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

All right. We're going to get started. We're going to let a few more people trickle in here. Ross Sandler, Head of the U.S. Internet team. I'm joined by my colleague, Trevor Young. We're very excited to have the team from LegalZoom here. Guys, welcome.

Maybe just to kick things off, I'm revisiting the story for the first time in a couple of years myself, but some folks on the webcast and in the room are probably new to the story. So could you just give us a quick elevator pitch on LegalZoom, where we're at today?

Yes. So LegalZoom's a 20-year-old company. I joined 4 years ago. The prior 10 years was under private equity ownership. A little bit of a different strategy. I joined from Intuit with a thesis of kind of reenergizing LegalZoom. One of the things that we got excited about in joining LegalZoom was the brand recognition, profitable business model, leadership in the category. Also, the fact that we generally -- our business generally is started when a small business is start with that company. And so came in with a thesis of there should be an ecosystem around a business forming. And also, we could do a better job of delivering attorneys through our platform. And so our business is relatively simple, in that the bulk of our customers come in through a formation event. Once they come in, we attach a set of subscriptions. Some of them are entity compliance subscriptions tied to the formation. Some of them are other types of compliance subscriptions such as bookkeeping and business licenses and things like that. And then ultimately, we want to also get them attached to an expert when they need it, whether that be doing their taxes or working with an attorney to get legal advice. So all those things combined are sort of like what we're trying to create with LegalZoom.

And you guys have talked about how the market, broadly defined, is SMB is kind of coming to do a business formation through 1 of 3 primary channels. There's online, there is going to the government office directly and then there's using kind of your local lawyer friend. So I guess, which buckets are you gaining share from? Are you gaining share? And who do you view as kind of primary customers?

Yes. So every year, there's about 5 million businesses that form as measured through Census data with the EIN. We see roughly 40% of them go directly to a Secretary of State site and form there. It's a difficult experience because there's not a lot of help and guidance. And then there's also multiple questions that you encounter that require a service like you having someone declared as your registered agent. So that's one end of the spectrum. 30% are in this DIY category that we participate in. And then another 30%, either working with an attorney or a CPA to get themselves started offline, typically at a premium price. So for those customers, it can cost $3,000 to $5,000 to get formed through that attorney. Where we primarily are participating and taking share right now is from people, who go to that free solution with the Secretary of State. And what we're trying to do is continue to bring our prices down as it relates to the formation events so that we can match that free offering that the Secretary of State has while also being able to cross-sell and upsell different subscriptions at the same time. We have not been going after the attorney piece of this yet because that would require us to be more messaging at the top of the funnel that we have attorneys that can help you through the process. We think that's an opportunity, longer term. But right now, we're really focused on the people who are more self-directed.

Got it. And Dan, when you came in, I guess, could you just rewind, like what was happening before you came to the company? And it seems like the volume and the speed of new product releases has picked up meaningfully in the last couple of years, since you've been here. So I guess, could you walk us through like the before and after? And then how are you guys managing the financial profile amidst all this new product development there?

Yes. So the prior 5 years, really, were a little bit more focused on monetization and building out this profitable business model. So some of the subscriptions around entity compliance were really just emerging 5, 10 years ago. There was less investment in the product. There was very little investments in infrastructure. A lot of the employees were highly tenured, great domain expertise, but didn't have the experience of scaling software. So we brought a new team, when I joined. I'd say the first 2 years were really about building out infrastructure and talent. COVID hit, which also added a different dynamic because we saw an acceleration of business formations as well. And we really weren't ready at that time to capture a lot of that volume because we weren't terribly efficient. If you fast-forward and think about the last couple of years, it's been much more moving up the stack into product engineering and product delivery. And so over those 2 years, we've launched 5 new products. Some of them have been replacing partners that we had that were disjointed from the experience. Some of them are brand-new opportunities like Books and Taxes. And so I think that's been a pretty significant evolution. What I'd say is if you click forward now and think about the next couple of years, it's going to be a little bit more about how do we bring that all together into a unique experience that's unified. And how do we change our marketing motion, so that we aren't just focused on monetizing at the point of formation, but really think about growing with the customer after the formation event. And I'll let you hit on the financial.

