LegalZoom.com, Inc. (LZ) Earnings Call Transcript & Summary

Great. Good afternoon, everyone, and thank you for joining Barclay's TMT Conference. My name is Mario Lu, and I'm on the Barclays Research Internet team. With us today is Dan Wernikoff, CEO of LegalZoom. Welcome to our conference, Dan. I'm very excited to have you here.

Thanks for having me.

Great. So just to start off, despite being a 20-year-old company, there has been many changes of late at LegalZoom, including going public earlier this year. So Dan, can you talk a bit about the history of the company? How it has evolved since you joined the firm?

Yes. I mean, so LegalZoom has been in business for over 20 years. It's almost like a heritage brand online. Started as a huge disruptor in the space of providing online legal documents and allowing self-directed individuals and small businesses to complete legal transactions on their own. So real interesting beginning of innovation, which then got augmented by the idea of once you've formed a business, you have to remain compliant. And so there was the introduction of new subscriptions, including compliance subscriptions, legal service subscriptions. And so the business model evolved over time to be a little bit more of a recurring revenue model. At a certain point, took investment from private equity. It became a little bit more cash flow-focused. That was roughly 8, 9 years ago. And when I joined, it was really to flip the bit and go back towards our heritage of growth and innovation. I think one of the things that our investors, our Board and the new management team that has recognized is we're really in a unique position where we're in an industry that has not gone through significant digital adoption. We happen to be the main brand in this space and have a pretty significant brand advantage. And we feel like we've been underspending to that opportunity historically. And so there's been a big shift over the last 2 years of getting ourselves ready for that phase of accelerated growth, which a lot of that is building the infrastructure underneath as well as the product innovation that people are starting to see.

Great. That's very helpful, Dan. And speaking to flipping back to growth, can you walk us a bit about how you define your TAM and LegalZoom's current share in that market? And then how much of that TAM would you say is still in the early stages of development at LegalZoom, including initiatives such as tax and experts-assisted services?

Yes. So legal services is a very large market. The way that we cut it down are the places where we're participating orient around the business formation transaction, which when we look at that space, it's just south of $20 billion of spend, and that's inclusive of business formation, tax and bookkeeping records. So the idea of getting you started properly as a business, the compliance services that we offer and intellectual property, most of that, it's right when you're forming. The second portion of TAM is around business operations. So now you're an established business, you're operating. This is north of $20 billion of spend that goes into contracts and legal forms, business tax returns, other legal matters that are relevant like HR, employee matters and the Board management, things like that. And then the last piece is south of $10 billion, which is really around consumer estate planning. And this is unique in that if you think about micro businesses, they are formed by consumers. And so we think there's a very symbiotic relationship between our estate planning business for consumers, which introduces them to the company, and then when they have a business need, they think of us first. But it's also symbiotic in the other direction because the moment someone forms a business, they often have to think about their estate plan and what they would need to pass on that business to their family. So all of this is related. It's roughly $49 billion of TAM. We can actually extend that by just adding additional matters, but we're really narrowly focused at this point because we have barely scratched the surface on this opportunity. If you think about that $49 billion, we're at roughly a point of recognition of that TAM. And then if you think about our sweet spot, which is really on small business formations, that's where we have much higher share, closer to 10% share when you think about the formations market very specifically.

Got it. And then you talked about this earlier, legal services online in terms of penetration is still fairly low at 8%. And when you compare it to other Internet categories, they're well in the double digits, high double digits. So I guess why would you say the penetration is so low in this category? And how quickly can that grow over, say, the next 5 years?

