Q3 2021 LegalZoom.com Inc Earnings Call

November 10, 2021

Yeah.

Good day, and thank you for standing by and welcome to the legal since third quarter 2021 earnings Conference call. At this time, all participants are in a listen only mode.

Sure the speaker's presentation there'll be a question and answer session.

To ask a question during the session you will need to press star one on your telephone.

Please be advised that today's conference may be recorded if you require any further assistance. Please press star zero.

Now I'd like to hand, the conference over to your Speaker today, Danny Vivier head of Investor Relations. Please go ahead.

Thank you operator, Hello, and welcome to <unk> third quarter 2021 earnings Conference call.

Joining me today is Dan Warner Cox, our Chief Executive Officer, and Noel Watson, our Chief Financial Officer.

As a reminder, we will be making forward looking statements on this call.

These forward looking statements can be identified by the use of words, such as believe expect plan anticipate will intend and similar expressions and are not and should not be relied upon as a guarantee of future performance or results.

Results could differ from those contemplated by our forward looking statements. We caution you to review the risk factors section of our reports and filings with the Securities and Exchange Commission for a discussion of factors that could cause our results to differ materially.

Forward looking statements we make on this call are based on information available to us as of today's date.

We disclaim any obligation to update any forward looking statements, except as required by law.

In addition, we will also discuss certain non-GAAP financial measures.

Our CEO and CFO use these measures to make their decisions regarding our business and we believe these measures provide helpful information to investors.

Reconciliations of all non-GAAP measures to the most directly comparable GAAP measures are set forth in the Investor Relations section of our website at investors that legal zoom dot com.

The non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP.

I'll now turn the call over to Dan.

Thank you Danny and thank you all for joining our Q3 earnings call at.

At legal zoom, we're on a mission to democratize law, we believe in harnessing the power of technology to unlock greater efficiencies, which in turn provides more affordable legal and compliance services to small businesses.

Our mission to Democratize law is more important now than ever before with the pandemic reshaping industries, causing economic hardship and sparkling a new wave of entrepreneurial activity as.

As the clear category leader in an industry undergoing rapid digital transformation. We believe that we are just at the beginning of our growth journey.

We will continue to leverage our significant brand advantaged differentiated product experience extensive network of credentialed experts in the history of navigating the complexity of the U S legal and regulatory system to further penetrate the $50 billion legal <unk> compliance vertical.

Let me start with a summary of our Q3 results.

Building on the strength of the first half of the year, we delivered total revenue of $148 million above the top end of our guidance range for the quarter and up 12% year over year.

The year over year deceleration from Q2 was expected and driven largely by challenging compares due to COVID-19, as a reminder, in the second quarter of 2020, the onset of the pandemic shutdown critical government functions across the country, including many secretary of state departments responsible for processing new business applications.

When restrictions were lifted throughout the third quarter pent up demand was filled creating a spike in formations in Q3 of last year.

Given the year over year complexity, we'd point you to the two year cumulative average growth rate, which we believe more accurately reflects the underlying growth trends in the business in the third quarter. The two year revenue CAGR was 19% roughly in line with the second quarter's two year CAGR.

Subscription revenue continues to be a highlight of 24% year over year in the quarter driven by the ongoing rollout of products and services to help our customers remain compliant after forming their business I'll provide a more detailed operational update on Lz tax later later in the call, but we're excited to see its integration into the LLC formation flow draw.

I've, a strong uptick in subscriber count in the period.

Adjusted EBITDA in the third quarter came in at $15 million or 10% of revenue as we continue to invest in our technology platform and media spend to build on our digital leadership, we will actively seek opportunities to invest strategically and more aggressively to accelerate our long term growth potential.

Given the increased focus intra quarter on the overall market for business formations as measured by the U S census data I'd like to provide some commentary on the topic.

First it's important to note that in EIA application does not one for one translate to a business formation.

Applications can do diverged from secretary of State formation data, which we believe is a more accurate benchmark for the total number of addressable formations we.

We use proprietary data to measure our performance relative to peers. We saw this divergence materialized in Q3 of last year when when sole proprietors rush to open business checking accounts in order to apply for PPP funding.

We also see it during tax season is existing businesses often apply for an <unk> at the advice of an accountant when these onetime or seasonal events occur we see a spike in EIA in applications over and beyond the growth in our internal formations benchmark.

Second I mentioned on our last call that we did see a step down in formation activity beginning in July at the time. It was too early to know if the step down was temporarily tied to the reopening of summer travel or the beginning of a new trend line.

August and September data and made it clear that the market had reverted to a more normalized seasonal pattern below the elevated levels. We saw earlier in the year.

Still business formations remained well above 2019 levels and given the strong secular tailwind of digital enablement in the gig economy. We expect the markets remained strong in future periods as well.

Finally, it is important to remember that a growing share of our revenue is derived from subscription services. This revenue stream is recurring predictable high margin and performed independently of the seasonal components of our business. We will continue to prioritize growing our base of subscription revenue in favor of driving incremental transactional revenue.

We see an opportunity to accelerate the lifetime valuable customer we will take it even if it means sacrificing in period revenue and profitability. We believe this approach best positions us to deliver subscription growth beyond our long term revenue growth targets.

I'd now like to provide an update on our three key growth vectors scaling our core business building, an ecosystem of SMB formation related services and integrating attorneys into our core experience, which we believe will collectively drive durable top line growth and long term margin expansion.

The biggest near term opportunities to drive growth relates to scaling our core offering by efficiently, increasing our marketing spend improving our product experience and ensuring efficient growth in our operations.

In mid October we announced a new multiyear brand partnership with the National Basketball Association the <unk>.

Partnership branded Fast-break for small business will provide $6 million in grants and services to small business owners, we expect to support more than 6000 small businesses over the life of the campaign many of whom are from the communities most impacted by the endemic in the qualities and the financial and legal systems.

