LegalZoom.com Inc
NASDAQ:LZ
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Earnings Call Analysis
Q2-2024 Analysis
LegalZoom.com Inc
In the recent earnings call, LegalZoom reported quarterly revenue of $177 million, marking a 5% increase year-over-year, exceeding expectations primarily due to stronger-than-anticipated fulfillment. However, the company also acknowledged a challenging macroeconomic environment, with a notable 6% decline in EIN applications, reflecting reduced business formations that are expected to persist.
Despite positive revenue trends, LegalZoom's performance in business formations showed signs of strain with a 17% decrease in completed formations compared to the prior year. This decline was tied to broader market trends, as the company observed a drop in its market share relative to census EIN data, which was noted to be around 10%. On a more positive note, subscription revenue reached $109 million, up 6%, thanks to a 4% increase in subscription units and improved average revenue per user (ARPU) of $271.
LegalZoom's gross margin improved to 68%, up from 65% a year prior, driven by lower filing fees and efficiencies in service delivery. However, operational costs surged, primarily in sales and marketing, which increased 13%. The company indicated that its customer acquisition expenses would normalize in the third quarter and expected overall operating expenses to yield approximately $25 million in annualized savings due to a workforce reduction and hiring freeze.
For the full year 2024, LegalZoom reaffirmed its revenue guidance between $675 million and $685 million, projecting a year-over-year growth rate of approximately 3% at the midpoint. This outlook reflects anticipated mid- to high single-digit declines in business formation metrics. Additionally, adjusted EBITDA is expected to be in the range of $135 million to $145 million, signaling strong margins despite ongoing macro pressures.
With the leadership transition to CEO Jeffrey Stibel, LegalZoom is reorienting its focus toward enhancing its subscription model while improving customer retention rates, which hovered around 60% for subscriptions. Efforts will include refining go-to-market strategies, particularly for its SMB products, and leveraging artificial intelligence tools to bolster customer services. Aiming to boost value perception and reduce churn, the company plans to explore bundling freemium products with compliance services.
During the second quarter, LegalZoom intensified its share repurchase program, increasing authorization from $100 million to $175 million, with $125 million invested in buybacks, reducing its share count by 7%. This move underscores the management's confidence in future growth, notwithstanding existing operational challenges.
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Thank you for standing by. My name is Alex, and I will be your conference operator today. [Operator Instructions]
I would now like to turn the call over to Madeleine Crane, Investor Relations. Please go ahead.
Thank you, operator. Welcome to LegalZoom's second quarter 2024 Earnings Conference Call. Joining me today is Jeff Stibel, our Chairman and 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 that just believe, expect, plan, anticipate, will, intend, and similar expressions and are not and should not be relied upon future 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 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 in making decisions regarding our business, and we believe these measures provide helpful information to investors. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations of all non-GAAP measures to the most directly comparable GAAP measures are set forth in the Investor Relations section of our website at investors.legalzoom.com.
I will now turn the call over to Jeff.
Good afternoon, everyone, and thank you for joining our call. I want to start by saying I'm honored to be serving alongside our talented leadership team, and I want to thank our former CEO, Dan Wernikoff. Under Dan's leadership, LegalZoom has built a deep bench of talent, improved its technology infrastructure and created key assets that we believe are positioned to empower LegalZoom for long-term success.
Let me briefly discuss my history with LegalZoom, our leadership transition, and why I am excited to take on this role before diving into what you can expect from us over the coming months and quarters. I've been deeply connected with the needs of the small business community since the founding of my first business, Simpli.com, early in my career, where I learned firsthand the complexities of business formation and ongoing compliance requirements.
In 2006, as CEO of Web.com, I was introduced to LegalZoom, as a large strategic partner. I quickly understood the power of the unique opportunity LegalZoom was capitalizing on, establishing relationships with small business owners at the earliest pivotal moment in an entrepreneur's journey, business inception. Watching the company's success unfold, I have seen a small business itself emerging to the powerhouse of the industry.
Almost 25 years since our founding in category creation, our brand has 5x the awareness of any competitor. We've incorporated 4.4 million businesses, helped over 4.2 million consumers with estate planning and have over 1.6 million active legal and compliance subscriptions outstanding, yet LegalZoom only accounts for just over 1% of our massive addressable market of over $50 billion. I have strong conviction in the opportunity that lies ahead.
I'm excited to be taking an active and direct role in executing the strategy of the business, operating on a day-to-day level and driving accountability throughout the organization, starting with myself. The Board felt my history and experience made me uniquely qualified to partner with our team to drive change. At Web.com, I helped establish the company's strong market share position. At a predecessor company acquired by Dun & Bradstreet, I helped to grow our free and paid subscriber count by over 500%. And at Bryant Stibel, we helped numerous companies accelerate growth and enhance profitability.
Having served as a Board member since 2014, a large investor since 2017, and our Chairman since 2018, I possess strong knowledge of our product offerings, technology infrastructure and attorney network, as well as a deep understanding of the competitive landscape and our customer segments. Finally, as the largest individual investor in LegalZoom, I am fully aligned with our shareholders, who see tremendous value potential in the business and want that value to be realized in the market.
