Earnings Transcript for LZ - Q4 Fiscal Year 2023

Operator: Good day, and welcome to the LegalZoom Fourth Quarter and Full Year 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, Madeleine Crane, Head of Investor Relations. Please go ahead.

Madeleine Crane: Thank you operator. Welcome to LegalZoom's Fourth Quarter and Full Year 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 review report on Form 10-Q 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 and 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.

Daniel Wernikoff: Good afternoon, everyone, and thanks for joining our call. 2023 was a pivotal and productive year at LegalZoom. We deployed a new freemium lineup, built out multiple new subscription offerings and created a unified post formation experience. All of these accomplishments put us a strong position as we enter 2024, and I'm excited to share the progress we continue to make against our strategy. But first, I'd like to recap the financial performance for the year, starting with Q4 results. In Q4, revenue came in at $159 million, up 8% year-over-year. Subscription revenue grew 17% and accounted for over 2/3 of the quarter's revenue. Adjusted EBITDA for the period was $33 million, reaching a 21% margin. Formations, as measured by Census data, grew 9% in Q4. Largely as a result of terminating multiple partnerships and our decision to restructure our sales organization at the end of Q3, our total formations declined 2% year-over-year. LLC units sold directly where our premium lineup is in market grew slightly faster than the macro. We have now substantially lapped the impact of the new lineup rollout. For the full year 2023, we delivered the following business results. Revenue was $661 million or a 7% increase year-over-year. Subscription revenue grew to $413 million, which represents growth of 15% for the year. Full year adjusted EBITDA increased 86% to $119 million, reaching an 18% margin. The macro remained healthy throughout the year with Census formations up 8% year-over-year. In 2023, our business formations grew 23%, driving 14% share growth for the year. LegalZoom branded LLC growth was 29% for the year, over 3x faster than the macro. Taking an even longer view of this business from 2019, when I joined at the end of the year, we've seen the formations macro grow at a 12% compounded annual growth rate, while we've had a CAGR for LegalZoom formations of 19%. During this time, the number of businesses that have formed with us annually has doubled to almost 600,000. Equally important, our mix of subscriptions has increased from 51% to 62% of total revenue. Even though we believe very much in the long-term strength of this macro, our goal is to grow independent of it, shifting more revenue to subscriptions is the most critical strategy to achieve this dislocation. As a result of the shift in continued formation growth, we've been able to grow our subscription revenue by 19% CAGR since 2019. We've been steadily recasting LegalZoom as a more modern software player in the legal, compliance and now financial space. When I joined, we focused on bringing the right team. As we built out the broader organization, we invested heavily in infrastructure to enable more product velocity. Modernizing our infrastructure has allowed us to drive better order efficiency which, in turn, enabled the launch of our freemium lineup. We committed to being more product-led and less dependent on marketing spend, and we clearly delivered against that objective, reducing our sales and marketing costs by 20% last year while still increasing our SMB product sessions by 25%. This focus is what helped us to achieve a dual goal