The program was created to address these disparities and gives small businesses in these communities a fair shot at turning their dreams into reality.

Beyond the incredible opportunity for social impact. We're also excited about the opportunity to reposition the legals and brand as an SMB first solution.

Despite our best in class improving aided brand awareness score of 74%. The majority of consumers still recognized legalism, primarily towards do it yourself. The state plans in fact, only 40% of our potential customers know that legal zoom can help them with the small business formation.

And given formations drive the bulk of our revenue, particularly on the subscription side. It's critical that we increase awareness of our formation services by repositioning our brand message the.

The NBA campaign is a major step in the right direction as it clearly distinguishes legalzoom as the go to destination to start your small business. This relationship is a great example of the kind of brand partnerships. We're pursuing as we look to improve awareness of our formation services.

We're also continuing to leverage insights from our media mix modeling to inform spend allocations and test new channels.

Historically legal zoom lack the systems to measure attribution accurately across channels as a consequence, we've been underinvested in emerging categories like digital video display and social in Q3, we ramped our spend here aggressively driving a $5 million quarter over quarter increase so inefficient in period we.

Believe ongoing channel testing like this is critical investment will that will enable us to efficiently scale, our media spend over the long term.

And lastly within operations, we're investing on our platform to increase automation reduce turnaround times and improved variable unit economics.

Turnaround times for the time between when a business customer completes an online application on our site and when the entity is legally recognized by the state is a primary.

Mary driver of our net promoter scores we've.

We've made investments this year to reduce human involvement and automate a majority of the fulfillment process driving down turn around times and reducing costs.

Our second key growth vector is creating a small business formations ecosystem, we are aggressively evolving our product offering to include subscription services that our small business customers need at a critical time of formation we.

We added to that ecosystem through our acquisition of Earth class Mail, a leading virtual mailbox solution for small businesses, which we announced this morning.

Earth class mail, which I'll refer to as ECM makes postal mail paperless easy and accessible $24 7 million from any device anywhere in the world.

As the digital economy continues to fuel the growth of remote first work environments small businesses are investing in tools to streamline operations, including software to manage physical mail, which can be often invoices and checks that need to be input into other back office solutions, such as bill Dot Com Quickbooks and box for instance.

We've been tracking the virtual mailbox space for a while now and believe Ecm's national footprint Tech stack and seamless user experience stands out among the competition ECM fits perfectly with both our channel and technology strategies.

With this acquisition legal zoom customers will be able to add the business address and virtual mailbox at the time of forming their business. We expect this subscription service to further increase customer lifetime value without any additional customer acquisition costs since it will be integrated directly into our formations product.

So ECM and our registered agent service use similar technologies, allowing us to leverage many capabilities that will allow us to streamline and advance our broader compliance offerings.

Like to congratulate our team and welcome Ecm's employees into the legal zoom family, we look forward to partnering together.

In addition to this exciting acquisition, we continue to ramp new compliant services under the Legals in brand, most notably Lz tax while also partnering with category leaders to offer our best of breed selection of complementary services, such as banking point of sale solutions website hosting and bookkeeping to name just a few.

The third quarter was an inflection point for our Lz tax offering with a number of significant milestones.

Throughout the quarter, we exposed a growing portion of LLC traffic to our tax offering at formation, culminating in a 100% coverage by the end of the quarter. We're very encouraged by the early results, which in the more than 50% increase in tax subscription units quarter over quarter and the growth isn't just for more traffic. We're also seeing improvements in attach rate.

As we continue to optimize our commercialization strategy and zero in on the things our customers care most about.

Second we doubled our team of in house experts CPA is an enrolled agents and on boarded supplemental resources in preparation for our first annual tax season next spring, we continue to see demand outpaced supply and are doing all that we can to scale supply quickly. While also prioritizing an excellent customer experience.

Third we continue to invest in the tech infrastructure needed to support this fast scaling revenue stream. This includes the launch of all new practice management software streamlining workflows and automating customer outreach.

We're very pleased by the momentum behind the Lz tax, which we continue to view as a multi year growth vector for the business on.

On the partnership front, you will have likely seen our recent press releases highlighting a handful of signed brands, including brakes, Intuit Quickbooks and square all Mark key service providers with high value offerings for our small business customers the.

The nature of each brand relationship is unique but our intent as we add new partners is to achieve the following core attributes one the relationships are bilateral we acquire new customers for our partners and they acquire for us to the economics are shared in a recurring model whereby a legals and participates in the ongoing value delivery of the partner.

Service and three legal Jim customers receive preferential pricing on the partner services by signing up through our platform.

As a leader in business formation services, we are uniquely positioned to establish trust with our customers very early in their business lifecycle, we collect the vast amount of data from our customers oftentimes before they even start operating we know theyre industry location hiring plans et cetera and to use this information to intelligently connect them with.

The right service providers for their unique situation.

Our vision is to partner with the most reputable technology enabled SMB service providers to make it simpler and less costly for small business owners to get the resources and support they need.

So they can devote their intention to running and growing their business with more and more partner brands, joining our curated network the value of our ecosystem continues to grow.

Our third and final growth vector as attorney assist our new hybrid model that Leverages, our core technology platform, while also integrating access to attorneys throughout the user experience.

On October one we announced that legal zoom subsidiary Lz legal services was approved and licensed by the Arizona Supreme Court to operate an alternative business structure or ABS in the state.

This announcement represents a big step forward in the ongoing push in the United States for regulatory reform that permits non lawyer owned entities to provide legal advice.

With the ABS license legal zoom essentially now owns a law firm in the state of Arizona, enabling us to directly provide select legal services to our customers.

We will continue to fulfill the majority of demand through our independent Attorney network. The new ABS structure provides a means for us to test new innovative ways to empower consumers with access to affordable and transparent legal services online.