Forming a business is exciting, but it's also overwhelming and incredibly complex. For our customers, forming a loan on a Secretary of State website is confusing and asking an off-line attorney for help is expensive and often out of reach. We've earned organic traffic through our brand name recognition, our reputation and our pre-proprietary educational content. So as small business owners try to navigate a formation on their own, they often find themselves at LegalZoom.
For our customers, forming with LegalZoom means they have found a trusted partner, and for the over 60% of customers, who are first-time business owners and sole operators, we may be their only partner. We support these customers through the 6 separate government agency requirements needed to form a business, including the Secretary of State, the IRS and the Financial Crimes Enforcement Network, or FinCEN.
We educate and guide these business owners on the requirements and provide solutions to keep them safe from non-compliance and hefty fines. This includes providing a registered agent, annual report filings and determining the right business licenses to operate, and we are the only online formations company with both an owned law firm and an independent 50-state attorney network at our customers' disposal.
LegalZoom provides our customers with protection and peace of mind. This is the core of what we do, but our execution has fallen short. We haven't effectively educated our customers on the long-term SMB journey and the value of our subscription products, which has limited our ability to fully monetize our customer relationships. This has led to an overdependence on transactional revenue tied directly to macroeconomic activity for small business formations, as evidenced in our latest guidance.
I believe our business should be tethered to the recurring services needed by millions of small businesses, well beyond the formation and regardless of where we sit in the macroeconomic cycle. Importantly, the last 2 quarters of our performance have shown a deceleration in our subscription revenue growth. And more recently, we have seen softer retention rates in our compliance subscriptions, particularly in our freemium cohort, where we have filled that gap in large part, has been through transactional revenues. We can do better, and we know what needs to be done. We need to do a better job educating our customers of the problems we solve over time. We need to offer the right products to the right customers at the right time. As a result, we will be changing key components of our execution.
To be clear, we are focused on 3 priority areas in the near term. You should hold us accountable for our success in this regard. First, optimizing our subscription business; second, reorienting our go-to-market strategy; and third, leveraging AI to deliver even greater expertise to our customers. We believe aligning our organization around these priorities will increase the predictability of our business, improve operational efficiencies and margins and help us accelerate and sustain growth at scale.
We are making changes to how we execute in order to best capitalize on the opportunities ahead. This includes the difficult decision to restructure the organization, including a recent reduction in our global workforce of 15%. These actions reflect the realignment of our business to drive efficient growth and affirm our commitment to driving operational efficiencies and a strong margin profile. We will also be highly selective in our future hiring efforts in line with our renewed focus. We expect these combined actions to drive approximately $25 million of annualized savings. This is a difficult, but necessary action to better align the business with the execution needs ahead.
Let me now turn to our 3 execution priorities: First, we are doubling down on subscriptions over transactions and focusing on customer lifetime value to help drive long-term sustainability. While our formation product has traditionally been offered, as a transaction, we do not believe that running a business is transactional by nature. For anyone trying to start a business, LegalZoom needs to be alongside them, as a partner not only during formation, but also during the difficult first years and well beyond. This is also true in other areas such as the state planning, where we need to be aligned and alongside our customers, as their lives evolve. This promise to our customers ensures a strong ongoing relationship that lends itself deeply to a subscription offering.
Across our business, we will be evaluating ways to better reorient our products towards subscriptions. This includes revisiting our pre-formation offering. LegalZoom is uniquely positioned to add significantly more value than any competitor or the government. Again, that is our promise to our customers. Yet, a free formation leaves customers exposed to compliance risk, ongoing government requirements and without registered agent services. We will be evaluating new recurring revenue products such as a free formation offering that may include compliance or other packages that are needed for businesses to ultimately be successful.
We believe this new approach can accomplish 3 things: first, deepen our relationship with our customers during those difficult first years; second, demonstrate the value of our subscription offerings, which will build trust and support retention; and third, improve the quality of our subscriber base, as we focus on growing the lifetime value of our customers. We are confident this decision will support our reorientation towards focusing on the lifetime value of our customers.
A second example is our BOIR report, which satisfies a new federal filing requirement by FinCEN. The filing requirement impacts roughly 90% of all business entities and is proof of how dynamic the regulatory environment is for small business owners. BOIR is a high-intent purchase, but we currently commercialize it as a stand-alone transaction post formation. While we are pleased with the current attach rate for BOIR, we are not capitalizing on the opportunity to leverage this requirement, as part of a broader subscription offering at a critical junction during formation, nor are we taking advantage of the opportunity to cross-sell our broader compliance subscriptions to existing customers through BOIR. As such, we are currently evaluating ways to better reorient this product towards subscription offerings.
A final example is our consumer business, which has been a headwind to revenue growth over the past few years, as we have focused on our SMB business. While we have made some progress recently, we will be reinvesting more deeply in our consumer channel for accelerated growth, as it is a market we have the right to own given our strong historical brand recognition and our significant market position.
Take estate planning. Every business has an owner behind it that needs estate planning products. Beyond our SMB customers, estate planning is a product that reaches across every American over the age of 18. Recent studies have shown that while nearly 2/3 of Americans say having a will is important, fewer than 1/3 have one. And of the minority of the population with the will, many don't revisit it regularly, but estate plan should not be thought of in a vacuum.
