Legalzoom.Com, Inc. Q3 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to LegalZoom's Third Quarter 2021 Earnings Conference Call. Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker today, Danny Vivier, Head of Investor Relations. Please go ahead.

Thank you, operator. Hello and welcome to LegalZoom's Third Quarter 2021 Earnings Conference Call. Joining me today is Dan Wernikoff, our Chief Executive Officer; and Noel Watson, our Chief Financial Officer. As a reminder, we will be making forward-looking statements on this call. These forward-looking statements can be identified by the use of words such as believe, expect, plan, anticipate, will, intend and similar expressions and are not and should not be relied upon as a guarantee of future performance or results. Results could differ from those contemplated by our forward-looking statements. We caution you to review the Risk Factors section of our reports and filings with the Securities and Exchange Commission for a discussion of factors that could cause our results to differ materially. The forward-looking statements we make on this call are based on information available to us as of today's date and we disclaim any obligation to update any forward-looking statements, except as required by law. In addition, we will also discuss certain non-GAAP financial measures. Our CEO and CFO use these measures to make their decisions regarding our business and we believe these measures provide helpful information to investors. Reconciliations of all non-GAAP measures to the most directly comparable GAAP measures are set forth in the Investor Relations section of our website at investors.legalzoom.com. The non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. I'll now turn the call over to Dan.