Yes. I think it's an interesting question in that we're in a category where there's a lot of fear of doing these transactions on your own. If you think about an analog, one of the clear ones is taxes, that oftentimes, people are afraid of doing taxes on their own and look to an expert to help them. Now this industry also has been very focused on just self-directed small businesses. So those people who feel comfortable doing it on their own. And if you think about it, all of the spend is with off-line attorneys. And so one of the things that we think more and more about is this is really a product innovation challenge, that we need to do a better job of removing that concern or barrier by integrating an expert into the software application so that not only can we reduce the cost to make it more efficient but remove that barrier that keeps people away from trying to do these things on their own. We have a ton of research that says small businesses don't like working with off-line attorneys because they find it highly inefficient and expensive. And so we know that we can offer these at a lower price, and we know that we can offer it in a way that saves time because we have all of the data about a small businesses they'd form, which is really a head start to that relationship. And we also know that most small businesses just have a handful of questions that can be handled really efficiently by the attorneys that are working on our platform. And so it's an advantaged solution that could open up the top of the funnel.

Got it. And then similarly, can you talk about how COVID specifically has impacted along legal services penetration and whether that is expected to normalize starting in 2022? And then just at a high level, like what factors would you point to in terms of leading indicators of acceleration of business formations?

Yes. So I mean it's interesting because I started at LegalZoom a little over 2 years ago, and we pretty quickly went into the pandemic. So I have a ton of history prepandemic in terms of the impact to our business. But it was very clear when the pandemic hit, that people, once they had the combination of stimulus checks and a little bit of time at home, it accelerated the overall business formations market. And it also accelerated adoption of an online service like ours because, obviously, access and being able to go out physically to meet with an attorney became less of an option during the pandemic. So we definitely saw a little bit of a benefit as well as if you think about the types of businesses that we're forming, oftentimes, they were more -- during the pandemic, more technology-leaning businesses where there is more comfort in being self-directed and completing it on your own. So all of that has played a role. We actually feel like that role is something that will persist over time. We've obviously seen a little bit of a step down in the macro, but we're well above the business formation trends that we saw in 2018 and 2019 because, again, people now have the ability to start a business with almost no barriers. I mean, the tools are inexpensive. They've been introduced to people. People can do it as a hobby or as a sideline business. And we're seeing the gig marketplaces as well enabling that to happen at an accelerated pace. So we love the macro. We think it will continue to be a strong macro, but we've already factored in the fact that it's come down from the pandemic levels where I think it accelerated partially due to stimulus checks.

Got it. And then, yes, I don't think you guys really talked about -- you mentioned gig economies, but are there certain category of businesses or demographic of entrepreneurs that you're seeing higher adoption of your services versus using the traditional online services? I believe in the past, you mentioned like [ case and rental ] businesses. Anything else to kind of point out in addition to those 2?

Yes. I mean, we're sitting on a lot of awesome data here because we know a lot about businesses when they form, and we have them before they've actually begun operations. So what's unique about what we see is we're typically seeing trends prior to them becoming fully adopted in the marketplace. So when the pandemic hit, we could see immediately, for instance, the rental market went down pretty significantly. There were not businesses forming. And on the flip side, we saw things like online retailers take off. And -- but there were real anomalies even within there. You could see things like clothing companies were one of the fastest-growing segments when the pandemic started because essentially, they filled a void in a market of comfortable clothes when people were staying at home. There were all these unique trends that we see in our data that I think you can now even take to today when the market opened back up. We saw things like transportation and warehousing take off. Even with the infrastructure building, you can start to see that momentum building up. The one thing, though, that is consistent across all of these different periods of COVID and the shifting in the economy is that our base leans a little heavier towards online businesses and tech-enabled businesses versus off-line businesses. But it's a large base. When we're doing roughly 10% of the formations, it is highly representative of the overall economy.

Got it. That's very interesting. Thanks for the color. So Dan, you've been in the seat over a couple of years now. Just at a high level, what would you say are things that you're most proud of accomplishing thus far? Any unexpected challenges that you faced worth noting?

