LegalZoom.com, Inc.

Q2 2023 Earnings Conference Call

8/8/2023

spk10: Good day and thank you for standing by. Welcome to the LegalZoom's second quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Madeline Crane, Investor Relations. Please go ahead.
spk08: Thank you, Operator. Hello, and welcome to LegalZoom's second quarter 2023 earnings conference call. Joining me today is Dan Wernickoff, our Chief Executive Officer, and Noelle 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 factor 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 consideration 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.
spk03: Good afternoon, everyone, and thanks for joining our call. I'm excited to discuss our strong Q2 financial performance and some significant product and platform updates. I'll begin with a brief summary of our financial results. Revenue came in at $169 million, up 4% year-over-year. Adjusted EBITDA was $30 million for the quarter, which equates to an 18% margin. Legal Zoom formations for the quarter significantly outperformed the market, growing 42% year-over-year, while U.S. Census formations grew 7%. As a result, share for the quarter rose 33% year-over-year, These results demonstrated continued momentum after a strong Q1 performance. Going deeper into the results, Q2 subscription revenue of $102 million grew 12% year-over-year, benefiting from both an increase in ARPU and new subscription growth from the premium lineup roll-up. Transaction AOV declined 26% year-over-year as a result of the premium lineup. Q2 represents the drop of lower year-over-year AOV performance and we expect a reversion of this trend in the back half of the year as we lap the new lineup rollout. Now I'd like to lead with an overview of an important product addition to our portfolio. Last week, we announced the launch of LZBooks, which supports all three of our strategic pillars to scale the business, build the ecosystem, and integrate experts. One of the biggest challenges our customers face when launching their businesses is navigating the complexities of bookkeeping and taxes. After being in the market with LZ Tax for two years, we've recognized there's a gap in the market for solopreneurs. These businesses have tax questions at formation that require an expert. They want a simple accounting solution to replace tedious offline methods like storing bank statements and receipts. And they want an integrated and simplified tax experience. Their main alternative today is to navigate complex and expensive accounting software and couple that with an offline accountant. These solopreneurs are a key customer demographic for LegalZoom. Based on a recent customer study, roughly two-thirds of our formation customers are solopreneurs, which we define as either single-member LLCs or sole proprietors. Over 90% of our formation customers form with us before they consult a business tax professional, and only a little over 5% have established a bookkeeping method prior to forming with us. We've built what we believe to be the most well-designed solution for this large market. With LZBooks, you'll be able to create your first proposal with access to an attorney if needed, send it for digital signature, go from invoice to electronic payment, download and auto-categorize expenses from your bank account, and even more importantly, seamlessly integrate with LZTax. During the launch, we'll also be providing free unlimited access to a CPA through the product to introduce and promote the value of our highly vetted network of accountants. LZBooks reaches across all our strategic pillars. Our first strategic pillar is to scale the business, and LZBooks represents a new customer entry point for LegalZoom. LZBooks can serve an SMB that formed with us already or someone who has not yet formed but is looking for a simpler, lower priced alternative to today's bookkeeping solutions. Our second strategic pillar is to build the ecosystem. LZBooks is a tool our customers will leverage beyond the point of formation, driving engagement while also opening up a new financial ecosystem of subscription services. Our third strategic pillar is to integrate experts, and LZBooks is designed to cohesively integrate with our expert offerings. Accounting and taxes go hand in hand, and LZBooks users who subscribe to LZTax will be able to transfer their data to our CPAs to simplify tax time. We believe this represents a meaningful opportunity to naturally upsell our LZTax service at the moment of need versus selling LZTax to customers that may not be required to file a return at the time of formation. In addition to our LZBooks announcement, we also continue to make significant progress across our entire subscription ecosystem. On prior calls, I've noted the lack of an integrated post-formation experience. In line with our second pillar to build the ecosystem, the creation of a cohesive experience within MyLZ has been a top priority. Along with the launch of LZBooks, we've launched a complete redesign of the MyLZ experience. This is important for a couple reasons. First, many of our solutions are more valuable together than apart, like forms and e-signatures, or proposals and attorney consults, and now books to taxes. And so the experience needs to be fluid across offerings. But equally important, as we're creating a central hub for small business compliance, our goal is to drive engagement that will enable post-formation discovery and cross-sell. Our formations channel is incredibly powerful. And over time, we