LegalZoom (NASDAQ:LZ) Beats Q1 Sales Targets, Stock Jumps 18.5%

Full Report / May 09, 2023
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Online legal service provider LegalZoom (NASDAQ:LZ) reported results ahead of analyst expectations in the Q1 FY2023 quarter, with revenue up 7.6% year on year to $165.9 million. Guidance for next quarter's revenue was $167 million at the midpoint, 2.94% above the average of analyst estimates. LegalZoom made a GAAP loss of $2.36 million, improving on its loss of $30.6 million, in the same quarter last year.

LegalZoom (LZ) Q1 FY2023 Highlights:

  • Revenue: $165.9 million vs analyst estimates of $155.2 million (6.94% beat)
  • EPS: -$0.01 vs analyst estimates of -$0.03 ($0.02 beat)
  • Revenue guidance for Q2 2023 is $167 million at the midpoint, above analyst estimates of $162.2 million
  • The company lifted revenue guidance for the full year, from $630 million to $640 million at the midpoint, a 1.59% increase
  • Free cash flow of $21.8 million, up 34.7% from previous quarter
  • Gross Margin (GAAP): 63.6%, in line with same quarter last year
  • Subscription Units: 1.5 million, up 139 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 14.5% annually. This quarter, LegalZoom beat analyst estimates but reported a mediocre 7.6% year on year revenue growth.

LegalZoom Total Revenue

Guidance for the next quarter indicates LegalZoom is expecting revenue to grow 1.91% year on year to $167 million, slowing down from the 8.93% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 1.45% over the next twelve months.

Usage Growth

As a online marketplace, LegalZoom generates revenue growth both by growing the number of users on the platform and the average user size in dollars.

Over the last two years the number of LegalZoom's paying users, a key usage metric for the company, grew 11.3% annually to 1.5 million. This is decent growth for a consumer internet company.

LegalZoom Subscription Units

In Q1 the company added 139 thousand paying users, translating to a 10.2% growth year on year.

Revenue Per User

Average revenue per user (ARPU) is a critical metric to track for every consumer internet product and for LegalZoom it is a function of the size of the average user on the platform and what is LegalZoom's take rate (cut) from each.LegalZoom ARPU

LegalZoom’s ARPU has declined over the last two years, averaging 4.61% annually. While the number of users has been still growing, it is not great to see the company losing pricing power. This quarter, ARPU shrank 2.36% year on year, settling in at $110.55 for each of the paying users.

User Acquisition Efficiency

Unlike enterprise software that is typically sold by sales teams, consumer internet businesses like LegalZoom grow by a combination of product virality, paid advertisement or incentives.

It is expensive for LegalZoom to acquire new users, with the company spending 59.2% of its gross profit on marketing over the last year. This level of sales and marketing spend efficiency indicates LegalZoom is not highly differentiated and points to LegalZoom likely having to continue to invest to maintain growth.

Earnings & Free Cash Flow

Investors typically look at a company’s operating income to get a sense of how profitable a core business is. Adjusted EBITDA is the most common profitability metric for consumer internet companies, similar to operating profit, but removes various one time or non-cash expenses to give a more normalized measure of profitability.

LegalZoom's EBITDA came in at $21.9 million this quarter, which translated to a 13.2% margin. Over the last twelve months, the company has exhibited strong profitability with average EBITDA margins of 13.3%.

LegalZoom Adjusted EBITDA Margin

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. LegalZoom's free cash flow came in at $21.8 million in Q1, up 147% year on year.

LegalZoom Free Cash Flow

LegalZoom has generated $64.7 million in free cash flow over the last twelve months, 10.2% of revenues. This strong FCF margin is a result of LegalZoom asset lite business model and provides it plenty of cash to invest in the business.

Key Takeaways from LegalZoom's Q1 Results

With a market capitalization of $1.53 billion LegalZoom is among smaller companies, but its more than $204.1 million in cash and positive free cash flow over the last twelve months give us confidence that LegalZoom has the resources it needs to pursue a high growth business strategy.

We liked to see that LegalZoom beat analysts’ revenue expectations pretty strongly this quarter. Business formations and transaction units, two usage KPIs, also beat. And we were also glad that both revenue and EBITDA guidance for the next quarter and full year exceeded analysts' expectations. While absolute revenue growth was a bit weak, it was overall a positive quarter, and shareholders can feel optimistic. The company is up 18.5% on the results and currently trades at $9.88 per share.

Is Now The Time?

When considering LegalZoom, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in the case of LegalZoom we will be cheering from the sidelines. Its revenue growth has been a little slower, and analysts expect growth rates to deteriorate from there. And while its strong free cash generation allows it to sustainably invest in growth initiatives, the downside is that its ARPU has been declining and its sales and marketing efficiency is sub-average.

At the moment LegalZoom trades at next twelve months EV/EBITDA 19.1x. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.

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