Yes. I mean, I think probably the thing I'm most proud of is the team that we've built up. We have built up a whole new leadership team and a whole new team underneath that really are coming from highly scaled companies that have focused on small business and consumer, direct to small business to consumer. And so if you think about our heritage, our heritage is deep domain expertise and an understanding of the legal industry and how to operate within it and be a disruptor. We're now feathering in people who know how to scale that up and to build a large business off of it. From a product standpoint, the thing I'm most proud of is the launch of our tax business. It's not easy to launch a business in a different domain so quickly, and I can talk a little bit about that progress later. But from beginning of launch to now scaling, we're setting ourselves up for a very large tax season next year, all coming from 0 customers when we started this year, which is pretty fascinating. It just shows the power of the channel itself. The things that have been more difficult, as you know, I talked about the company over the last 10 years became a little bit more cash flow-focused. And that meant that a lot of the investments that you need to make to scale were being deferred. And so if you think about many of the investments we've made the moment I got here, they're not visible from a customer standpoint necessarily yet, but the infrastructure we're putting in place is what's going to enable our growth in the future. And so there's been a deep investment that we've been making in parallel to scaling the business, which is probably going to help us accelerate in the future.

Got it. Great. So why don't we just dive straight into the tax. It's been an area of focus for your company. It's been fully rolled out to the LLC traffic. And you mentioned you guys doubled the team of in-house experts in that area. So can you talk a bit about the process of scaling up these new verticals like tax? And how do you decide how to balance growth and then -- versus user metrics, such as NPS score and retention?

Yes. Great question. So I mean the first thing, I guess, is just thinking about like why we went into this space, and it really does start from customer insights. And one of the surprises to me when I joined LegalZoom was listening to customer calls, we would get as many tax questions as we would get legal questions. And so when we started to really dig through the data, the thing that we recognized is 70% of the people who are forming businesses with us had no accountant relationship at all. And that pain point right off formation because they wanted to know what was a deductible expense. They wanted to understand how they should think about capital expenditures. They wanted tax advice. They wanted to understand if they should establish a C Corp or an S Corp, which is really just a tax declaration. So we started to think about, well, this is an ecosystem that overlaps with the formations ecosystem. It's an adjacency in that it's a compliance requirement. If you have income, you were going to be required to file a return, which is in our wheelhouse. And our channel is essentially a 0-cost channel. You combine that with the fact that many people -- our leadership team have experience in the tax base as well. We felt like this was a pretty ripe area for us to enter. And so this year has been building out -- again, all the infrastructure required because you're talking about practice management solutions, you're talking about the ability to do some matching with accountants. You're talking about commercialization of the product and making sure that you have the right packages. So we've been focused on that component of how do we scale it. We've introduced it just to our LLC traffic, and we've been ramping that up throughout the year, and now we are going out to 100% of traffic. But we're still throttling this solution in many ways in that we're not offering it to customers who form a corporation or nonprofit or a DBA. We're not marketing to our existing base yet. And we're just making sure that we solve for this first tax season and we get the Net Promoter Score right so that we can continue to scale it next year as well. So we're shifting a little bit of energy right now as we get ready for a tax peak season to really focus primarily on Net Promoter Score.

Great. Yes. It definitely seems like a natural extension to your business. So just hoping to dive into numbers a little bit more. AOV, the last couple of quarters has been a tailwind to the top line, partially due to increased fulfillment rates in higher AOV. So can you speak a little on that dynamic? How should we think about this trend of increased fulfillment rates in the long term? And then you guys also mentioned you're aiming to be more competitive on the pricing side. So how does -- how do we compare that versus your AOV increasing?