Thank you, Danny and thank you all for joining our Q3 earnings call. At LegalZoom, we're on a mission to democratize law. We believe in harnessing the power of technology to unlock greater efficiencies which in turn provides more affordable legal and compliance services to small businesses. Our mission to democratize law is more important now than ever before with the pandemic reshaping industries, causing economic hardship and sparking a new wave of entrepreneurial activity. As the clear category leader in an industry undergoing rapid digital transformation, we believe that we are just at the beginning of our growth journey. We'll continue to leverage our significant brand advantage, differentiated product experience, extensive network of credentialed experts and the history of navigating the complexity of the U.S. legal and regulatory system to further penetrate the $50 billion legal and compliance vertical. Let me start with a summary of our Q3 results. Building on the strength of the first half of the year, we delivered total revenue of $148 million, above the top end of our guidance range for the quarter and up 12% year-over-year. The year-over-year deceleration from Q2 was expected and driven largely by challenging compares due to COVID-19. As a reminder, in the second quarter of 2020, the onset of the pandemic shut down critical government functions across the country, including many Secretary of State departments responsible for processing new business applications. When restrictions were lifted throughout the third quarter, pent-up demand was filled, creating a spike in formations in Q3 of last year. Given the year-over-year complexity, we pointed to the two-year cumulative average growth rate which we believe more accurately reflects the underlying growth trends in the business. In the third quarter, the two-year revenue CAGR was 19%, roughly in line with the second quarter's two-year CAGR. Subscription revenue continues to be a highlight, up 24% year-over-year in the quarter, driven by the ongoing rollout of products and services to help our customers remain compliant after forming their business. I'll provide a more detailed operational update on LZ Tax later in the call but we're excited to see its integration into the LLC formation flow drive a strong uptick in subscriber count in the period. Adjusted EBITDA in the third quarter came in at $15 million or 10% of revenue as we continue to invest in our technology platform and media spend to build on our digital leadership. We will actively seek opportunities to invest strategically and more aggressively to accelerate our long-term growth potential. Given the increased focus intra-quarter on the overall market for business formations, as measured by the U.S. Census data, I'd like to provide some commentary on the topic. First, it's important to note that an EIN application does not one-for-one translate to a business formation. EIN applications can and do diverge from Secretary of State patent data which we believe is a more accurate benchmark for the total number of addressable formations. We use proprietary data to measure our performance relative to peers. We saw this divergence materialize in Q3 of last year when sole proprietors rushed to open business checking accounts in order to apply for PPP funding. We also see it during tax seasons as existing businesses often apply for an EIN at the advice of an accountant. When these one-time or seasonal events occur, we see a spike in EIN applications over and beyond the growth in our internal formations benchmark. Second, I mentioned on our last call that we did see a step-down in formation activity beginning in July. At the time, it was too early to know if the step-down was temporarily tied to the reopening of summer travel or the beginning of a new trend line. August and September data made it clear that the market had reverted to a more normalized seasonal pattern, below the elevated levels we saw earlier in the year. Still, business formations remain well above 2019 levels. And given the strong secular tailwind of digital enablement and the gig economy, we expect the market to remain strong in future periods as well. Finally, it's important to remember that a growing share of our revenue is derived from subscription services. This revenue stream is recurring, predictable, high margin and performs independently of the seasonal components of our business. We will continue to prioritize growing our base of subscription revenue in favor of driving incremental transactional revenue. When we see an opportunity to accelerate the lifetime value of our customer, we will take it even if it means sacrificing in-period revenue and profitability. We believe this approach best positions us to deliver subscription growth beyond our long-term revenue growth targets. I'd now like to provide an update on our three key growth vectors: scaling our core business, building an ecosystem of SMB formation-related services and integrating attorneys into our core experience which we believe will collectively drive durable top line growth and long-term margin expansion. The biggest near-term opportunities to drive growth relates to scaling our core offering by efficiently increasing our marketing spend, improving our product experience and ensuring efficient growth in our operations. In mid-October, we announced a new multiyear brand partnership with the National Basketball Association. The partnership, branded Fast Break for Small Business, will provide $6 million in grants and services to small business owners. We expect to support more than 6,000 small businesses over the life of the campaign, many of whom are from the communities most impacted by the pandemic and the inequities in the financial and legal systems. The program was created to address these disparities and give small businesses in these communities a fair shot at turning their dreams into reality. Beyond the incredible opportunity for social impact, we're also excited about the opportunity to reposition the LegalZoom brand as an SMB-first solution. Despite a best-in-class improving aided brand awareness score of 74%, the majority of consumers still recognize LegalZoom primarily for its do-it-yourself state plans. In fact, only 40% of our potential customers know that LegalZoom can help them with a small business formation. And given formations drive the bulk of our revenue, particularly on the subscription side, it's critical that we increase awareness of our formation services by repositioning our brand message. The NBA campaign is a major step in the right direction as it clearly distinguishes LegalZoom as the go-to destination to start your small business. This relationship is a great example of the kind of brand partnerships we're pursuing as we look to improve awareness of our formation services. We're also continuing to leverage insights from our media mix modeling to inform spend allocations and test new channels. Historically, LegalZoom lacked the systems to measure attribution accurately across channels. As a consequence, we've been underinvested in emerging categories like digital video, display and social. In Q3, we ramped our spend here aggressively, driving a $5 million quarter-over-quarter increase. Though inefficient in period, we believe ongoing channel testing like this is critical investment that