Noel Watson: Thanks, Dan, and good afternoon, everyone. We had a strong fourth quarter with both revenue and adjusted EBITDA exceeding our expectations. Before I share details on the quarter as well as guidance for Q1 in the full year 2024, I'd like to reflect on the strong execution of our team. The investments in our infrastructure are paying off. As we experience ongoing efficiency improvements in many areas of our business. Today, we are only halfway through our road map of investments in technology and automation, which we expect will support continued margin enhancement in the years ahead. Next, our product delivery. We rolled out a record number of products and services in 2023, providing many new opportunities for commercialization. Finally, we successfully executed a new business strategy and have experienced stable customer retention during this transition. The results of these efforts are evident in our latest financial performance and support our expectations to deliver both revenue growth and increased profitability in 2024. I'll now shift to provide additional details on our results for the quarter. Please note all comparisons will be on a year-over-year basis unless otherwise stated. As announced last quarter, we are no longer reporting partnership revenue as a stand-alone item. Beginning this quarter, partnership revenue has been incorporated into our transaction and subscription revenue line items. All prior period comparisons in my remarks today also reflect this change. Please refer to the supplemental presentation posted on our Investor Relations website for more details. Total revenue was $159 million for the quarter or up 8%. We completed 113,000 business formations in Q4, down 2%. Our market share of business formations was 9.7%, down sequentially and year-over-year. While we continue to see growth in our LLC formation product, headwinds from exiting certain partner channel relationships and the impact from our sales reorganization drove the formation and market share declines. Transaction revenue was $52 million, down 6%, driven by an 8% decline in average order value, partially offset by a 2% increase in transaction units. We recorded 215,000 transaction units in the quarter. The 2% increase was a result of strength in LLC formations and other SMB products such as annual reports, offset by lower consumer transactions and the impact from partnership exits. Average order value was $242 for the quarter, down 8% due to our lower price lineup and an increasing mix of our lower price formation and non-formation business transaction products. We expect AOV to decline in the mid-single digits in Q1 2024 with some choppy AOV trends in the following quarters as we lap the impact of partnership exits and BOIR timing where we expect to see higher order volumes in Q1 and even more so in Q4. For the full year, we expect this will translate into a low single-digit decline in AOV compared to the full year 2023. Subscription revenue was $107 million in the fourth quarter, up 17% due to continued growth in our subscription unit base and ARPU expansion. Subscription revenue outperformed our expectations, driven primarily by retention improvements in our compliance subscriptions. We ended the quarter with over 1.5 million subscription units, up 7% and our continued strength in core compliance, where growth was partially offset by the impact from the exit of legacy partner relationships. We also saw strength in our Virtual Mail and Forms and e-Signature subscriptions. Excluding the contribution from partner channel units, our subscription units increased 14% year-over-year in Q4. Our 2024 subscription units will be impacted by the continued roll-off of approximately 100,000 units from our partner channel exits, which will result in low single-digit year-over-year growth in subscription units in the first half of the year. We expect sequential improvement in subscription unit growth in the back half of the year. ARPU came in at $277 for the quarter, up 7%, driven by the transition of lower-priced department channel subscriptions. Turning to expenses and margins, where all of the following metrics are on a non-GAAP basis. Fourth quarter gross margin was 68% compared to 70% in Q4 2022. 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. Looking ahead, in Q1 2024, we expect to see a similar year-over-year decline in gross margins due to the aforementioned impact of reinstated California filing fees. For the full year, we expect our gross margin to be relatively stable versus 2023 with margin improvements in our core business continuing to be offset by lower gross margin services such as Virtual Mail and LZ Tax. Sales and marketing costs were $43 million in the quarter or 27% of revenue, down 4 percentage points from last year. Customer acquisition marketing costs were down sequentially due to seasonality but up by $1 million or 4% from the same time last year. Non-CAM sales and marketing expense was down $4 million or 27% as a result of ongoing efficiencies we have implemented in our marketing strategy as well as impact from the reorganization of our sales team. We expect total sales and marketing costs to remain relatively flat in 2024 as we fully realize the benefits from the sales reorganization which translates to approximately $8 million of savings for the year. These savings will be more than offset by an increase in CAM, including higher levels of brand spend as we look to optimize our mix of brand and performance spend. Technology and development costs were $16 million, up $2 million or 14% as we invest in product and engineering talent. Looking ahead, we expect full year technology and development expenses to grow at a slightly accelerated rate versus 2023 as we shift further into a product-led growth organization. General and administrative expenses were $15 million or down 5%. We expect a modest increase in G&A expenses in 2024 as we remain committed to expense discipline. Our strong performance in the fourth quarter resulted in $33 million of adjusted EBITDA or 21% margin compared to $27 million of adjusted EBITDA and margin of 18% at the same time last year. Deferred revenue decreased by $9 million in the quarter. As of December 31, 2023, our cash and cash equivalents were $226 million. We had no debt outstanding and no outstanding borrowings under our $150 million revolving credit facility. We did not repurchase any shares in the fourth quarter under our existing $100 million share repurchase program. For the full year 2023, we repurchased approximately 5.9 million shares for a total of $55 million or an average cost of $9.35 per share which represents a reduction of approximately 3% of our prior year fully diluted share count. Subsequent to year-end, we have been active in our share repurchase program, and we plan to continue to opportunistically repurchase shares of our common stock as part of our balanced approach to capital allocation. Our 2024 capital allocation priorities remain consistent. We will first prioritize organic investments in the business, followed by strategic acquisitions, and lastly, stockholder returns via repurchases of our common stock. Our strong cash position enables us flexibility to execute against all three of these priorities simultaneously. I will now provide guidance for the first quarter and full year 2024. For the first quarter of 2024, we expect total revenue of $172 million to $176 million or 5% year-over-year growth at the midpoint. We expect first quarter adjusted EBITDA of $25 million to $27 million or 15% margin at the midpoint. For the full year 2024, we expect total revenue of $700 million to $720 million or 7% year-over-year growth at the midpoint. This includes the following drivers

