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

I think we are ready to begin. Welcome, everybody. I'm Aaron Kessler, senior Internet analyst at Raymond James. Pleased to have with us for our next presentation, LegalZoom. And with us from LegalZoom today will be Dan Wernikoff, CEO. Welcome, Dan. Maybe to start off, and we'll run through some Q&A for about 30 minutes. [Operator Instructions]

So to start off, Dan, maybe if you can just give us a brief overview of LegalZoom and maybe some of the changes that you have made since joining over the last -- since you have joined over the last year or so.

Yes. So thanks for having me, and good to e-meet everybody. I'm Dan Wernikoff. I've been the CEO for about 2 years now. But LegalZoom has been a company that's been around for over 20 years, one of the early online disruptors for legal services and it really started with the idea of creating legal forms over the Internet, which has evolved pretty significantly over time to now be a full suite of products that are really there to help democratize law, the ability of providing legal services to people at a lower cost and provide accessibility. Our primary focus is on small business. So 90% of our business is really tailored towards small businesses. And in the moment that we try to own is business formation. So right when someone's forming, you need to register your business, but you also have to think about how you maintain compliance on your business and also a whole other set of suite of products and services that are really relevant as you get started as a business. So that's what we focus on. Like I said, 90% is small business, 10% consumer, which is estate planning and business formation is the core.

Got it. Great. And then in terms of the TAM, just give a brief overview of kind of the online legal services TAM today for SMBs and consumer. And relative to other sectors, the penetration rate for online is still pretty small for kind of legal. Why do you think that is? And kind of what's the opportunity to significantly expand that online penetration?

Yes. So we think of our TAM as in 3 different areas. So one is just, again, in this business formation space. So right when you're forming, there's a set of services that are both registration and compliance-related. Then there's things like tax and bookkeeping records that are required. And also when people form, they start to protect their intellectual property. So that, combined, is about $18 billion of TAM. Then as you're up and running, there's the business operations, which can mean reviewing contracts and helping with ongoing legal forms, business tax returns, different types of legal matters beyond formation, like board governance or employment matters. And that's a little bit over $20 billion as well. And then the final piece is the consumer side, which is roughly $9 billion in spend around last will and testament, power of attorney, living wills, all these estate planning-related services. The interesting thing is that consumer side is not a big focus for us on its own, but it's highly symbiotic in that micro businesses are started by consumers essentially. So the introduction of our brand as a consumer offering is helpful. And then as you create a business, that is an estate planning event, and you usually have to really think about estate planning. And so small business owners require it. So it's highly relevant to what we do. Now having said that, that's close to $50 billion of spend, and we're the largest digital player. And yet, if you think about our size, it's just north of $500 million of revenue. So the penetration into that TAM is relatively low still. And a lot of that has to do with a lack of category leadership. And if you think about -- even before I got here, there was a little bit more of a focus on cash flow generation instead of focusing on growth and establishing the category. And then it's -- a part of the challenge also is offering-related. So if you think about legal matters, many small businesses are not comfortable doing legal matters on their own. And this industry has been an all or none. It's been a do-it-yourself industry or go to an off-line attorney. What we're increasingly focusing on is how can we make that more of a hybrid where we can integrate attorneys into our platform, provide it at a lower cost and remove that fear of doing legal transactions on your own, which we think will open up the top of the funnel considerably.

Yes. Great. And then maybe just moving on to kind of the business formation, which is really kind of the core of your service today. You've noted that you're roughly at 10% share of LLC formations. Where do you think this can go over the longer term and where are the biggest opportunities to take market share from?

Yes. I think there's so -- I'm used to being -- if you're category leader to sort of seeing more of like a 30% or 40% share level. And so that's what we aspire to have longer term. To do that, again, you have to establish the category and you have to do product innovation. And so from a product innovation standpoint, if you think about the segments of customers that we don't yet attract in a meaningful way, we're not -- we have not traditionally targeted price-sensitive customers, and there's opportunities to do more business model innovation there with freemium type solutions. And then separately, we haven't gone after those customers who have been lacking confidence on their own to do it. And so the integration of attorneys. If you think about LegalZoom though, very specifically, we're a very well-known brand and yet many people don't know that we stand for small business formation. So even that alone is an opportunity, just to have people recognize us as the leader in the space, which we are, and then sort of understand that you can do these through us versus going to Secretary of State or going to an offline attorney is, in and of itself, a pretty big opportunity.

