Welcome. This is John Byun. I'm on Brent Thill's team in the software team. Thanks for coming to the LegalZoom session. Today we have Dan Wernikoff, CEO. That's better. Noel Watson, CFO. I think Dan flew down, and Noel's local. It's great. If you do have any questions, please feel free anytime to pop those questions. We'll repeat them for the webcast. Well, this is a webcast. You know, we have got 25 minutes, we'll try to dive right in. I think Freemium strategy has been something big since late last year. Obviously, that's really kicked in in Q1 information. Maybe, you know, to start off, you could explain maybe, you know, what does the Freemium strategy entail?
Which product does it affect? For those that are unfamiliar with that.
Yeah. Hi, Dan Wernikoff. You know, just stepping back for one second, LegalZoom has had a long history. This is a 20-year-old company. Our focus today is very much on small business. The main thing that we do for small businesses is help them get started. They traditionally get started or formalize their business by creating an entity. The way they do that is 1 of 3 ways. You can go directly to the Secretary of State and complete a filing there, or you can go seek out an attorney, and get their advice, and they can help you file all the right documents, or you can go to an online DIY provider like LegalZoom.
That's where we've traditionally played, and if you think about the size of the market or how it spreads out, it's almost a third, a third, a third in terms of those behaviors. The third that actually decide to use a DIY provider, we're probably, you know, north of 30% market share in that space. We really didn't participate with people who were incredibly price sensitive in the past. Historically, we haven't participated in the market of working directly with an attorney as well through our platform. What we did, over the course of the last six, nine months, is we tested a new lineup that really provided all three alternatives for a small business.
You could come in and just complete that transaction for free of creating an entity, but have us as the support to help you walk through that process. We, in that business model, will offer additional transactional products. We also offer subscription products. A second SKU is sort of the full bundle of all the things that you need to get started. The third SKU is a SKU that not only has all the complete package, but it includes access to an attorney for 90 days, so you can also get advice. We're really trying to go after all three of those markets. We launched the free SKU in March, but we were largely sending traffic to one variation or another of free all throughout the quarter.
What we saw was 32% growth in the number of formation transactions. The macro that we compare ourselves is to the EIN census data, which grew 4%, some rounding was in the mix there, that meant that we gained 27% share year-over-year, which was the largest gain we've ever seen. We also then saw a shift in mix from transactional revenue, heavier into subscription. Overall, the revenue picture looked relatively neutral of this test. Clearly, if it's mixing more customers into subscription, you'd see a better lifetime value or longer-term value from those customers. There was a lot that went into that.
I'd say the other component that was really important is it allows us to dial down some of the marketing spend that we had, because the free messaging is doing a lot more of the work. Came down pretty significantly as well, and we expect it to do that for the rest of the year, which allowed us to take up our margins, with an increase in the guidance. It's sort of a lot of moving parts all at once, but something that we worked on for quite some time, and I'm happy to say, when we deployed it, there really wasn't a surprise for us.
I think it was a little bit of a surprise just in terms of the size of the share gain for a lot of people, but it pretty much played out the way that we thought it would.
Yeah, I mean, obviously, you had some pretty big plans in terms of the way the market share turned out. I mean, 32% versus 4% for the U.S. Census Bureau. I mean, you know, how sustainable do you think that sort of outperformance is? I mean, that is a huge differential. This is what the market's growing, right? I mean-
Yeah. I think, you know, we look at that, and we think of it as a step function change, and that's something to build off of over time. The, the only way that we'd see that going down is if it was, a choice that we were making. One of the things that Noel and I both inherited when we joined LegalZoom is some, relationships or contracts where, you know, we're actually a supplier to some of the online alternatives or competitors, and a low-cost supplier. We may take this opportunity, to actually exit some of those relationships, which may bring that share down a little bit more, but it's really no revenue impact. That just frees us up to go even more aggressively into this market and really just focus on the direct channel, specifically.
Yeah, no, I would just say those are, you know, largely wholesale relationships. Muted on the revenue impact side. There would be some revenue impact, but it would be muted just based on the pricing in the arrangement.
Mm-hmm. Free is very attractive in the beginning in terms of the entry point, but how quickly do they, in turn, you know, get monetized and spend on other things, you know, after they see the free?
Yeah
Offer?