Operator: [Operator Instructions] Our first question comes from Ron Josie with Citi. Your line is open.

Jake W: Hey, guys. This is Jake on for Ron. Thanks for taking the question. I wanted to ask about the -- basically, I wanted to ask about the bundling test and iterate approach that you guys took in 4Q. What were your top learnings regarding your pricing on of? Any plans there to make pricing or bundling changes more permanent? And then second was really more on mobile app optimization. I wanted to just get a sense for any progress you've made optimizing mobile for the freemium approach and the opportunity there?

Daniel Wernikoff: Great. Thanks for the question, Jake. Yes. On the first point on testing, we've been pretty clear that, that's an ongoing effort that we'll have. And really, if you think about what's happened over the last year, a portion of our customers and the majority of our customers are coming in through our free SKUs, which changes some of the behavior around some of the subscriptions that we also market within the formations flow. And so we've done lots of different tests. Just to remind you, the goals of those tests, we kind of look at it as a 1-year bookings or 1-year return, and we always lean towards the mix of subscriptions if all other things are neutral. We also prefer to have more customers coming into our ecosystem because we feel confident that over time, we're going to get better and better at post formation monetization. And so if you step back, it's sort of the rubric we have is that we want the transactional costs upfront to be as low as possible. to get that mix to subscription. And the more we have success in the post formation monetization side, the more it just beats that flywheel and allows us to take less upfront pricing from our customers. So most of the testing that we do is sort of aligned with that strategy. We learn something every single time we do one of these tests, and we'll continue to do it, but there's nothing to announce about what we're changing. And we also are in a competitive environment. So we don't like to flag exactly what we're going to change in the upcoming quarters. Mobile is a huge focus for us. Roughly half of our sessions today that come in, the traffic with prospects is through mobile. It converts about a third of what our desktop does. So right off the bat, that there's an opportunity there. That's also a place where as you continue to increase the free messaging, you see the mix increase as well in terms of the prospects that come in through mobile. And so that's a place where you will see us doing multiple things starting in the next quarter, where I think you'll see a new experience around mobile from us that is really addressing some of the concerns we have around conversion.

Operator: Our next question comes from Andrew Boone with JMP Securities. Your line is open.

Andrew Boone: Thanks so much for taking my questions. I wanted to go back to business formations and your guys' thoughts on 2024. It's a little bit hard to parse thinking about share gains, understood, branded LZ is taking share. But how do we think about share gains for 2024 and how you guys are thinking about that? And then the beneficial ownership report seems like a significant opportunity. I think you guys said 90% plus of U.S. businesses are available now for this report. Can you just help us understand the size of this opportunity and how you guys are approaching it in 2024? And when exactly this should start to hit the model? Is it more of a 4Q thing or should it roll through the year?

