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

Good morning, everyone. Thank you for joining us at the Morgan Stanley TMT Conference. My name is Elizabeth Porter. I'm an analyst on the U.S. software equity research team. And I'm very pleased to have with us today ZoomInfo's (sic) LegalZoom's CEO, Daniel Wernikoff; and CFO...

LegalZoom.

LegalZoom. What did I just say?

ZoomInfo.

Oh my God. I'm going through my question list already for the rest of the day. So sorry about that. And CFO, Noel Watson. Thank you guys so much for joining us today.

Thanks for having us.

So we are going to take audience Q&A, and then mic will be going around at the end. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And with that, thank you so much for joining us.

So just to level set kind of bigger picture, ZoomInfo IPO-ed in...

LegalZoom.

Oh my God. I'm so sorry. I was reading my question list first. IPO-ed in 2021, and you guys have been around for over 20 years. Can you just talk about how the business has evolved, been providing online legal services and some of the changes you've made since joining?

Sure. LegalZoom is a bit of a heritage brand in a way. It was founded in 2001, really in the backdrop of the dot-com bust. And at the time of launch, it was a really disruptive online legal form solution. It's hard to remember that. But at that time, that was actually disruptive. For multiple years, it sort of had the lead in the legal space. At a certain point, really started to focus on small business and formations. And also launched a subscription service, which was tied to compliance. And that was in the early 2010. Also, at that point, book private equity ownership and investment, and I'd say it went a little bit more on a journey of monetization and building out the business model, which was actually one of the pieces that attracted me. So in 2019, when I joined, I had thought at that time the markets were pretty frothy. And I really wanted to be at a place that has established the business model, had a real solution that customers used. And I was a couple of years early on that frothiness. But ultimately, when I looked at it, it felt a lot like an industry that I was used to, which was working with accountants and attorneys were pretty far behind. Accountants and small businesses really struggled with doing some of the simple legal and regulatory solutions that they need to do when they launch. So we've been on a journey of really creating that ecosystem. We wanted to both reinvigorate with an investment in the product and build a true platform and automate a lot of the processes behind the scenes so we can make the product scale. And then when we did that, we also want to create a big ecosystem around it of all the services that small businesses need right when they launch. So it's really shifted from being focused on -- purely on profitability to a balance of being a profitable growth company with a real product strategy.

And so on the new business formation side, that has been the primary acquisition channel for LegalZoom, that naturally just gives you some visibility into the health of entrepreneurs and SMBs in the U.S. economy. So what's your perspective on the demand backdrop from kind of that top-down view?

Yes. I mean there's 2 different ways to look at that. One way is to look at it year-over-year and there's some weakness. So we came out of COVID and clearly benefited from a lot of demand in our industry, a lot of small businesses formed during COVID. But there's a different way to look at it, too, which is against 2019, pre-COVID. And if you look at those levels, we're roughly at about 40%, 45% above where we were at that point. And one of the things that's interesting to think about when you think about formations is it's a pretty stable macro typically. So over 20 years, it's been growing about at a 5% CAGR, pretty consistently with a couple of hiccups at different points around the recession. And obviously, now post COVID. And so what we're seeing is it normalized and just kind of revert back to the mean. We expect that it will revert back to the mean in the next couple of years with a gentle decline.

And when you say revert back to the mean, is that going back towards that...

Not to 2019. We see it as going back to establishing and picking up the trend line that was a 5% CAGR. And the reality is, if you ask me my personal opinion on top of that, we're relatively conservative people at this point in terms of trying to forecast out a macro. My personal opinion is that there has been a little bit of a shift and you are seeing more businesses form primarily as a result of a lot of people working out of their house. Some people ask me, when people lose their jobs, do they form a business? And I think it's not like you have this immediate moment where you say, well, I just lost my job now I have this great idea. A lot of people have great ideas while they're working, and they've never been able to actually act on them. And now they're sitting at home and have a little bit of time. And so we do see a bit of a shift in the types of businesses that are forming.

And so is this more of a structural shift and how easy it's been to form a business online, you can start with out of your homes that gives you confidence that we can sustain above that pre-COVID 2019 trend?

Yes. I think there's lots of components. So one is it's never been easier to start a business. Another is people are literally sitting in their houses. So as much as we think everybody is 100% allocated against their primary employer. I think the reality is a lot of people are actually doing a little bit of moonlighting during the day. And I don't see that changing. I mean, there's a component of the industry that will remain working from home. I mean we're probably in the heart of that. When you think about engineers, I don't think a lot of the bigger companies are actually getting those engineers back in the office.

