Lemonade, Inc. (LMND) Earnings Call Transcript & Summary

Thank you for standing by. My name is Sydney, and I will be your conference operator today. At this time, I would like to welcome everyone to the Lemonade Q1 2023 Earnings Call. [Operator Instructions] We will now turn it over to Yael to begin the conference.

Good morning, and welcome to Lemonade's First Quarter 2023 Earnings Call. My name is Yael Wissner-Levy, and I am the VP Communications at Lemonade. Joining me today to discuss our results are Daniel Schreiber, Co-CEO and Co-Founder; Shai Wininger, Co-CEO and Co-Founder; and Tim Bixby, our Chief Financial Officer. A letter to shareholders covering the company's first quarter 2023 financial results is available on our Investor Relations website, investor.lemonade.com. Before we begin, I would like to remind you that management's remarks on this call may contain forward-looking statements within the meaning of the Private Securities Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our Form 10-K filed with the SEC on March 3, 2023, and our other filings with the SEC. Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligation to update them. We will be referring to certain non-GAAP financial measures on today's call, such as adjusted EBITDA and adjusted gross profit, which we believe may be important to investors to assess our operating performance. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our letter to shareholders. Our letter to shareholders also includes information about our key operating metrics, including in force premium, premium per customer, gross loss ratio and net loss ratio and a definition of each metric why each is useful to investors and how we use each to monitor and manage our business. With that, I'll turn the call over to Daniel for some opening remarks. Daniel?

Good morning, and thank you for joining us to discuss Lemonade's Q1 results and our updated outlook for the year. We are heartened by the continued progress we're seeing across all the KPIs that we rely on in managing our business, our growth metrics, IFP, of course, but also its component parts like annual dollar retention and premium per customer, all moved up nicely. And at the same time, our loss ratio and adjusted EBITDA loss, both moved to down nicely. And I think that tells a compelling story. Looked at from another angle we see that our gross earned premium and gross profit, both grew by over 60% year-on-year even as our operating expense grew by only 4%. Whichever way you look at it, Q1's results suggest that the business is progressing, both in size and profitability, very much in line with what we'd hoped to see. As Tim will share shortly, we're boosting our adjusted EBITDA guidance for the year by some 20%, suggesting that we don't see this goodness as limited to Q1, but rather that we believe Q1's results will be reflective of an improved trend line on our path to profitability. Drilling on the loss ratio for a minute longer, despite continued inflation and increased frequency of natural disasters, or CATs, our loss ratio continued its descent, clocking in at 87%, down from 89% in the previous quarter and 94% the quarter before that. This welcome decline is even more pronounced when examining the underlying progression net of CAT. Using this filter, we see a 7 percentage point drop quarter-on-quarter and a 16% drop over the past 6 months. As mentioned in previous calls, we expect our current trajectory to broadly continue, albeit with occasional hiccups when outside CATs introduced a brief reversal. Powering this progress is continuous advancement in our AI and machine learning capabilities and the increasingly predictive power of the data sets on which they are fed. At our Investor Day last November, we demonstrated LTV6, our integrated array of AI is able to predict churn, cross-sells and claims with what we believe is unprecedented precision. In the first quarter of this year, we deployed our latest model, LTV7, and its successor, LTV8, will supplant LTV7 by midyear. Each new generation represents a significant milestone within our company. LTV7, for example, refined our CAT loss predictions pretty dramatically. While LTV6 predicted CAT exposures at a ZIP code level. LTV 7 increased that resolution, and we now assess CAT exposure of each discrete home individually. Our models will continue evolving as our data becomes richer and more extensive bringing us ever closer to achieving true precision pricing and underwriting. Finally, I want to highlight that our much anticipated Chewy partnership launched in Arizona this week and we'll continue to roll out across the U.S. in the weeks to come. We're eager to see the results of combining 2 such tech-powered and values aligned companies to serve CAT families nationwide. With that, I'll hand the call over to Shai to dig a little deeper into what's happening in the world of AI and the welcome implications for Lemonade. Shai?