Yes. On the financial side, a lot of it builds on some of the things that Dan was just saying, where over the last few years, we've really been staffing up on talent in building out the organization, and now we expect to gain leverage from that as well as investing in infrastructure. So a few years of building in automation and various processes that help us to be more efficient over time. We're starting to see benefit of that, and we'll continue to grow into that. And so we've been taking a pretty healthy, balanced approach to -- with all the new products and commercialization, trying to look for vectors to drive revenue growth. But also making sure we're keeping an eye on profitability and showing margin expansion at the same time.

You guys went public during a fairly tumultuous time. And just overall, SMB environment, it's changed a lot since then. So how have you adapted? How have the long-term financial goals changed? When do you expect to achieve those?

Yes. I mean, to your point, in the midst of the pandemic is when we sort of -- we're on the road in going through the IPO process and set those targets. And a unique environment and lots of different dynamics going on at the time. I'd say the good news and really important to note about our business is we've seen -- the business has been run profitably at high levels of profit previously, so 20%-plus adjusted EBITDA margins. We've proven with a healthy macro backdrop of strong revenue growth, so in 2021, we grew over 20% in revenue. Obviously, the macro has been more volatile over the last couple of years. We've gone through a business model shift with the rollout of freemium, and we're in the process of commercializing and testing all of these new products, all of which create really good revenue vectors for us while we continue to progress along the path toward our long-term targets on the profitability side. So...

That makes a lot of sense. Just hitting on something you just said about the kind of the tumultuous macro environment, something we always have a challenge with is getting a read on what's going on with business formation today. You guys are at the front end of that. What are you seeing today? Kind of what's your current sense of the environment relative to that normalized $5 million per year run rate? How is that trending into year-end? And kind of what are your expectations into '24, just on business formation?

Yes. I always like to start with this has been an incredibly stable macro up until COVID. And it's worth mentioning that. So if you looked at a 20-year history, it was sort of growing in the CAGR of 5%. And I think that's reflective of a continued environment of less capital required to start a business. It has a lot to do with the tools are very simple to create a storefront. There's different gig platforms. There's just so many tailwinds, when you start to think about the potential of small businesses. And so that's a clear backdrop that we think is -- has been reflective of the prior more stable environment. Now you layer in the concept of work from home. And we do expect that it's -- will continue to probably accelerate at some level because most people start a business actually when they're working, not when they're laid off. And now that people are working, but they're also working from home, unfortunately gives them the opportunity to take some of that time and carve it into a side business. So that's all positives. If you think about COVID, what we saw was everybody froze. And then we saw tons of businesses form. Those businesses that formed were more ephemeral. So we also saw a lot of dissolution. And then we've started to see over time, getting back to what looks like a more normal pattern. And we typically look at a basket of years, looking at like '16 to '19 and look at the seasonal pattern and started to reflect that seasonal pattern. This year, Q1 business formation growth, 4%, Q2, 7%, Q3, 12%. We feel like there's probably a little inflation in that 12% partly tied to some of the issues the IRS has had with the employee retention credit, which, oftentimes -- well, it always requires you filing a return. And a return requires an EIN. And so you saw some people getting -- or you see an inflation of the EIN numbers. But if you strip that out, we feel like it's probably more reflective of that 4% to 7%. And it's still a very healthy environment for small businesses.

And go forward, should it be kind of like a GDP, GDP-plus type metric, mid-singles?

Our goal is to sort of dislocate more from the macro our own performance. And so, if you think about the fact that we're offering a formation for free and we're shifting more to subscriptions, the goal should be that our subscription revenue line doesn't map at all to the formation line, and that we should have ample opportunities to gain share in that 5 million small businesses that form a year. We're only sitting at roughly 10% today. So it's -- I try to stay away from forecasting next year because it's just -- it's impossible to do.

Right. Yes. And on that point on share gains, I think on the most recent print, you had called out a decelerating pace of market share gains. What drove that deceleration? And has it since stabilized? And then do you envision getting back to those share gains as we head into '24?