Daniel Wernikoff: Yes. Thanks for the questions, Andrew. Yes, on the market share side, there are a lot of moving parts here. And just to say one more time, the partnership exits are really making that a little bit more cloudy as well as us making structural changes in our sales organization. So in the near term, as we think about the first half of next year, we expect the overall number to be lower than it was in the prior year. What we start to see at the end of the year, though is, we'll start to see a rebuilding of the share gains as more of the mix and the compares are right against our direct business. And so that's something that I think over time, it's going to write itself. We expect to exit the year in from a standpoint of our direct channel up year-over-year on share, albeit slightly. And I think the thing that we continue to do, though, is we balance monetization. I mean if you were to go back thematically and think about last year, we specifically provided share goals partially because we were also providing profitability goals. We want people to understand that this was not just about profitability, but it's about customer growth. Now that we've got a much larger base of customers we're starting to think more and more about monetization and also just deviating the base of customers and to free customers who are highly price sensitive, but we still have a lot of premium customers as well. And so we want to focus our energy there as well. So there's a lot of things to consider here, especially as that customer count gets larger over time. It compounds when we think about new products, which also dovetails with your question maybe on BOIR. So BOIR is a really interesting opportunity. We very purposely included entitlement to this offering with our existing compliance customers. We felt like if you have a subscription called Total Compliance and someone's previously bought it, that it should include entitlement to new compliance requirements that are coming out. And so that is something that actually mutes the opportunity a little bit. But we also feel like it's an opportunity to acquire new customers into our franchise. And we still have other customers who don't subscribe to the compliance bundle. So this gives us an opportunity to either upsell them into that bundle or help them just specifically with this one compliance requirement. Now the interesting thing here is this is a brand new requirement, and the rollout is going relatively slow with intend, I think at this point, they've said that they've got about 500,000 customers who have complied with the requirement. It's -- our expectation is that it will be heavily back-loaded that the -- it's most likely that most of these customers come in at the fourth quarter when you start to see the requirement probably being messaged more aggressively by FinCEN. And again, we're trying to get as many of our customers compliant as soon as possible. The requirement also for new formations is 90 days post formation for those that have formed in 2024. So you'll see it integrated into our lineup as well. So there's a lot of moving parts there. I will say that we have a pretty modest expectation for this year because of all those moving parts, but that could be a place where we surprised ourselves a little bit.

Operator: Our next question comes from Matt Pfau with William Blair. Your line is open.

Matthew Pfau: Hey, Great. I wanted to perhaps follow up on last question a little bit. Maybe just help us understand why it's a trade-off between focusing on LTV and then market share gains? Does it have to do with how you allocate marketing dollars or what's sort of behind that?

Daniel Wernikoff: It's really customer behavior. I mean what we see from our customers, especially in their initial purchase, that the more we bundle into the initial purchase to lower the conversion rate. So it's not that people start to drop things out of the cart, but they actually leave the cart entirely and probably start to consider other alternatives because what you have to remember is most people who are forming a business don't fully understand what the suite of products and services they need to stay compliant as an entity are. And through that discovery process, you see some businesses fall off. So the concern is primarily just on that initial cart purchase. The opportunity is if we can get that cart size down, and bring our customer base up and increase the size of the customer base, we can actually monetize them post formation. So a lot of our investment over the last couple of years, both in terms of creating new subscriptions, but also creating this cohesive experience in MyLZ. It's all centered on the idea that you don't need to buy all these things, the moment that you're forming your entity. Historically, we have done that because that's been the place where we've had their attention. But now we're starting to shift that into the post formation experience, which is really a very large opportunity for us over the long term. And something that we're still really early stages into and we have a fair amount of resources invested and dedicated to enhancing that experience, which is an important opportunity for us. some in this year, but even more meaningful as we look into '25 and beyond.

Matthew Pfau: Got it. It makes sense. And then Noel, can you give us any directional guidance for how to think about the split between transaction and subscription revenue growth for '24?