believe we can expand our relationship post-formation through the MyLC experience. I'm excited by this significant redesign and by the realization of our goal of creating a new software category serving small businesses' legal, compliance, and financial needs in a single destination, which is something that doesn't exist anywhere else today. And while it's a meaningful first step, we'll continue to invest, and our customers can expect ongoing enhancements as we continue to build out the experience. Turning to our core business and our first strategic pillar, scale to business, In Q2, we drove impressive market share gains while also improving operational efficiencies in our core formation business. We're benefiting from our infrastructure investments to streamline fulfillment, which are lowering the cost per formation unit while helping us fulfill orders quicker for our customers. In the near term, these efficiencies will continue to be offset by higher filing fee costs and the scale of LLC tax and virtual mail. Our premium offering continues to resonate in the market. In Q2, CAM was down 18% with traffic improving and almost all marketing efficiency measures showing strong results. Overall user session growth was strong, up 13% for the quarter. A better measure to assess health and intent is SMB product sessions, which was up more than two times our user session growth. This metric strips out the consumer side of the business as well as lower intent educational traffic and focuses solely on people that begin the product purchase flow. As a result of increasing traffic, we believe there are more opportunities to improve conversion as we refine the offering to fit this new expanded audience. Finally, regarding our third strategic pillar, integrate experts, we continue to make steady progress. In our first tax season, our focus was on understanding our customers' needs while beginning to build out an online experience. In our second season, we rolled out enhancements to the LZTax product and platform improved commercialization, and increased service levels. As a result, we remain on track to double the number of tax returns we file in 2023. But as I mentioned in our last earnings call, we remain constructively dissatisfied with the retention rate of this service. In anticipation of our third tax season, we've identified a clear set of opportunities within our control to make sure that we're getting the right experience to the right customers and retaining them for longer. Our actions here will focus on driving higher customer consideration of our tax products. As we narrow in on the right audience, the resulting impact will likely be a period of lower attach rates while still experience higher attrition rates from our existing base. We expect this will drive long-term positive results, but will be a headwind to revenue into 2024 as we work to implement these changes. We remain confident in the long-term opportunities surrounding ELSI tax. especially as you consider the most important feature of taxes is integrated bookkeeping, which we now offer. We're also hard at work to integrate experts with a generative AI-powered product. By the end of the year, we expect to have a reimagined product and platform that will help small businesses review, understand, and collaborate with experts on legal documents. As I've said before, generative AI can't replace attorney advice given challenges with accuracy, as well as regulations around the unauthorized practice of law. We believe that only when coupled with access to an attorney can the full power of GenAI be realized. LegalZoom stands apart from our competitors as a platform with an established network of independent attorneys available to unlock this opportunity. We believe this platform will drive many growth opportunities. Recall that legal documents are a very small portion of our business today. As the brand and market leader in the SMB legal services space, This is an unrealized opportunity that we feel like is ours to win. In addition, it will leverage the power of our ecosystem. Our attorney network and e-signature offering are core components needed to bring legal forms to life through a very contextual cross-sell. We look forward to providing more details on our efforts here in the coming quarters. Last quarter, we unveiled our new mission to unleash entrepreneurship, and it's clear we're making significant progress against this goal. We're setting ourselves apart as the sole online platform providing the solutions small businesses need right at the time of formation and beyond, all under one roof. Product innovation is what drives long-term growth. I've been mentioning product velocity as a focus over the last couple of quarters, and I'm energized by the pipeline. There's still more to come this year, both in terms of our LZBooks roadmap and other new product releases in the queue. In closing, I'm extremely pleased with our second quarter results. During Q2, we demonstrated solid performance with record share gains and continued fiscal discipline. I'm excited about the talent we have in place, the customer growth we're achieving, and most importantly, the pace of our innovation. I'm also excited for what's to come as we're still in the early innings of our product evolution. I'd like to acknowledge and thank all of our LegalZoom employees for their hard work and dedication towards helping unleash entrepreneurship. And with that, I'll turn it over to Noelle. Thanks Dan and good afternoon everyone.
