Lemonade, Inc. Q3 FY2022 Earnings Call

Hello everyone, and welcome to the Lemonade Q3 2022 Earnings Call. My name is Maxine, and I will be leading the call today. I will now pass it over to Yael Wissner-Levy, VP of Communications at Lemonade, to start. Please proceed when you're ready.

Good morning, and welcome to Lemonade's third quarter 2022 earnings call. My name is Yael Wissner-Levy, and I'm 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, Chief Financial Officer. A letter to shareholders covering the company's third quarter 2022 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 Litigation 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 1, 2022, 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, who will begin with a few opening remarks. Daniel?

Good morning, and thanks for joining us to review our Q3 results and the outlook for the remainder of 2022. I'm happy to share that we had a strong quarter with our top and bottom lines coming in better than expected. Year-on-year, our IFP, or In Force premium grew 76%, and our premium per customer grew 35%. At $65 million adjusted EBITDA loss, our bottom line also exceeded our expectations. Our loss ratio had been coming down in recent quarters, and Q3 saw a reversal in that welcome trend. The spike in loss ratio, however, was not unexpected. We had cautioned that the Metromile deal would have an adverse effect on loss ratios in the short term, and Hurricane Ian added several points to the loss ratio too. With that said, we do anticipate the overarching downward trend to continue in the coming quarters, notwithstanding the occasional bumps. Q3 is moving season and usually our most efficient time to acquire customers. COVID played a little havoc with seasonal patterns in recent years, but this year, the familiar seasonality was back and on full display. Accordingly, we pulled in some of our marketing spend from Q4 to Q3. This helped boost our Q3 top line, but will come at the expense of growth in Q4. All told, we expect our second half of the year to be as guided although the allocation between the quarters has been adjusted to optimize our spend. Much else has happened since our last call, but two highlights are the deal we announced with Chewy and our launch in the United Kingdom. Starting with Chewy, Chewy is the foremost destination for pet parents in the U.S., and in the spring, they will start selling Lemonade Pet to their 20 million customers. Chewy's revenue share compensation consists of a few components but will be paid out primarily in the form of Lemonade equity. We're thrilled Chewy chose Lemonade and we're thrilled they chose Lemonade stock. In addition to amounting to a huge vote of confidence in what we're building, this structure aligns our interest with Chewy's, incentivizing them to drive sales of Lemonade Pet and deliver long-term growth at an extraordinarily low cash burn for Lemonade. As for our situation in the U.K., at the risk of sounding too sentimental, this is a meaningful step for us. Insurance as we know it hails from the U.K., and on a personal note, so do I. So both professionally and personally, bringing Lemonade to the U.K. is a homecoming of sorts. Beyond the sentimentality of it all, the U.K. is the largest insurance market in Europe, and thus represents a material addition to our total available market. Finally, we are looking forward to next week's Investor Day, where my colleagues and I will delve deeper into our strategy, metrics, path to profitability, and how we're running the business. We'll be sharing more about our AI lines of business and our financial modeling than we've ever done before, and we very much look forward to seeing you there. If you haven't registered yet, please head over to our investor.lemonade.com site and sign up under the News section. And with that, let me hand over to Tim. Tim, over to you.