Thanks, Daniel. I'd like to spend a few minutes on the hottest topic around generative AI. AI has always been an integral part of our DNA. Lemonade was built as a tech-powered insurance company. We were the first to provide customers with human-like chat-based experience that works 24/7 and handles all of our direct sales. On the back end, we built a first of its kind insurance operating system that lets our team service our customers efficiently and delightfully. This year, ChatGPT 4 and other large language models made a huge leap forward, a jump that I believe will change our lives in ways we can't fully imagine. But even before we let ourselves wonder how artificial intelligence will impact society, the potential impact this technology brings to businesses like ours is substantial. Generative AI and specifically GPT and its successors are technologies that can reason and learn like never before. They have the potential to not only improve efficiency and customer service but to revolutionize the way we assess risk and make decisions. This technology will help us better anticipate customer needs, respond to more claims instantly and ultimately provide better coverage at lower costs. For our competitors, though, adapting to this change will not be easy. A traditional insurance company depends on hundreds of disparate software tools to run its business. Many of which are outdated legacy systems built decades ago by third-party vendors with little to no control over the development of these tools, integrating generative AI technologies like ChatGPT will require a significant amount of time, effort and investment. And even then, it may never live up to its full potential. Lemonade on the other hand was built for this moment. Nearly 8 years ago, we took a bet on conversational UI and chatbots. And since then have sold nearly 100% of our policies with no human intervention. Over the years, we've updated our systems to use the latest AI technology as models evolved and became increasingly better. Today, we use dozens of AI models to do pricing, underwriting, customer service, payments and many other internal operations. We even built our own internal AI framework to help us manage and deploy models seamlessly and quickly across the organization. In just a matter of days, our team was able to add ChatGPT and other generative AI tools to our platform. We now have more than 100 different initiatives, which we believe can have a meaningful impact on our business. As a result, we expect to see more savings in the next 18 months and anticipate continued improvements in both our expense and loss ratios. And with that, I'll turn the call over to Tim, who can provide more detail on our Q1 results and a view into the rest of 2023. Tim?