spk06: I'm pleased to discuss our continued strong performance. We remain focused on re-accelerating revenue growth and improving profitability. In the second quarter, we significantly expanded our adjusted EBITDA margin year over year through continued marketing efficiency and cost discipline while also growing our top line. Looking at our second quarter results in more detail, Total gap revenue in the period was 169 million, up 4% year-over-year, and exceeded the top end of our guidance range. Transaction revenue was 60 million, down 7% year-over-year. We experienced strong growth in transaction units, offset by a reduction in average order value, driven by the full rollout of our new premium lineup in Q1. Transaction units were 283,000, up 26% year-over-year, led by the increase in business formation transactions and partially offset by a decline in consumer and intellectual property transactions. We completed 161,000 business formations in Q2, up 42% compared to the same period last year. Our market share of business formations increased 33% year-on-year to 11.4% due to the new lineup. Looking ahead, while we expect to achieve at least a 15% year-over-year increase in market share for the full year, we do expect year-over-year growth and share gains to moderate in the back half of 2023 as we begin to lap the initial testing and expanding rollout of our free product and wind down certain channel partnerships. Average order value is $214 in the second quarter, up sequentially from the first quarter and down 26% year-over-year, driven by our lower-priced lineup. We expect the year-over-year decline in average order value to improve to low single-digit declines by the end of 2023 as we lap our freemium rollout and exit certain historical partnerships. Subscription revenue was $102 million in the quarter, up 12% year-over-year due to an 11% increase in the number of subscriptions and continued improvement in ARHU. Looking ahead, we expect subscription revenue growth to decelerate slightly through the remainder of the year as a result of headwinds and LZ tax, and to a lesser extent, the aforementioned changes in our partnership channel. ARPU came in at $259, up 3% year-over-year, and flat sequentially from the first quarter. The year-over-year increase can primarily be attributed to the increased mix of higher price tax and virtual mail subscriptions within the total subscription base and pricing improvement in our consumer subscriptions. Looking ahead to the back half of 2023, we expect year-over-year ARPU growth to remain in the low to mid single digits. However, as we launch new products and continue to test and optimize our lineup, we are focused first on solving for the best overall outcome from a customer experience and lifetime value standpoint. Partnership revenue was $6 million, up 2% year-over-year. Turning to expenses and margins, where all of the following metrics are on a non-GAAP basis. Second quarter gross profit margin was 65% compared to 67% in Q2 of last year. The decline was driven by higher filing fees as a percentage of revenue as a result of increased business formation volumes, as well as an increase in revenue mix from LZ tax and LZ virtual mail. which are still subscale in an investment mode. Sales and marketing costs for $51 million in the second quarter were 30% of revenue, an 11-point improvement from Q2 of last year. This includes an 18% reduction in customer acquisition marketing costs year over year. We expect sequential declines in CAM spend in each Q3 and Q4 as we remain focused on marketing efficiency gains. Technology and development expenses were $14 million in Q2, up 3 million or 25% year-over-year. We expect similar year-over-year growth in this line in the back half as we invest in product and engineering talent. General and administrative expenses were $15 million in Q2, up 1 million year-over-year. Our solid revenue results and continued focus on profitability drove stronger than expected adjusted EBITDA of $30 million for the quarter, reflecting an 18% margin. This compares to adjusted EBITDA of $18 million or 11% margin in the second quarter of 2022. Our deferred revenue decreased $2 million from the prior period. In the second quarter, we continued to execute on our $150 million share repurchase authorization. we repurchased a total of 378,000 shares of our common stock at an average price per share of $8.04 for a total repurchase of $3 million. Since inception, we have completed approximately $105 million in buybacks with a total of 10.4 million shares repurchased. As of June 30th, 2023, we had cash and cash equivalents of $239 million and no debt outstanding. I'll now provide guidance for the third quarter and full year 2023. Macro conditions remain a key factor in our performance and outlook. Census business formations remained healthy in the second quarter and have been steady year to date. We've adjusted our outlook to reflect current trends. Based on these factors, we currently expect third quarter total revenue of $159 to $161 million, or 3% year-over-year growth at the midpoint. and third quarter adjusted EBITDA of $26 to $28 million, or 17% of revenue at the midpoint. For the full year of 2023, we are raising and narrowing our guidance for total revenue to $642 to $652 million, or 4% year-over-year growth at the midpoint. As a result, we are also raising our full year adjusted EBITDA to a range of $105 million to $110 million, or 17% of revenue at the midpoint. And with that, let's please open the call for questions.