And in 2Q 2022, you guys announced a -- shift a bit in the strategy around the new business formations product, which included kind of lowering the price of the product for free. And most recently in the recent -- in the latest quarter, you said that you actually think that dropping that price to free. Overall, it's going to have a neutral impact to the financials. So what's the trade-off or benefit that LegalZoom gets in lowering that core product to free? And what are some of the dynamics and assumptions that underpin your confidence that you can have a neutral revenue impact?

Yes. So our goal, as soon as I got here, was to really go after share as the leader in the market. We have 75% awareness, and our next closest competitor is sort of in the under 20% range. And as the most scaled player, we want to go after share. And especially in an environment like this, when some of our competition has been fueled by VC funding and sort of been spending, what I would say is more inappropriately, and this is the time to go after it. So we've been thinking about how we do that. And the reality is there's parts of our business that are commodity. I mean actually registering your business as a company with the secretary state, it's not that difficult. And so things that aren't difficult always go to 0. There's -- that's just a reality. And so we have to think about what the value that we provide is. It's much more guidance. It's an ecosystem of all the other services that people need right at formation. So like these are not vitamin-type solutions. These are things that are required for a business, and we have an entree to them. And the more that we bring in, the more we have that entree. So we've been testing this, the confidence part. We've been testing this for too long. It's been over 6 months. We have measured about 50 times and we've cut once now. We know the results, it's [ stat sig ] and it's revenue neutral, but it did what we wanted it to do which is it actually pushed what was transactional revenue into subscription revenue. So the LTV component of it is positive.

And I want to go back on the share gains. You initially expected to grow share by about 15%. And the progress that you've shown thus far has been really impressive on that share gain front. So what's the latest thinking on this target? And are these share gains coming from other online competitors? Or is it the off-line attorneys?

Good question. I mean our industry is probably still majority nonconsumption. And by nonconsumption, I mean either people going directly to the Secretary of State and then cobbling together a suite of services that they need or going to an off-line attorney and the off-line attorney is extremely expensive. People leave the attorney confident, but they paid $3,000 to $5,000. People leave the Secretary of State completely confused. And we measure net promoter in both ends of the spectrum. And what we're trying to do is kind of straddle that middle piece. And that middle piece is -- we can give you access to an attorney at a lower price and very efficiently. And we can also provide you low-cost guidance along the way and introduce you to the ecosystem. So I mean, the bulk of what we really do is go after nonconsumption. We do have competitors in the DIY space, but I don't consider them to be like the main opportunity.

And then you also just mentioned on the subscription side. So part of this whole shift has been pushing away from transaction towards subscription. And if I think back about at the IPO, about 60% of customers purchased at least 1 subscription at the time of their initial business formation purchase. And the portfolio of subscription services has also definitely increased with kind of Earth Class Mail and LZ Tax. So how has this attach rate changed? And where do you see that trending longer term?

Yes. The attach rate has remained pretty stable. It may change a little bit as we go to free because you see lower attach rates, but you see a higher absolute number of subscriptions as a result. The way we really think about it, because we have introduced a lot of subscriptions. So if you -- one of the things that was a precursor to going free is making sure we had an ecosystem that had LTV that none of our alternatives compete with. Most use partners, they're very low cost kind of transactional bounty type relationships, and we wanted to have the lifetime value associated with it. So when we think about what we've offered, I mean, we've introduced LZ Tax, we've introduced Earth Class Mail, which is virtual mail, and now we've -- we're going to be introducing e-signature. The goal for us is not necessarily just attach rates. It's going to be what's the dollar attach. And so some of these are much higher value like LZ Tax, which could have an impact on some of the other subscriptions. But the goal, again, is all about absolute subscription growth, and that can come in a lot of different ways.

Yes.

And I think just to jump in, I think equally as important is the type of subscriptions that we've introduced are higher engagement subscription. So you think tax and virtual mail and e-signature, which allows us to keep a close relationship with our customers. So as we use freemium to drive customer growth. We're attaching subscriptions at that point of formation. But now we have higher engagement, which allows us to attach additional subscription and additional monetization opportunities as those businesses grow and evolve.