These are living, breathing documents that need to grow and adjust over time, as families evolve. To serve our customers, we need to be with them over time. Estate planning is one of a number of our historically transactional products, where we believe we can create another enduring subscription channel that can be used to offset periods of weakness in small business starts.
Let me now turn to our second key area of execution, reorienting our go-to-market strategy. One of the most interesting things about a small business is that there is no such thing as a typical small business. The needs of a wedding photographer and a pizza shop owner are incredibly different. Going deeper, the needs of a first-time pizza shop owner and a pizza shop owner opening her third location are distinct.
Most importantly, for our customers, their businesses are not just small businesses. They are their way of making their dreams a reality. We have a deep understanding of the businesses, who form with us, and we will start to better leverage our robust data in that regard. We know, for example, that approximately 20% of our businesses are in the professional services sector; another 15% are in trade and retail, but we haven't historically used that information. Yet, it can enable us to grow alongside these businesses, as they become more distinct through success in their verticals.
Similarly, understanding that businesses become more inelastic over time is instrumental to how we will go to market. New businesses are far more fragile than established ones, and we see that cycle unfold across our customer base. To improve subscription conversion, we will better leverage data to shift our go-to-market for SMBs from a one-size-fits-all approach to micro segmentation. This means further refining our customer and take questionnaire to better understand our customer needs. We'll begin targeting vertically by type of business, again, a pizza shop owner versus a wedding photographer and horizontally by life cycle of business, newly formed, for example, versus businesses in later years of their lives.
At formation, we will emphasize our core legal and compliance offerings, where we have earned the right to win through our decades of experience, and we will stay connected to our customers to cross-sell [ in ] ancillary areas at the right time. We will also be reallocating our customer acquisition marketing. Recently, we have focused our marketing efforts almost exclusively on driving formations through performance marketing.
That dependence on a single channel to market to a single audience prevents us from better efficiency and scale. Our one brand partnership with the NBA was also largely geared towards business formations. Looking ahead, we will be testing into a broader mix of digital and offline channels, partnerships, spokespeople and influencers, all to balance our investments more efficiently across product categories.
We are aggressively focused on spend efficiency and brand health. We have confidence in this approach. In part, these are our ability to leverage our rich customer data alongside almost 25 years of historical marketing knowledge. We will also look to drive share gains by better leveraging our partnership channels and sales and service teams.
Our new outsourced sales team is fully ramped, and we look forward to optimizing the experience over time. We believe these efforts will also support market share expansion. However, as I noted earlier, our priority will be driving long-term customer value in the form of subscriptions. We are focused on delivering exceptional value with superior products, which we are confident is a winning combination.
Post formation, our myLZ customer platform is a huge untapped opportunity. We invested heavily in this platform, and it has paid dividends in usability engagement. We do not effectively leverage this channel as a go-to-market opportunity yet. We will also do a better job cross-selling, up-selling, bundling and packaging to our businesses during their life cycle. As customers graduate from being a new business to an emerging one, their wallet size increases alongside their needs. We have earned the right to offer and include more products to our customers over time. Yet, we have not taken advantage of that.
We have strong traction in many areas of our ancillary ecosystem, including virtual mail and our partnership offerings, like business banking, insurance and web services. We also know that taxes and bookkeeping are an important part of a post formation life cycle, but we need to be offering the right products to the right customers at the right time. By way of concrete example, we were previously selling our tax services within the formation flow, yet robust tax solution is not needed on day 1. The result was high attach, but also cannibalization of other subscription products in the order flow and ultimately, very high churn.
We are reviewing opportunities to offer a simple, cost-effective solution early in the life cycle, and we will cross-sell our more robust tax offering through myLZ, and our sales teams during more appropriate stages of businesses life cycle. We expect to benefit from introducing the right products to the right customers at the right time with the goal of increasing the lifetime value of our subscribers.
Lastly, we believe we can continue to build our ecosystem via our partnership network in support of our customers. Our expanded partnership directive will focus on adding vertical-specific partners as prioritized by our segmentation analysis. For example, providing point-of-sale solutions tailored for brick-and-mortar retailers or fleet management software for trucking companies, multiply a number of partnerships across even 5% of our base each, and you can quickly see the compounding benefits to our customers and our company.
Finally, our third execution change will be driving further integration of artificial intelligence. LegalZoom is, first and foremost, a technology company. We've worked hard to integrate technology into everything we do to give our customers and partners the best, most efficient products and services. What we have not yet capitalized on is effectively leveraging artificial intelligence into our solutions.
We are now actively testing AI features within our subscription offerings to drive consumption, engagement and ultimately, retention and greater lifetime value. For example, we launched an AI-assisted NAICS code navigator just last week, which allows our customers to describe their business activity in plain English and lets our AI map that to the appropriate government code for the purposes of licenses and permits. More will come in this regard.