spk10: Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Andrew Boone from JMP Securities.
spk07: Thanks so much for taking my questions. Two pleas on LZBooks. I'd like to step back and think about becoming more of a system of record business. Dan, what does that unlock in like three to five years? What does this enable you to do as you guys become, just have higher touch points with consumers? And then secondly, nearer term, how do we think about LZBooks in 23 and 24? What do we think about in terms of timing? Thanks so much.
spk03: Yeah, thanks for the question, Andrew. Yeah, LZBooks is a big bet for us. I mean, I think it's probably worth just stepping back and explaining why we entered this space first and then get to the question on engagement. But first principles is we go where our customers take us. And we just haven't found a solution that maps really well to the core segment of customers that we have that are solopreneurs. And these are smaller businesses, single-member LLCs, sole props, typically don't have employees. And what we've seen is that most providers use a simple SKU more as a teaser to move a customer up the lineup than to really solve that very specific need. And what that means is, you know, one of, one of a couple of things happens either. Um, they're sort of limited in terms of the functionality to drive people up a lineup or over time, it just gets bloated. It gets feature rich. And if it gets successful, it gets over monetized. And so, um, again, two thirds of our base are these types of customers, and we just haven't found something that's been purpose built for them. Um, so, you know, when we think about our channel. 95% of our customers, they come in without an accounting solution. We know that a lot of people come in with tax questions, and they don't need a full-time accountant, but they have very specific tax questions that they want to ask, and two-thirds of them have never even spoke to an accountant about their business. So this is a group that's being introduced to finances, introduced to taxes, And so we felt like we have to be there to get them established right in their books. And if you want to do that, you have to do it in a way that's going to get to the ultimate integration with doing taxes as well. One of the things that we've been talking about from the beginning is we have this extremely powerful formations channel. But post formations, historically, there hadn't been as big of an investment. we're now making that investment. And the key opportunity there is to drive ongoing engagement, which then also opens up the opportunity to expand our relationship with customers in a way that's more organic and natural for them. So even if you take an example of LZ tax, I've mentioned this before, almost half of our customers, you know, they're, they're non-operational when they come to us. And yet we market in the formations channel to them, because we traditionally haven't had a place to market post-formation. So something like LZ Books really provides ongoing value and engagement, and then in a much more natural way, as it becomes tax time and we've helped you with your books, we can introduce you to an account, we can introduce you to LZ Tax in a way that's going to be much more of an expansion of the relationship. And that goes well beyond just books and taxes. I mean, that goes into, you know, forms turning into e-signatures. You know, it goes into legal doc reviews turning into, you know, attorney consults. Most of our products want to work together. And so that's what we're really trying to do is drive that engagement on an ongoing basis. And then Noel, you can take the second one on the revenue.
spk06: Yeah. If that's a forecast question, Andrew, um, for, for 2023, we don't have anything in the forecast for it right now. Um, we're really just focused on, on the user experience and learning, uh, over the next few months. And then that'll help to shape some of our assumptions around it from a modernization standpoint, moving forward.