We will also be testing new business models that will allow legal zoom to deliver additional legal services beyond the scope initially contemplated and participate in the ongoing economics of that value delivery throughout the life of the customer relationship.

In conclusion, we are committed to making the right strategic investments to capitalize on the large market opportunities that exist within the legal and compliance vertical where patient operators and we will continue to make decisions aligned to our long term growth oriented mindset to that end, we will continue to strategically prioritize and accelerating mix of subscription revenues.

These revenues performed independently of the broader formations macro and position us to deliver on our long term growth and profitability targets with that I'll now turn the call over to Noel to discuss our financial results.

Thanks, Dan and good afternoon, everyone I will start today with a review of our performance in the third quarter and end with our outlook for the remainder of the year.

Total GAAP revenue in the period came in at $148 million up 12% year over year.

Dan mentioned, we lapped a challenging compare from Q3 of last year as the reopening of the economy led to a surge in pent up business formation volumes.

The two year revenue CAGR of 19% remained healthy and we believe more appropriately reflects underlying growth trends in the business.

Transaction revenue was $67 million in the quarter, representing 45% of total revenue.

Completed a 106000 business formations in the third quarter.

Formations include LLC, Inc, and nonprofit formation events, which are critical entry points to which we cross sell our suite of subscription services.

Go down 9% year over year business formations have grown 24% annually over the two year period pacing well ahead of our internal market benchmarks.

Total transaction units, which also include other transactions involving intellectual property and a state planning, where 229000 units in the quarter performing in line with the business formation.

Average order value, which represents the average revenue contribution from each transaction unit remained strong at $291 in the period.

The quarter over quarter increase was due to improvements in order fulfillment rate.

Subscription revenue was $73 million in the quarter were 50% of total revenue.

We added 49000 net subscription units in the period with a growing portion of those driven by the successful integration of LG tax within our LLC formation flow.

Growing our base of subscription units remains a top priority given its impact on LTV.

We will continue to leverage our unique position early in the SMB lifecycle to connect our customers to the right set of tools and services they need to operate their business.

<unk> for the average annual revenue contribution per outstanding subscription unit was $231 up 5% year over year.

We continue to expect modest growth in this metric over time has higher RP services like Lv tax account for a growing share of our subscription unit.

As a reminder, we provide <unk> on a last 12 month basis to account for the fact that the majority of subscriptions are billed upfront on annual terms.

Partnership revenue was approximately $8 million in the quarter, representing 5% of our total revenue.

In the near term, we continue to expect lower sequential performance in our partner revenue as we transition away from legacy partners that do not align with our strategic direction and we evolve our relationships from Bonnie based economics to recurring revenue.

We are very excited about the opportunity that our newest partnerships represent and remain confident in the long term opportunity to build an ecosystem of marquee brand partners complete with high margin recurring revenue structures.

Now turning to expenses and margins, where all of the following metrics are on a non-GAAP basis.

Cost of revenue, which includes government filing fees and other fulfillment and care costs was $45 million in the period up 8% versus last year.

Gross margin came in at approximately 70% of revenue up 200 basis points from Q3 of last year due to improvements in order fulfillment.

We expect a typical seasonal decline in gross margin in the fourth quarter and anticipate additional downward pressure driven by our investments in Lv tax ahead of the spring tax season.

Sales and marketing costs were $65 million in the third quarter or 44% of revenue.

Within that customer acquisition spend of $50 million was up 46% year over year as we continue to scale, our media budget to grow transaction and subscription volume and build on our category leadership.

As Dan mentioned, we allocated incremental spend in the third quarter to new channel testing, we leverage results from these tests to inform our media allocation and to drive greater efficiencies over the long term.

Inclusive of this in period testing spend we believe we are continuing to generate LTV and a highly efficient manner.

Technology and development spend was $12 million in the third quarter or 8% of revenue up $1 6 million quarter over quarter.

Sequential increase was expected as we continue to build out a best in class product and technology organization and make investments to modernize our infrastructure.

Finally, G&A spend was $11 million in the quarter or 7% of revenue in line with Q2.

The year over year increase in G&A was driven by incremental public company costs and head count investments.

We expect G&A to increase sequentially in the fourth quarter, primarily due to additional consulting costs.

Adjusted EBITDA was $15 1 million in the quarter or 10% of revenue.

Our base of deferred revenues remained roughly flat in the period as growth in subscription bookings was offset by improving transaction fulfillment times.

Free cash flow was $17 million in Q3 down from $29 million in the same period last year.

As of September 32021, we had cash and cash equivalents of $311 million and no debt outstanding.

I'll now turn to guidance for the fourth quarter and full year 2021.

We expect full year revenue of $575 million to $579 million or year over year growth of 23% at the midpoint.

This full year range implies a fourth quarter revenue of $140 million to $246 million up 18% year over year at the midpoint.

Our revenue guidance considers the continuation of a more normalized seasonal pattern of business formations and our proactive decision to drive subscription bookings in favor of in period in transaction revenue.

We expect full year, adjusted EBITDA of 45% to $47 million or 8% of expected revenue at the midpoint.

We are continuing to invest in the business to drive durable multiyear growth in the fourth quarter, we will deploy incremental spend to support the NBA campaign, which we view as a unique opportunity to accelerate our brand repositioning efforts. We are also continuing to ramp investments in LNG tax both in people and infrastructure to keep.

Paced with outsized demand for that service.

Because of these investments and the strength that we're seeing in the subscription side of our business. We remain confident in our ability to deliver on long term growth and profitability targets.

We will not provide explicit 2022 guidance at this time, but plan to do so in our Q4 earnings call early next year.

And quickly before wrapping we will be participating in several upcoming investor conferences, including credit Suisse Barclays and Raymond James.

With that let's open it up for questions.

Thank you as a reminder to ask a question you will need to press star one on your telephone to withdraw.