Yeah, one of the things that really attracted me to LegalZoom was the power of the channel that is LegalZoom. We're you know, think of us as helping about 500,000 businesses form in any given year. What's interesting about that is, when you form as a business, there's some things you know you need to do, and there's some things you don't know that you need to do, and so we start to Uintroduce them to those services. You know, a couple examples, when you form an entity with the Secretary of State, right at that moment, you have to declare who's your registered agent. A registered agent has requirements associated with it. You need to be physically in an office, able to receive notifications from the government or a service of process.
If you don't have a location or if you don't have an address in that state, obviously you need help. If you don't have a someone who's there working physically, 20, you know, not 24/7, but during business hours, you need someone there. We help them understand that. We help them understand that they're gonna have to do annual filings, all the things that maintain your entity and so it doesn't pierce it. Those are things that they don't really know when they come in, and they're attached right at formation. There are some things that we just observed that customer behavior would show us was an immediate problem as well. An obvious one was tax. When you form an entity, it's actually a tax event.
Oftentimes, small businesses, their very first question is: "How do I pay myself?" Are you gonna declare yourself an S corp? Are you gonna be a traditional LLC? What should you be deducting? How should you start to manage your finances? We see stuff like that as well. There's some things that we don't do ourselves, but customers ask us immediately as well, or have not yet found a solution, and a good example of that is websites. 80% come in, don't have a web presence at all yet. We try to find a best-in-breed partner. In that case, we work with Wix.
Same thing, when you come in to get an EIN, oftentimes you're trying to get a bank account, and you can't do it without an EIN. We have a partnership with B of A, but we also have a new partnership with Chase. All of those are partners that we're very deliberately working with because we think they also have very large ecosystems of small businesses where we can distribute our product as well.
Yeah, I mean, if we kind of continue on that topic with the partnerships, obviously, it's an area you've been trying to kind of overhaul, you know, in terms of the type of partners that you're willing to work with and becoming much more strategic. You know, how far along are you in that process of kind of changing the mix of partners you work with? You know, when do you think you can start to see, actually see a boost, again, in that segment?
Yeah, we're pretty far along. A lot of the partnerships that were bounty relationships, we've exited, and in some cases, we've decided to build ourselves, like LZ Tax, where now we are the tax provider. You know, there's some cases where we've taken bounty relations out, and we've replaced them with residual relationships, like websites. You know, we also work with Next Insurance. A lot of businesses come in, they don't realize that if they have an employee or if they're in a regulated business, they need to actually have insurance as well. You know, when you come in as a small business, you don't have a favorite insurance company. There's just no such thing. We help introduce them to the best-in-class, which is Next. I think we're, you know, 90% of the way there.
There's still some things we consider that we think would be better integrated into our experience versus us moving them to a partner, but that transition is largely over.
That's great. In terms of the revenue mix that's generated from that, does it tend to be more recurring in nature, or is it still somewhat transactional to the partners?
Yes, sure. You know, as Dan mentioned, that's been part of our focus is to shift from what was almost entirely bounty relationships to more recurring revenue structure. Happy to say that the newer partnerships that we've been bringing on have been structured with that recurring model, where it's a, you know, a rev share or it's a percent of, you know, gross receipts on our partner side. We do still have some important relationships that are, you know, bounty, in nature. Oftentimes, that checks another box for us where it's bilateral, where not only are we providing their products to our customers, but we're also, that's an acquisition channel for us as well.
Right. Great. I want to come back to the freemium topic again. There's probably a surge in leads that came in that way. I mean, is there a way to think about, you know, how you think about the quality of the free type leads that walk in that door? I mean, are you satisfied with the quality or in terms of, you know, conversion rates and all that?
Yeah, well, conversion rates obviously improved quite a bit. Like, one of the things that we had observed for a long time is, you know, people would go through our experience and get somewhat educated, and if the price tag was too high, that's the moment that they would comparison shop. So that was one of the real objectives was, you know, take that comparison away and just own that customer relationship earlier. The way to do that was discounting the transactional side because we actually have a pretty significant ecosystem where a lot of the alternatives don't. So that was always a bit of an expectation for us.
Quality-wise, you know, we haven't seen anything different in terms of ongoing usage with the cohorts that have come in, but there's some big moments of truth for us. One of them is more annual renewal of the compliance subscriptions, and so we'll just have to lap that to understand. The good news is, the behavior we've seen is really no different in this space than what we've seen traditionally with our other customers.
