LegalZoom.com, Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022. Amounts below are in millions of dollars unless stated otherwise. LegalZoom provides online legal, compliance, tax and related services to small businesses and consumers.
Financial performance and liquidity
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $154.4 | $147.9 | $472.5 | $432.9 |
| Gross profit | $104.4 | $100.6 | $309.1 | $291.9 |
| Gross margin | 67.6% | 68.0% | 65.4% | 67.4% |
| Operating loss | $(9.6) | $(27.5) | $(47.3) | $(59.4) |
| Net loss | $(10.1) | $(39.7) | $(53.9) | $(87.9) |
| Adjusted EBITDA (non-GAAP) | $17.5 | $15.1 | $36.6 | $40.7 |
| Adjusted EBITDA margin (non-GAAP) | 11% | 10% | 8% | 9% |
- Q3 revenue grew 4%; nine-month revenue grew 9%. Subscription revenue drove growth, rising 25% in Q3 and 28% year to date. Transaction revenue fell 14% in Q3 and 7% year to date; partner revenue fell 29% and 25%, respectively.
- Q3 gross profit increased 4%, but gross margin slipped to 67.6%. Nine-month gross margin declined to 65.4%, as cost of revenue grew faster than revenue, reflecting higher fulfillment, customer care and tax-service costs.
- Cash provided by operating activities was $52.0 million for the first nine months, versus $60.2 million a year earlier. Capital expenditures were $16.4 million; free cash flow, as defined by the company, was $35.6 million versus $51.7 million.
- Cash and cash equivalents were $211.8 million at September 30, down from $239.3 million at December 31, 2021. Current assets were $264.7 million and current liabilities $256.5 million. Management said available cash and expected operating cash flows should cover operational needs for at least the next 12 months.
- No borrowings were outstanding under the $150 million revolving facility, and the company reported compliance with its covenants. The facility includes a 4.50:1.00 leverage covenant, tested only if usage exceeds the specified threshold.
- Deferred revenue was $169.7 million, up from $147.9 million at year-end. The company reported an accumulated deficit of $865.9 million and continued to report GAAP net losses.
Changes, outlook and management commentary
- Subscription units increased 12% year over year to 1.415 million; average revenue per subscription unit (ARPU) rose 12% to $259. Business formations increased 3% in Q3 to 117,000, but declined 6% for the first nine months to 359,000. Transactions fell 1% in Q3 and 6% year to date.
- Management attributed subscription growth to partner-channel subscriptions, registered agent, compliance and tax advisory products, and the Earth Class Mail acquisition. It said lower transaction volume reflected reduced estate-planning and consumer activity and discontinuation of the do-it-yourself trademark product in favor of attorney-assisted service.
- Average order value fell 12% in Q3 to $255, influenced by lower-priced and free formation tests, partner-channel mix and revenue-recognition timing. Management expected year-over-year average-order-value growth to remain negative through the rest of 2022. It also expected near-term partner revenue to decline as it transitions away from certain legacy partners.
- Management expects cost of revenue to rise as it scales tax advisory and expert-assisted offerings. It expects gross margin to be affected in the short term by tax investment, with modest longer-term improvement anticipated from subscription mix and automation. It expects adjusted EBITDA and free cash flow to increase in absolute dollars over the longer term; no specific revenue or earnings guidance was provided in the filing.
- During the first nine months, the company repurchased 5.66 million shares for approximately $64.0 million, at an average $11.30 per share. The $150 million authorization had approximately $86.0 million remaining at September 30. Additional repurchases of $10.3 million were reported after quarter-end through the filing date.
- The company classified its Austin operational headquarters, with a carrying value of $22.7 million, as held for sale; no impairment was recorded. It acquired United Agency Services in August for $3.5 million, including contingent consideration, and acquired Revv for $8.5 million on October 14, after quarter-end.
Risks, contingencies and unusual items
- Management concluded disclosure controls were not effective as of September 30 because of three previously identified material weaknesses in financial reporting controls: control environment/accounting resources, accounting for complex or unusual transactions, and the financial close process. Remediation was underway, but the company said the weaknesses might not be remediated during 2022.
- Two material legal matters remained unresolved without accrual because losses were not considered probable: a Dun & Bradstreet demand alleging $5.6 million in overpayments, and a Wyoming citation against its subsidiary alleging registered-agent violations, with an initial $4.1 million penalty and revocation of commercial registered-agent status. The filing says an unfavorable Wyoming outcome could materially affect results, cash flows and financial condition.
- Macroeconomic uncertainty, inflation, rising interest rates and declining U.S. business formations may pressure demand. Other highlighted risks include subscriber retention and conversion, competition, service quality, data security and privacy, regulatory restrictions on legal services, and the ability to remediate control weaknesses.
- Foreign-currency transaction losses were $2.6 million in Q3 and $6.0 million year to date, primarily related to British-pound-denominated intercompany loans. The company also recorded $0.8 million of Q3 restructuring costs and $0.4 million of other non-recurring costs in its adjusted EBITDA reconciliation.
Most important facts for investors to verify
- Whether subscription growth and ARPU can offset weaker transaction revenue, lower average order value and declining business formations.
- Whether operating cash generation and free cash flow recover, considering increased fulfillment costs and capital expenditures.
- Progress in remediating the financial-reporting material weaknesses, particularly ahead of required annual reporting assessments.
- Developments and potential exposure in the Wyoming registered-agent matter and Dun & Bradstreet dispute.
- Remaining repurchase authorization and the capital-allocation effects of buybacks, acquisitions and the Austin property sale.
- Whether management’s longer-term margin, adjusted EBITDA and free-cash-flow expectations are achieved; adjusted EBITDA and free cash flow are non-GAAP measures and should be assessed alongside GAAP results.