LegalZoom.com, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Amounts below are in U.S. dollars; financial-statement amounts are in millions unless noted. The 2022 comparable financial statements were restated.
Business context
LegalZoom provides online legal, tax and compliance products and services to small businesses and consumers. Revenue comes from transactions, subscriptions and partner referrals. The company is shifting toward a “freemium” model, including nationwide free LLC formations, to acquire customers and convert them to subscriptions.
Key financial results
| Metric | Q2 2023 | Q2 2022, restated | H1 2023 | H1 2022, restated |
|---|---|---|---|---|
| Revenue | $168.9 | $162.6 | $334.8 | $318.1 |
| Gross profit / margin | $105.1 / 62.2% | $105.5 / 64.9% | $210.6 / 62.9% | $204.7 / 64.4% |
| Operating income (loss) | $4.7 | $(11.4) | $3.9 | $(36.5) |
| Net income (loss) | $1.4 | $(12.7) | $(1.0) | $(38.5) |
| Adjusted EBITDA / margin | $29.6 / 18% | $18.1 / 11% | $51.5 / 15% | $20.3 / 6% |
Q2 revenue increased 4%; subscription revenue rose 12% to $102.2 million, while transaction revenue declined 7% to $60.5 million and partner revenue increased 2% to $6.2 million. In H1, revenue grew 5%, led by 14% subscription growth; transaction revenue declined 6%.
Q2 sales and marketing expense fell 25% to $53.5 million, while technology and development expense rose 23% to $19.9 million and general and administrative expense fell 7% to $26.9 million. H1 sales and marketing expense declined 24%; technology and development rose 16%; general and administrative declined 9%. Lower marketing spend and stock-based compensation contributed to the operating expense reductions.
Cash flow and liquidity: H1 operating cash flow was $74.4 million, capital expenditures were $15.2 million and free cash flow was $59.1 million, versus $24.8 million, $10.4 million and $14.4 million, respectively, in restated H1 2022. Cash and cash equivalents were $238.9 million at June 30, up from $189.1 million at year-end. The company reported no borrowings or letters of credit under its $150 million revolving facility, leaving the full amount available. Management said available cash and expected operating cash flow should meet needs for at least 12 months.
Balance sheet: Total liabilities were $280.3 million and stockholders’ equity was $168.3 million. Current deferred revenue was $179.4 million, with another $0.7 million non-current. The company held $22.7 million of Austin operational headquarters assets for sale; no impairment was recorded.
Operating indicators: Q2 business formations increased 42% to 161,000 and transactions rose 26% to 283,000, while average order value fell 26% to $214, mainly reflecting free LLC formations. Subscription units increased 11% year over year to 1.553 million; ARPU rose 3% to $259. Annual small-business retention was approximately 63%.
Changes, outlook and notable items
- The nationwide free LLC rollout increased formations and transaction volumes but lowered average order value; management expects average-order-value growth to remain negative through the rest of 2023.
- Management expects near-term pressure on business formations and subscription-unit growth from exiting certain legacy partnerships. It also expects lower LZ Tax customer purchases and retention to weigh on revenue into 2024, while aiming for improved long-term LZ Tax retention.
- Management expects partner revenue to decrease in the near term as it exits legacy relationships. It expects cost of revenue to rise in absolute dollars and near-term gross margin to be affected by filing-fee mix and investment in tax services; it anticipates modest longer-term gross-margin improvement and expects Adjusted EBITDA and free cash flow to grow in absolute dollars over the longer term.
- On August 3, 2023, the company launched LZ Books and a redesigned customer account experience. These are management initiatives, not reported-period results.
- Q2 GAAP net income was $1.4 million, but the six-month period remained loss-making. The tax provision was $6.1 million for Q2 and $10.0 million for H1; effective tax rates were unusually high at 81.5% and 110.7%, respectively, primarily due to non-deductible stock-based compensation and discrete adjustments.
- The company restated 2022 quarterly financial statements for an income-tax error involving Internal Revenue Code Section 162(m), and corrected other immaterial revenue and marketing-credit timing errors. The restatement changed restated Q2 2022 net loss to $12.7 million from $13.2 million as originally reported; restated H1 2022 net loss was $38.5 million versus $43.8 million originally reported. H1 2022 operating cash flow was unchanged.
- Material weaknesses in internal control over financial reporting remained unresolved at June 30, 2023. Management concluded disclosure controls and procedures were not effective. Remediation work includes hiring and training, and implementing and testing controls; management cautioned that sustained validation is required.
- H1 stock-based compensation expense was $35.4 million. The company granted 4.2 million options to senior leaders, 7.8 million RSUs to employees and 1.3 million performance stock units to senior leaders.
Risks and contingencies
Key risks include dependence on U.S. business formations and subscriber conversion, renewal and retention; execution of the freemium strategy; macroeconomic pressures; competition, including emerging generative-AI services; and complex rules governing legal services and unauthorized practice of law. The company also cites privacy and cybersecurity exposure, reliance on third parties and government agencies, and risks from operating and financial reporting controls. No material legal proceedings were reported. Contractual commitments included $5.3 million of future advertising and media commitments, $43.2 million remaining under vendor agreements, and $11.5 million of minimum operating lease payments. The revolver includes restrictive covenants and a leverage test that applies above specified facility utilization.
Investor verification points
- Track whether free formations convert into paid subscriptions and whether the resulting lower order value is offset by subscription growth, retention and ARPU.
- Monitor formation volumes, subscription-unit growth and the approximately 63% small-business retention rate, particularly after legacy partnership exits and LZ Tax changes.
- Assess gross-margin trends and cash generation alongside the company’s use of Adjusted EBITDA and free cash flow, which exclude certain expenses.
- Follow remediation and independent validation of the material weaknesses, and review future filings for any further corrections or restatements.
- Review the unusually high effective tax rate, unrecognized tax benefits of $9.4 million, and potential tax examination outcomes.
- Confirm the status and proceeds of the Austin property sale, future share repurchases, and compliance with revolving-facility covenants.