will enable us to efficiently scale our media spend over the long term. And lastly, within operations, we're investing on our platform to increase automation, reduce turnaround times and improve variable unit economics. Turnaround times, or the time between when a business customer completes an online application on our site and when the entity is legally recognized by the state, is a primary driver of our Net Promoter Scores. We've made investments this year to reduce human involvement and automate a majority of the fulfillment process, driving down turnaround times and reducing costs. Our second key growth vector is creating a small business formations ecosystem. We are aggressively evolving our product offering to include subscription services that our small business customers need at the critical time of formation. We added to that ecosystem through our acquisition of Earth Class Mail, a leading virtual mailbox solution for small businesses which we announced this morning. Earth Class Mail, which I'll refer to as ECM, makes postal mail paperless, easy and accessible 24/7 from any device anywhere in the world. As the digital economy continues to fuel the growth of remote-first work environments, small businesses are investing in tools to streamline operations, including software to manage physical mail which can often be invoices and checks that need to be input into other back-office solutions such as Bill.com, QuickBooks and Box, for instance. We've been tracking the virtual mailbox space for a while now and believe ECM's national footprint, tech stack and seamless user experience stands out among the competition. ECM fits perfectly with both our channel and technology strategies. With this acquisition, LegalZoom customers will be able to add a virtual mailbox business address at the time of forming their business. We expect this subscription service to further increase customer lifetime value without any additional customer acquisition costs since it will be integrated directly into our formations product. Also, ECM and our registered agent service use similar technologies, allowing us to leverage many capabilities that will allow us to streamline and advance our broader compliance offerings. I'd like to congratulate our team and welcome ECM's employees into the LegalZoom family. We look forward to partnering together. In addition to this exciting acquisition, we continue to ramp new compliance services under the LegalZoom brand, most notably LZ Tax, while also partnering with category leaders to offer a best-of-breed selection of complementary services such as banking, point-of-sale solutions, website hosting and bookkeeping, to name just a few. The third quarter was an inflection point for our LZ Tax offering with a number of significant milestones. First, throughout the quarter, we exposed a growing portion of LLC traffic to our tax offering at formation, culminating in 100% coverage by the end of the quarter. We're very encouraged by the early results which include the more-than-50% increase in tax subscription units quarter-over-quarter and the growth isn't just from more traffic, we're also seeing improvements in attach rates as we continue to optimize our commercialization strategy and zero in on the things our customers care most about. Second, we doubled our team of in-house experts, CPAs and enrolled agents and onboarded supplemental resources in preparation for our first annual tax season next spring. We continue to see demand outpace supply and are doing all that we can to scale supply quickly while also prioritizing an excellent customer experience. Third, we continue to invest in the tech infrastructure needed to support this fast-scaling revenue stream. This includes the launch of all-new practice management software, streamlining workflows and automating customer outreach. We're very pleased by the momentum behind LZ Tax which we continue to view as a multiyear growth vector for the business. On the partnership front, you will have likely seen our recent press releases highlighting a handful of signed brands including Brex, Intuit, QuickBooks and Square, all marquee service providers with high-value offerings for our small business customers. The nature of each brand relationship is unique. But our intent as we add new partners is to achieve the following core attributes: one, the relationships are bilateral. We acquire new customers for our partners and they acquire for us. Two, the economics are shared in a recurring model, whereby LegalZoom participates in the ongoing value delivery of the partner's service. And three, LegalZoom customers receive preferential pricing on the partner services by signing up through our platform. As a leader in business formation services, we are uniquely positioned to establish trust with our customers very early in their business life cycle. We collect a vast amount of data from our customers, oftentimes before they even start operating. We know their industry, location, hiring plans, et cetera and can use this information to intelligently connect them with the right service providers for their unique situation. Our vision is to partner with the most reputable technology-enabled SMB service providers to make it simpler and less costly for small business owners to get the resources and support they need, so they can devote their attention to running and growing their business. With more and more partner brands joining our curated network, the value of our ecosystem continues to grow. Our third and final growth vector is Attorney Assist, a new hybrid model that leverages our core technology platform while also integrating access to attorneys throughout the user experience. On October 1, we announced that LegalZoom subsidiary, LZ Legal Services, was approved and licensed by the Arizona Supreme Court to operate an alternative business structure, or ABS, in the state. This announcement represents a big step forward in the ongoing push in the United States for regulatory reform that permits non-lawyer owned entities to provide legal advice. With the ABS license, LegalZoom essentially now owns a law firm in the state of Arizona, enabling us to directly provide select legal services to our customers. While we will continue to fulfill the majority of demand through our independent attorney network, the new ABS structure provides a means for us to test new, innovative ways to empower consumers with access to affordable and transparent legal services online. We will also be testing new business models that will allow LegalZoom to deliver additional legal services beyond the scope initially contemplated and participate in the ongoing economics of that value delivery throughout the life of the customer relationship. In conclusion, we are committed to making the right strategic investments to capitalize on the large market opportunities that exist within the legal and compliance vertical. We are patient operators and we'll continue to make decisions aligned to our long-term, growth-oriented mindset. To that end, we will continue to strategically prioritize an accelerating mix of subscription revenues. These revenues performed independently of the broader formations macro and position us to deliver on our long-term growth and profitability targets. With that, I'll now turn the call over to Noel to discuss our financial results.