spk03: And we really do want to learn from our customers there. I mean, it, it, it's definitely is a, is a business in and of itself. But we also feel like one of the real benefits, again, is going to be retention on the LZ tax solution and subscription, where people we've seen come in, they get a couple of questions answered, but they don't necessarily have any more. And it's six months from tax season. And so we see higher attrition as a result of that. The idea of driving that ongoing engagement, we think, will definitely lead to a better LZ tax retention rate as well. But we really, to Noel's point, that's not something that we're necessarily focused on initially in terms of driving revenue necessarily. It's much more let's learn from our customers and then let's build off of that.
spk07: Thank you.
spk04: Thank you.
spk10: Thank you. One moment for our next question. Our next question comes from the line of Ron Josie from Citi.
spk01: Great. Thanks for taking the question. Maybe a little bit more on the here and now. And can you just talk a little bit more, Dan Noel, around just business formations? It looks like in June there was a change in trajectory overall from what we saw in May. And so any thoughts on the updated broader macro picture? I'm sure you do in terms of how you think about S&P formations and where we stand overall. And then maybe just on the trends in the quarter, Insights on just a subscription upsell, right? We're seeing benefits in terms of greater share gains. Talk to us about these newer premium customers. What are they buying? How are they acting? Things along those lines. Thank you.
spk06: Thanks, Ron. This is Noel. I'll take the first half and then maybe pass the second half to Dan. So on the macro, yeah, you called it. The macro has really been steady year to date and consistent, which is great. We did see some improvement in Q2, and as we said on our prior call, we had updated our expectations for the macro for the second quarter relative to the trends that we were seeing. And we're doing the same thing here with our third quarter guide, looking at the recent performance, factoring that in, and then raising our Q4 expectations as well. So we're overall a bit more bullish, just given the length of the consistency that we're seeing there. We are still leaving some room and embedding some room in terms of caution, particularly in our fourth quarter expectation for the macro. Just as we've done year to date, just being cautious as we know things can soften and we know there's still some prognostication around the overall economy slowing. But overall, we've taken up our expectations for the macro.
spk03: Maybe just a quick add on the macro. I think macro is, you know, we've talked about there's the historical growth in the macro and whether or not there's a little bit of a trajectory change post-COVID. And I think, you know, we've given the data before of, you know, it's just simple to start a business. There's little risk of capital, lots of platforms. There's, you know, tech that can, you know, make reduced barriers, get you sort of, into a market much quicker at a lower cost. All that's really pretty incredible. And we think durable. The thing that I think is newer is the work from home dynamic. And one of the studies that we recently just put out on our own base showed that over half of our customers started their business while they were working in their prior employer. And a good portion were obviously working from home as well. And if you think about the dynamic of people going back to work, a lot of that is part-time going back to work versus sort of more of like a hybrid model. And we think that that's a pretty durable trend as well. So the macro feels like it's strong. It remains stronger than we expected. And yet at the same time, we're just cautious. That's just kind of how we've been managing it. On the subscription attach for new customers, I'd say it's doing exactly what we'd expected it to do. The core subscriptions that we look at are the compliance subscriptions, as well as our attorney assist subscription, and they continue to attach at a nice rate. The rate, again, is slightly lower than what it was in the past, but it's overwhelmed by the fact that you're seeing such significant formation growth as well. And we're also really starting to track to the retention dynamics of those customers, and they look relatively stable relative to the prior cohorts that we have. Although the one thing we'd say is we're going to be kind of cautious in thinking about what that looks like when we get to annual renewal, because that's where the bulk of our customers actually renew, and we're conscious of there's many different types of customers in our base, and so we'll watch that closely.
spk01: That's great. Thank you, Dan. Thank you, Noelle. Thanks, Ron.
spk10: Thank you. One moment for our next question. Our next question comes from the line of Matt Foe from William Blair.
spk00: Great. Thanks for taking my questions. I wanted to ask around the commentary on the LZ tax changes. I think just some more detail there. In terms of, you know, what you're doing and why it's going to create some additional churn this year would be helpful to understand that dynamic with better.