Yes. There's 2 big components that drive the deceleration. One is we're starting to lap the rollout of our freemium offering. So just naturally, you're going to see the share gains. They almost behaved in a step function. As we did the rollout, we got a benefit in share, and now we're sort of hitting against those. In combination though with that, we also exited some partnerships that we had. And there's 2 forms of partnerships we have. One is we're distributing a third-party solution through our platform. But another is someone distributing our product through their platform. And we had some legacy relationships, where we are almost acting as a vendor for some of the people that we compete with. That's included in our formations numbers. We've been looking to get out of those relationships for a long time. We flagged it for multiple quarters, and this was really the beginning of that exit. So in this quarter, we actually released our LLC direct unit number, which still showed growth of 30%, which was significantly higher than the macro growth, just as a proof point that the core business is still strong.

Got it. So taking share, but kind of a purposeful pull back on some of those partnerships lapping that impact from the freemium?

Exactly. And we were also kind of clear you wouldn't see much of a financial impact from those exits. And obviously, the Q3 results reflected that. And so again, from a strategic standpoint, it didn't make much sense to enable some of our competitive alternatives. And just -- there wasn't much of a financial risk to it because they were very low ARPU relationship and low transactional relationships.

And just to remind people of the timing of the rollout of freemium, we had started testing freemium variants in Q3 of last year, really advanced the testing in Q4 and got a full rollout in Q1 of this year.

Can we drill into that a little bit? So how is just the pivot to freemium LLC changed the go-to-market and the flywheel, if you will, of the business?

It changes almost everything. So more than half of our customers now come in through that free solution. One thing that's really important to note is the thing that went free is the actual creation of the entity. There are other transactions that most customers still attach like getting an operating agreement or an EIN. And then the goal was to see higher attach rates on an absolute basis, when you start to talk about our subscriptions that are offered. And so the goal was always reduce transactional revenue, increase the mix of subscriptions, which drives a deferral of revenue in the short term but compounds in the longer term. And it's played out pretty much exactly -- I mean, we tested this for 6, 9 months. So we pretty much knew the answer when we deployed it, and it's played out -- it's pretty much exactly as we expected, with maybe one slightly better outcome in that we thought there would be a lower-quality cohort that came in from a success of the business standpoint of the free customers, but they actually look very similar to our prior cohorts. They're not that different. And again, most of our businesses are very micro businesses. So the distinction of saving $79 on an entity didn't drive a different profile of customers coming in. It almost just acted as a better marketing mechanism to attract people.

One other thing just to mention and build on Dan's comments is that we saw and we're hoping to see was being able to message free out from our end marketing channel standpoint, allowed our marketing dollars to work harder for us and to be more efficient. And so we were able to bring our marketing spend down year-over-year, while still driving the outcomes on the transaction and revenue side that we were looking for.

Which also then changed our sales strategy. As you know, which is we used to touch every customer multiple times. And we just -- in an environment where we now have better data about our customers and have done also testing there, we figured out which components of our sales strategy are incremental versus which were just attribution. And so we've shifted a bit to not touching the free customers as much, focusing our sales organization on the highest value solutions, which can be over $1,000 SKUs on an annual basis. And so it's kind of like it's rejumbled everything. And I'd say we're there, we're probably 70% of the way through that, and we're still working through the marketing motion about our customers, stripping people from managing just focusing primarily on monetization and formation to focusing post-formation.

And outside of the freemium LLC, just thoughts on overall pricing of other items within that formation or subsequent down the road?

There's interesting opportunities in both directions. Like one of the things that we adopted was a -- like when I joined, it was definitely a monetization strategy with pricing increases. Our brand is a premium brand, and it can support that. But our strategy is to get to 20%, 30% share, be in a position of clear market leadership before we go back to that monetization journey, that's very specific to pricing. Right now, where we're focused on, what is the optimal pricing that drives overall subscription bookings and transaction bookings combined in a given period? And so we're finding at times when we test it, reducing our pricing actually drives a higher gross bookings across both transaction and subscription on the initial card purchase. And so we're still not optimal in our lineup. And I'm hesitant to say whether we'll price increase or price reduce because all of that gets tested.