Our largest opportunity when it comes to AI, however, is our expert offerings. Integrating expertise is perhaps the singular area that sets LegalZoom apart amongst all of our potential competitors. On the one hand, we own a law firm. We can offer legal services directly through an alternate business structure. We can also offer other advice and services through our rich network of attorneys, but combining these services with the power of AI presents a game-changing opportunity. Generative AI alone cannot replace attorney advice. There are known accuracy hurdles and more importantly, will establish regulations around the unauthorized practice of law. Put simply, this means legal advice cannot be given without a license.
LegalZoom stands apart from our technology competitors, as a platform with an established network of independent attorneys available to leverage the power of AI to unlock this opportunity. We are continuing to see solid traction with our first generative AI product, Doc Assist. Doc Assist was designed to empower our customers to better understand their legal documents and to promote our attorney network if customers need more help. It allows our customers to upload agreements and other documents and have our proprietary AI engine breakdown clauses, facts, figures and ultimately provide questions and answers in simplified language. This product currently sits behind myLZ, and we have scaled to over 500 documents uploaded every day from our customers. We are now testing connecting customers, who show intent with an attorney through one of our subscription offerings.
Today, we are developing a robust strategy to further deliver AI expertise to our customers when and where they need it. We will have a cost rationalized approach to AI investments that will drive us toward an integrated model of expertise, one that leverages human and machine intelligence to provide legal advice efficiently and at an affordable price. We expect a lot more to come, as we continue to leverage our technology to drive machine and human expertise to improve the customer experience and drive lifetime value. I look forward to providing you more details on our plans and subsequent announcements.
To summarize, I feel confident that these changes in our execution will enable us to disconnect from our dependence on small business formations for growth, accelerate our subscription revenue and drive continued margin expansion over time. This will ultimately translate into sustained value creation. I also want to once again acknowledge that our current revenue growth is unacceptable. As for our mix, we currently generate approximately 40% of our revenues from transactional purchases and roughly 60% from recurring subscriptions. I believe we can do better.
As we execute on these initiatives, we will be able to provide you with greater insight regarding how we expect the trajectory of our business to change. Less than 30 days into our work, it's too early for us to make long-term financial commitments. However, our goal is to be transparent and communicate often. So we look forward to sharing greater details of our progress and an updated long-term outlook [ in the ] upcoming announcements.
With that, I will hand the call over to Noel to discuss our second quarter results and outlook in more detail. Noel?
Thanks, Jeff, and good afternoon, everyone. Before I begin, I'd also like to express my gratitude to Dan. His leadership left an indelible mark on this organization and his contributions were vital to what was accomplished during his time here at LegalZoom. He has left us well positioned, as we move forward into our next chapter. Along those lines, I am very excited to welcome Jeff and look forward to partnering closely with him to drive LegalZoom to even greater success.
I'll now turn our focus to our second quarter financial performance. Please note all comparisons will be on a year-over-year basis, unless otherwise stated. Total revenue was $177 million for the quarter or up 5%. Our results exceeded the top end of our outlook, primarily due to higher-than-expected fulfillment.
Looking at business formations, we saw a softer macro environment in the quarter with Q2 census EIN applications declining 6% year-over-year, below our expectations and a 4-point deceleration from Q1. We expect the macro will decelerate further, as the year progresses, and we'll discuss this in more detail shortly.
We completed 134,000 business formations in Q2, down 17%. Looking at LegalZoom branded LLC formations, which excludes the impact of a partnership exit in the third quarter of 2023, formations were down 12% year-over-year. This is more closely aligned to Secretary of State formation data, which continues to show a steeper year-over-year decline relative to EIN data.
Subsequent to the end of the quarter, we have seen a deceleration in census EIN applications, with the last 4 weeks of print averaging a 12% year-over-year decline. We have updated our macro expectations to reflect this softer environment, and this is a component of our lower revenue outlook. Our market share of business formations relative to census EIN data was 10% for the quarter.
Now turning to our revenue performance. Transaction revenue was $69 million, up 4%, driven by a 3% increase in transaction units and a slight increase in average order value. We recorded 292,000 transaction units in the quarter. The 3% increase was primarily due to an increase in non-formation business related transaction products, such as annual reports, our new BOIR offering and corporate dissolutions.
Average order value was $234 for the quarter, up slightly year-over-year. We expect AOV to be relatively flat sequentially in Q3, but down year-over-year due to the aforementioned mix shift toward non-formation transactions, which are generally lower priced, and we continue to expect a mid-single-digit decline in AOV for the full year 2024 compared to the full year 2023.
Subscription revenue was $109 million, up 6% due to an increase in both subscription units and ARPU. We remain dedicated to continuing to shift our revenue towards subscription over the long term. We ended the quarter with over 1.6 million subscription units, up 4% year-over-year, as we saw an increase in forms and e-signature subscriptions due to the bundling of these products into certain business formation offerings and growth in our virtual mail subscriptions. This growth was partially offset by the impact from the exit of legacy partner relationships, which have now largely transitioned from our platform.
ARPU came in at $271 for the quarter, up 4%, driven by a mix shift toward our higher-value subscription offerings. ARPU was also impacted by the exit of certain channel partner relationships and the introduction of our forms and e-signature subscription offerings, both of which carry lower price points.