Great. Thanks, Daniel. I'll give a bit more color on our Q3 results as well as expectations for the fourth quarter and the full year, and then we'll take your questions. We had another strong quarter of growth driven by additions of new customers, a portion of them related to the acquisition, as well as continued increase in premium per customer. In Force premium grew 76% in Q3 compared to the prior year to $609 million. We believe that this key operating metric is useful to understand the full scope of our top line growth before the impact of reinsurance and regardless of the timing of customer acquisition during the quarter. Premium per customer increased 35% versus the prior year to $343. 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. Gross earned premium in Q3 increased 71% compared to the prior year to $136 million, roughly in line with the increase in In Force premium. Revenue in Q3 increased 107% from the prior year to $74 million. The growth in revenue is driven by the increase in gross earned premium as well as a reduction in the proportion of premium ceded to reinsurers to 55% in the quarter as compared to 70% in the prior year. Our gross loss ratio was 94% for Q3 compared to 77% in Q3 2021 and 86% in Q2 2022. Operating expenses, excluding loss and loss adjustment expense, increased 33% to $110 million in Q3 compared to the prior year, and this is primarily driven by increased personnel expense, stock-based compensation expense, and legal and professional fees, partially offset by lower sales and marketing expense. We also continue to add new team members in all areas of the company, albeit at a more modest pace we've seen for several quarters in support of customer and premium growth and geographic expansion. Global headcount grew 36% versus the prior year to 1,371, primarily due to the impact of the closing of the Metromile acquisition in July. Net loss was $91.4 million in Q3 or $1.37 per share, compared to the $66.4 million net loss we reported in the third quarter of 2021. While adjusted EBITDA loss was $65.7 million in Q3, compared to $51.3 million in the third quarter of 2021. Our total cash, cash equivalents, and investments ended the quarter at approximately $1.1 billion, reflecting an increase of $164 million due to the Metromile acquisition, partially offset by a use of cash for operations and capital expenditures of $131 million since year-end 2021. With these goals and metrics in mind, I'll outline our specific financial expectations for the fourth quarter and an updated full year 2022. For the fourth quarter of 2022, we expect In Force premium at December 31 of between $612 million and $615 million; gross earned premium between $147 million and $150 million; revenue between $77 million and $80 million; and adjusted EBITDA loss between $65 million and $62 million; stock-based compensation expense of approximately $16 million; capital expenditures of approximately $3 million, and a share count weighted for additional shares issued in connection with the Metromile acquisition, totaling approximately 70 million shares. And for the full year, we expect again, In Force premium, December 31, between $612 million and $615 million; gross earned premium between $486 million and $489 million; revenue between $245 million and $248 million; and adjusted EBITDA loss between $238 million and $235 million; stock-based compensation expense for the full year of approximately $60 million; capital expenditures of approximately $11 million, and a share count, again, weighted for additional shares issued in connection with the Metromile acquisition, totaling approximately 65 million shares. And finally, a reminder again that our first Investor Day is happening next Tuesday, November 15, starting at 9:00 a.m. Eastern Time in our New York offices and via webcast. Please RSVP, if you haven't already, using the link provided in our shareholder letter or join us via webcast during or after the event. And with that, I would like to turn the call back to Shai. Shai?

Thanks, Tim. We'll now turn to the top-loaded shareholder questions. The first one is coming from Darren, who's asking how much growth should we expect to see from the Chewy partnership? And will it include any alliance with PetSmart? We’re really excited about the Chewy partnership and we believe that the deal can easily deliver significant growth at extraordinarily low cash burn. Being able to offer Lemonade Pet to Chewy’s 20 million customers and those they'll add in the coming years can easily become one of our primary growth channels for Lemonade Pet. By the way, this partnership relies heavily on the Lemonade API, which we continue to strengthen as we grow our partnership-based distribution channels. I believe that using our technological advantage to integrate with partners quickly is strategic for Lemonade. To the second part of your question, PetSmart was once owned by Chewy, but the two brands separated, I believe, in 2020. And so the deal does not include any alliance with them.

Well, it's been just a few months since the Metromile deal closed, but the synergies between our teams, data, and tech are in full force. In fact, all of the Metromile employees who were offered a role at Lemonade have accepted. It's already become difficult to tell who's a former Metromile employee and who's not. Regarding Metromile's loss ratio, you're right. Some regulators take more time to approve rate changes than others. In California, where 65% of Metromile's business was, the regulators have taken an unusual position and resisted rate changes across the auto industry as a whole. Several major carriers have reported elevated loss ratios as a result, and many of them have effectively pulled out of that market until this impasse is resolved. Along with the rest of the industry, we look forward to bringing rates back in line with risk as soon as possible.