Yes. And of those 2 buckets kind of going to an offline attorney, Secretary of State, kind of DIY, either bucket, you think are a big opportunity for you guys to gain share from?

Yes. I mean there's -- if you -- the research we have shows that the minority of formations are happening digitally. And then those 2 bookends are seeing close to 30%, 40% of the transactions happening on both sides. The really interesting thing is if you go offline to an attorney, that can be 5x the cost. If you go directly to the Secretary of State, it has the lowest Net Promoter Score, even though it has 0 cost because people end up spending a considerable amount of time trying to navigate some of the sites as well as navigate some of the decisions without any context or help. And so both of those are really material opportunities.

Yes. And you mentioned kind of a freemium offering. How would that potentially work? As most times when these companies are forming, they probably don't have much business yet, obviously. So how would you be think about the freemium offering there?

Yes. So I mean the interesting thing here is there's lots of different things that we do when you form a business. And one of them is the base of that, which is registration with the Secretary of State. And so if you think about that, though, in and of itself, that does not get you established as a business. There's things that you have to do like an EIN or an operating agreement or you might have to start thinking about business licenses. The moment that you form a business, it has to stay compliant with a subscription called registered agent. And so the way to think about a freemium model could be as simple as we will do the registration for free. And then here are the things you need to start your operations if you're ready to start your operations, which will be fee-based. But that, in and of itself, would open up the top of the funnel pretty considerably for people who are extremely price-sensitive.

Right. So kind of the TurboTax model as we've seen.

It's very similar. It's like a 1040EZ filing, and then there's everything that's on top of that, which you still have to consider getting a return.

Got it. Okay. Makes a lot of sense. And then just maybe quickly, a comment. Obviously, there's been a little bit of investor concern. We had really strong growth in business formations in 2020 from a number of constituents, then we've seen the tougher comps throughout 2021. How should investors be thinking about the comps this year and then as we go into 2022?

Yes. So we definitely did see an acceleration in business formations with COVID. And it was actually pretty interesting to see it real time. As soon as the lockdowns happen and as soon as also some stimulus money was in consumers' pockets, and that combination led to lots of entrepreneurial ambitions being realized. Whether that was starting a business as a sole job or if it was starting a side business, both of those accelerated during that period of time. And then they have come down post June of this year to more normalized levels. But what I would say is those normalized levels are still significantly higher than they were in 2019. And we actually feel quite good about the current trend line where it's sort of normalized there and gone back to a normal seasonal pattern where we're still seeing volumes 30%, 40%, depending on which metric you're looking at above that 2019 level. And we don't see that changing. And if you think about the trends behind the industry, there are now tools that make it drop-dead simple to start a business that are almost enterprise-level tools that every small business can have access to. There's also a freelance economy that we're seeing bloom and blossom. And part of that is being built on top of gig platforms. And so like all of those are sort of tailwinds that we think will be there for the long term. Now that people have sort of been introduced to the simplicity of starting a business.

Yes. Great. And then maybe if you can just quickly review some of your key subscription services. And then I think you already mentioned kind of registered agent. And then in your S-1, you kind of noted 68% 13-month retention rate. Kind of where do you see that retention trending over the longer term?