spk03: Yeah. Thanks for the question, Matt. You know, I've said this before, tax is just such a unique business because you get one swing every season. And, you know, our first season was, was one where we relied on people to be the glue and didn't really have a lot of software in place to make the process efficient. and also make it delightful. And I think, you know, in the second season, we made a lot of changes, a lot of updates, and improved the experience. We're seeing filing, you know, increase, which is great because we know that ties to better retention. But we still have a lot of work to do there. And if you step back, what I'd say is interesting to reflect on, I mean, this is a very fast-growing business. Probably in some ways it grew faster in then I think we were capable of supporting that business as we went through that scale with an incredible experience. And now we're sort of right-sizing that experience. We're continuing to invest in it. We're also starting to tamp down Attach in a way. We want to get the Attach lower because we keep finding that our customers, they know they have a tax question, but they aren't really sure what it is. And so they sign up for the service, and then they may ask that question, and then they realize they either don't have more questions or they don't have a return to file, and so we see higher attrition. And that churn is something that is expensive for us to support, but it's also not a great customer experience because they have to go through a cancellation process. And so what you'll start to see us do is make the purchase a little bit more considered. So we've done this as a monthly subscription. We're testing things like doing an annual subscription. You might see us pull it out of specific segments of customers, not really offer it as cross-sell. And the great news there is we now have other products that we can cross-sell that are more relevant, like LZBooks. And we also have a post-formation experience where we can we can actually cross-sell with to an engaged customer. But the reality is, what that means is, in the short term, our attach rates will come down for newer customers. And in the near term as well, we'll still have those higher attrition rates until the new channels pick up and the new motion, it hardens. I would say that we're extremely excited about LZ Tax, especially when we have LZ Books in the mix as well. And it's been a fast grower. But in some ways, we're taking this opportunity as well to make sure that we create the right experience and we're focused on long-term durable growth versus more episodic growth tied to the churning customers.
spk00: Great. And then just was hoping to follow up on the other component of the deceleration in a subscription growth in the back half of the year that the channel partner component, maybe just a little bit more commentary on that would, would be helpful.
spk03: Yeah. I mean, I think one of the things we we've said for a couple of quarters here is that, you know, given the share gains that we're, we're starting to realize, we felt like this was the right time to reset on some of our partnerships where they weren't bilateral. And instead, they were vendor-like relationships where, in most cases, they're dilutive to economics. And so, you know, that's what we're doing. We committed at the beginning of the year. If you remember, at the middle of last year, we committed for this year to have a 15% share gain while also getting to 15% EBITDA margin. We take both of the commitments really seriously. And, you know, we're going to achieve both. We expect to achieve both. And so I think in some ways that share tied to those partners didn't really fit within that profitability goal. And so that's all we're doing. We're cleaning that up. I think in a lot of ways, hopefully you've seen us, you know, multiple times really manage our portfolio and take an opportunity when we have some strength to work through something that we don't necessarily feel like is a long-term strategy. And that's exactly what we're doing here.
spk00: Great. Very helpful. Appreciate it.
spk10: Thank you. One moment for our next question. Our next question goes in the line of Jackson Ader from Moffitt Nassainson. All right.
spk05: Great. Thanks for picking our questions, guys. Dan, you touched on this a little earlier, but can you remind us the mechanics or maybe some numbers around that first-year retention rate that you have traditionally seen in the past from business formation and maybe subscription customers? And then... Yeah, just any color you think about as we look to 24 and we start to renew this kind of much larger 2023 cohort, what we should be expecting from the different segments.
spk03: Yeah, we don't share any cohorted retention numbers for our subscriptions at this point. I think we talked about before, one of the challenges we have, we have a portfolio of subscriptions how they attach their relative nature, all of that plays into what we see at the individual level of subscriptions. And so, you know, we've recently provided more like an annual churn number, which is slightly improved for the quarter. What I have said in the past is, you know, we obviously are serving small businesses that almost verge on the side of like a consumer behavior in that, you know, a good portion, almost half of the businesses that form with us are not yet in operation. And then at the same time, you know, the stats are out there that about 30% of businesses fail in the first year. And so you can almost assume that just on the failure side alone, that's sort of the ceiling that you can, you can reach of, you know, probably a little bit below 70% on retention.