In response to Darren's question about whether prolonged inflation, a hardening reinsurance market, increased claim costs, limits on rate changes, and higher reserve requirements could jeopardize Lemonade, I believe the answer is no. I don't foresee these issues converging to create a perfect storm that would threaten Lemonade. You've highlighted various risks, so let me address them individually. Inflation leads to rising prices, impacting claim costs immediately, while the process of adjusting prices lags behind due to regulatory timelines. There will be a period where the premiums collected will not meet what is necessary to maintain a healthy loss ratio. We have made adjustments to some of our products to account for inflation. For others, we are establishing a filing rhythm that should align with inflation. However, it will take time for these adjustments to be fully implemented and for policies to reflect the new rates. Regarding reinsurance hardening and increased reserve requirements, reinsurance companies have faced challenges in recent years, but this does not mean they will alter our business model or cease providing support. We anticipate this primarily affecting reinsurance costs, which are expected to rise. Concurrently, we are diversifying our offerings and expanding into different regions, which we believe will allow our reinsurance to serve two main purposes: safeguarding against rare catastrophic events and optimizing our surplus requirements. Tim will elaborate on this at our Investor Day next week.

Darren, I think this point was misunderstood. When we say that a large part of our marketing campaigns are failures, it doesn't mean that they've brought in zero business or led to losses. Just like everything else we do, we approach advertising in a data-driven way. Unlike traditional marketing, where you'd have one campaign to bet your annual marketing budget on, we create thousands of different variations and test them with very small budgets. There are so many because we run ads for different products with different creatives, different audience segments, and different targeting. You can think about this as a sports tournament. We run many ads and put small budgets behind them to see which one works. We then take the winners, apply what we've learned to improve them, and then have them compete against each other. This process leaves you with the best performing ads while spending a fraction of the cost of a full campaign. You also learn a lot in the process, so the next set of ads will perform better straight out of the gate. Thanks for the question, George. Our primary focus for '23 is our path to profitability, which translates into three main pillars: loss ratio, cross-sells, and efficiency. As a reminder, we are in the midst of making hundreds of changes in all of our product lines to adjust for inflation and accuracy based on our customers' lifetime value predictions. We're starting to see encouraging signs of improvement, and our team will continue this focus throughout the year. On cross-sells, we're seeing continued improvement as our team focuses on bundling, upsell, and cross-sell initiatives through our newly created customer group. On efficiency, we'll be focusing on further improvement of our APIs and our ability to integrate with distribution partners as well as investing in our internal automation tools. We'll provide more insights on all three in our Investor Day next week, and I invite you to tune in. And with that, let me turn the call back to the operator for more questions from our friends.

Our first question today comes from Michael Phillips from Morgan Stanley. Please go ahead, Michael, your line is open.

You mentioned there in the final comments, reinsurance impacts of diversification of product, and I assume geography, too, to help offset the hardening market there. But anything else besides that? Like I guess, specifically, would you be willing to take a higher retention on your business to offset prices there?

Yes. Mike, the short answer is yes. Our view on reinsurance generally is optionality. Historically, we've taken advantage of good markets and good terms that fit with our overall goals, the size of the business, and the risk profile. Our bias is to lean towards reinsurance more for surplus efficiency and capital efficiency now that we are getting a good grip around our loss ratio and claims risk. We are much more comfortable now than three or four years ago in terms of balancing that risk. Yes, I think we'll be open to taking a little more risk, balancing the terms, and we’ll see how the market plays out; our next renewal comes up mid-year next year, but we would be open to that.

And then I don't know if you're willing to give kind of the mix of home versus renters today versus the prior period, but I'm curious to hear your thoughts on the impact of inflation between those two sets of books. How inflation affects a renter policy differently than a home policy.

Yes. It definitely affects both, but more concentrated in homeowners just because of the more likely significance of reconstruction and remodeling. In renters, you're usually talking more about possessions. But the reality is inflation is really across the board. So while more concentrated in home, we're doing our best to offset and mitigate inflation in all of our products. There really is no product untouched, but it's definitely a little more concentrated in home. Cars have gone from quite small to a significant part of the business for us. So it's a little more concentrated in those products.

And just a quick numbers question. On the loss ratio, you mentioned the Metromile impact. Could you give us the exact dollar amount of claims paid and how much of an impact on the loss ratio was there?

Yes, it was fairly minimal, something on the order of less than $3 million to date.

Ian, was that what you said? Is that correct? Just making sure.

I'm sorry?

You said it was minimal. Is that correct? Just making sure I understood.