Yes. So the services that we have traditionally had have been tied to managing your entity's compliance. So as you register as a business, say, you're an LLC, you now have to stay compliant and that can mean things like our registered agent service where we can take government notifications, we can take service of process, and we're always available to receive that on behalf of the small business and then ensure that they can access it immediately because those are typically very urgent messages. Separately, we have a compliance subscription, which if you think about some of the compliance requirements that happen on an ongoing basis, like every year, you have to file an annual report with your state. And so we manage those things that you have to do to keep your LLC current. And then we also have a legal services subscription, which gives you access to an attorney through a monthly fee from a small business' perspective. And then since I've joined, we've also launched a tax subscription. And so again, if you think about what we're trying to do as an ecosystem, we're trying to be there for everything that you need right when you form. 70% of the people who come to us to form a business don't yet have an accountant relationship and they have immediate tax needs. So they're trying to figure out what of their formation costs are deductible or should they form as an S-corp or C-corp because there's different tax implications. Or even they may be close to having to do a filing because they may already be in operations, and they need to start thinking about doing their taxes. So we've launched that service beginning this year and have seen some good uptake there. And it's a good representation of the type of subscription that you'll see us doing ongoing as customers are just getting started.

Got it. And you also made an acquisition of Earth Class Mail recently. Can you just briefly discuss that and the motivations behind that?

Yes. So Earth Class Mail is really interesting because there's some product synergies and then there's some technology synergies. So I'll start with the technology side. When you're a registered agent, you have to have a physical location in all 50 states to receive those notices. And then when you receive them, you truncate them by scanning them and then you display them digitally and alert the customer. When you think about Earth Class Mail, what it is, is a virtual mail solution, where in all 50 states, we enable a physical business address where your mail will be received. It will be truncated and scanned and it will be displayed on a mobile device or any device that you need to get access to your mail. It also goes further in allowing you to truncate a check and actually deposit it or take an invoice and input it into Bill.com through an API. So there's lots of interesting technology synergies that we feel like are relevant to even make our RA service better. But the real opportunity here is, again, on the channel side. So when you're forming a business, you have to declare a business address. And as more and more people are finding that they're creating a home-based business or they're creating a business and don't have a physical address or even if they're traveling remotely and need access to that mail, they have to declare that right at that moment. And that's data that we actually capture. So that channel can be a pretty powerful channel. And in fact, what we saw from Earth Class Mail is their acquisition patterns tracked almost 1:1 with the business formation category because people do this right when they're forming. So really clear technology synergy as well as acquisition synergy.

Got it. Great. And then one of the initiatives you've done since you've gotten to LegalZoom is kind of the third-party solutions. How is LegalZoom evolving a third-party network of partners? What are some of the financial implications of this in terms of when we should start to see some stronger growth here as a result of these changes?

Yes. So this is one of the areas that I feel like when it came in, we needed to really rethink how we are approaching it. As I mentioned, 2/3 of our customers come to us before they've even opened their doors. So they're just getting their business started. And while we'll help them with registering their business and keeping them compliant, we know that there's a lot of things that we won't do. And that we're still a very valued and trusted partner of these small businesses, and they're asking us for these things, but we won't build them ourselves. And an example I'll give you like an obvious one is we don't want to be an e-commerce provider. There's plenty of great best-in-class solutions out there. So when you think about those types of solutions, and I'll use a specific example of a partner we have on the point-of-sale side, if you're a retailer, we will point you to Square, and we have a special deal for our customers. And then very specifically, we have a rev share versus a bounty, which historically we had done with a lot of our partners. And so we're building up a recurring business with those partners. But ultimately, what we also want to do is we know that Square has a lot of small businesses that have not registered as an LLC. And so we think that there's opportunities to work as a channel partner the other direction as well, given just how big their base of customers are. So that's way more indicative of the type of partnerships that you'll continue to see us sign are people who are best in breed, have large customer bases already and are willing to co-market our solution along with us marketing theirs. The impact, though, is we've left bounty relationships, which you'd recognize the revenue upfront. And we're now transitioning to recurring revenue, which defers some of those going forward. So that has been a headwind over the last couple of years as we've been doing that transition. And if you start to look at next year, our guess is it starts to normalize a little bit more with the business growth and then be accelerating past that in '23.

Got it. Great. And then I think you've mentioned attorney network is kind of your -- one of the large opportunities longer term. So if you can discuss the attorney network opportunity a little bit and then also with the regulatory changes we're seeing in Arizona and potentially other states, how does changing regulations impact the attorney network as well?