Now turning to expenses and margins, where all of the following metrics are on a non-GAAP basis. Second quarter gross margin was 68% compared to 65% in Q2 '23. The year-over-year improvement was driven by lower filing fees, as a percentage of revenue and improvements in our service delivery operations due to automation and process improvements. As a reminder, we generally experienced lower gross margins in the first half of the year due to the seasonality associated with tax season and business formation, and therefore, expect margins to improve in the second half.
Sales and marketing costs were $57 million or 32% of revenue, an increase of 13% from last year. Customer acquisition marketing costs were up 31% year-over-year and increased by $7 million sequentially, primarily due to an increase in brand marketing spend, which was time to maximize the benefit of our NBA sponsorship. In Q3, we expect CAM expenses to revert to levels more consistent with the prior year quarter. As a reminder, our investments in CAM in 2024 are offset by savings we are experiencing from our sales reorganization and subsequent rebuild. Non-CAM sales and marketing expense was down $4 million or 31%, primarily due to the impact from the sales reorganization.
Technology and development costs were $17 million, up $3 million or 23%. After several years of significant investment, we believe we now have a fully built-out technology team that is sufficiently resourced to deliver against our product road map.
G&A expenses were $16 million, an increase of $2 million or 12%, largely driven by onetime legal expenses.
Our performance drove adjusted EBITDA of $29 million or a 16% margin. This represents a 2% year-over-year decline compared to adjusted EBITDA of $30 million for the same period last year. Deferred revenue increased by $2 million in the quarter.
Free cash flow was $17 million compared to $37 million for the same period in 2023. This reflects a $13 million year-over-year increase in cash tax payments due to the full utilization of certain tax credits and interest expense carryovers in the prior year, as well as the timing of working capital changes.
We ended the quarter with cash and cash equivalents of $119 million. We remain debt-free with no outstanding borrowings under our $150 million revolving credit facility.
During the second quarter, we announced an increase in our share repurchase authorization from [ $100 million to $175 million ] and repurchased 13.9 million shares of our common stock for a total of $125 million. This was a record level of share repurchases for LegalZoom and represents a 7% reduction in our share count. Since our first share repurchase program beginning in the first quarter of 2022, we have returned close to $300 million to shareholders in the form of share repurchases, reducing our share count prior to the program by approximately 15%.
As of the end of the second quarter, we had approximately $37 million remaining under our share repurchase authorization. Following our record repurchase activity in Q2, we will continue to evaluate our share repurchase program alongside maintaining a flexible cash position to support our capital allocation priorities.
Turning to our outlook for the second half of this year. I'll start with the financial impact of our recent headcount actions, which include both a restructuring, as well as a reduced hiring plan in the back half of this year. We estimate the combination of our headcount reduction and reduced hiring plan will realize approximately $5 million and $7 million of savings in Q3 and Q4, respectively. We estimate these actions will generate approximately $25 million in annualized savings. This reduction in operating expense is a reflection of a reprioritization of resources to fuel growth more efficiently, while maintaining a strong margin profile.
With that in mind, let me turn to our financial outlook in more detail. For the full year, we are reiterating our guidance originally announced on July 9th, 2024. We currently expect revenue to be in the range of $675 million to $685 million or 3% year-over-year growth at the midpoint. Our revenue outlook primarily reflects the impact from a mid- to high single-digit decline in the census EIN formations macro for the full year 2024 versus our previous expectation of a mid-single-digit decline. In the future, we believe our 3 execution priorities will reduce our sensitivity to macroeconomic trends.
Our full year revenue outlook also reflects softer retention rates in our core compliance subscriptions, which we attribute to a challenging macroeconomic environment for small business owners and a 5-point headwind to our subscription revenue growth from our LZ tax offering versus our previous 4-point expectation, given our decision to keep the product out of our formation flows. This decision will also be a headwind to subscription revenue in 2025.
We have reiterated our adjusted EBITDA range of $135 million to $145 million, which reflects a 21% margin at the midpoint. Once again, the reiteration of our adjusted EBITDA outlook reflects the impact of our restructuring efforts and our steadfast margin commitment.
We expect free cash flow to be in the range of $75 million to $85 million. Our free cash flow outlook reflects the estimated impact of approximately $5 million in expected severance costs, lower net interest income and reduced expectations for deferred revenue in the back half of the year.
Moving to our revenue and adjusted EBITDA expectations for the third quarter of 2024, we expect total revenue of $165 million to $169 million, and we expect third quarter adjusted EBITDA of $39 million to $41 million or 24% margin at the midpoint.
In closing, we'd like to thank the entire LegalZoom team for their ongoing dedication to our business. We are confident in our next chapter and look forward to updating you on our progress in the coming quarters.
And with that, let's please open the call up for questions.
[Operator Instructions] And your first question comes from the line of Andrew Boone with JMP Securities.
Jeff, I just have one big picture question. As you look across the business formation, the SMB services segment, however we want to define this, what do you think becomes the defensible strategy that you guys are going to focus on? How do you guys create something that is more immune to competition and allows you to build a long-term sustainable business.