Great. Well, given the success of the free entry to business formation, I mean, are there any other areas where this could work, whether, you know, it's a, it's a free transaction upfront or maybe just a free trial for three months, six months? I mean, what areas are you exploring or you might be testing already?
All we've done so far is deployed a free LLC transaction, and that's, you know, three-quarters of the formation transactions. There's things like incorporation, DBA, nonprofit, so we'll start testing in other areas as well. We also have a lot of services where we can start to bundle and try different things of how we're commercializing the product. What I would say is, right now, we're we've gone from being an, like, almost an over-optimized lineup when we were focused on nearer-term revenue, to now being an under-optimized lineup because it was just our first swing at reimagining it. You'll start to –
You'll see us do a lot more testing in terms of commercialization, and my guess is tests will win at a higher percentage rate now than they were before the shift into this new lineup, because there are some obvious things that should be adjusted. Just give you one clear example. If you have a certain number of customers who are price sensitive coming in, you know, we may want to adjust the pricing on the tiers of our subscriptions as well, so that we improve conversion there, maybe at a lower price point. Again, the goal is to get as many people in the top of the funnel because we have a really, really rich ecosystem, and we have a product roadmap that hasn't been fully realized yet.
There's a couple other additional products that are going to be coming out at the by the end of this year, as well as, you know, a new experience around MyLZ that I think is the place that really creates, you know, the holistic destination for all the compliance solutions.
Right. Yeah. You mentioned earlier on LZ Tax, I think this was your second full season. You know, and then the other tax specialized vendors obviously, you know, mentioned, you know, weakness in the overall tax volume from the IRS and so on. I don't know if that had any impact on you, since you're still kind of growing at the start, but just want to recap kind of the tax season.
Yeah
The lessons from it.
Well, I'll answer that question because we're too small to feel that weakness. Like, we're in a growth phase, so we didn't notice any of that. But we have a really unique offering. If you think about the traditional tax players, they're waiting till a business is established, and their channels are tuned specifically for tax season. You know, I just described our customers. They come in and form their business, and they have immediate tax needs, and that happens all year round. What we're trying to do is give them early and strong advice and guidance, and access to a CPA in a way that's tech-enabled, and get them started the right way, so that when it is tax season, they think of us to file for them.
There's some things that we're doing, and you can see it, you know, as an example with something like Virtual Mail, where we're starting to collect more and more data, and we can give them a head start on their tax season as well. We're trying to really solve a problem for a segment of small businesses that I think, today don't really have a solution other than going to a neighborhood accountant, which, again, is going to be less efficient, it's going to be a little bit higher priced, and it's not going to adopt as, you know, robust or modern tools as we expect to have. We've only been in tax two seasons.
The first year was admittedly moving very fast and not having any of the tech platform in place, and really just focusing on: How can we give them access to experts, learn as much as possible. You know, we weren't focused on OpEx at all. We said: We're going to probably be very unprofitable and just learn. We flipped into second year, changed some of the commercialization because we realized some of the challenges in how we were even marketing it. Built out some infrastructure that made it a more cohesive experience and an online experience, which included things like onboarding, tax intake, all the forms, upload and download, and communications with accountants happening on our platform.
I'd say we still missed a bunch because we're still early in the journey, and we just couldn't fit in all the things that we wanted to do in that season. We're still learning. Like, I'd give ourselves, you know, a solid C- on the season, and yet at the same time, we doubled the number of returns that we did from the prior year. I get super excited about tax. I obviously have a background there. I think we're onto something unique, and we have a different motion than anybody else in the business. We've got to win it. Like, we have to invest in it. We have to make the right decisions there.
Yeah. I think, very critical with a C- if you double the business, but, ...
C- , you know, in terms of the potential. you know, I just think we're very early here, and I don't like any experience that isn't an end-to-end experience that's working, you know, very clearly for customers. I think when we measure the end-to-end experience all the way through filing, I would say that I wasn't as happy with the Net Promoter experience. When people engaged with our CPAs, they loved our CPAs. The Net Promoter Score there is in the high 80s.
I see. In terms of the work that might need to be done for the third season, is it more on the product side to improve that score, or is it more on kind of convincing, you know, small business to sign on, or is it more also about attracting the right CPAs to work on it?