Thanks, Dan and good afternoon, everyone. I'll start today with a review of our performance in the third quarter and end with our outlook for the remainder of the year. Total GAAP revenue in the period came in at $148 million, up 12% year-over-year. As Dan mentioned, we lapped a challenging compare from Q3 of last year as the reopening of the economy led to a surge in pent-up business formation volumes. The two-year revenue CAGR of 19% remains healthy and we believe more appropriately reflects underlying growth trends in the business. Transaction revenue was $67 million in the quarter, representing 45% of total revenue. We completed 106,000 business formations in the third quarter. Business formations include LLC, Inc. and nonprofit formation events which are critical entry points through which we cross-sell our suite of subscription services. Though down 9% year-over-year, business formations have grown 24% annually over the two-year period, pacing well ahead of our internal market benchmarks. Total transaction units which also include other transactions involving intellectual property and estate planning, were 229,000 units in the quarter, performing in line with business formations. Average order value which represents the average revenue contribution from each transaction unit, remained strong at $291 in the period. The quarter-over-quarter increase was due to improvements in order fulfillment rates. Subscription revenue was $73 million in the quarter or 50% of total revenue. We added 49,000 net subscription units in the period, with a growing portion of those driven by the successful integration of LZ Tax within our LLC formation flow. Growing our base of subscription units remains a top priority, given its impact on LTV. We will continue to leverage our unique position early in the SMB life cycle to connect our customers to the right set of tools and services they need to operate their business. ARPU or the average annual revenue contribution per outstanding subscription unit was $231, up 5% year-over-year. We continue to expect modest growth in this metric over time as higher ARPU services like LZ Tax account for a growing share of our subscription units. As a reminder, we provide ARPU on a last 12-month basis to account for the fact that the majority of subscriptions are billed upfront on annual terms. Partnership revenue was approximately $8 million in the quarter, representing 5% of our total revenue. In the near term, we continue to expect lower sequential performance in our partner revenue as we transition away from legacy partners that do not align with our strategic direction and we evolve our relationships from bounty-based economics to recurring revenue. However, we are very excited about the opportunity that our newest partnerships represent and remain confident in the long-term opportunity to build an ecosystem of marquee brand partners, complete with high-margin recurring revenue structures. Now, turning to expenses and margins where all of the following metrics are on a non-GAAP basis. Cost of revenue which includes government filing fees and other fulfillment and care costs, was $45 million in the period, up 8% versus last year. Gross margin came in at approximately 70% of revenue, up 200 basis points from Q3 of last year, due to improvements in order fulfillment. We expect a typical seasonal decline in gross margin in the fourth quarter and anticipate additional downward pressure driven by our investments in LZ Tax ahead of the spring tax season. Sales and marketing costs were $65 million in the third quarter or 44% of revenue. Within that, customer acquisition spend of $50 million was up 46% year-over-year as we continue to scale our media budgets to grow transaction and subscription volume and build on our category leadership. As Dan mentioned, we allocated incremental spend in the third quarter to new channel testing. We leverage results from these tests to inform our media allocation and to drive greater efficiencies over the long term. Inclusive of this in-period testing spend, we believe we are continuing to generate LTV in a highly efficient manner. Technology and development spend was $12 million in the third quarter or 8% of revenue, up $1.6 million quarter-over-quarter. The sequential increase was expected as we continue to build out a best-in-class product and technology organization and make investments to modernize our infrastructure. Finally, G&A spend was $11 million in the quarter or 7% of revenue, in line with Q2. The year-over-year increase in G&A was driven by incremental public company costs and headcount investments. We expect G&A to increase sequentially in the fourth quarter, primarily due to additional consulting costs. Adjusted EBITDA was $15.1 million in the quarter or 10% of revenue. Our base of deferred revenues remained roughly flat in the period as growth in subscription bookings was offset by improving transaction fulfillment times. Free cash flow was $17 million in Q3, down from $29 million in the same period last year. As of September 30, 2021, we had cash and cash equivalents of $311 million and no debt outstanding. I'll now turn to guidance for the fourth quarter and full year 2021. We expect full year revenue of $575 million to $579 million or year-over-year growth of 23% at the midpoint. This full year range implies a fourth quarter revenue of $142 million to $146 million, up 18% year-over-year at the midpoint. Our revenue guidance considers discontinuation of a more normalized seasonal pattern of business formations and our proactive decision to drive subscription bookings in favor of in-period transaction revenue. We expect full year adjusted EBITDA of $45 million to $47 million or 8% of expected revenue at the midpoint. We are continuing to invest in the business to drive durable multiyear growth. In the fourth quarter, we will deploy incremental spend to support the NBA campaign which we view as a unique opportunity to accelerate our brand repositioning efforts. We are also continuing to ramp investments in LZ Tax, both in people and infrastructure, to keep pace with outsized demand for that service. Because of these investments and the strength that we're seeing in the subscription side of our business, we remain confident in our ability to deliver on long-term growth and profitability targets. We will not provide explicit 2022 guidance at this time but plan to do so in our Q4 earnings call early next year. And quickly, before wrapping, we will be participating in several upcoming investor conferences, including Credit Suisse, Barclays and Raymond James. With that, let's open it up for questions.