Interesting. And Dan, given your background, you guys, I believe, in the last year or 2 rolled out Tax and Books. What's the attach like on that? Where do you see that going? And then what other products like that do you see potentially adding to the suite down the road?

Yes. So one of the things that really surprised me when I joined LegalZoom was my first couple of months, I would go into the contact center and listen to phone calls. Surprisingly, we got more tax questions than we got legal questions. Because people are starting in creating an entity, they know that's a taxable event. There's decisions like becoming an S-corp versus an LLC that they have to consider. There's deductions that they have to think about, the relationship between their personal taxes, how do they pay themselves. There's all these things. And so right away, we started to realize that's an area where it's a close adjacency, and it's a compliance event, and so we want to be part of it. We also realized really quickly that every offering in the market is overserving our customer base. These are very simple businesses that really need to send an invoice. They need to categorize expenses. And they really manage their books just to do their taxes. They're not looking at fancy P&Ls or anything like that. They just want a very streamlined tax solution. So our goal here is to create a product that is a bookkeeping product that's designed to flip into a tax solution with minimal effort. And so that is a unique product in the market. Most of the people who have been in the bookkeeping space have partnered with accountants as a channel. And so they cede the tax business to the partners, and that becomes a pain point for these businesses, because now they have to kind of transfer data and all that good stuff. So we're in a unique position with this one. there's a very clear pattern when you enter bookkeeping. You quickly have customers asking you for payroll. Like even the people who have 1 employee will typically like payroll as a solution. You definitely -- if you're doing invoice and you do electronic payments, these customers, you want them to segregate their bank accounts, so you want to find the right partner on the banking side to be that small business banking solution. And it can continue from there, depending on -- as your base grows with you. But for right now, we're focused on the very micro products and the smaller businesses that really have simple needs.

You guys have talked about -- you mentioned the partner program. You overhauled that recently, you moved away from certain partners, legacy partners, kept others. So just, I guess, where are we in that evolution? And how should we think about the financial impact?

Yes. I think we're pretty much through the reimagination of our partner program. We had partnerships before, where our customers would move off our platform, and they wouldn't have the benefit of integration. And those typically tied to compliance. So the last one of those that we brought in was Business Licenses in the last quarter. And if you think about the data that we already have on our businesses, it makes it very easy to give them a sense of what licenses they need, and then we can help manage their licenses for them ongoing. So that's a good example of something that we brought in. Now what we're left with is we have partnerships where we have no intention to enter their space. It's a completely different domain. And so what we look for is the best-in-breed partner in that space, and look for them to distribute our solution through their platform. That's an emerging space. It's not material right now. If anything, we're finding we're much better at distributing our partners than they are us at this point. But we hope that, that grows over time.

Sticking with the partnerships a little bit. You have a partnership with Wix as exclusive on the website creation side of things. Just help us understand how that partnership is scaling. How does it work? Are you more selling their products? Or providing people to Wix or vice versa? And then second part, to your comment on having kind of repositioned on the partner side, do you feel like you have all the right partners for those pieces of business formation that you don't want to own in-house? Or is there still more work to be done there?

So the Wix partnership, and just to clarify, it's not exclusive. But we've done a pretty material investment to integrate it deeply, and we feel like the only partnerships that really work is when you integrate them into the experience so that it feels like it's a single provider. It's done much better than I would have expected. In fact, we see the paid attach rates on the Wix side through our platform as approximating some of our own solutions, which is surprising. We haven't done some of the investments that we know can continue to accelerate that attach yet, and that's just more resource allocation decisions. On the flip side, to be fair to them, we got a very quick head start on our side. We knew how to do sites integration. Formations is a little bit more of a highly considered purchase over multiple months. And so it takes some time for the channel to demonstrate strength, and we're starting to see the right things happen there, but it's earlier. And I wouldn't say it's a big component of our financial plan. On the partnership side, overall, I think we're happy with the group we have now. We've got banking, where we have Chase, B of A, we've got Novo that we just launched. We have NEXT Insurance and business insurance, Wix on the website side. We don't want to do too much. One of the things that we are working on, by the way, is we now have much better customer data. We're working on targeting and segmentation. Over time, you could imagine that we can do industry-specific cross-sell. We just have to have the ability to do that without creating tons of impressions through our product. And so that will be a gradual approach.