Great. Thanks, Shai. I'll give a bit more color on our Q1 results as well as expectations for the second quarter and the full year, and then we'll take your questions. It was a strong quarter on every key metric with good progress on loss ratio, marketing efficiency and expense management. In force premium, or IFP, grew 56% in Q1 as compared to the prior year to $653 million. Absent the impact of the Metromile acquisition, organic annual growth was approximately 32%. Customer count increased by 23% to 1.9 million as compared to the prior year. Premium per customer increased 26% versus the prior year to $352. This increase was driven primarily by the Metromile acquisition impact and to a lesser extent, the combination of increased value of policies over time as well as a continuing mix shift toward higher-value homeowner car and pet policies. Annual dollar retention, or ADR, increased by 5 percentage points to 87% versus the prior year, a new high. We measure ADR, as a reminder, on an annual cohort basis, and include the impact of changes in policy value, additional policy purchases in churn. Gross earned premium in Q1 increased 61% as compared to the prior year to $154 million, roughly in line with the increase of in force premium. Revenue in Q1 increased 115% from the prior year to $95 million. The growth in revenue was driven by the increase in gross earned premium as well as a reduction in the proportion of premium ceded to reinsurers to roughly 56% in the quarter as compared to approximately 71% in the prior year. Our gross loss ratio was 87% for Q1 as compared to 90% in Q1 2022 and 89% in Q4 2022. The impact of CATs in Q1 was roughly 14 percentage points within the overall gross loss ratio. Absent the impact of all CATs, in Q4 and Q1, the underlying non-CAT loss ratio showed solid improvement of roughly 7 percentage points from Q4 to Q1. Operating expenses, excluding loss and loss adjustment expense, increased just 4% to $96 million in Q1 as compared to the prior year. And this increase is primarily driven by increased personnel expense and stock-based compensation expense. In large part due to the Metromile acquisition, but partially offset by lower sales and marketing expense. Other insurance expense grew 49% in Q1 versus the prior year, roughly in line with the growth of our earned premium. Total sales and marketing expense declined by $10.1 million or 26%, primarily due to lower growth acquisition spending to acquire new customers. Notably, our growth spend efficiency improved in Q1 Each dollar spent on growth generated roughly 12% more IFP this quarter versus the prior year. Technology development expense increased 29%, primarily due to the Metromile acquisition, while G&A expense increased 16% as compared to the prior year, but notably increased just 5% as compared to the prior quarter. Personnel growth continued at a very modest pace. Our headcount increased just 1% as compared to year-end 2022 to 1,384. Headcount increased 19% as compared to the prior year, again, primarily due to the impact of the Metromile acquisition in Q3. Net loss was $65.8 million in Q1 or $0.95 per share as compared to the $74.8 million loss we reported in the first quarter of 2022 or $1.21, excuse me, per share. While adjusted EBITDA loss was $50.8 million in Q1, an 11% improvement as compared to the $57.4 million adjusted EBITDA loss in the first quarter of 2022. Our total cash, cash equivalents and investments ended the quarter at approximately $993 million, reflecting a use of cash for operations of $46 million since year-end 2022. And with these goals and metrics in mind, I'll outline our specific financial expectations for the second quarter and for the full year 2023. For the second quarter, we expect in force premium at June 30 of between $665 million and $668 million, gross earned premium between $156 million and $158 million, revenue of between $96 million and $98 million, and adjusted EBITDA loss of between $58 million and $55 million. Stock-based compensation expense of approximately $15 million, capital expenditures of approximately $3 million. And our weighted average share count, we estimate to be approximately 70 million shares. And for the full year of 2023, we expect in force premium at December 31 of between $700 million and $705 million, gross earned premium of between $645 million and $650 million, revenue between $392 million and $396 million, and an adjusted EBITDA loss of between $205 million and $200 million. We expect stock-based compensation expense for the full year of approximately $60 million and capital expenditures of approximately $12 million and a weighted average share count of 70 million shares. And with that, I would like to hand things back over to Shai.