spk05: Okay. All right. Got it. And then, um, just on, on healthy tax and healthy books and compliance and turning all these, all these things that are kind of like, I think some of these that, you know, like you're becoming more of a system of record. And I'm curious whether, you know, just strategically, whether you're thinking at the moment, it's like a bunch of different separate offerings, right? Like 99 or $9.99 a month for this. And then a separate thing for that. Any thoughts on just, one big broad bundle or something, or like a package, a bunch of different stuff together that might drive additional stickiness?
spk03: Yeah, it's a really good question. And actually, like, if you think about one of the big announcements we have this quarter, it's a complete redesign of the experience post-formation. We called it internally Project Negroni, but externally, it's really just our MyLZ experience, which had been almost a launch of multiple different applications that had very different experiences across. What you'll see now if you go into the account experience in MileZ is a uniform experience. And that's the first step of starting to think about how we commercialize all the post-formation applications that we have a little bit differently so that they maybe over time instead of selling in LZ books and an LZ tax solution separately with e-signature, maybe there's a package very specifically as sort of like a premium skew tied to books to tax and it includes something like signature. Or maybe there's something where you sort of have a good, better, best lineup that gets into you have simple legal needs, more complex, and then premium needs. So the first step in being able to even approach commercialization differently than how we've done it historically, is to make the experiences uniform so that they can become integrated solutions and can be packaged differently. And that's what we did with this release. So I encourage everybody to go log in. It's a bit night and day. I mean, it's a complete redesign of the product, and it looks more like a traditional SaaS application. Awesome.
spk05: All right, great. Thank you.
spk03: Thanks.
spk10: Thank you. One moment for our next question. Our next question comes from the line of Mario Lu from Barclays.
spk04: Hi, this is Jack Butler. I'm from Mario. Thanks for taking my questions. Starting out, regarding the freemium model, so you've had a great amount of success the past couple quarters with 27% in share gains in Q1. I think you said you had around 33% share gains in Q2. Given the strong performance you have demonstrated these past few quarters, are you seeing any signs that the competitive landscape could be changing for the freemium offering moving forward or anything like that? And then just unrelated, I know you've talked about this a bit on prior calls, had one announcement earlier in this call about it, but in terms of generative AI, I was just wondering whether there was any update to how you were thinking about the role that Gen AI might play in the business, whether the focus might be on improving current offerings you have, or if there's a way, you know, further ways AI could expand your offering suite, or just, you know, maybe anything else about how the strategy is evolving.
spk03: Yeah, okay. Thanks for the questions, Jack. First one on competition, I think we have seen competitors adjusting price down in response to our new lineup, and And all of that's great for all small businesses. So we encourage prices down, especially on the formation side. It's worth noting, though, one thing we haven't seen from competition is a heavy investment in their product experience and launching new subscriptions and creating that ecosystem, which is what, in our case, is helping us fund that reduction in pricing. So I think it's probably impacting them disproportionately relative to us. You know, we haven't seen a big change in marketing spend levels by competition. And I think, you know, one of the things I would say that is probably, it goes without saying, is the biggest opportunity for us is a little bit more around non-consumption and going to attracting customers that typically have gone to the Secretary of State site themselves and kind of muddled through the experience. We know that that has had a strong negative net promoter score associated with it. And we also know that the customers that visit us have disproportionately visited the Secretary of State site before us, much more so than any of our competitive alternatives. So I think a lot of what we're doing on the pricing side is actually pulling from people who may have tried to navigate those sites on their own, get all their questions answered, done a lot of research in different disparate spots. We've just made that whole experience much more simple and taken the decision point away by reducing that price so that they could form with us. And then when they form with us, they're being introduced to a lot of new subscriptions. So I think that's probably the bulk of the trend that we're seeing. On the generative AI side, we talked about this last call. you know, foreshadow product releases before they're out there. I think the thing I'd say is that we're making steady progress. We're trying to do something a little bit different than I think most of the alternatives in the market in that we wanted to serve small businesses directly. You're seeing a lot of Gen A products, Gen AI products that are built very specifically for attorneys and law firms and And so there's some things that we need to work through to make that possible. But it will most likely be integrated in a way where, you know, you start to think about how people interact with docs, how they interact with their attorneys through documents, and, you know, how they get insights out of their documents. And so it's very similar to what I said last quarter, making good progress. And you'll hear some announcements in the next quarter or two.
