, we expect total revenue of $166 million to $168 million, a 3% year-over-year growth at the midpoint. We expect adjusted EBITDA of $27 million to $29 million or 17% of revenue at the midpoint. For the full year of 2023, we are raising our total revenue to $630 million to $650 million or 3% year-over-year growth at the midpoint.

As a result, we now expect adjusted EBITDA to increase to $105 million or 16% of revenue. And with that, let’s please open the call for questions.

Q&A Session

Operator: [Operator Instructions] And our first question comes from the line of Andrew Boone with JMP Securities.

Operator: And the next question comes from the line of Matthew Pfau with William Blair.

Operator: [Operator Instructions] And our next question comes from the line of Mario Lu with Barclays.

Operator: Our next question comes from the line of Ron Josey with Citi.

Operator: And our next question will come from the line of Brent Thill with Jefferies.

Operator: And our next question comes from the line of Jackson Ader with SVB MoffetNathanson.

Operator: And our next question comes from the line of Elizabeth Porter with Morgan Stanley.

Operator: I’m currently showing no further questions at this time. This concludes today’s conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.