All your question press the pound key our first question comes from Sterling Auty with Jpmorgan. Your line is open.

Yes, Thanks, Hi, guys.

Hey, Sterling.

Two questions.

Hi, Syed one question one follow up so on the business starts in the comment that you made about the transactional portion.

I think as you guys came through the IPO process.

You mentioned the long term growth goals, there was a belief that you could drive acceleration.

With a 25%.

What do you still need even with kind of the modification of the transaction subscription that you mentioned in the call. What do you need as a baseline in terms of business starts to still be able to deliver upon that goal.

Yeah, well thanks for the question Sterling and I think when we talked about this on the road show, there's really three dimensions to growth.

One is the macro itself and we still feel really good about the macro tailwind. If you look at the current new business starts relative to where they were in 2019, and we're still seeing solid growth and obviously there was a little bit of a step down in Q3.

But long term, we feel good about that the second piece is really around share gains.

We know that we have a superior offer to the offline alternatives and so we continue to be aggressive in marketing to go after share and then the third piece is we don't think of our business is a transactional business, we think of ourselves as a formation service and so.

So the more that we continue to add subscription services that people need right when theyre, forming a business. The more successful we will be not only in terms of solving for in period results, but really accelerating long term growth with higher visibility. So those are really the three dimensions of how we think we.

We exceed the hopefully the long term targets that we've put out there.

Got it and then the follow up is you talked about choosing subscription versus transaction how much control do you have to drive the business in that subscription side and what are the leading subscription that investors should look for you to drive to make that happen.

Yes, that's a great question and actually one of the things that we think about a lot and that we will also test for a lot.

Because when people come into our solution Theyre doing a combination of buying a transaction the registration of their business and even some other ancillary transactions like an operating agreement for <unk> and.

But they're also adding subscription services that help them stay compliant as a business and even further now we're getting into more back office operations with something like the acquisition of ECM and so what we do is we often test different forms of commercialization and what we typically.

<unk> C is there can be both a combination of increasing the overall value of the shopping cart, but also really a transition in the mix of the car to be heavier into the subscription side and one of the interesting things is we knowingly we'll lean into some of the subscription bookings even if we know it has a short term.

In the future.

That makes sense. Thank you guys.

Thank you.

Thank you. Our next question comes from Mario Lou with Barclays. Your line is open.

Great. Thanks for taking my questions just wanted to hone in on this quarter as the drivers came out a little bit different than what I expected.

Who would be able to hire.

<unk> be able to lower so just wanted to see if we could double click.

Especially on the transaction side like how sustainable.

Are these levels are food cardboard.

Conversely.

The volume side.

Should we expect that to kind of pick up sequentially is that.

Seasonally you guys talking about <unk> being stronger as that but we should expect to report. Thanks.

Yeah. Thanks for the question Mario I think you were saying.

Should we expect <unk> on the transactional side to continue to go up because that did increase slightly this quarter or <unk> was relatively flat just slightly better than what it was in the prior quarter and so I'll answer that and then you can correct me if that's not the question.

On the <unk> side.

We actually did benefit a little bit from increased fulfillment rates one of the things that.

That is really a key.

Focus area for US is the customer experience and one of the top drivers of both promotion in terms of net promoter and attraction is turnaround times and so we've done a pretty significant investment on the fulfillment side, we continue to automate and some of that did pull in order.

<unk>.

Essentially would increase the <unk> in period.

<unk> along with the historical increases and it will be that have been really commercialization driven a better job of marketing the product we.

We don't expect it will be.

To continue to climb even just aligned with the question I just answered in some ways, we would be comfortable with.

Goes down and really that we see a higher mix of <unk> and subscription services going forward. So you'll you'll see you can almost think of.

O V as a tradeoff between Cam spend in a way some in some cases, we might test lower prices.

In order to reduce our cam spend reliance and so.

Might even be the opposite but that's all things that we test into and tried to understand from watching consumer behavior.

And Mario this is Noel just to add in.

<unk> was up 30% quarter over quarter year over year in Q2, it was up 16% this year.

As we mentioned on the prior call we expected.

The growth rate in ARV to decelerate sequentially and each quarter in the back half of the year and so we I would reiterate that here that.

We'll see because <unk> was increasing sequentially each quarter last year that the year over year growth.

The closer they absolutely would be closer and the year over year growth would decelerate even in queue for.

Thank you both.

Thanks, Brian.

Our next question comes from Elisabeth Elliot with Morgan Stanley. Your line is open.

Great. Thank you so much that question I just wanted to dig in on kind of a share gain as an element for what are the key driver I think your ground can you. Let us know what you are seeing in terms of illegal in share with an overall business formation.

Should we think about the balance between maybe can weaker macro year over year versus the accelerating digital penetration to help offset thinking.

Yeah. Thanks for the question Elizabeth.

This is this is one of those things that depends on what you are looking at it.

As the macro.

And we know that the published macro data that everybody's viewing as the census data.

Q3 data on the census was sequentially down 19%.

And it was also down year over year, 17% now it's also worth noting that the two year cater is up 22%, but but it's definitely was a step down in one of the things that I would say is unique as we have our own internal data source, which really links directly to the majority of the secretary of state's day.

Data sources directly and so what we actually saw was a little bit different in September and I think what census, printed and actually I would say it was lower.

Then what they actually had on their numbers, which again, we've always said that the data is not perfect.

It's a super set of of what we essentially see in terms of business formations because some people will have an existing business and then they go get an AI and because they hired an employee or they're opening a bank account and so we often see how variation.

I would say is given the fact that September was lower in our own view.

And you can see the data as it relates to our share relative to the census, macro we did gain sharing the quarter I mean, it's pretty clear, but we will not be sharing our own internal data, it's a pretty unique data source and it gives us more visibility than we think any of our competitors have and it also helps us from a forecasting person.

Fective and from a marketing spend perspective, so we consider it pretty proprietary.