spk04: Great. Thanks. That's really helpful.
spk10: Thank you. One moment for our next question. Our next question comes from the line of Brent Thill from Jefferies.
spk02: Hi, this is John again for Brent Thill. Thanks. The question, obviously, you've done very well with the business formation, the freeman product, very high growth, 42%. Transaction units also very fast with 26%, but obviously there's a doubt. I'm wondering how you're thinking about Is that according to your expectations? How do you expect a lot of those that don't actually end up attaching to convert over time if there's a certain cadence? And then second, I'm wondering how you're managing the weight on the gross margin from the free filing fees.
spk03: Yeah, great. Great question, Sean. Yeah, on the first one, what weighs down some of the aggregate transaction growth is really the consumer side of the business. And we've been clear that we've been prioritizing pretty aggressively on the small business side relative to consumer. One of the interesting things, though, is that the foundation of our consumer business are forms. And so the nice thing about making the investment that we're currently making that is both an integration of Gen AI capabilities as well as attorneys directly onto a new forms platform should ultimately translate into a reinvigorating of our consumer side of our business. And, you know, we have nothing new to announce at this point or any, you know, this year, I would say, on the consumer side. But I will say that it's the first time there's been an investment there in probably almost a decade. And so I would expect that, you know, we'll start to turn that corner hopefully in the next year or so. On the margin side, you want to take that, Noel?
spk06: Sure. Yeah, on the margin side, so as you mentioned, I think, at the beginning of your question, John, the business formation growth that we saw in the quarter at 42%, that higher volume is driving higher filing fees, and so that's what we're seeing impact margins as filing fees as a percentage of revenue have increased. We also have two businesses that are growing fast that are still subscale in tax and virtual mail that have a slightly different margin profile. And as those kind of take up a bigger share, it weighs on margins a bit. We are excited about the fact that we continue to make progress on the core business in terms of the efficiencies that we're driving in delivering the services. So over time, as those businesses, the faster growing businesses start to get to scale and we get more leverage, we'll see some margin improvement in support of the efficiencies we're driving on the core side of our margin profile. Okay, thank you.
spk10: Thank you. One moment for our next question. Our next question comes in the line of Elizabeth Porter from Morgan Stanley.
spk09: Hi, good evening, everybody. This is Fiona Hines. I'm for Elizabeth Porter. Thank you for taking the question. I wanted to ask on the channel partner side of the business, where are we in resetting that side of the business? Any view on what inning we're currently in? And longer term, sort of what the vision is for that part of the business on a go-forward basis?
spk03: Just for clarity, do you mean the partnerships where we're marketing third parties or the partnerships where we're distributing our service through a channel?
spk09: I guess an update on both would be very helpful.
spk03: Okay. Yeah, on the partner channel side, we mentioned it up front that we're currently exiting a couple relationships because They have dilutive economics, and we're not just focused on share, but we're also focused on profitability. And so that will lead to a deceleration in growth in the back half on share gains. But on the partner side, where we're distributing third parties through our platform, that's going extremely well. Um, and there's a couple of moving parts there. We've exited some partnerships that we talked about at the beginning of the year. Um, while at the same time we have newer partnerships where, you know, we're, we're actually seeing, um, growth that is exceeding the growth of our core business. It's just at a, on a very, very small base at this time. So, um, we're excited about it over time. Again, we, we have an incredibly powerful channel, um, and, and our customers are, are quite actively asking us what are best in breed solutions. And we're getting better and better at targeting what we offer specific customers. So, you know, we'd expect that to continue to accelerate. But again, off a much, much smaller base than the core business.
spk09: Understood. Thank you for the question.
spk10: Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.
Disclaimer

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Q2LZ 2023

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