Thank you, and great question. The bottom line is we, in large part, created this category. And we've, in some respects, allowed it to be commoditized. The fact of the matter is we have the strongest brand around. This does not need to be a race to the bottom. So what we need to do and continue to do is build the best products and make sure that we're fitting the right products to the right customers at the right time. This is about orienting back to customer needs and making sure that we're aligned with the customer on their journey. They want to use LegalZoom. They have wanted that for a long time. And we need to empower them to make sure that we're giving them the right products and services that these customers need, as their businesses and their lives unfold and grow.
I have every confidence that this is a highly, highly defensible business, and it's going to allow us to own this market again. And I'll end by saying, I don't see a lot of aggressive competition. I see our inability to take ownership of what we can do for our customers. And then I'm watching a lot of others copy us. So we will continue to take the lead and build that defensible position.
And then, Jeff, can I ask a clarifying question. It sounded like you're revisiting some of the freemium products in terms of maybe turning them more into subscription products or gating them differently. Can you just clarify anything there about as you guys think about what may be now moved into more of a pay package versus what's available for free? How do you think about that strategy?
Sure. And again, another good question. This one, I'm going to own the fact that I've only been in the seat for a few short weeks. So the right answer is we're going to test, we're going to listen, and we're going to learn. But more specifically, to give a concrete example, we need to make sure that we're bringing the right customers into our ecosystem, and sometimes you effectively get what you pay for with free. We need to make sure that we don't have looky-loos. We have real customers, who are trying to build businesses.
And those businesses, frankly, shouldn't be leaning towards fully free solutions because they've got a business to run and build. And in the early first year, it is incredibly precarious. We don't want them focused on the things that we do better than they do. And we don't want them wasting money on going to law firms or local lawyers. So we want to help them incorporate quickly and efficiently. Then we want to get them a registered agent. We want to get them to be fully compliant initially and over time. And then eventually, we want to help them build web services, marketing services, tax, bookkeeping, all of the things that we've been talking about historically. But we need to make sure that we reorient back to the life cycle of the customer, and that is a longer journey.
The first years are incredibly difficult. About half of all businesses don't make it through that first year. We want to focus on helping them make it through that year. Once they're through that year, yes, then they have sufficient revenues, then they're going to start thinking about marketing and expanding, and that's where we will have earned the right to offer more value-added services.
Your next question comes from the line of Ron Josey with Citi.
This is Jake on for Ron. Jeff, really appreciate you giving more details on the 3 priorities. Really wanted to double-click on the first priority of focusing on subscriptions. You talked about segmenting your customer base. Could you double-click on that and maybe give us 1 or 2 examples of key segments that you think have been maybe where there's an opportunity to market better and target those specific segments?
And then Noel, we just wanted to also double-click on the headcount reductions. Any more details you could give on where those headcount reductions were focused or any products that you would expect to be deemphasized?
Sure. Thank you, Jake. I'll take that first piece on customer segmentation. I'm going to answer it first in a slightly different way, which is what have we historically been focusing on because I think that will show you the clear opportunity that we have. Almost entirely, we have been focused on formation, which means a brand-new business or prosumer. So someone who is coming in for the first time typically wants an LLC, and we are offering them a formation product, most typically in LLC. So our go-to-market and our segmentation has been one and the same, try to drive people into that formation funnel. And from there, we drop off pretty rapidly.
So to give you some key segment examples, we know that from day 0 to month 12 is a certain type of business, and they are very price sensitive. They are at risk of failure, and they are still trying to figure out what their business ultimately is. From then, you've got years 1 through 3, where they're starting to emerge and build and gain stability and sustainability in their business. And after that, you've got from year 3 on, where they are an established business, and they are looking to go from their core competency to broadening out whatever that means in their category.
Those are 3 distinct segments that we sell in the exact same way right now at the exact same time at formation, and we rarely go back to them. So that is one example of how we can spread out our go-to-market and then leverage our progress in product and in value-added services over time when those customers need it.
Other areas are just looking at different categories of business. And what a florist might want versus a pizza shop owner because those needs are different. And we are going to look over time to figure out what the right solution is rather than come up with a one-size-fits-all solution. And I would say, historically, we have tended to try to find these broad-based opportunities where a product can serve our entire customer base.
And we lost sight of the fact that we aren't serving small businesses because there's no such thing as a small business. Every business is unique and distinct and either category and/or time segmented. So such that it affords us a much bigger opportunity to in the beginning own the market by establishing trust and relationship with these businesses and then over time, leveraging our data, figure out what the right product services and solutions are that they need and then either through our own organic products through acquisition or through partnership offer those products to the customers,as and when they need it.
And Jake, this is Noel. With regards to your question on the headcount reduction, the reduction was dispersed pretty broadly across the company. I would say it was somewhat heavier on the cost of sales side, in particular, given the lower volume expectations and with a concentration, as it relates to LZ tax. The rest was pretty well split across marketing, G&A and technology and development. And so, I'm sure there will be areas of narrowed focus, as we continue to evaluate testing and sort of our new execution priorities. But as we mentioned in our remarks, we feel confident that we have the right level of resource to sufficiently deliver on our existing initiatives.
Your next question comes from the line of Trevor Young with Barclays.
Great. First one, it just looks like the long-term guide slide was removed this quarter. Is it fair to assume that its part of the management transition and the shift in strategy here, we might get some sort of updated framework at some point, perhaps maybe as we look towards '25 expectations in a few quarters.