Yes. So there's a couple of things to unpack there. I think the first thing I'd say is that the bulk of the AOV improvements historically have been driven by the fact that we continue to shift mix from the consumer side of our business to the small business piece. And so 90% of our revenue at this point is actually coming from small business, in the bulk of the transactional revenue as well. And so there is a mix shift that's happening over time and has happened over the last couple of years, especially coming out of COVID, where we saw the consumer side of our business grow pretty significantly as a result of people wanting to put estate plans in place. So that's one component. The second thing that's really important to note is one of the most important drivers of the Net Promoter experience for our customers is how quickly we can fulfill their orders. So we've been very focused on automation and really reengineering the process of how we fulfill orders. Turnaround time is how we measure that. As we speed up that turnaround time, it actually has the impact of having us recognize more of that revenue in period. And so it has a dual benefit. And it's durable, and we're going to continue to invest in it over time so that we continue to get those turnaround times as low as possible. And it just has that recognition benefit. There's one other thing, though, that it also enables. The more that you automate the platform, the lower the COGS are on transactional revenue, which would allow us to be more aggressive in how we even price our solutions so that we can bring that cost down to consumers and start to go after a different segment of customers who are more price sensitive, especially in a world where we have great subscription ecosystem opportunities to cross-sell in. So if you think about going after price-sensitive customers, it opens up the top of the funnel again, and we would monetize them more through our subscription offerings than we would from the actual transactional offerings that we have historically offered our customers. So there's a good opportunity there that would essentially bring AOV down, but it will probably bring down our CAM spend as well. But the thing to remember, too, is that while we're bringing the CAM spend down or the AOV spend down for free customers or freemium customers, we'd also be bringing it up to serve premium customers with an assisted solution at a higher cost. So it's -- at this point, it's an unoptimized lineup, which usually means lots of opportunities, and there's lots of testing to do to make sure that we have the optimal lineup, but you'll probably see us go in both directions at once.

Got it. And then speaking of CAM, can you describe what the marketing environment looked like over the past few quarters in the midst of IDFA? And then while also trying to raise awareness to your brands, any channels that you can point to that are performing better than others that you're seeing yourself leaning into more in quarters to come?

Yes. And I think this is an area where there has been a big change in how we've approached our strategy. So historically, the company has been highly dependent on SEM very specifically. The good side of that is we aren't as impacted by things like IDFA. Like we haven't had as much of an investment in DDM-type channels, social, display, retargeting. Those are all upside opportunities for us instead of being places where we're becoming less efficient. So right now, we're focused pretty heavily on how do we open up new channels beyond just SEM. Part of that means also thinking about a more consistent brand spend in one of our highest-returning channels. Interestingly, once we put media-mix modeling in place has been -- linear TV and the combination of linear plus SEM has helped us at both the top and the mid-funnel. So this is actually a place where you see our CAM spend going up, and it was up close to 46%, I think, in the last quarter while still maintaining the guardrails that we've put into place when we went through the IPO process, was that we expect to see a 13-month return on that CAM spend in the aggregate. And along the way, there are some channels that are more efficient, like TV and SEM are still highly efficient. And there's newer channels that we're testing and scaling like digital video and social that are going to be less efficient in the short, but then become more integrated in our overall marketing strategy in the long.

Got it. And just to talk about margins overall. During the IPO process, you mentioned that the long-term EBITDA margin goal was to be 30% plus versus this year. Obviously, still early but the guidance is for 8% EBITDA margin. So given the low penetration of online services today, is there a scenario where LegalZoom will prioritize growth over profitability and kind of push back that time line?

Yes. I think so long as we see the right marketing return that we will continue to spend into growing share and taking more of this market. We feel really confident in our long-term margin goals because we've actually achieved them historically. And so that's not our goal to get there fast. In many ways, you'll know we're successful as our margins are eroding because it means that we're spending more but spending to the same return and probably shifting more of our revenue to subscriptions, which are deferred. And so that combination will have a short-term impact, but we know that the long-term outcome is a very large subscription base at a very high margin. So yes, I think our goal is to sustain lower margins, oddly, knowing that, that means that we continue to see opportunities to gain share.

Got it. That makes sense. And just to take a step back, can you talk a bit about the most recent acquisition, Earth Class Mail, in terms of your motivation? Like what that status is in terms of integration? Any areas that you guys might look to acquire?