Yes. Great question. The -- so the way our attorney network works today is that we have a platform and we have independent attorneys that work on that platform with our customers. It's a monthly subscription product, and it's sold separately from our core offerings. And what we've discovered, and this is very unsurprising, is that most people who buy that subscription consume it heavily in the first couple of months as it's related to their business formation transaction. And so in some ways, we feel like we haven't been going to market with the proper solution and a better solution would be to bundle legal services with that business formation transaction for most small businesses. So they can ask all of the questions that are relevant. Like I just hired my first employee, like what's an employment contract. And my first partner with them, working with -- on the supplier side, and they need an NDA. Like all these things, I have my first trading partner. I have a contract that needs to be reviewed or I have a lease I need to sign. So all of that is something that we feel like we can bring together into a single bundle, which would allow customers essentially to have access to an attorney for multiple months while they're forming an unlimited question and answer. Now the good news here is we know that most of the questions are -- probably there's 10 or 15 questions that are 90% of what small businesses ask. And so we can handle those incredibly efficiently and even enable those attorneys to spend less and less time on the administrative side and just providing the expertise. So we believe we can offer for a significantly lower cost than if you went just to an offline attorney. So that's kind of the vision around that. And we've been investing in that for the last couple of years. There's some platform work that has to happen before you deploy it. And so we've been busily working in how we're approaching it, and then we have commercialization tests and you'll start to see some activity there next year.

Got it. Great. And then maybe just on the sales and marketing side. Maybe just talk a little bit about how LegalZoom is evolving its marketing and advertising strategy. And I think you've obviously made a change since you've commented as well on that.

Yes. So this was one of the surprises to the upside when I joined the LegalZoom was just how efficient it was from a marketing standpoint. And when I -- actually, when I first got there, I realized that for every dollar we were spending on marketing, we were returning $1.40 in profit on day 1. And then we have an ongoing subscription relationship. So we've been on a journey of okay, let's scale that up, and let's start to look a little bit more like traditional SaaS companies that are willing to spend further to lifetime value, which we are still not doing. We're spending primarily to a 12-month return at this point. But what I would say is traditionally, we also were overweighted in SEM and then there was a history of pulsing TV on and then turning it off. And part of that was because the right infrastructure wasn't in place to really have a more performance kind of mindset around marketing spend. And so we put media -- a mixed media modeling in place. We're now looking at the cross-channel interactions. We're entering new channels like -- it's not a new channel, but new for us on digital video and social. And so a lot of that is what's been driving and fueling some of our near-term growth is just an increased spend level while maintaining that ROI over 12 months, which is less efficient than we used to be, but we were overly efficient historically.

Got it. Great. And then just maybe if you can just talk a little bit about some of your key investment initiatives over the next kind of 12 to 18 months? And then how are you thinking about kind of balancing growth versus margins as we -- over the next few years as well?

Yes. So there's 3 sets of investments that I would say that we're focused on. One is really scaling this existing business. There's things that we're doing to improve the experience end-to-end, thinking about turnaround times how we create better support levels, even just the product experience itself as you go through the product and how we do better targeting and some of the things that are just baseline opportunities. The second investment is really around the ecosystem, all those services that we're introducing that happened at the time of formation. And tax is a really good example of this where, if you think about what we're doing right now is, we are becoming an extremely large practice for tax. We're investing heavily in the platform itself. We're hiring CPAs, and we're about to do our first tax season in Q1 and Q2. And so the expense is now carried and yet a lot of the revenue isn't recognized until next year. And that's a good example of when you're shifting the business model more towards the subscription, where you'll see that a little bit of a heavy investment upfront for that deferral in revenue coming and going. And then the third piece is around how do we integrate attorneys into our solutions. Like how do we commercialize that differently and create the platform for independent attorneys to work on our platform.

Okay. Great. Anything we left out today, Dan? I think that's pretty comprehensive.

I think you've hit on most of the salient points already.

Right. Well, great. We appreciate your time today, and have a good rest of your day, and we'll talk to everybody soon.

All right. Thank you, Aaron.

Thanks, Dan. Have a good one.