LegalZoom (NASDAQ:LZ) Misses Q1 Sales Targets, Stock Drops 14.8%

Full Report / May 07, 2024

Online legal service provider LegalZoom (NASDAQ:LZ) missed analysts' expectations in Q1 CY2024, with revenue up 5% year on year to $174.2 million. Next quarter's revenue guidance of $174 million also underwhelmed, coming in 2.5% below analysts' estimates. It made a GAAP profit of $0.02 per share, improving from its loss of $0.01 per share in the same quarter last year.

LegalZoom (LZ) Q1 CY2024 Highlights:

  • Revenue: $174.2 million vs analyst estimates of $175.4 million (small miss)
  • EPS: $0.02 vs analyst estimates of $0 ($0.02 beat)
  • Revenue Guidance for Q2 CY2024 is $174 million at the midpoint, below analyst estimates of $178.4 million
  • The company reconfirmed its revenue guidance for the full year of $710 million at the midpoint (below expectations)
  • Gross Margin (GAAP): 60.7%, down from 63.6% in the same quarter last year
  • Free Cash Flow of $24.72 million, up 75% from the previous quarter
  • Subscription Units: 1.61 million, up 104,000 year on year
  • Market Capitalization: $2.28 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 10.6% annually. This quarter, LegalZoom reported rather lacklustre 5% year-on-year revenue growth, missing analysts' expectations.

LegalZoom Total Revenue

Guidance for the next quarter indicates LegalZoom is expecting revenue to grow 3% year on year to $174 million, slowing from the 3.8% year-on-year increase it recorded in the comparable quarter last year. Ahead of the earnings results, analysts were projecting sales to grow 9.8% 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 10.2% annually to 1.61 million. This is decent growth for a consumer internet company.

LegalZoom Subscription Units

In Q1, LegalZoom added 104,000 users, translating into 6.9% 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 growth has been decent over the last two years, averaging 6.8%. The company's ability to increase prices while growing its users demonstrates the value of its platform. This quarter, ARPU grew 5% year on year to $272 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 60.7% this quarter, down 2.9 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 $0.61 for every $1 in revenue to invest in marketing, talent, and the development of new products and services.

LegalZoom Gross Margin (GAAP)

Despite declining over the last 12 months, LegalZoom still retains reasonably high gross margins, averaging 62.9%. 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 48.6% 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.

LegalZoom reported EBITDA of $27.9 million this quarter, resulting in a 16% margin. Furthermore, LegalZoom has shown strong profitability over the last four quarters, with average EBITDA margins of 18.6%.

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 $24.72 million in Q1, up 13.5% year on year.

LegalZoom Free Cash Flow

LegalZoom has generated $95.65 million in free cash flow over the last 12 months, an impressive 14.3% 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 Q1 Results

We struggled to find many strong positives in these results. Its revenue guidance for next quarter missed analysts' expectations and its revenue growth was quite weak. Full yea revenue guidance, while maintained from previous, also missed. Overall, this was a mediocre quarter for LegalZoom. The company is down 14.8% on the results and currently trades at $10.39 per share.

Is Now The Time?

LegalZoom may have had a tough 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 sales and marketing efficiency is mediocre, 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 16.5x next 12 months EV-to-EBITDA. We don't really see a big opportunity in the stock right now, but in the end, beauty is in the eye of the beholder. If you like the company, it seems to be trading at a reasonable price.

Wall Street analysts covering the company had a one-year price target of $14.21 per share right before these results (compared to the current share price of $10.39).

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