And with some of those subscriptions being much more higher priced, is it the overall subscription average prices around [ $250, $260. ] So things like LZ Tax can be north of $1,000. So one, kind of first question is when that product first came out, it was new for you guys. There was a lot of learnings. So what did you learn kind of from the last tax season to this tax season? And second, how should we think about the impact to blended ARPU?

Yes. We launched -- and we said we were doing this. We launched it very fast, and we formed it with bodies last year. And I'd say, I would give us a C minus. Like I -- we just -- we didn't deliver an efficient service, and because it wasn't integrated into our product, there were lots of steps for a customer to work with an accountant. But there were 2 really interesting -- well, 3 things we learned. One was that the channel itself is super powerful. Like we're able to sell an LZ Tax solution, people at formation, they generally are confused about what the tax implications are, so we proved that out. We also proved out that if they worked with one of our accounts, they'd love the experience with the accountants specifically. And then we also learned that we have a -- different segments of customers. When we talk about some of our customers, almost half of them, they're pre-revenue. So they don't really need a filing transaction. They just wanted advice. We didn't offer an advice SKU, so what they did was they purchased the filing SKU, and then after a couple of months of working with the accountants, they just -- they had tried it, which made a lot of sense, and we just kind of embraced the learning. And now we have an advisory SKU that's lower priced and a monthly subscription that goes side-by-side with these other ones. The interesting thing is that becomes a feeder for filing. So it's a pretty natural channel, and it's a much more -- it's a way that embraces the customer and kind of how they approach taxes versus kind of us forcing a filing transaction initially. But probably the bigger thing is we're building an online assisted tax experience. So in the off-season, we built onboarding in our products. We built tax intake, which is really all the questions. So if you -- any of you use the DIY solutions, all the questions that lead up to then uploading your forms and it kind of helps set you which forms have to be uploaded. And then ultimately, it's interacting with your account directly through our application. So it's as good as any solution that's out there from a product standpoint at this point. And this tax season is dramatically different because now we can watch every customer go through the funnel, and we know exactly, and we're continuing to learn those things that we're going to screw up, but we learn where they get stuck when they -- we need to insert the accounts, and we're just driving them down the funnel to a good tax return.

And Noel, I'd love to hit on some financial questions. When I think about this initial 2023 guidance, held for about 1.5% revenue growth at the midpoint. There's also some headwinds in there from exiting some legacy partnerships. But kind of embedded within that full year guidance, it does assume some improvement in the back half of the year, particularly related to subscription. So can you just help us unpack what are the assumptions and the sources of confidence that give you that visibility into subscription, revenue growth being stronger in the back half of the year?

Yes. I think importantly, everything that Dan was just talking about in terms of the rollout of freemium, so you saw the share gains that you alluded to in Q4, weren't fully rolled out in Q4. We're going to -- our plan is to have it fully rolled out pretty imminently here. We said...

A couple of days.

We said by the end of the quarter, but we're targeting earlier than that. And so what that does is in driving that customer growth. There's a trade-off of average order value, so you don't necessarily see the growth on the transaction side from a revenue standpoint, but we're driving more customers, expanding the targeted audience, a little bit more of a price-sensitive customer. So you do see some attached degradation. But as Dan mentioned earlier, overall, many more subscribers and subscription units, and that allows us to get to that reacceleration in the back half.

It's also worth just mentioning that embedded in our assumption is a pretty bad macro in the back half of the year. I think we are assuming a full-on recession and deceleration in the macro. So that -- while it may not look like a large growth in the back half, it's sort of baking in what we're not yet seeing, to be honest. In fact, if you look at January, the macro is just down a couple of points against prior year. February, we do think it will be up the prior year. And so every month where we see some late benefit relative to our forecast, it sort of accrues throughout. Because you won't see a drop on a dime, you'll see it sort of gradually bake in.

And on the margin side, the initial guidance calls for about 600 basis points of year-over-year expansion despite the fact that you are absorbing some of those top line headwinds. The first part is, where are you most focused on taking cost out of the business to achieve that target? And second is, does -- how much of the reduction is structural versus more just navigating the tougher macro that you embedded in guidance?