And then bigger picture, as we progress through this shift in strategy, it seems like you're looking to move it quickly and that's really great, Jeff. Very encouraging to hear. At the same time, macro might be getting a little bit worse. These sorts of transitions do take some time and some legacy headwinds do persist. So as such, should we assume '25 starts the recovery? Is it 2H '25? Or is it more of like a '26 story at this point?
Sure. Thank you, Trevor. I'll take this at a high level. Noel, you can give some more details because you have more context in terms of what we've said in the past. Your first part of that question, in many ways was asked and answered. You're exactly right. Our expectations are that we're going to move quick. We're going to be testing regularly. We're going to be leaning into sustainable growth through recurring revenue. And our expectation is that's going to put us in a really good spot over time. That said, we're still too early to speak to long-term guidance. However, we will, as soon as we can start providing interim updates and then long-term updates, as we get more visibility into some of these changes. But again, we are moving aggressively because we do see that path forward.
Yes. And on your other question in terms of the softer macro, you pointed out, we did see a decel in the macro in Q2, and we've included carrying forward that softness relative to our expectation into our full year guide and now expect mid- to high single-digit declines in the macro for this year. So definitely a headwind that impacts us both on the transaction and even more importantly, on the subscription side, that will be a headwind in 2025 as well.
And then we mentioned some of the softer retention rates that we're seeing relative to what we had forecasted. And part of that is relative to some initiatives that we had that were targeted at improving retention and some of it is just a softer trending relative to prior performance, which I would also box into just being in an overall more challenging economic environment for small businesses. And to the extent that impacts the back half of the year, the subscription side has some carryover, as well as the decision. Right now, our forecast does not have us re-commercializing LZ tax in the formation flow, and so that impacts the back half of the year and into '25.
So to your point, there is definitely some headwinds heading into '25. But we're squarely focused on driving the subscription side of the business, focused on lifetime value, and we'll be aggressively testing in the back half of this year. And we've built in some room in our guide for those activities.
And the only thing I'll add, Trevor, before we hand over either to another question, or a few of it. Second one, is the macro is a problem to solve for. It is not an excuse. And this is a solvable problem. And you see this solved across many other businesses with many other macros and businesses that are affected by our primary macro, which is small business formations. So from our standpoint, this is a solvable problem and a scalable growth business irrespective of where the macro is, despite the fact that we have pronounced headwind.
The bigger concern that we have and the reason that we're attacking this concern so aggressively is we don't want to see deceleration in our subscription revenue growth, and we have seen that in the prior couple of quarters. That is the core problem to solve because that creates greater defensibility long term. So that really is our core focus, and why it is the first of the 3 things that we're focused on in order of priorities from an execution standpoint.
Your next question comes from the line of Josh Beck with Raymond James.
Yes. Thank you, and Jeff, thanks for the detailed update there. I guess, kind of high level, are you envisioning that the product footprint doesn't really change maybe as much as the go-to-market and the onboarding. Obviously, that's a very high-level comment. But strategically, is that how you're approaching it?
And then just on the comments around compliance, I think you kind of mentioned the idea of maybe having a free formation that could include compliance or other packages. Is that kind of moving away from the maybe more purely transactional freemium model for obviously some transactions that's in place today?
Yes, and that's a good point, Josh, and I do agree with the comment. I think our product ecosystem is really strong. One of the things we've done incredibly well reduce the amount of tech debt that we've had over the years, built a really strong technology stack. Our underlying platform, including myLZ is industry leading. And both the core products and the ancillary products that we have built are really, really good. So I think that this is more of a go-to-market focus.
And I mean that in 2 respects. One, in terms of business model, so that push towards recurring revenue and following customers' journey over their life cycle. And then second, how we actually go to market to making sure that we're doing it with greater breadth, if you think back to the last question, so that we're more insulated and protected from small business starts.
And then with regards to your second point on the free model, I see nothing wrong with a freemium model. But there too, we have to make sure that we're bringing the right customers in for the long term. And the overall objective is to be bringing more businesses into existence that can be sustainable and sustained long term. So what we need to do is, we need to rethink the types of businesses that are coming into our free channel. And as we said earlier, the businesses that we are seeing in our basic SKU, which is the free SKU relative to some of the others, they have higher churn and a worse profile.
So we need to relook at why that is. And our hunch is part of that is because we have looky-loos because it was free, part of that is just the way in which we're going to market. By saying something is free, people automatically get defensive about paying for things even if they need it just because it costs something relative to free.
And then finally, part of it is because these businesses think that if something is free, that everything should be free such that maybe they don't need these other products and service that actually are valuable to them in the medium and long term. So that's the reorientation that we're thinking of. It's hard to be more concrete. So I apologize for that. So I'm glad you asked the clarifying question, Josh, only because we're in the middle of testing what the right solution is.