Noel Watson: Yes. I would say that we are continuing to focus on where we can, driving, as Dan was speaking to, the shift from transaction into subscription. I think -- on the subscription side, obviously, as we've indicated the last couple of quarters, LZ Tax is going to be a headwind for us in 2024, particularly in the first half of the year. So we'll see some of that headwind. And we gave you in the prepared remarks some specifics around it a 4-point headwind on subscription growth alone. So we'll see some moderation there. And then the transaction side is going to be largely a function of our combination of the macro, our ability to take share in all of the commercialization testing that we're doing, incorporating new products into the line up testing card size and balancing conversion with pushing customers into subscription.

Operator: Our next question comes from Brent Thill with Jefferies. Your line is open.

John Byun: Hi, thank you. This is John Byun from Brent Hill. I have two questions. One on macro and not really referring to formation, but just in SMB health and behavior. I wanted to see what you're seeing from your base? And then second, you've launched a lot of new products in '23. Just want to see how would you say the early responses among the most meaningful ones? And which one is the most exciting of those products for '24?

Daniel Wernikoff: Yes. Thanks for the questions, John. The macro, it's interesting coming out of last year, where we saw the macro grow 8%. We're entering this year a little bit more cautiously. Year-to-date, we're sort of looking at very low single digits right now in terms of growth. But one of the interesting things that we always see is when the calendar flips there's some volatility. And so we're not necessarily calling a weak macro but we're just always planning for a weaker macro because we feel like that's the right way to approach resource allocation and thinking through how we can be responsive depending on what's happening in the environment. In Q4, we were a little bit surprised by the strength in retention across a lot of our subscriptions, which would point to some nice health in small business. And then it was also interesting because we saw elevated dissolution as well. So I'd say it's a pretty muddled market and macro at this point, but we're ready for whatever direction it turns, and we don't have significant expectations around the macro for this year in terms of our guide. On your second question on how new product launches are going, what are we excited about? I mean I'd call it a couple of different things here. I mean, obviously, books and tax is sort of I think of it as peanut butter and jelly. I mean we were out with tax before, but the reality is most of the customers who come into our eco-system, they actually want to get tax insights first. And oftentimes, they have that need well before we the actual tax filing requirement. And so books is really that product that helps give them a sense of how they're doing from a tax perspective as a brand-new business and helps them get organized and think about managing their business appropriately as a brand-new small business. I'd say business licenses is just core to what we're doing as a sort of a compliance-related ecosystem. And so that one, you'll see some new releases coming out probably in the next quarter that I think will provide a little bit more clarity about how we're approaching that from a go-to-market standpoint. And probably the biggest opportunity that we don't talk a lot about is the consumer space and also becoming a platform for people to interact with attorneys. And so a lot of the things that we've done on the small business side are absolutely analogous to what we need to do on the consumer side as well as what we need to do from a platform perspective to provide experts to our small businesses. in a really low cost efficient way. And so you'll start to see some of those things coming out in the next couple of quarters as well. So we have a lot on the docket. One of the exciting things is the velocity that we had in the back half of last year is continuing through the beginning of this year.

Operator: Our next question comes from Elizabeth Porter with Morgan Stanley. Your line is open.

Elizabeth Porter: Great, thank you very much. I just wanted to ask on the investment that you're making in additional channels after cutting back on some of the direct sales heads. You noticed some increased CAM into 2024. So I just wanted to double-click on kind of the strategy there, where you're looking to make other investments in customer acquisition, where you see the biggest opportunity.