Got it and then.

A follow up on some of the retention I think the retention rates are on kind of a 13 month basis and can you really trying to see that the kellen for demand in July and August.

So and and that'll be locked that 13 months carrying any color, how and retention rate and training, especially for 10 minutes.

<unk>.

Come on quickly.

Yeah, that's a really good question and actually we had a sense of this and that this would happen some of those businesses were pretty ephemeral.

And so we did see a reduction in the cohort that was acquired in July and August.

On the 13 month retention, what's interesting is we actually saw strengthening and strengthening and all of our other cohorts. So the overall churn rates improved and what I would also say is it was very specific to that July and August cohort and we've already seen it start to climb back up on the 13 month percent pretension.

Side as well.

Great. Thank you so much.

Thank you.

And we have a question from Andrew Boone with Jmp's Kennedys. Your line is open.

Hi, guys. Thanks for taking my questions.

Can you please so.

So the first can you talk about any mornings on LD tax and just drew level of confidence since you've built supply out of 2022 tax season, and then a macro question just coming back to formations.

Admittedly I'm asking for an opinion here, which is given the strong job market.

Do you feel like that is more of a headwind for business formation and so we should be looking at job number's as well or does the hiring market last correlated with business formation. Thanks.

Yeah, Let me take that last one first.

It's a really interesting question and that there are a significant amount of job openings out there, but there still is a pretty significant amount of unemployment and it feels like there's a nice behavior change that seems to be happening of people both being willing to go out on their own.

Or even also have.

A potential side business and so when you start to look at the data itself I actually feel like that unemployment data is a little bit of a misnomer and that the great resignation in many ways is actually like the great entrepreneurial.

Blum in some ways so.

We were really bullish on this like we look at this macro and we see a very stable floor at this point, which were forecasting off of we're not assuming any improvements and by the way we read forecasts off of our own internal macro data on a monthly basis and so we start to build off of that.

I wouldn't be surprised if there is a little bit more of a recovery just given the fact that it's never been easier to start a business than it is today I mean, you have all of the enterprise level tools you have the ability to get started quickly you can test something and try it you can run it as a side business you can do it when you are.

Working from home as well so we feel you feel pretty good about that.

Anything you would add their knowhow before I jump into the Lz tax question, Okay, Yeah Lz tax.

We're learning a lot. This is one of those services, where I think I've I've said in the last call.

One of the things that was a massive surprise for me when I joined was that we would get as many tax questions. When someone forms of business as we get legal questions and it's playing out that way. We are seeing attach rates that are very similar to what we see in our legal subscription service.

Now along the way we are growing so fast that we're making sure that at the same time, we are providing a great experience. So we've deployed practice management. We've been hiring experts ahead of the of the tax demand and we're also augmenting that with other service providers and so we have a combination.

Of many different ways that we're trying to solve for this season's tax business and to be totally clear where throttling the volume as well like we are not reaching our full potential we just wrapped it up on LLC were not included in that are other workflows like ink and nonprofit and we're not really marketing actively to our existing base of this.

Because the goal here is providing the best experience possible and our first tax season.

Great. Thank you.

Thank you.

Our next question comes from Matt So with William Blair. Your line is open.

Hey, guys. Thanks for taking my questions nice results.

<unk>.

The EBITDA guidance implied for the fourth quarter I think it would be helpful. If you can just give us some more details on the magnitude of the Lz tax NBA partnership investments and where these expenses sit on the income statement and then as he is going to be more one time or should we think.

[noise] about them is ongoing when we put together a models.

Hey, Matt This is Noel I will take this one and and can jump and if he has anything to add so certainly in queue for we're continuing to be aggressive in terms of how we are investing in the business and that starts with our investment and people are aggressively hiring to increase capacity and capability in the business and continue to focus on.

The technology.

Function.

On the marketing side, we talked about the investment we made this quarter into testing new channels, we're going to continue to do that aggressively in the quarter and then two items as you pointed out in terms of the NBA partnership we're certainly investing a fair amount in terms of from a brand standpoint.

To just helped launch that campaign in the proper way and so it'll be a little heavier in queue for but it's a.

A longer term partnerships. So there will be continued will continue to allocate dollars to that investment moving forward and then Lz tax were.

The brand costs in the MBA they sit in the obviously in Ah Kam spend.

And then for Lz tax, we're investing Holy to scale operations in support of the growth there in in particular as we ramp up for tax season, the tax experts, where we're really focused on hiring in our most critical for that support they sit in our cost of sales so you'll notice.

Our prepared remarks, we talk about the sequential step down and gross margin and that's.

In part related to the attacks investment that we're making their and as Dan mentioned earlier.

Again, as we grow their subscribers on on the <unk>.

Tax side of that recent growth and subscriptions related tells you tax a lot of that revenue over the majority of that revenue will be recognized in 2022. So this is a bit of an investment in advance some of that revenue.

And the only thing I'll add in.

Maybe.

A gratuitous AD because it's not the question you're asking I think on the brand side.

We've talked about this before that we have a very high aided brand awareness you talk about 74%.

But one of the big challenges, we have is more on the brand familiarity and product knowledge side. So a lot of people, who know who we are.

But they're not exactly sure what we do and they still probably have a legacy view of us being focused on estate planning and so just to put that into context.

Only 40% of our potential consumers are aware that we have a business formations product. So that is a big limit or to growth and growth and share and that is why we're making such a significant investment on the brand side. So if you think about that NBA partnership I mean, it is called Fast-break for <unk>.

All business or if you think about what type of partner. We are we're not the legal partner, where where the online business formation partner and this is very explicitly done because we're reintroducing our brand primarily as a small business brand.

And Algeo of users, it's almost like if if everybody knows what Coca Cola as in there is 90% awareness, but imagine 60% of the people thought you eat it with a fork I mean, that's.