Okay. That's super helpful. And then maybe just a follow-up on just kind of what you're observing in the macro thus far. Obviously, it sounds like kind of down 6% for Q2 in terms of formations. And overall macro data points, I mean, they are pretty mixed obviously. The jobs report disappointed some folks, and you've had GDP be okay, but this does seem like a market that's maybe slowing down more than I would have expected. So I don't know if it's maybe the effects of a pull forward or maybe how you would characterize that? And I know, we obviously don't have financials going back to a major recession or a financial crisis, but generically, how would you think about the sensitivity to the macro, as we look ahead?
Look, at a high level, we've been about as good as many others have been predicting the macro, which is pretty poor. So I see our job as building this business around -- around a set of macros, not just -- not just small business formations, so that we can insulate ourselves from the risk and uncertainty that we're seeing. The reality is, I don't think that this is a pull forward situation necessarily so much as a regression to the mean. We had a very, very high increase in small business starts from COVID to about the mid- to end of last year. We have to regress to the mean. And I don't think it is clear yet what that mean is, and whether that regression to the mean will pull us to a number below or at where we roughly are right now.
So we've seen recent acceleration. We are acting in a conservative fashion from a modeling standpoint. But from a business standpoint, from an execution standpoint, we're saying, what do we do to be independent or more independent of that macro? And frankly, how can we lean into some of the other macros, as they evolve and develop, where our business tends to find strength.
As an example, we know that small business formation tends to happen towards the middle end of recessions. We know that when joblessness increases you start to see more businesses form. So one of the things that we're looking at more broadly is the macroeconomic environment and where we can play to create that independence, not just to build the business, but to create that independence so that we have an insulated business.
Your next question comes from the line of Elizabeth Porter with Morgan Stanley.
Great. This is Katie Keyser on for Elizabeth Porter tonight. I wanted to ask one on kind of leaning back into that consumer side of the business, maybe taking it from 2 sides. First, are you able to size that kind of potential revenue opportunity and maybe relative to that with small businesses? And then is the go-to-market strategy pretty transferable there? Or are there any kind of incremental changes that will allow you to win with consumer?
You bet. Great question. Look, from a sizing standpoint, we don't have specific details, but the consumer market is obviously significantly bigger than the small business market. And when you look at the needs of consumers, wills and trusts are way up there. I think the stat we used was that 2/3 of people when surveyed self-advocate for needing a trust or will and about 1/3 actually have them. And on top of that, very few go back and look at those wills over time.
I mean I, for one, have a will. I don't like looking at it ever. It's very morbid. But I know, I need one, and I know, I should be looking. And I know, as my family evolves, as my life situation changes, I should be going back. So our thinking is, we can productize this space to make it easy and convenient to do the right thing for the people you care most about. So from our standpoint, there is a very big largely untapped opportunity.
In terms of the go-to-market, it is very much in line and incredibly transferable from what we've been doing. In fact, when you ask most people, a portion -- a big portion of the unaided awareness comes from the consumer side, not from the small business side. So most of us still remember how LegalZoom got its start, which was on the consumer side with wills and trust. So we can go back to leaning in on that. And the beauty there is our marketing can serve double duty because every small business has a small business owner behind them that needs a trust and will. So as we build our brand in one respect, it adds some strategic advantage in the other. So we see this as very symbiotic.
Your next question comes from the line of Ella Smith with JPMorgan.
Good evening, Jeff and Noel. So maybe first for you, Jeff. So LegalZoom has legal -- has retention rates from the subscription business around 60% or so, whereas there are website builders, which serve a somewhat similar customer base with rates in the [ 80s ]. Do you think that LegalZoom can get there? And in general, what else do you think needs to happen to improve the quality of your subscribers?
Good question, and I'm going to unpack it a little bit. And I think this is a good way to think about subscription businesses in general. I know you look at this as well. There's early life churn and late life churn in all subscription businesses, and everyone defines what early life is differently than others, mostly in the web services space, that's about 3 months.
I think what you've got to do is unpack our business and look at it as a tale of 2 cities. So our early life is not similar to web services businesses at all because included in our early life are new business formations, where we have a much higher failure rate than you would see in a web services business, where someone has already been in business likely or at least in some cases, might already have incorporated or formed an LLC or an S Corp.
In our case, these are prosumers in the best case or people, who have an idea otherwise who then form and ultimately try to build their business, many of whom fail. So I think the way I would answer that business, and I think this is the right way to think about it is our late life churn should be similar to other SMB ecosystems. Our early life churn will likely always be higher, as it should. And that's because part of what we do for these businesses and business owners is we help them get their start despite the fact that we know, and they know that many of those businesses won't survive even to the time when they're going to have a website. That's very clear. Thank you for that, Jeff. And Noel, maybe for you. So this evening, you announced the reduction in the force, but made no change to the profitability guide. Can you just remind us why that's the case?
Sorry. Can you -- I didn't quite get the second half of that, Ella. Can you just repeat that? [ Sorry ], I gave you some details on the [ rep ], but then you said...
Absolutely. So you announced the guy -- excuse me, you announced the risk today, but there was no change to your profitability guide. It was unchanged from last quarter. And I'm just curious, despite the newly announced risk, why are we not seeing an impact to the guide because of that?
Yes. So that was contemplated in the guide that we held. So we had already kind of factored in an estimate for that.
That concludes our Q&A session. Ladies and gentlemen, thank you all for joining. You may now disconnect.