Our first question comes from Sterling Auty with JPMorgan. Your line is open.

Yes, thanks. Hi, guys. So two questions from my side. One question, one follow-up. So on the business starts and the comment that you made about the transactional portion. I think as you guys came through the IPO process, you mentioned the long-term growth goals. There was a belief that you could drive acceleration north of 25%. What do you still need even with kind of the modification of the transaction subscription that you mentioned in the call, what do you need as a baseline in terms of business starts to still be able to deliver upon that goal?

Well, thanks for the question, Sterling. When we talked about this on the road show, there's really three dimensions to growth. One is the macro itself and we still feel really good about the macro tailwind. If you look at the current new business starts relative to where they were in 2019, we're still seeing solid growth and obviously, there was a little bit of a step down in Q3. But long term, we feel good about that. The second piece is really around share gains. We know that we have a superior offer to the offline alternatives. And so we continue to be aggressive in marketing to go after share. And then, the third piece is we don't think of our business as a transactional business. We think of ourselves as a formation service. And so the more that we continue to add subscription services that people need right when they're forming a business, the more successful we'll be not only in terms of solving for in-period results but really accelerating long-term growth with higher visibility. So those are really the three dimensions of how we think we exceed, hopefully, the long-term targets that we put out there.

Got it. And then the follow-up is, you talked about choosing subscription versus transaction. How much control do you have to drive the business in that subscription side? And what are the leading subscriptions that investors should look for you to drive to make that happen?

That's a great question. One of the things that we think about a lot and that we also test for a lot is when people come into our solution, they're doing a combination of buying a transaction—the registration of their business—and some ancillary transactions like an operating agreement or an EIN, but they're also adding subscription services that help them stay compliant as a business. And even further now, we're getting into more back-office operations with something like the acquisition of ECM. What we do is we often test different forms of commercialization. We typically see both a combination of increase in the overall value of a shopping cart and also a transition in the mix of the cart to be heavier into the subscription side. We knowingly will lean into some of the subscription bookings even if we know it has a short-term impact on revenue and actually brings revenue down, because it's reducing the transactional revenue that's recognized in period. We know it's the right decision to make for long-term growth and we're building up this larger subscription base over time. So a lot of this is testing. As all of you know, we run a lot of different tests to try and understand consumer behavior in the cart. The more services that we can add during formation, the more things we have to test and learn on. The biggest one is LZ Tax. LZ Tax, as an example, is a service that's a much higher-priced ARPU. Also, the revenue is further deferred because it's not recognized in the current period; it's mainly recognized in the tax season itself. Today, we're building up a lot of infrastructure. We're building up capabilities. We're building up headcount to support a future tax season. You can see that even in the Q4 guide in EBITDA and we're really investing for the future.

That makes sense. Thank you, guys.

Our next question comes from Mario Lu with Barclays. Your line is open.

Great, thanks for taking the questions. Just wanted to hone in on this quarter as the drivers came in a little bit different than what we expected, with ARPU being a little bit higher, volumes being a little bit lower. So just wanted to see if we could double-click, especially on the transaction side, like how sustainable are these levels of ARPU going forward. And then conversely, on the volume side, when should we expect that to kind of tick up sequentially? Is it seasonally, you guys talked about 1Q being stronger. Is that what we should expect going forward?

Thanks for the question, Mario. On AOV, we actually did benefit a little bit from increased fulfillment rates. One of the things that is a key focus area for us is the customer experience. Turnaround times drive Net Promoter and retention. We've made significant investments on the fulfillment side and continue to automate. Some of that pulled in orders that essentially increased AOV in period. That's along with the historical increases in AOV that have been commercialization driven, doing a better job of marketing the product. We don't expect AOV to continue to climb indefinitely. In some ways, we'd be comfortable if AOV goes down and the mix becomes heavier into subscription services going forward. You can almost think of AOV as a trade-off with acquisition spend. In some cases, we might test lower prices to reduce CAM spend reliance. So it might even be the opposite. That's all testing to understand consumer behavior.

Mario, this is Noel. Just to add in, AOV was up 30% quarter-over-quarter. Year-over-year in Q2, it was up 16% this year. As we mentioned on the prior call, we expected the growth rate in AOV to decelerate sequentially in each quarter in the back half of the year. Because AOV was increasing sequentially each quarter last year, the year-over-year growth would be closer and the year-over-year growth would decelerate even in Q4.

Got it. Thank you, Dan.

Our next question comes from Elizabeth Elliott with Morgan Stanley. Your line is open.