Yes, that's right. Yes. And maybe just as a reminder on that, Florida, in aggregate, represents less than 1% of our business. So we're relatively unexposed there, and it's essentially a renters book. We had some impact, but relatively quite nominal compared to folks who have a large homeowners book in Florida, which we do not.

And the next question comes from Tracy Benguigui from Barclays. Please go ahead. Your line is open.

Just going to follow up on Mike's question about the loss ratio. If Ian was a huge contributor, can you just walk through the sequential decline, which was worse in that 3 point to 5 points that you shared previously?

Yes. We obviously didn’t guide to loss ratio, but we did have an impact from Metromile, which has been running at a somewhat higher than historical assertion, certainly higher than our car. We've made a healthy number of filings; only about a quarter of the book of business has aged into those filings, and so we're still seeing that benefit. It will take several quarters before the existing filings have an impact on that business. We will continue to work hard to keep up with inflation impact. Think of it as home, Metromile, and the other parts were more or less as expected.

Maybe on Metromile, I mean, auto is a tough market. What are you seeing specifically? Can you make any comments on bodily injury or physical damage claims?

We don't have much on that at hand prepared for this call today; maybe that's something that we'll look to provide a little more detail and a little more disclosure going forward. But to the extent we are looking at the specific parts, it tends to be cars. In general, cars are more expensive to repair. From our experience in our book of business, which we've had a little longer experience for Metromile, it tends to be more around the repair, replace as opposed to the injury. But that's probably something where we'll think about maybe providing a little more color in the coming quarters.

All right. So maybe this question you're more prepared to answer. How do you see your business mix shifting post-Chewy deal, between Pet insurance, homeowners, renters, and auto?

I wouldn't describe Chewy at this point because it's early; it hasn't really launched next year formally. What the benefit gives us is the ability to add significant Pet policies potentially but at a much lower cash cost. We'll have some optionality there. We see nice incremental growth through the Chewy partnership. We can choose to let that flow through and increase the natural growth rate of Pet or we could also offset and grow some of our other lines of business knowing that we'll achieve our Pet goals through the Chewy channel versus the direct channel. So we have that choice. Let’s see how that plays out. We have a healthy target in the first year, and it grows over time. We think it's a really nice structure that will give us significant Pet policies if we achieve those targets at a much lower cost. In terms of overall share, I wouldn't expect a dramatic shift in share, but Pet has continued to grow modestly, representing a pretty sizable share, 20% of the overall book, and I would assume it will continue to represent a healthy part of the total book.

The next question comes from Tommy McJoynt from KBW. Please go ahead, Tommy, your line is open.

The first one, could you talk a little bit about some of the math or at least some of the theory behind your reference to that optimal cash burn equating to 20% to 25% growth. And what sort of runway does that give you, given your existing capital resources?

Sure. A couple of data points that we've shared. Our cash balance is just under $1.1 billion in cash, investments, and equivalents. We've set aside something less than $300 million in terms of supporting surplus within the insurance carriers themselves. Looking out over the coming years, and this is something we're going to delve into in more detail at our Investor Day, we think of our growth rate as a primary lever of how much cash we burn. It’s a growth rate of our choice. If our growth is slowing, it's not because the market demand is changing, that's not the case. We're choosing to grow at a certain pace because our unit economics and acquiring new customers are healthy and predictable. We've dialed back the growth rate. You saw it in Q3, and you see it in the guidance for Q4. That 20%-plus growth rate gives us comfort that we've got not months or quarters but many years of runway before we have to be concerned about the ultimate availability of capital.

And then switching back to a question on the Chewy partnership. Just want to clarify, is Chewy's compensation solely driven by the top-line number of policies and referrals rather than the underwriting profitability of those policies? And then do you think that the concept of paying those partners with warrants or stock will become part of your regular playbook as you explore new partnerships?

So on the first question, yes, the structure is focused on customer acquisition. We're very comfortable with what customers do once they enter the Lemonade funnel. It's focused on giving us access to 20 million pet owners and leveraging Chewy's capabilities to bring them into the Lemonade family, but they will become true Lemonade customers in every sense of the word and go through our underwriting process, just like any other type of customer. In terms of the structure, come back to our history. This is the first time we've done this. The bar is high, and there are much simpler structures, but this is one where the scope of their customer reach, the strength of their brand name, and the synergies with pet as a core of our business made everything come together for us to structure it this way. There are firm guardrails around that equity so it must be earned. They must achieve targets to generate value from those warrants. It’s a good balance of risk and reward for both sides.