Essentially the challenge, we're trying to get through right now, it's a big opportunity in many ways. This is unrealized potential and it's why we think this brand spend is so important.

Got it that's that's helpful detail guys. Appreciate it just just one follow up on the Lz tax revenue recognition.

So first does that flow through the subscription line and then the second of all as it is that more seasonal and the way it gets recognize and maybe it's too and material now, but do you expect that to create some seasonality.

With respect to your to your revenue on maybe the first and second quarters of the year.

Yeah, Hey, Matt. This is Noel great question. So Lz tax is recognized in our subscription revenue line, it's largely monthly subscriptions and so.

There is there are components of it that we separate in terms of our revenue revenue recognition. Some of it is recognized ratably over the term and then there are pieces that are tied to kind of dairies entitlements late tax preparation that will be more seasonal in nature, and so you will see especially.

As it becomes more material a bit of a seasonal impact from it.

Just to punctuate that to the we originally deployed this <expletive> with different choices, we had a choice of a skew that was tax advice and bookkeeping and.

And then a different one which was tax prep and what we realized is everybody wanted tax prep.

And so we've shifted in the way we are commercializing. It has two flavors of tax prep, which then again has the exact impact that that Noel just just talked about which is.

That revenue into tax season.

Great. Thanks, guys I appreciate it.

Yes. Thank you.

We have a question from Brett sale with Jeffries Your line is open.

Great. Thank you this is that John again frequent cell.

Another question into Diz taxes, just trying to get a better understanding of how much you ramping into that I mean.

Is it more tax experts as opposed to the infrastructure and technology out in the Neath It and then.

When you ramp Hassan.

Terms of the mix will it be primarily tax prep as opposed to bookkeeping.

How much will anything in terms of head count overall.

That kind of come around too much.

And a much higher percentage versus what it is today.

Hello up on.

Yeah, well I mean, I would think of this as we're creating.

Very large scale tax practice and so essentially all of those are being built in parallel we started with the foundation of a very small acquisitions. So we had some of the capabilities already but as I mentioned in the opening remarks practice management as investment, bringing in Cpa's and enroll.

The agents as an investment.

Marketing as an investment there's a sales component because we also have lots of customers coming into our general floor and were able to introduce it through the sales team and so it's a pretty across the board investments that just to the last question pre pre will predate the actual recognition of the revenue, which primarily happens.

Tax season I think.

Again the value here is very much overweighted on tax prep relative to bookkeeping.

But we also feel like the two things have suffered have such a strong relationship that we really want the small businesses to be successful and keep the right books and and get the right ongoing advice from accountant. So we offer we offer those in combination.

It's very helpful and then on the.

You mentioned the fulfillment input fulfillment does that I guess just to clarify does that mean that that you're able to.

Bring those in.

So are you able to recognize it revenue it will be faster than it might've been in the past.

Yes, that's right. This is noel so you've got to remember from a year over year standpoint last year was really unique there is.

Significant impacts from Covid, both on our fulfillment operations as well as the secretary of state and it's processing time so.

A lot of those impacts.

Largely used in so our fulfillment productivity has improved.

We've also made.

Investments in our fulfillment process, we're both in our customer experience as well as in the infrastructure that supports our fulfillment and so we're realizing kind of durable, especially efficiency improvements in our fulfillment productivity.

And are just able to get customer orders out the door faster than our fulfillment of orders is tied to the timing of a record of revenue recognition.

We view it as like a durable benefit like this is something that even over time, we expect to be faster, we expect to continue to automate.

So this is this is something that is a really critical critical focus and I mentioned before it's really driven by what customers one main customers.

Oftentimes are forming a business because they have an immediate need like they need to bank account or they're working with a trading partner who requires them to be incorporated has to be an LLC for liability reasons and so they needed as fast as possible, which is which is really the underlying reason for that investment.

Okay. Thank you very much.

And our next question comes from Stephen Jew with Credit Suisse. Your line is open.

Hi, this is transformed with Steven Thanks for taking my question. So one of the.

The key strategies, you outlined is to improve the service levels for the consumer with the attorney assist.

Could you update us on sort of that type of level uptake, you're seeing for those solutions and the political and products you have ruled it out too and sort of any incremental update on the split between DIY versus attorney assistant. Thank you.

Yeah, it's still very early in the journey an attorney assist the main place where we've deployed it is on our trademark product.

And we've seen the mix of customers, who are choosing to get assistance from an attorney continue to rise.

And essentially be pretty close to half of the customers who are looking for trademark health, which is a great indicator. What we haven't done yet is deployed this into our formation product lineup, which is the much bigger opportunity and this is an area where we have a couple of.

Things going in parallel.

One is we're working to innovate on being able to provide the service ourself and test and learn which is part of getting what's called the alternative business structure and the second is commercialization testing as well and so you'll continue to see stuff that we're doing to try and learn how customers.

Want this product delivered.

And that's something that we'll start to see next year.

Thank you.

Thank you and there's no further questions in queue I'd like to turn the call back to Dan one a call for closing remarks.

Great well, thanks to everyone for dialing into the call and thanks for your questions really appreciate everything that you guys are asking to the legal team I want to thank you guys for the quarter not only for the amazing execution, but also the incredible passion and energy you bring to work each and every day.

Also want to thank our newest team members from Earth Class Mail welcome aboard we're thrilled to have you and can't wait to get to work with.

We will talk to all of you soon thanks again for your time.

This concludes today's conference call. Thank you for participating you may now disconnect.

[music].

Good day, and thank you for standing by and welcome to the legal systems third quarter 2021 earnings Conference call. At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session.

To ask a question. During this session you don't need to press star one on your telephone please.

Please be advised that today's conference maybe recorded if you require any further assistance. Please press star zero.

Now I'd like to hand, the conference over you speak your day, Danny Vivier head of Investor Relations. Please go ahead.