Yes. I would say, first, revenue is growing next year; two -- or this year. Two is, a lot of the cost savings were realized throughout this year with adjustments that we made in the business and efficiencies that we realized in our operations. And so we're annualizing the benefit of that in this year. We continue to look to automate manual processes. And we've said before, we're kind of still in the middle innings of that and have more opportunities. But overall, the business is becoming more efficient. We also hired -- the last few years, we've hired a lot in our corporate functions and kind of fully nourish them. We'll start to see leverage there. And then importantly, from the marketing side, with the freemium rollout, we're converting a lot more of the traffic that we currently have on this site. Our marketing dollars are working harder for us. So we're expecting to benefit from that in terms of paid marketing efficiencies. We said we're pulling back on our brand spend, which from a marginal return standpoint is our lowest-returning dollar, which helps efficiencies. And then as we roll out freemium, even through the testing, we haven't really been able to test the messaging around free. And so as soon as we go to 100%, we're -- through all of our different channels, we'll be able to change the content and the deliverables in there so that we can really [ expose ] sort of the free messaging, and that will help not only on our paid efficiencies, but in the free traffic we're able to partner to the site as well.

And then...

You didn't ask it, but I'll answer it. I'll answer myself. One place that we didn't cut from in any way and that we're nourishing pretty aggressively is the product investment. So if you think about the last couple of years, admittedly, there was more of an infrastructure and foundational investment than even I expected when I joined, and we're pretty far through that at this point. I mean, I'll give you an example. We were completely on-prem. We had no data warehouse. There was no infrastructure. So you have to rebuild the team, build infrastructure, and now we're doing the fun part. I mean we're building product. I came to build product. That's what I do. And we're now building things that I think when people see it snap together, which you'll start to see at the end of this year, it's basically the destination for small business compliance. And that doesn't exist as a category. Small businesses, they actually keep all of their information in disparate places. They have a different insurance broker. They have their licenses in a folder. They have tax stuff in the shoebox, they get their mail and their mail has important documents. They don't look at it. They get notices from the Secretary of State. They miss it. This is what we're pulling together, and it just doesn't exist as a category. So that product investment is critical. And if anything, we're probably growing our product team much faster than the industry.

And so we're going to a little bit more pushing the gas on that product, maybe more of -- a little bit more product-led growth motion rather than relying more so in marketing dollars to be that traditional way that you attract customers in. Another opportunity is partners. And you recently have announced Wix as a go-to-market partner in order to acquire new customers. So what's the opportunity to add more partners like Wix? And can that kind of be a change in the longer term necessarily? How much you invest in marketing?

Yes. I mean, there's 2 ways we -- traditionally partners have been something that's opportunistic, let's just market something that customers don't have. And the reality is that when small businesses come to us, for instance, 80% don't have a domain, which was pretty amazing. I was actually shocked by that. I assume a lot of people start with the site and then eventually form. So there is an opportunity to market services like that, that we won't -- we never want to play outside of the compliance space directly. So what we look for now is not just to market that third party, but look for the brands where people might start with them before they actually create an entity. And so it's not a massive set of people at the end of the day. So we know sometimes people will get insurance because they get a job and the person who's hiring them says like, you need to carry insurance. And then during that process, they might find a [ need ] to form. So we're working with next insurance. Then we market them and they're going to ultimately market us. Wix is a great example. There are -- I mentioned 80% don't have domains. They have so many customers that don't necessarily even consider creating an entity, so they need an education as well. But they have 20% that are in operation, so that's a channel. And so we want to work with them as well. We just struck a deal with Chase, when people go get a bank account and they're starting to really consider the separation of their personal and their business financials, like that should be a channel. And we're already a big channel for getting people their first bank accounts, so we want to work with the premier partner there. So it's a handful, and we're not going to -- we don't want to be spamming our customers. We want it to be highly targeted, and that's part of that platform investment we're making, where we have so much information that we collect at the setup of a business. We essentially have a profile, and we want to get smarter about what are we offering them? Like is this tailor-made to this specific customer. And so that's the strategy.

I'm going to open it up to audience Q&A. But before I do, I want to ask about generative AI. It's been top of mind for many, and then...

That's shocking.

Yes.

First time as we weren't expecting that. Really all...

See the panel yesterday. Well, we have coming up later today. And people are just trying to think through the ramifications of this new -- just capability that you can do and how that impacts existing software solutions? So how do you think about the potential implication for the online legal services space?