Well, the CPA piece we feel really good about. it's a little of everything. We learned a couple of things that we do on the commercialization side, where we have too high of attach rates. We see some churn. We see some customers choosing the wrong SKUs at time, because, again, they're brand-new businesses. They're not exactly sure what they need, we'd have to change what SKU as they came in. You know, we see some things in the filing experience where it should be happening automatically online, or we should be able to identify when a customer has an issue and reach out proactively to them.
Probably the most important is we still have some opportunities on the practice management side, our own platform, so that a customer always feels like they're working with one CPA versus a team of CPAs and having to repeat things. They're all obvious things. Like, going into the season, we knew there were challenges. You know, we got as far as we could. Tax season doesn't wait for you to deliver the perfect product, unfortunately. It kinda happens on a date. We're already off building for next season.
Great. Great. quick, maybe around a macro question? I think in your guidance, you're still assuming a recession in the second half. Obviously, trends look a little bit better maybe than expected in the first half so far, I'm wondering how you think about that in general, how that's gonna impact also, you know, maybe your strategy around testing a lot of the products if macro does get tougher?
Yeah, we've you know, I think overall, the macros remain pretty healthy, right? We saw in Q1, the macro data I mentioned earlier was up 4%, so more in line with that historical long-term CAGR that we saw with the macro and well above our expectations. That we've seen that trend kinda continue into Q2. We noted on our call that we increased our forecast to align, and our guidance is aligned around what we're seeing for trending in the macro, and we're gonna keep a really near-term view on changing any of our assumptions on our plan. We took up Q2, still have a, you know, relative to the trends we're seeing today, a conservative view on the macro in the back half. That represents opportunity if we see, you know, the current trends continue.
It also, it's a forcing function for us to create the right discipline around the investments that we're making, and from the cost side of the business and managing it very tightly. It does encompass the investments that we wanna make that are currently in our kinda product roadmap and testing pipeline, so that's all kinda baked into our forecast. We'll continue. Just given we're still in a rising interest rate environment, we'll continue to take a conservative, longer-term view on the macro. Think, you know, two, three, four quarters out, and then just get more constructive as it comes into clearer focus.
You know, one thing to add there, too, is we've said that this is, you know, flipping into a pure products story going forward. The proof is in sort of how we're thinking about operating expenses, where we're really managing it to relatively flat year-over-year. At the same time, like, our product investment is seeing a pretty significant acceleration. There's a lot of adjusting that we did coming out of COVID, where, you know, we were spending quite a bit on brand, we were spending quite a bit on sales and in marketing, where we quickly adjusted back down to performance marketing. Part of that was abridging, because we knew that we were waiting until Free was in the market to really change our whole marketing go-to-market motion.
Now that we're there, we're really just pulling back on a lot of those other expenses and just accelerating product.
Great. Great. Thanks. We only have a couple minutes left, and we still haven't talked about AI. Wondering, you know, your thoughts on that. I mean, can generative AI replace the filing and the incorporation process, and how do you see the threats and also some of the opportunities, maybe, provided?
Yeah. A lot more opportunities than threats, although I take any change in technology as really a time when you have to think about your leadership position. You know, when you think about our core business of filing, it's a pretty complex workflow, and actually, we have a lot of AI or machine learning specifically embedded in our application because, you know, we deal with 3,000 county agencies, 50 states, bunch of federal agencies, and not a single one of them has an API. Most of what we try to do is automate a process and understand the rules associated with all of those different governing bodies, and you can only do that if you have a high volume, and we are the volume leader in the space.
That's a space where I think we feel relatively confident in our position, and we'll think about ways to augment our offering with generative AI. On the form side, it is disruptive. I mean, we're gonna see drafting innovations, and I think the important thing there is, when you get into innovations in drafting legal documents or contracts, it does require that at the end of the day, if advice is provided, it's got to be provided by an attorney. We're one of the only players that actually has an independent attorney network. How we're thinking about this is, you know, it is essentially, you know, becoming a way for them to be more efficient through our platform. And you'll start to see things. This wasn't a surprise to us. GPT-3 was sort of the big innovation.
ChatGPT added a UI that made it easier for a lot of people to understand. We acquired Revv, you know, back in October, November, specifically because we saw these types of capabilities built in, and you'll start to see some stuff released by the end of this year.
Awesome. I think we're at the end of the session. Thanks very much for coming in.
Thank you.
Thanks for having us.
Appreciate it.