LegalZoom.com, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. LegalZoom provides online legal, tax, accounting, compliance, and related services to small businesses and consumers. Comparative 2022 figures are restated.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Revenue | $167.3 million | $155.3 million | $502.1 million | $473.4 million |
| Gross profit / margin | $108.1 million / 64.6% | $105.0 million / 67.6% | $318.7 million / 63.5% | $309.7 million / 65.4% |
| Operating income (loss) | $10.3 million | $(10.2) million | $14.2 million | $(46.7) million |
| Net income (loss) | $7.5 million | $(12.0) million | $6.6 million | $(50.5) million |
| Adjusted EBITDA / margin | $33.7 million / 20% | $16.9 million / 11% | $85.3 million / 17% | $37.2 million / 8% |
| Operating cash flow | Not presented for the quarter | $101.8 million | $52.0 million | |
| Free cash flow | Not presented for the quarter | $78.6 million | $35.6 million |
Q3 revenue grew 8%, primarily from subscription revenue, up 14% to $104.5 million; transaction revenue declined 2% to $57.4 million, while partner revenue was essentially flat at $5.5 million. Nine-month revenue increased 6%, with subscriptions up 14% and transaction revenue down 5%.
For the nine months, cash and cash equivalents were $212.1 million at September 30, 2023, versus $189.1 million at December 31, 2022. Total liabilities were $279.2 million, including $177.4 million of deferred revenue. The company had no borrowings outstanding on its $150 million revolving facility and reported covenant compliance. It expected available cash and operating cash generation to cover operating needs and material cash requirements for at least the next 12 months. Capital expenditures were $23.2 million; share repurchases used $54.9 million of cash.
Material changes and business trends
- Q3 business formations increased 17% to 137,000; nine-month formations increased 30% to 468,000, driven mainly by nationwide free LLC formations. Transaction counts rose 5% and 15%, respectively.
- Average order value declined 6% in Q3 to $242 and 17% for the nine-month period to $217, largely reflecting free LLC offers. Management expected year-over-year average order value growth to improve as the initial rollout was lapped.
- Subscription units grew 11% year over year to 1.568 million; ARPU rose 2% to $265. Annual small-business retention was approximately 63%.
- Gross margin declined as cost of revenue grew faster than revenue, including higher filing fees associated with formation growth. Q3 sales and marketing expense fell 24%, while technology and development expense rose 23%.
- Cash from operations increased year over year, supported in part by a $12.3 million increase in deferred revenue, reflecting subscriptions generally billed in advance.
Outlook, risks, and unusual items
- Outlook: The filing gives no specific numerical revenue or earnings guidance. Management anticipated near-term pressure on partner revenue after exiting certain channel relationships, and said those exits could also weigh on formations and subscription-unit growth. It expected LZ Tax customer and subscription-unit declines to create a revenue headwind into 2024, while aiming for improved long-term retention. Management also expected cost of revenue and technology and development spending to rise with product and service investments; long-term gross margin improvement was tied to subscription mix and automation.
- Products: LZ Books launched in August 2023; Doc Assist, a generative-AI document summarization tool, entered beta in September. A business-license compliance product was announced in November.
- Restatement and controls: 2022 quarterly and year-to-date statements were restated for an income-tax error involving Section 162(m), with other immaterial corrections to marketing expense, revenue, and cost of revenue. Management reported continuing material weaknesses in financial reporting controls and concluded disclosure controls were ineffective as of September 30, 2023. Remediation efforts include hiring and training, enhanced review controls, and external support; effectiveness still requires sustained testing.
- Tax: The nine-month effective tax rate was 68.7%, primarily reflecting nondeductible stock-based compensation and discrete adjustments. Gross unrecognized tax benefits were $9.7 million.
- Capital allocation: In September, the company repurchased 4.72 million shares from a selling stockholder for $45.1 million at $9.55 per share, in connection with a secondary offering. The 2022 authorization was exhausted; a new $100 million repurchase program was approved in October.
- Property transaction: A proposed $41 million sale of the Austin operational headquarters was terminated by the buyer in November after due diligence; the $835,000 escrow deposit was to be returned. The property remained classified as held for sale at September 30, with a carrying value of $22.7 million.
- Other risks: The filing highlights dependence on business formations and subscription conversion and renewal, competition, macroeconomic conditions, changing legal and tax regulation, privacy and cybersecurity, and generative-AI accuracy and compliance risks. No material legal proceedings were reported. The company had $35 million remaining under non-cancelable vendor agreements over a five-year period.
Investor verification priorities
- Review the restatement disclosures and monitor whether the identified control weaknesses are remediated and disclosure controls become effective.
- Assess whether free formations generate durable paid subscriptions and customer value, particularly given lower average order value and approximately 63% small-business retention.
- Track subscription growth, ARPU, LZ Tax customer trends, and the expected 2024 revenue headwind.
- Evaluate cash generation excluding deferred-revenue timing effects, capital spending, and the pace and price of repurchases under the new $100 million authorization.
- Confirm the status and carrying value of the Austin property after termination of the sale agreement.