Great, thank you so much for the question. I just wanted to dig in on kind of the share gains as an element for one of the key drivers of your growth. Can you let us know what you're seeing in terms of LegalZoom's share within overall business formations? How should we think about the balance between maybe some weaker macro year-over-year versus the accelerating digital penetration to help offset?

Thanks for the question, Elizabeth. This depends on which macro dataset you look at. The published macro data most people view is the Census data. Q3 Census data was sequentially down 19% and down 17% year-over-year. It's worth noting the two-year CAGR is up 22% but there was a step down. We have our own internal data source which links directly to many Secretary of State data sources. What we saw in September was a little different than Census printed and, in our view, it was lower than Census numbers. EIN data is not perfect; it's a superset of business formations because some people have an existing business and then get an EIN for hiring or bank accounts. We often see variation. Given that September was lower in our view, and looking at our share relative to the Census macro, we did gain share in the quarter. We will not be sharing our proprietary internal data. It gives us more visibility than our competitors and helps with forecasting and marketing spend, so we consider it proprietary.

Got it. And then just a follow-up on some of the retention. I think the retention rates are on kind of a 13-month basis. And you really started to see the tailwind for demand in July and August last year. So now that we lost that 13-month period, any color how retention rates have trended, especially for some of those cohorts that might have come on quickly?

That's a really good question. We had a sense this would happen. Some of those businesses were pretty ephemeral, and we saw a reduction in the 13-month retention for the July and August cohort. Interestingly, we actually saw strengthening in all of our other cohorts. So overall churn rates improved. The diminution was specific to that July and August cohort and we've already seen retention start to climb back up on the 13-month metric as well.

Great. Thank you so much.

We have a question from Andrew Boone with JMP Securities. Your line is open.

Hi guys, thanks for taking my questions. I've got two, please. So the first, can you talk about any learnings on LZ Tax? And just your level of confidence as you build supply ahead of the 2022 tax season? And then a macro question, just going back to formations. Admittedly, I'm asking for an opinion here. But given the strong job market, do you feel like that is more of a headwind for business formation and so we should be looking at job numbers as well? Or is the hiring market less correlated with business formations?

Let me take the macro first. It's an interesting question. There are significant job openings, but also a significant amount of unemployment. It feels like there's a behavior change: people are more willing to go out on their own or run a side business. The 'great resignation' in many ways is like a great entrepreneurial bloom. We're bullish on this. We look at the macro and see a very stable floor which we're forecasting off of, and we're not assuming improvements. We reforecast off of our internal macro data monthly. I wouldn't be surprised if there's some recovery, given it's never been easier to start a business. You have enterprise-level tools, you can test quickly, run a side business while working from home. So we feel pretty good about that. On LZ Tax, we're learning a lot. One of the surprises was how many tax questions we receive when someone forms a business—similar level to legal questions. We're seeing attach rates similar to our legal subscription service. We're growing rapidly and making sure we provide a great experience. We've deployed practice management software, hired experts ahead of the tax demand, and are augmenting with other service providers. We have many ways to solve for the season's tax business. We're also throttling volume; we are not reaching full potential. We ramped it up on LLCs, but we're not including it yet in other workflows like incorporation and nonprofit, and we're not actively marketing to our existing base. The goal is to provide the best experience possible in our first tax season.

Great, thank you.

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

Hey guys, thanks for taking my questions; nice results. On the EBITDA guidance implied for the fourth quarter, I think it would be helpful if you can just give us some more details on the magnitude of the LZ Tax and NBA partnership and investments and where these expenses sit on the income statement? And then are these going to be more one-time? Or should we think about them as ongoing when we put together our models?

Matt, I'll take this one and Dan can add if needed. In Q4, we're continuing to be aggressive in investing in the business: hiring to increase capacity and capability, and continuing to focus on technology. On the marketing side, we invested this quarter into testing new channels and will continue aggressively. Two items you asked about: the NBA partnership—we're investing a fair amount from a brand standpoint to launch the campaign properly. It will be heavier in Q4 but it's a longer-term partnership, so we'll continue to allocate to it. For LZ Tax, we're investing to scale operations in support of growth and in particular as we ramp up for tax season. The tax experts that we're hiring and are critical for that support sit in our cost of sales. You'll notice in our prepared remarks we discussed a sequential step-down in gross margin that is in part related to the tax investment we're making. Much of the recent growth in subscriptions related to LZ Tax will be recognized in 2022. So this is an investment in advance of that revenue.