If we shift gears, fairly new tech development, you guys rolled out MyLZ recently. So I guess, how's that going -- how is it going? What's the overall strategy there? And it seems like this could be a big game-changer. Like what was the flow before to now with this dashboard approach?

Yes. One of the biggest problems we've had as a business is people form with us, and then there's been no experience for them to have. So most of what the product has been is a bunch of e-mail alerts or SMS text, but it didn't really drive them back into an ongoing experience. About 6 months ago, we launched MyLZ as a post formation experience. So now as you complete your order, you go there, you check your order status, you can access customer support. But really, the goal is to integrate all of these different applications so that it becomes a software solution. So when you get there now, you can do any of the compliance events, like if you have to do an annual filing or an amendment, you can access an attorney and schedule time with them. You can see your books. You can see where all your licenses are and when they're going to be expiring. And you can start to imagine, it's sort of like a compliance back office. Today, when you go to visit a small business, that's their file cabinet. Like they have an insurance, they have all their insurance documents here. They have a bunch of tax receipts here. They've got licenses in a folder, it's a bit of a mess. And so we're trying to standardize that and create an application against it. Very early innings, but what could happen is we get good enough at driving engagement there that we -- and cross-sell there, that we don't have to do as much in the formations flow. We can take things out of the formations flow. And we know the less you put in the formations flow in terms of cross-sells, the higher the conversion rate. So it's sort of a symbiotic with the idea of share gains. If you get good at monetizing post formation, it's going to drive significant share gains in the longer term.

And what kind of -- I think it's been out for a quarter, but what kind of early uptake are you seeing new formations that have happened since it has been out?

It's early innings. We -- 98% of our customers create the account. And initially, they go in and visit for their order status. We still have a lot of our alerts that aren't pointing people back in, and we're early. As you know, we just launched LZ Books. So that base is not material at this point where it's driving tons of engagement directly. But this is where it's going to be a continual improvement quarter-over-quarter to the point where we start to then lean harder into post formation monetization.

Got it. And then, it seems like the product velocity is picking up. And I would guess that when you got there, there was probably a lot of technical debt. Where are we today in terms of overcoming some of that? And like, are we at the point where we can release on a more frequent basis and drive growth retirement?

Yes. I mean, we're like delivering a new business every quarter right now. So I don't know how much faster we want to go there. In fact, I think now, if anything, we've probably created a little bit of a challenge of just integrating the experience. But I'd say that is definitely a shift from where we were. So when I joined, the whole business was on-prem from our contact center telephony to like our site was managed on-prem. There was no data warehouse. We had old ERP systems. I mean, the whole thing had to be rebuilt. Probably the biggest investment that had to be made was just automating our whole back office as well. And this was a prerequisite to going free because the way our order system used to work is you used to order a product, and then there would be 7 or 8 people, who would touch that order in a back office, and we've now gotten that down on a lot of our transaction types to straight-through processing with the Secretaries of State. So I'd say on the product side, we've modernized our whole stack. We now have modern testing infrastructure. We've got a good segmentation of our customers. And now we're working through some of the longer tail of our product. On the infrastructure, I'd say we're probably 50% of the way there. The good news is a lot of that translates into better margins as we continue to release it, just automating and allowing us to be more efficient.

Last question on our end. Unrelated to the day-to-day operations, but your -- you had a private equity owner that recently kind of exited. So I guess, rationale behind that, and like how do you guys feel generally about your current investor base and whether or not those types of situations might emerge in the future?

Yes. So the investor who just completed their second secondary was Permira. They're fully out of the stock. They had -- this was a 10-year-old fund which they did quite well on. And I think for reasons independent of our performance, I think it made a lot of sense for them to provide liquidity to their LPs. Our other investors are newer. I mean they came in, in 2018. I obviously can't say whether or not -- what their intention is, but I would say, as a Board, we're really aligned in the long-term growth strategy. And I think all of them are pretty happy right now.

Guys, thanks for attending, on behalf of me and Trevor and Barclays. That's great.

Thank you.

Thank you very much.

Thanks.