Thank you operator, Hello, and welcome to Illegals in its third quarter 2021 earnings Conference call.

Joining me today is Dan Warner Cox, our Chief Executive Officer, and Noel Watson, our Chief Financial Officer.

As a reminder, we will be making forward looking statements on this call.

Forward looking statements we make on this call are based on information available to us as of today's date.

We disclaim any obligation to update any forward looking statements, except as required by law.

In addition, we will also discuss certain non-GAAP financial measures.

Our CEO and CFO use these measures to make their decisions regarding our business and we believe these measures provide helpful information to investors.

Reconciliations of all non-GAAP measures to the most directly comparable GAAP measures are set forth in the Investor Relations section of our website at investors that legal dot com.

The non-GAAP financial measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP.

I'll now turn the call over to Dan.

Thank you Danny and thank you all for joining our Q3 earnings call at.

At legal Jim we're on a mission to Democratize law, we believe in harnessing the power of technology to unlock greater efficiencies, which in turn provides more affordable legal and compliance services to small businesses.

Our mission to Democratize law is more important now than ever before with the pandemic reshaping industries, causing economic hardship and sparking a new wave of entrepreneurial activity as.

As the clear category leader in an industry undergoing rapid digital transformation. We believe that we are just at the beginning of our growth journey.

We will continue to leverage our significant brand advantaged differentiated product experience extensive network of credentialed experts and a history of navigating the complexity of the U S legal and regulatory system to further penetrate the $50 billion legal <unk> compliance vertical.

Let me start with a summary of our Q3 results.

Building on the strength of the first half of the year, we delivered total revenue of $148 million above the top end of our guidance range for the quarter and up 12% year over year.

When restrictions were lifted throughout the third quarter pent up demand was filled creating a spike in formations in Q3 of last year.

Subscription revenue continues to be a highlight of 24% year over year in the quarter driven by the ongoing rollout of products and services to help our customers remain compliant after forming their business I'll provide a more detailed operational update on <unk> tax later later in the call, but we're excited to see its integration into the LLC formation flow draw.

I've, a strong uptick in subscriber count in the period.

Given the increased focus intra quarter on the overall market for business formations as measured by the U S census data I'd like to provide some commentary on the topic.

First it's important to note that in EIA application does not one for one translate to a business formation.

Applications can and do diverged from Secretary of State formation data, which we believe is a more accurate benchmark for the total number of addressable formations we.

We also see it during tax season is existing businesses often apply for an <unk> at the advice of an accountant when these onetime or seasonal events occur we see a spike in <unk> applications over and beyond the growth in our internal formation benchmark.

Second I mentioned on our last call that we did see a step down in formation activity beginning in July.

At the time it was too early to know if the step down was temporarily tied to the reopening of summer travel or the beginning of a new trend line.

August and September data and made it clear that the market had reverted to a more normalized seasonal pattern below the elevated levels. We saw earlier in the year.

Finally, it's important to remember that a growing share of our revenue is derived from subscription services. This revenue stream is recurring predictable high margin and performs independently of the seasonal components of our business. We will continue to prioritize growing our base of subscription revenue in favor of driving incremental transactional revenue.

We see an opportunity to accelerate the lifetime value of a customer we will take it even if it means sacrificing in period revenue and profitability. We believe this approach best positions us to deliver subscription growth beyond our long term revenue growth targets.

I would now like to provide an update on our three key growth vectors scaling our core business building, an ecosystem of SMB formation related services and integrating attorneys into our core experience, which we believe will collectively drive durable top line growth and long term margin expansion.

The biggest near term opportunities to drive growth relate to scaling our core offerings by efficiently, increasing our marketing spend improving our product experience and ensuring efficient growth in our operations.

In mid October we announced a new multi year brand partnership with the National Basketball Association. The partnership branded fast break for small business will provide $6 million in grants and services to small business owners, we expect to support more than 6000 small businesses over the life of the campaign many of whom are from the communities most impacted.

By the endemic in the qualities and the financial and legal systems.

The program was created to address these disparities and gives small businesses in these communities a fair shot at turning their dreams into reality.

Beyond the incredible opportunity for social impact. We're also excited about the opportunity to reposition the legals and brand as an SMB <unk> solution.

Despite our best in class improving aided brand awareness score of 74%. The majority of consumers still recognized legals them, primarily for its do it yourself. The state plans in fact, only 40% of our potential customers know that legal zoom can help them with a small business formation and.

And given formations drive the bulk of our revenue, particularly on the subscription side. It's critical that we increase awareness of our formation services by repositioning our brand message the.

The NBA campaign is a major step in the right direction as it clearly distinguishes legal zoom as the go to destination to start your small business. This relationship is a great example of the kind of brand partnerships. We're pursuing as we look to improve awareness of our formation services.

We're also continuing to leverage insights from our media mix modeling to inform spend allocations and test new channels.

Believe ongoing channel testing like this is critical investment will that will enable us to efficiently scale, our media spend over the long term.

And lastly within operations, we're investing on our platform to increase automation reduce turnaround times and improved variable unit economics.

Turnaround times or the time between when a business customer completes an online application on our site and when the entity is legally recognized by <unk>.

As a primary driver of our net promoter scores we've.

We've made investments this year to reduce human involvement and automate a majority of the fulfillment process driving downturn around times and reducing costs.

We added to that ecosystem through our acquisition of Earth's class mail, a leading virtual mailbox solution for small businesses, which we announced this morning.

First class mail, which I'll refer to as ECM makes postal mail paperless easy and accessible 24, 7% from any device anywhere in the world.

We've been tracking the virtual mailbox space for a while now and believe Ecm's national footprint Tech stack and seamless user experience stands out among the competition.

<unk> fits perfectly with both our channel and technology strategies.

Also ECM and our registered agent service use similar technologies, allowing us to leverage many capabilities that will allow us to streamline and advance our broader compliance offerings.