Daniel Wernikoff: Yes. Thanks for the question, Elizabeth. We've been a little bit centered on performance marketing over the last year. And we -- coming out of 2021 and '22, where we had heavy brand investments, at this point, we now have our model pretty well tuned against premium. And I think we're starting to branch out into channels like social and video but also we'll do a lighter brand investment as well. The brand investment this time will be much more actionable because again, the model to convert is kind of tuned against those -- those different customers that we're trying to reach. And then I'd also say, I just want to call out, while we restructured the sales team, we also believe that, that's going to be an opportunity as we start to go through the year because this is where we now have better -- a better view of our customers and segmentation, and we're building propensity models, and we have a multichannel approach, including MyLZ, which can now do dynamic targeting for our customers. but also the high-value customers moving more towards just specifically in sales, so we can do it a little bit more efficiently than we've done historically. So I'd say we're moving much more into like an omnichannel strategy, but still heavily reflective in being able to respond quickly with performance marketing as well at the core.

Elizabeth Porter: Great. And then just as a follow-up, I believe initially you expected subscription revenue growth to slow in Q4, but you actually -- due to the change in commercial strategy with LZ Tax. But we actually got a nice acceleration in growth in that segment. So what surprised you in the quarter? I know you mentioned kind of good retention. But was there anything else to call out there?

Noel Watson: Yes. So we were really happy with our revenue performance in the quarter, and particularly on the subscription side. And we saw the strength across multiple products in the quarter, really, Elizabeth, and Virtual Mail, LZ Tax a bit as well, but primarily in our core compliance subscriptions where we saw really improved retention that exceeded our expectations for the quarter and allowed us to outperform the guide that we had for -- we had set for Q4.

Operator: Our next question comes from Ella Smith with JPMC. Your line is open. Hi, thank you so much for taking my question.

Eleanor Smith: My first question is, I think you called out 7,500 LZ Books subscribers. I was hoping you could either qualitatively or positively profile the subscribers, for example, had most of them use LZ before? And are they cross attaching any other products?

Daniel Wernikoff: Yes. So the data point there is 7,500 subscribers for LZ Books, and they are all coming from our ecosystem. So we really didn't deploy -- initially, we deployed this just through MyLZ, and so it was cross sold post formation. And then as we proved out the experience and start to get customer feedback. We decided to put it also into our formation flow, which we really did right at the end of October. And we've seen strong attach. I think the things that we're looking for right now is good activation our customers oftentimes come in before they're operational and purchase things, and then they need to sort of have the income or the expenses before they start to use the products. And so we're -- we have a lot of activities decked against that. And we're also really watching the up-sell motion into tax, especially with season right now going on. So that's where I think we get really excited. As you are going through your taxes, if you use LZ Tax, I mean, it's a single click to upload all your data directly in it. And then also as you finish taxes, if you didn't have a way to organize your books, it's a very simple cross-sell back the other direction to introduce you to LZ Books. And so it's really built -- it's custom built as a single platform that works all the way across from just managing your expenses and connecting your banks and sending invoices all the way through to filing.

Eleanor Smith: Got it. That's very helpful. And for a quick follow-up. I am curious when thinking about the restructuring changes in your sales operations, which you've been asked in the past few years, what are the biggest key changes now and moving forward versus what we've seen at LegalZoom in the past?

Daniel Wernikoff: Yes. I mean, historically, because we didn't have a great view of our customer, we contacted just about all of our customers through sales. And it start in -- we would do an abandoner program. We would do on-boarding and then we would do continuous cross-sell depending on sometimes seasonal needs like tax. And it's a pretty inefficient motion, right? If you think about that, that's indiscriminate. So we're marketing to you in the formations flow. We're marketing to you an e-mail, and we're calling you as well, which there are a segment of our customers that are extremely high value that we can identify now, and we have propensity models that we're building, so that we're only targeting those customers with a very consultative sales experience that's much more tailor made to them. and then driving the other customers towards our lower cost self-directed channels like e-mail and MyLZ. So it's -- I would say that we're moving from more blunt force into like a much more scientific approach to how we market to our customers.

Noel Watson: And one thing just to reiterate, I think Dan said it earlier, but we're actively managing our reinvestment in sales headcount, and we have a targeted ROI and if we were able to exceed that ROI, then we will continue to invest in that organization, and that would have an impact on our top line versus our plan as well.

Operator: Thank you. There are no further questions at this time. Thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.