Thanks, Tim. We'll now turn to the top-voted shareholders' questions submitted through the [ SAY ] platform. Darren asks, how can we expect investors to support the current team if insiders aren't buying shares at today's low levels? Darren, thanks for the question. As you can imagine, we concretely get into our team's personal financial considerations. Each of our colleagues have their own situation, Their decisions to buy and sell shares are guided by personal factors that I'm unaware of. And I'm not involved in. But I can speak for myself, and I know Daniel is in a similar position. Lemonade has been and remains by far our largest holding, and we don't plan for that to change anytime soon. We are both heavily financially invested in Lemonade and wholeheartedly believe in the long-term vision we shared with our shareholders. For that reason, we're both completely aligned with our investors financially. By the way, throughout the life of the company, both Daniel and I chose to have our compensation updates paid in shares with a high strike price. We believe that this aligns us with our investors even further and ties our financial success with the success of those who decided to invest in the company. In any event, though, I believe that personal financial decisions of other people shouldn't be the main factor for anyone when deciding to invest in a company. People have different considerations, including availability of cash, portfolio balancing as well as family and other commitments. I wouldn't recommend investors buy or sell shares by mistakenly treating insiders liquidity decisions as signals. Instead, I hope you and others will focus on whether you believe Lemonade can deliver on the vision we've outlined and how that would benefit today's shareholders. Well, the second question, Brian A., asked about Lemonade Car progress and plans for the next 6 months. Well, Brian, we are extremely pleased with the progress made in our car product and especially since acquiring Metromile. We've taken tremendous strides forward in 2 key areas. Firstly, in data infrastructure. It was an enormous undertaking, but we are now fully leveraging Metromile's decades worth of data in our machine learning models. Our risk and pricing models rely on this data, which includes claim frequency and severity and customer retention. Secondly, in cost realization. Over the past year, we have achieved tens of millions in annualized cost savings by consolidating Lemonade's and Metromile's management, operations and vendor expenses. We continue to optimize our operations. And once we are able to transition all of Metromile's customers to Lemonade systems, we will unlock even more savings. In the next question, George asked if path to profitability is management's top priority and if so, to elaborate on the strategy. Certainly, George. Profitability is our top priority, and our updated guidance reflects our commitment to further improving the bottom line. We're focused on 2 key areas: loss ratio and expense ratio. The fact that we're investing in this isn't new, but we're definitely starting to see the results of the hard work by our team. For loss ratio, we've increased our rate filing significantly compared to prior years. And I'll touch upon that in the next question as well. Our improved LTV models enhance our underwriting and pricing, and our claims technology is becoming more and more efficient. In fact, if you can see in the graph we included in the shareholders' letter, this is delivering a steady and significant quarter-over-quarter improvement in loss ratio. Regarding expense ratio, we're constantly focused on optimizing our operations. For example, removing redundancies of vendors and systems between Metromile and Lemonade. As we continue to automate and add more self-service capabilities using our chatbots and AI, we're starting to see investments in our internal systems pay off with reduced reliance on headcount per policy sold. This approach brings us closer to structural completeness. It allows us to dramatically reduce our need for hiring this year. The fact that contributed in part to the updated adjusted EBITDA guidance we are giving today. In the next question, Paper Bag asked about our usage of AI, which I hope I addressed in my previous comments and in the letter. So I'm jumping to your next question, Paper Bag, which is about the progress we're making with our regulatory rate changes. Thanks for this question, Paper Bag. Regulatory approvals are a significant factor in ensuring where pricing customers precisely and play a major role in our downward trending loss ratio. But as discussed extensively in previous quarters, the process of getting rate changes approved can take time, but we're seeing some strong signs that our increasing pace of rate filings is paying off. In Q1 this year, we filed 30% more rate changes than in the same quarter last year, while 55% more filings were approved in comparison to Q1 '22. In fact, more than 50% of our earned premium in our book today for our home and pet customers is using the need rates. Take for example, our pet product. Last year, new rates were approved and implemented in 30 states across the country, impacting more than 50% of active pet policies. This year, pet loss ratio saw a 9.5 points of improvement, all in the season typically known for its higher frequency of pet claims. This major reduction in loss ratio can be attributed to price accuracy rate changes that were earned in. Overall, our rate changes, coupled with our improving technology to price risk correctly, put us on track to continue to reduce our loss ratio across the book. In any event, though, do bear in mind that even once rates are approved and implemented, their impact still has a time line. New rates flow in one policy at a time on renewal. This means that it can take up to a year for the full impact to register on our loss ratio. Turning to Amandeep, who asked about SoftBank seemingly exiting their Lemonade position. Actually, SoftBank has not exited its position as far as we are aware. What you're probably referring to is our recent SEC filing triggered by a change in regulatory compliance structure put in place a few years ago. For some more context, several years ago, we put into effect the regulatory compliance structure called the JIC, which was required by our New York regulator in order to deal with SoftBank's 20% ownership of Lemonade. Now that SoftBank ownership has decreased below 20%, by the way not due to share sales, but actually due to dilution, the structure is no longer needed and was dissolved as of March 31. The SEC filing was solely to reflect that this entity was dissolved. And with that, let me hand over the call to the operator so we can take some questions from our friends on the Street.

[Operator Instructions] Your first question comes from the line of Yaron Kinar.

I guess my first question, just looking at the growth that you achieved this quarter and I think you even called out [Indiscernible]. It was better than you expected and then didn't quite meet the expectation of -- or the ability to slow down. I guess one, what actions are you taking now to better execute on the slowing growth? And does the stronger growth that you saw this quarter potentially risk the loss ratio improvement targets? Or in other words, are you confident that you're not getting selected against here with these wins when other insurers are also trying to hold growth?