I'd like to congratulate our team and welcome Ecm's employees into the legal zoom family, we look forward to partnering together.

In addition to this exciting acquisition, we continued to ramp new compliance services under the <unk> brand, most notably Lz tax while also partnering with category leaders to offer our best of breed selection of complementary services, such as banking point of sale solutions website hosting and bookkeeping to name just a few the third.

Third quarter was an inflection point for our Lz tax offering with a number of significant milestones.

First throughout the quarter, we exposed a growing portion of LLC traffic to our tax offering at formation, culminating in 100% coverage by the end of the quarter. We're very encouraged by the early results, which more than 50% increase in tax subscription units quarter over quarter and the growth isn't just for more traffic. We're also seeing improvements in attach.

Rates as we continue to optimize our commercialization strategy and zero in on the things our customers care most about.

Second we doubled our team of in house experts CPA and enrolled agents and on boarded supplemental resources in preparation for our first annual tax season next spring, we continue to see demand outpaced supply and are doing all that we can to scale supply quickly. While also prioritizing an excellent customer experience third.

We continue to invest in tech infrastructure needed to support this SaaS scaling revenue stream. This includes the launch of all new practice management software streamlining workflows and automating customer outreach.

We're very pleased by the momentum behind the <unk> tax, which we continue to view as a multiyear growth vector for the business.

On the partnership front, you will have likely seen our recent press releases highlighting a handful of signed brands, including brakes, Intuit Quickbooks and square all marquee service providers with high value offerings for our small business customers the.

The nature of each brand relationship is unique but our intent as we add new partners is to achieve the following core attributes one the relationships are bilateral we acquire new customers for our partners and they require for us to the economics are shared in a recurring model whereby a legal and participates in the ongoing value delivery of the partners.

Service and three legal zoom customers receive preferential pricing on the partner services by signing up through our platform.

As a leader in business formation services, we are uniquely positioned to establish trust with our customers very early in their business lifecycle, we collect the vast amount of data from our customers oftentimes before they even start operating we know theyre industry location hiring plans et cetera, and can use this information to intelligently connect them with.

The right service providers for their unique situation.

Our vision is to partner with the most reputable technology enabled SMB service providers to make it simpler and less costly for small business owners to get the resources and support they need so they can devote their intention to running and growing their business with more and more partner brands, joining our curated network the value of our ecosystem continues to grow.

Our third and final growth vector as attorney assist our new hybrid model that Leverages, our core technology platform, while also integrating access to attorneys throughout the user experience.

On October one we announced that legal zoom subsidiary LG legal services was approved and licensed by the Arizona Supreme Court to operate an alternative business structure or ABS in the state.

This announcement represents a big step forward in the ongoing push in the United States for regulatory reform that permits non lawyer owned entities to provide legal advice.

With the ABS license legal zoom essentially now owns a law firm in the state of Arizona, enabling us to directly provide select legal services to our customers. While we will continue to fulfill the majority of demand through our independent attorney network. The new ABS structure provides a means for us to test new innovative ways to empower consumers.

With access to affordable and transparent legal services online.

In conclusion, we are committed to making the right strategic investments to capitalize on our large market opportunities that exist within the legal <unk> compliance vertical where patient operators and we will continue to make decisions aligned to our long term growth oriented mindset to that end, we will continue to strategically prioritize and accelerating mix of subscription revenues.

Thanks, Dan and good afternoon, everyone I will start today with a review of our performance in the third quarter and end with our outlook for the remainder of the year.

Total GAAP revenue in the period came in at $148 million up 12% year over year.

As Dan mentioned, we lapped a challenging compare from Q3 of last year as the reopening of the economy led to a surge in pent up business formation volumes.

The two year revenue CAGR of 19% remained healthy and we believe more appropriately reflects underlying growth trends in the business.

Transaction revenue was $67 million in the quarter, representing 45% of total revenue.

We completed 106000 business formations in the third quarter.

Business formations include LLC, Inc, and nonprofit formation events, which are critical entry points through which we cross sell our suite of subscription services.

Go down 9% year over year business formations have grown 24% annually over the two year period pacing well ahead of our internal market benchmarks.

Total transaction unit, which also include other transactions involving intellectual property and a state planning, where 229000 units in the quarter performing in line with business formation.

Average order value, which represents the average revenue contribution from each transaction unit remains strong at $291 in the period.

The quarter over quarter increase was due to improvements in order fulfillment rate.

Subscription revenue was $73 million in the quarter for 50% of total revenue.

We added 49000 net subscription units in the period with a growing portion of those driven by the successful integration of LD tax within our LLC formation flow.

Growing our base of subscription units remains a top priority given its impact on LTV.

We will continue to leverage our unique position early in the SMB lifecycle to connect our customers to the right set of tools and services they need to operate their business.

<unk> for the average annual revenue contribution per outstanding subscription unit was $231 up 5% year over year. We continue to expect modest growth in this metric over time has higher RP services like Lv tax account for a growing share of our subscription unit.

As a reminder, we provide <unk> on a last 12 month basis to account for the fact that the majority of subscriptions are billed upfront on annual terms.

Partnership revenue was approximately $8 million in the quarter, representing 5% of our total revenue.

We are very excited about the opportunity that our newest partnerships represent and remain confident in our long term opportunity to build an ecosystem of marquee brand partners complete with high margin recurring revenue structures.

Now turning to expenses and margins, where all of the following metrics are on a non-GAAP basis.

Cost of revenue, which includes government filing fees and other fulfillment and care costs was $45 million in the period up 8% versus last year.

Gross margin came in at approximately 70% of revenue up 200 basis points from Q3 of last year due to improvements in order fulfillment.

We expect a typical seasonal decline in gross margin in the fourth quarter and anticipate additional downward pressure driven by our investments in <unk> tax ahead of the spring tax season.