Online legal service provider LegalZoom (NASDAQ:LZ) reported Q4 FY2023 results topping analysts' expectations, with revenue up 8.2% year on year to $158.7 million. On the other hand, next quarter's revenue guidance of $174 million was less impressive, coming in 1.2% below analysts' estimates. It made a GAAP profit of $0.04 per share, down from its profit of $0.10 per share in the same quarter last year.
LegalZoom (LZ) Q4 FY2023 Highlights:
- Revenue: $158.7 million vs analyst estimates of $156.6 million (1.3% beat)
- EPS: $0.04 vs analyst estimates of $0.02 ($0.02 beat)
- Revenue Guidance for Q1 2024 is $174 million at the midpoint, below analyst estimates of $176.1 million
- Management's revenue guidance for the upcoming financial year 2024 is $710 million at the midpoint, missing analyst estimates by 0.6% and implying 7.5% growth (vs 6.6% in FY2023)
- Free Cash Flow of $14.12 million, down 27.4% from the previous quarter
- Gross Margin (GAAP): 64.8%, down from 67.5% in the same quarter last year
- Subscription Units: 1.55 million, up 104,000 year on year
- Market Capitalization: $1.83 billion
LegalZoom (NASDAQ:LZ) is an online platform that provides online legal services to individuals and small businesses. The company’s co-founders found it difficult and expensive to find lawyers and file paperwork when trying to start a business so they started LegalZoom instead to address this pain point.
LegalZoom’s key product is an online legal document preparation service that allows customers to create legal documents without having to hire an often expensive lawyer. Whether you need a will, power of attorney, or a trademark registration, the company can be of assistance. Some legal documents generated by LegalZoom do not involve an attorney’s work or review.
When there is a lawyer involved, LegalZoom activates its partnerships with independent attorneys and law firms. These attorneys and law firms are not LegalZoom employees but rather independent contractors. LegalZoom charges a fee for its services, and the attorneys who do the work are paid compensated by LegalZoom.
LegalZoom charges a fee for its online legal document preparation services, with prices ranging from $39 to $799 depending on the complexity of the document. For example, let's say you're starting a small business and need to draft articles of incorporation. Instead of hiring an expensive lawyer, you can use LegalZoom's service to create the document for just $149.
Online Marketplace
Marketplaces have existed for centuries. Where once it was a main street in a small town or a mall in the suburbs, sellers benefitted from proximity to one another because they could draw customers by offering convenience and selection. Today, a myriad of online marketplaces fulfill that same role, aggregating large customer bases, which attracts commission-paying sellers, generating flywheel scale effects that feed back into further customer acquisition.
Competitors offering online legal or document services include H&R Block (NYSE:HRB) as well as private companies Jackson Hewitt and Rocket Lawyer.Sales Growth
LegalZoom's revenue growth over the last three years has been unremarkable, averaging 12.5% annually. This quarter, LegalZoom beat analysts' estimates but reported mediocre 8.2% year-on-year revenue growth.
Guidance for the next quarter indicates LegalZoom is expecting revenue to grow 4.9% year on year to $174 million, slowing down from the 6.8% year-on-year increase it recorded in the same quarter last year. For the upcoming financial year, management expects revenue to reach $710 million at the midpoint, representing 7.5% growth compared to the 6.6% increase in FY2023.
Usage Growth
As an online marketplace, LegalZoom generates revenue growth by increasing both the number of users on its platform and the average order size in dollars.
Over the last two years, LegalZoom's users, a key performance metric for the company, grew 10.7% annually to 1.55 million. This is decent growth for a consumer internet company.
In Q4, LegalZoom added 104,000 users, translating into 7.2% year-on-year growth.
Revenue Per User
Average revenue per user (ARPU) is a critical metric to track for consumer internet businesses like LegalZoom because it measures how much the company earns in transaction fees from each user. Furthermore, ARPU gives us unique insights as it's a function of a user's average order size and LegalZoom's take rate, or "cut", on each order.
LegalZoom's ARPU has declined over the last two years, averaging 4.1%. Although the company's users have continued to grow, it's lost its pricing power and will have to make improvements soon. This quarter, ARPU grew 0.9% year on year to $102.69 per user.
Pricing Power
A company's gross profit margin has a major impact on its ability to exert pricing power, develop new products, and invest in marketing. These factors may ultimately determine the winner in a competitive market, making it a critical metric to track for the long-term investor.
LegalZoom's gross profit margin, which tells us how much money the company gets to keep after covering the base cost of its products and services, came in at 64.8% this quarter, down 2.7 percentage points year on year.
For online marketplaces like LegalZoom, these aforementioned costs typically include payment processing, hosting, and bandwidth fees in addition to the costs necessary to onboard buyers and sellers, such as identity verification. After paying for these expenses, LegalZoom had $0.65 for every $1 in revenue to invest in marketing, talent, and the development of new products and services. 
Despite declining over the last 12 months, LegalZoom still retains reasonably high gross margins, averaging 63.8%. These margins are ahead of the industry average and point to LegalZoom's solid business model, competitive products and services, and lack of meaningful pricing pressure.
User Acquisition Efficiency
Consumer internet businesses like LegalZoom grow from a combination of product virality, paid advertisement, and incentives (unlike enterprise software products, which are often sold by dedicated sales teams).
It's relatively expensive for LegalZoom to acquire new users as the company has spent 50% of its gross profit on sales and marketing expenses over the last year. This level of efficiency indicates that LegalZoom has to compete for its users and continue investing to maintain its growth trajectory.
Profitability & Free Cash Flow
Investors frequently analyze operating income to understand a business's core profitability. Similar to operating income, adjusted EBITDA is the most common profitability metric for consumer internet companies because it removes various one-time or non-cash expenses, offering a more normalized view of a company's profit potential.
This quarter, LegalZoom's EBITDA came in at $33.44 million, resulting in a 21.1% margin. Furthermore, LegalZoom has shown strong profitability over the last four quarters, with average EBITDA margins of 18%.
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. LegalZoom's free cash flow came in at $14.12 million in Q4, down 12.6% year on year.
LegalZoom has generated $92.72 million in free cash flow over the last 12 months, an impressive 14% of revenue. This high FCF margin stems from its asset-lite business model and strong competitive positioning, giving it the option to return capital to shareholders or reinvest in its business while maintaining a cash cushion.
Key Takeaways from LegalZoom's Q4 Results
It was good to see LegalZoom narrowly top analysts' revenue expectations this quarter. That stood out as a positive in these results. And while its full year revenue guidance missed analysts' expectations, it still indicates a slight acceleration of growth. The stock is up 7.4% after reporting and currently trades at $10.55 per share.
Is Now The Time?
LegalZoom may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
Although we have other favorites, we understand the arguments that LegalZoom isn't a bad business. Although its revenue growth has been a little slower over the last three years, its growth over the next 12 months is expected to be higher. And while its ARPU has declined over the last two years, its strong free cash flow generation allows it to invest in growth initiatives while maintaining an ample cash cushion.
At the moment LegalZoom trades at 14.2x next 12 months EV-to-EBITDA. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that LegalZoom doesn't trade at a completely unreasonable price point.
Wall Street analysts covering the company had a one-year price target of $13.79 per share right before these results (compared to the current share price of $10.55).
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