Our next question comes from Andrew Kligerman from Credit Suisse. Please go ahead. Your line is open.

Could you share with us some of the products and distribution channels that prompted you to spend a bit more on your marketing this quarter?

I think we've seen nice marketing efficiency, but we've actually been tempering the total marketing spend over time. Perhaps, the comment that we made in the letter about pulling in spend from Q4 to Q3 is behind your question, I’m guessing. We have continued to see nice efficiency, and seasonality has been persistent even through the last few years where COVID made things unpredictable. We’ve continued to see moving season, which is when people are relocating and kids are going back to school, continuing to drive better results. In terms of channels, I wouldn’t point out any major shift. Two years ago, you didn't see many checks going out to TikTok. That has changed, but it's not a surprise and I think the channel would be expected across other consumer customer acquisition efforts. We're focused on direct acquisition rather than brand marketing, and we do see continued improvements in our LTV to CAC models. When those improve, we feel more comfortable making adjustments. We did a bit more of that in Q3, and we guided to a pullback in Q4. If we see more efficiency, we obviously have the ability to adjust our approach.

Unfortunately, my line was breaking up when I heard you talking about the loss ratio and rate. So apologies if this was touched on. But in the auto insurance line, could you specify what your underlying loss ratio was, ex-cat, ex-prior year development in the auto line? What was your aggregate rate increase across the country, and what you filed and received in the quarter?

That is more detail than we've disclosed, though very interesting, of course. We're going to get into more detail about car loss ratios and how we see it breaking down by product at our Investor Day again. So I'll hold off on that, but for a reasonable feel for how loss ratios have generally evolved, I'd point to the public filings of Metromile, which had loss ratios above 100% for some time. We expect to bring those in line with our target rates over time, but for now, those rates have persisted at an elevated level.

Our next question comes from Jason Helfstein from Oppenheimer. Please go ahead, your line is open.

This is Steve on for Jason. Just two quick questions. One is, can you help us understand the impact on Metromile for third quarter gross profit? And then secondly, how do you think about scaling the auto insurance side of the business over the next 12 months and its impact on the P&L?

We don't break out Metromile. We're really reporting as one consolidated company at this point. I can give you some data points to guide you. Historically, looking at Metromile’s standalone premium levels, you would see numbers running at roughly 110%. If you isolate Metromile, it would still be above $100 million in IFP, combined with the historical loss ratios above 100. So you can infer the material impact on the gross margin line, but we don't break out Metromile specifically. The loss ratio in general is the primary driver of the gross profit change, and as that loss ratio comes closer to our target, I would expect that both the gross margin and the adjusted gross margin will align with what we saw when our loss ratio was in the 70s a couple of years ago. As for scaling cars, with Lemonade Car before the merger of Metromile, we have launched in three states, and Metromile brought us up to about 10 states in total. We expect additional launches throughout 2023. By the end of the year, we expect several new state launches, and we’ll provide clarity on that as we get closer to launching them.

The next question comes from Josh Shanker from Bank of America. Please go ahead, Josh, your line is open.

My first question relates to the guidance for premium in force in Q4. It's very little higher than it is in Q3. I guess you're not renewing the Metromile customers, and you're growing in other places. If that supposition is correct, can you talk about that plan?

That's a fair proxy. Metromile is no longer viewed as a stand-alone business; it's part of Lemonade. Our car product is made up of pay-per-mile, which historically was Metromile, as well as a fixed-price product. If you were to isolate those customers acquired through Metromile, there's a typical attrition rate, and we're not investing heavily at this point to grow that business. The guidance for Q4 reflects the natural attrition happening in that Metromile customer base, with a retention rate that has been solid, which is providing some benefit to the IFP growth. The remainder comes from our reduction of spend in Q4, part of which we pulled into Q3 to achieve an increased growth rate.

Thank you. We have no further questions. So this concludes our call today. Ladies and gentlemen, thank you all for joining. You may now disconnect your lines.