Well, I'm highly qualified because I'm old and I worked in products. So I've seen a lot of platform shifts. I've been -- everything started in the desktop and then moved online and then moved to mobile. And you see different technologies that really can change an industry, and it's clearly one of them. Our industry is unique. It's almost like medicine that it's highly regulated. And so you have to be credentialed to provide advice. So the way it will probably work in our industry is helping us invest in a platform that makes attorneys much more effective and efficient. Now what's interesting, and I said this before, our big competition is the Secretary of State, and I don't consider them competition. I shouldn't say that, that's an alternative. The Secretary of State, if someone really knows what they want to do, it's a great way to go -- just go directly to the Secretary of State inform. I don't think they're going to make massive innovative investments in the ChatGPT or in generative AI. And then on the flip side, the main attorneys for small businesses are like neighborhood attorneys, onesie-twosie shops. You don't go to a big law firm. And the bar association is a gild, like let's just be clear, and they're there to protect the status quo. So they even have rules that you cannot give any equity to a non-attorney. So it's not like there's a tech investment happening in these little shops. And so in a lot of ways, I think you can look at this and say, it's probably a huge benefit for the market leader to think about how we integrate it into our platform and then distribute it to all those people that need it on both sides of the equation. So obviously, we're thinking about all of that. And we're not going to share any plans yet. I don't think it's a race, by the way, like -- it's not a race. And you'll see all types of c*** essentially deployed. And I'm sure our competition will do some sort of tactical thing that's not impactful. That's not how we play. Like we play very long term.

Do we have any audience questions?

Come on, give us a hard one.

I'd love to just switch a little bit on the M&A side. You guys have done some acquisitions where there was Earth Class Mail or REV, which was the most recent one for the e-signature capabilities. So specifically on REV, how do you imagine that fitting into the broader portfolio also in terms of like pricing and how you're bringing it to market? And then how should we think longer term about the approach to M&A going forward?

Yes. We -- I mean we have pretty clear capital allocation principles. We focus first on our own internal investment, we're pretty nourished there. And then we do think about the way to accelerate it is small tuck-ins. And so we've done a couple of those this last year. REV being the most recent one. And then after that, it's share repurchase, and we think about like how can we distribute back. But there's really an interesting part of REV that I'm glad you brought that one up specifically, if you think about us, it's like we started and talked about our heritage, we were an online forms company. And -- this is somewhat bizarre to me, but somewhere along the way, there was no investment in online forms. And if you think about the main use case for an online form is it's sent to someone and they sign it. I mean it's just obvious. And we are a place that has a repository of all of your legal documents. And so what we know is about 40% of our customers have subscribed to a subscription -- or to a signature service. And what we also know is that they're like overcharged because they're buying an enterprise solution because no one's really designed and priced it for small businesses. And so that's really the objective there. If you think about virtual mail, the objective there was that most small businesses have form now are home-based business. I talked about work from home very clearly. When you form your business, you have to provide a business address. If you use your home address, all of your customers know where you live, and you're in a public database. And so right at that moment, we help them understand that, that's a really important decision and they should consider virtual mail. And there's also many use cases where your business is in a different state, let's say you have real estate. So you can't even get that mail. So these are all things that just accelerate our roadmap of being this compliance back end for customers. And there -- this is a really -- this is a great time to have cash, and we generate cash and have cash. And so this is an area where I think you'll see us continue to try and do small tuck-ins, nothing big. We are a platform. We don't buy platforms. That's one of our principles. And so that's really been something that's been super helpful for us.

And then about 1 minute that we have left, we covered a lot of great topics, whether it's the adjustments to the go-to-market strategy with the freemium rollout, the expansion of the portfolio. As you look into 2023 and even beyond, what are you most excited about? And what do you want to leave for the investors?

Yes. I mean it's product, product, product. If you haven't heard -- if you're not following, we have -- this has been a strange journey for me coming to LegalZoom. I joined in October 2019. We changed the management. Well, I exited the management team and then COVID hit. And as COVID hit, we had to scramble because volumes went up. And then we benefited from it a little bit and did an IPO, and the IPO cleaned up our balance sheet, put cash on the balance sheet. But in the background, at all times, we're building a platform. We're building a foundation. And what you're going to start seeing is that being realized. And by the end of the year, our goal is that it's very visible to everyone. Now right now, it looks like point solutions because we're deploying lots of functionality, but it will come together, and we're super excited. We know it doesn't exist in the industry. So we're creating something pretty new and pretty novel.

Great. Dan, Noel, thank you so much for sharing your insights on LegalZoom with us today, and we look forward to watching the story.

Thanks for having us.

Thank you.