Yes. So when we think about inorganic opportunities, we think primarily about looking for capabilities to plug into our business formations platform. And so if you think about Earth Class Mail, it is a virtual mail solution. What it enables is the ability to digitize physical mail and have access to it wherever you want. And there's a couple of benefits to that component. One is privacy in that many businesses now are home-based businesses. And if you publish your address, your customers, your marketers can all reach you at your home. And the second piece is many people are working remote and need to have access to their mail. And so both of those are big opportunities. If you look at the acquisition pattern of Earth Class Mail, it maps almost 1:1 with the business formations market. So most people consider this as they're forming. And in the experience of our product, we actually are probably the first one to make you think to yourself, this is a need because we ask you for your business address. And you may not have even considered like, "All I have is my home address," at that point. So the integration point is very, very clear. So when we think about acquisitions, we look for capabilities that overlap with this platform. We don't want a large base. We don't want revenue. We want tech and teams. And so this was a tiny acquisition. It will be very easy to integrate and works alongside the technology that enables our compliance solutions as well because a lot of what we do there is digital scanning and truncation of physical notices that you get from the government or from a service or process. So lots of synergies there. I think you'll see other spaces, if we're in the acquisition arena, relatively presumably kind of similar composition to Earth Class Mail.

Got it. And then in terms of the competitive landscape, I understand most of it today is still off-line. But can you talk a bit about comparisons to your online software peers? And where you see LegalZoom structurally advantaged to continue being the leader for years to come?

Yes. I mean there is digital competition in our space. I would say most of it is emulating our model and then trying to discount on pricing very specifically. It's a healthy thing. By the way, when you're creating a category, you're often going to create competition that's just looking to create a discount and in conquest off of your brand spend. So we fully expect it. I think when you think about how we differentiate ourselves, ultimately, it's the ability to start on your own, self-directed with a low-cost solution all the way up to our independent network of attorneys and the ecosystem that goes along with business formation. Most of our digital competition is really going after the formation transaction and a single point of the compliance subscription of a registered agent. That's why we feel like once we build out that ecosystem and it's all integrated into a single experience, it really can't be replicated by any of our digital competition. And they also -- they don't really have that scale of the independent attorney network that allow them to go up market and go after the nonconsumption that is off-line primarily today.

Great. That's very helpful. And just the last question in terms of partnerships. You currently have marketing partnerships with the NBA and business partnerships with companies such as Stripe and Brex. So for these partnerships, how do you decide who to partner with? And can you kind of explain how the strategy has deferred into choosing your partners today versus before, where it was more one-sided and more legion-based?

Yes. Historically, our partnerships had been bounty-related and a little bit more off-brand. As we've stepped back, we've said, given our place in formation and being a trusted adviser, we want to work with large brands that offer bilateral relationships. So we can acquire for them, but they can also apply for us, and that these should be more a recurring-revenue relationship. So you mentioned one with Brex. We also have a partnership with Intuit. We have a partnership with Avalara. These are all set up in a way where we think about it more as like a larger strategic opportunity. What I'd say that as we go forward, where we'll play versus where we'll partner. If we think that it's -- our channel itself is extremely relevant to the compliance solutions that people need right when they form, that's something that we feel like, over time, we should own. If we feel like it's gone vertical or if it's something that is in a different domain outside of compliance, that's when we'll partner. And so like I'll give you a data point that's fascinating. When people form with us, 80% of them don't have a website yet, which was actually a little bit surprising to me. I assumed that chicken and egg would be -- you may have the website and then decide to formalize your business. The reality is the opposite. We have no interest in creating a website solution, there's plenty of players out there, and it's not really a compliance solution, but that's an area where we'll likely look to partner as an example. But separately, as you think about anything that's tied to compliance, if it's required, that we're investigation -- we're investigating whether or not we should own it.

Understood. Great. Well, this whole discussion has been very insightful. So Dan, thank you so much for joining us today.

Thank you. Pleasure being here.

Great. Take care.

Thanks.