LegalZoom (NASDAQ:LZ) Beats Q2 Sales Targets

Full Report / August 08, 2023

Online legal service provider LegalZoom (NASDAQ:LZ) beat analysts' expectations in Q2 FY2023, with revenue up 3.04% year on year to $168.9 million. The company also expects next quarter's revenue to be around $160 million, roughly in line with analysts' estimates. LegalZoom made a GAAP profit of $1.4 million, improving from its loss of $13.2 million in the same quarter last year.

LegalZoom (LZ) Q2 FY2023 Highlights:

  • Revenue: $168.9 million vs analyst estimates of $167 million (1.1% beat)
  • EPS: $0.01 vs analyst expectations of $0.02 (46.8% miss)
  • Revenue Guidance for Q3 2023 is $160 million at the midpoint, roughly in line with what analysts were expecting
  • The company lifted revenue guidance for the full year from $640 million to $647 million at the midpoint, a 1.09% increase
  • Free Cash Flow of $37.4 million, up 71.6% from the previous quarter
  • Gross Margin (GAAP): 62.2%, down from 65% in the same quarter last year
  • Subscription Units: 1.55 million, up 159 thousand year on year

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.

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 which 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 mediocre, averaging 13.4% annually. This quarter, LegalZoom reported lacklustre 3.04% year-on-year revenue growth, in line with analysts' expectations.

LegalZoom Total Revenue

Guidance for the next quarter indicates LegalZoom is expecting revenue to grow 3.62% year on year to $160 million, slowing down from the 4.42% year-on-year increase it recorded in the same quarter last year. Ahead of the earnings results, analysts covering the company were projecting sales to grow 4.94% over the next 12 months.

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 11.3% annually to 1.55 million. This is decent growth for a consumer internet company.

LegalZoom Subscription Units

In Q2, LegalZoom added 159 thousand users, translating into 11.4% 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 ARPU

LegalZoom's ARPU has declined over the last two years, averaging 5.34%. 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 declined 7.51% year on year to $108.73 per user.

Pricing Power

A company's gross profit margin has a major impact on its ability to extert 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 62.2% 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 $0.62 for every $1 in revenue to invest in marketing, talent, and the development of new products and services.

LegalZoom Gross Margin (GAAP)

LegalZoom's gross margins have been stable over the past year, averaging 65.3%, and remain ahead of other consumer internet companies. This outperformance points to its solid business model, competitive products and services, and a relatively stable pricing environment.

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 expensive for LegalZoom to acquire new users as the company has spent 54.8% of its gross profit on sales and marketing expenses over the last year. This relative inefficiency indicates that LegalZoom's product offering can be easily replicated and that it must 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.

LegalZoom reported EBITDA of $29.6 million this quarter, resulting in a 17.6% margin. Furthermore, LegalZoom has shown strong profitability over the last four quarters, with average EBITDA margins of 15%.

LegalZoom Adjusted EBITDA Margin

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 $37.4 million in Q2, up 573% year on year.

LegalZoom Free Cash Flow

LegalZoom has generated $96.5 million in free cash flow over the last 12 months, an impressive 15% 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 Q2 Results

With a market capitalization of $2.96 billion, LegalZoom is among smaller companies, but its $238.9 million cash balance and positive free cash flow over the last 12 months give us confidence that it has the resources needed to pursue a high-growth business strategy.

It was good to see LegalZoom add new users this quarter. Business formations and transaction units beat expectations. We were also happy that its revenue growth outperformed Wall Street's expectations, even if just narrowly. On the other hand, its weak revenue growth wasn't great. Also, while next quarter's revenue guidance was in line, adjusted EBITDA guidance was below. Overall, this was a mixed quarter for LegalZoom. The company is down 4.89% on the results and currently trades at $14.6 per share.

Is Now The Time?

When considering an investment in LegalZoom, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter. Although LegalZoom isn't a bad business, it probably wouldn't be one of our picks. Its revenue growth has been a little slower, but at least that growth rate is expected to increase in the short term. And while its strong free cash flow generation allows it to invest in growth initiatives while maintaining an ample cash cushion, the downside is that its ARPU has been declining and its sales and marketing efficiency is sub-average.

At the moment LegalZoom trades at 26.9x next 12 months EV/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.

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