I'll just add one point on brand. We have very high aided brand awareness, but many people have a legacy view of us. Only 40% of our potential consumers are aware that we have a business formations product. That limits growth and share, which is why we are making a significant brand investment. The NBA partnership—Fast Break for Small Business—is explicitly to reintroduce our brand as an SMB-first solution. This is an important initiative to realize unrealized potential.

Got it. That's helpful detail, guys. I appreciate it. Just one follow-up on the LZ Tax revenue recognition. Does that flow through the subscription line? And then is that more seasonal in the way it gets recognized? And maybe it's too immaterial now but do you expect that to create some seasonality with respect to your revenue in the first and second quarters of the year?

Great question. LZ Tax is recognized in our subscription revenue line. It's largely monthly subscriptions. There are components recognized ratably over the term and pieces tied to entitlements like tax preparation that will be more seasonal. So as it becomes more material, you'll see a bit of seasonal impact from it.

To add, we originally deployed different SKUs. We had tax advice and bookkeeping separate from tax prep. We realized everyone wants tax prep, so we've shifted to two flavors of tax prep which results in the seasonal deferral of a portion of revenue into tax season.

Great. Thanks, guys. Appreciate it.

We have a question from Brett Thill with Jefferies. Your line is open.

Hi, great. Thank you. This is John for Brent Thill. Another question into LZ Tax. Just trying to get a better understanding how much you're ramping into there. Is it more tax experts as opposed to the infrastructure and technology underneath it? And then when you ramp this up, in terms of the mix, will it be primarily tax prep as opposed to bookkeeping? How much will it impact in terms of headcount overall? Does that mean headcount is going to ramp to a much higher percentage versus what it is today? And then I have a follow-up on AOV.

We're creating a very large-scale tax practice, and all of those investments are being built in parallel. We started with a small acquisition so had some capabilities already. As I mentioned earlier, practice management is an investment, bringing in CPAs and enrolled agents is an investment, marketing is an investment, and there's a sales component because customers coming into our funnel can be introduced to it. It's across-the-board and it will predate the actual recognition of the revenue which primarily happens in tax season. The value here is heavily weighted toward tax prep relative to bookkeeping, but the two are strongly related, so we want small businesses to keep proper books and get ongoing advice from accountants, offering those services in combination.

Great, that's very helpful. Then on AOV, you mentioned improved fulfillment. Does that mean you were able to get filings recognized faster, so you're able to recognize the revenue a little bit faster than in the past?

Yes. Last year was unique with COVID impacts on our fulfillment operations and Secretary of State processing times. Many of those impacts have eased. Our fulfillment productivity has improved. We've made investments in our fulfillment process and supporting infrastructure, realizing durable efficiency improvements and enabling us to get customer orders out the door faster. Our fulfillment of orders is tied to the timing of our revenue recognition.

We view this as a durable benefit. We expect turnaround times to continue to improve and automate. Customers forming a business often have an immediate need, such as opening a bank account or meeting a trading partner requirement. They need it fast, which is the underlying reason for that investment.

Great. Thank you very much.

And our next question comes from Credit Suisse. Your line is open.

Hi, this is Francois on for Stephen. Thanks for taking the question. One of the key strategies you outlined is to improve the service levels for the consumer with Attorney Assist. Could you update us on the level of uptake you're seeing for those solutions in the verticals and products you have rolled it out to? Any incremental update on the split between DIY versus Attorney Assist?

It's still very early for Attorney Assist. The main place we've deployed it is on our trademark product, and we've seen the mix of customers choosing attorney assistance rise to be close to half of the customers seeking trademark help, which is a strong indicator. We haven't deployed Attorney Assist into our formation products yet, which is a much bigger opportunity. We're working in parallel to innovate on providing the service ourselves under the ABS structure and running commercialization tests. You'll continue to see efforts to learn how customers want this product delivered; that's something we'll start to scale next year.

Thank you.

There are no further questions in the queue. I'd like to turn the call back to Dan Wernikoff for closing remarks.

Great. Well, thanks, everyone, for dialing into the call and thanks for your questions. Really appreciate everything that you guys are asking. To the LegalZoom team, I want to thank you for the quarter, not only for the amazing execution but also the incredible passion and energy you bring to work each and every day. I also want to thank our newest team members from Earth Class Mail. Welcome aboard. We're thrilled to have you and can't wait to get to work. We'll talk to all of you soon. Thanks again for your time.

This concludes today's conference call. Thank you for participating. You may now disconnect.