Yaron, good to talk to you, Daniel here. Yes, we spoke about this slowdown. As a maneuver, we've not quite mastered yet somewhat tongue in cheek. Tim referenced earlier that we saw a significant improvement in our marketing efficiencies. So for every dollar that we spent, we got 12% more sales than we had planned. And therefore, all of our sales are kind of ahead of plan. But no, it doesn't impact the loss ratio plans that we have. What it does mean is that we are earning in dollars at a suboptimal loss ratio. So just it just means that these sales will not be as profitable as if they were made 6 months hence. But we do not anticipate that adversely affecting the progress or introducing adverse selection against us.

Got it. And then maybe a clarification on the guidance. Are any expected changes in the reinsurance program or in reinsurance costs factored into the updated guidance? And if not, maybe you could offer your expectations on the impact from those?

Yes. Great question. So this is an area where I would note that we've made a modest shift in how we put the guidance together by choice and by design. So the last couple of quarters, as we've noted, we have a reinsurance structure that's almost entirely renewing at July 1. This is something we've known about for some time and have been working actively on. Things are going well. But as we noted in the letter, we won't be sharing the details until we have them in stone, which will be over the coming couple of months. In terms of the guidance, the previous guidance assumes that our existing reinsurance structures would continue in place that we knew that it was likely that they might change. Our current guidance anticipates nearly all the outcomes that we think are reasonably likely. We don't know the exact terms, but we've factored in, call it, the 80% or 90% probability range of what the outcomes will likely be and factored that into our guidance. It won't be perfect, but it will be -- we're quite comfortable that it represents where we expect to be when those deals are inked shortly.

Your next question comes from Jason Helfstein.

Two questions. The first, can you talk, I guess, at a high level, if you embraced more of a kind of a [Indiscernible] or a captive structure that some others in the insurtech industry are thinking about some private companies have been doing. How that potentially impacts kind of reported financial results and if that potentially goes to address, what are kind of underlying strain, but then ends up being offset by kind of CAT and other noise? And then the second question I mean, right now, you basically have a buyer strike, right? The stock is trading kind of give or take a cash kind of in the market, I'm putting any kind of multiple even on the gross profit and because you have insurance investors who want profitability and you want -- have tech investors who basically either don't want decelerating growth or don't want to take the time to understand the complexity of insurance and accounting. So maybe even if you want to merge those 2 questions together, how do you think you kind of address that broadly?

So I'll take the first one. We don't -- again, we don't want to get too far ahead of ourselves and talk about terms that are not in place yet. That said, a captive structure is something we've thought about and designed as a potential option going forward. You shared some details on how we are thinking about that at our Investor Day. And I anticipate that will be part of the mix. I would expect that we'll retain more risk perhaps than we have previously. I expect we'll leverage a captive where and how that makes sense. And I think no, we don't have final terms. I wouldn't be surprised that there is some aspect of [Indiscernible] that continues. So I believe it will be a combination of those things, and we'll figure out the proportions that makes sense, and we have factored the likely outcomes into our guidance. So we're down that path, and we're looking forward to update when we have the hard facts. In terms of a buyer strike, I'll let you characterize the market as the expert. But I think what I would point folks to who are holders of our shares, we're considering holding our shares, who might be on strike or not, depending on how you think about it, to the key metrics. And I think this is the second quarter in a row where on the 3 primary pillars of progress we delivered significant improvement in loss ratio, strip away to CAT and it's more significant still. Second quarter in a row of significant improvement on the operating expense ratios. The 3 or 4 quarters before, we saw a -- I'm sorry, 3 quarters before versus the most recent 2 quarters, something like a 20-point improvement in the ratio of expenses to gross earned premium. And then the guidance, I think, kind of cements the fact that we believe that this is not a decent anomaly, but these are and trends, but we have some real confidence will continue. So loss ratio, marketing efficiency, operating expense efficiency, those are the 3 primary metrics, I tell you, we are on track. We're not satisfied. We're 1 quarter into the year. And I think the notable adjustment in guidance tells you that not only is the business performing but we're taking this very seriously. And I hope that we have communicated that we're very well aligned with folks who are either holders or potential holders of our stock.