Earnings Call Transcript - LMND Q1 2024

Operator, Operator

Good morning, everyone, and welcome to the Lemonade First Quarter 2024 Financial Results. My name is Angela, and I'll be coordinating your call today. I will now hand you over to your host, Yael Wissner-Levy, VP, Communications at Lemonade. Please go ahead.

Yael Wissner-Levy, VP, Communications

Good morning, and welcome to Lemonade's First Quarter 2024 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, CEO and Co-Founder; Shai Wininger, President and Co-Founder; and Tim Bixby, our Chief Financial Officer. A letter to shareholders covering the company's first quarter 2024 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 2023 Form 10-K filed with the SEC on February 28, 2024, and our other filings with the SEC. Any forward-looking statements 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 performance indicators, including customers' in-force premium, premium per customer, annual dollar retention, gross earned premium, gross loss ratio, gross loss ratio excluding catastrophe losses, 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 will turn the call over to Daniel for some opening remarks. Daniel?

Daniel Schreiber, CEO

Good morning, and thank you for joining us to discuss Lemonade's Q1 results. I'm happy to report that 2024 got off to a strong start. Year-on-year, our top line grew 22%, our adjusted EBITDA loss improved fully by one-third, and our gross profit more than doubled. The quarterly loss ratio came in at 79%, down 8 points from this time last year, while our trailing 12-month loss ratio came in 6 points lower than the same time last year. These loss ratio improvements indicate that the growing sophistication and diligence in our rate modelings and filings are bearing fruit. In addition, they reflect that our claims accuracy is strong and getting stronger, which is helping with favorable prior year development. Indeed, our growing underwriting precision is delivering a lower frequency of claims. Overall, a strong quarter, very much keeping us on track, or perhaps better than on track. In fact, we're happy to update that we now project to be net cash flow positive by the end of this year. This acceleration in our cash flow profitability is made possible by a couple of factors, the most notable being how technology, in general, and AI, in particular, continue to deliver on the promise at the very core of Lemonade's thesis. This quarter, for example, saw a 22% top line growth, but only a 2% increase in operating expense and an 11% decrease in headcount, all year-on-year. These numbers tell a powerful story. With this in mind, let me hand over to Shai to tell you more about our recent efficiency improvements. Shai, over to you.

Shai Wininger, President and Co-Founder

Thanks, Daniel. This quarter, I wanted to highlight a metric we don't often talk about called loss adjustment expense or LAE. LAE represents the costs associated with handling claims and by extension, operational efficiency. LAE is an essential piece of the loss ratio, and for large insurers who enjoy the benefits of scale, it typically runs around 10%. I'm happy to report that after years of technology-driven improvements in our claims automation and operations, with nearly 50% improvement in the last 2 years alone, we ended Q1 at an impressive 7.6% LAE ratio. This achievement was made possible by the ongoing advancement of our blender insurance operating system, which incorporates AI, machine learning, and other cutting-edge technologies to help our team become more efficient. Blender uses AI to minimize human involvement at multiple points of the claims journey. It automatically validates and extracts important information from documents, itemizes invoices, detects pre-existing conditions, and much more. As we continue to break apart our claims process and automate it piece by piece, our loss adjustment expenses improve and our loss ratio continues to trend down. I believe that building our core technology in-house buys us an ever-growing advantage over the industry, both in efficiency and capabilities, and I expect to continue seeing this positive impact flowing into our financial results and plans. And with that, let me hand it over to Tim to cover our financial results and outlook in greater detail. Tim?

Timothy Bixby, CFO

Great. Thanks, Shai. I'll review highlights of our Q1 results and provide our expectations for Q2 and the full year, and then we'll take some questions. As Daniel and Shai noted, it was a great quarter with good progress on all of our key metrics, including growth, gross loss ratio, and our cash outlook. Premium per customer increased 8% versus the prior year to $379, driven primarily by rate increases. Annual dollar retention or ADR was 88%, up 1 percentage point since this time last year. We measure ADR on an annual cohort basis and include the impact of changes in policy value, additional policy purchases, and churn. Gross earned premium in Q1 increased 22% compared to the prior year to $188 million, in line with our in-force premium growth. Revenue in Q1 increased 25% from the prior year to $119 million. The growth in revenue was driven by the increase in gross earned premium, a slightly higher effective ceding commission rate under our quota share reinsurance, primarily related to reserve adjustments, and a near doubling of investment income. Our gross loss ratio was 79% for Q1 compared to 87% in Q1 2023 and 77% in Q4 2023. The impact of catastrophes or CATs in Q1 was roughly 16 percentage points within the gross loss ratio and was nearly all driven by convective storm and winter storm activity. Absent this total CAT impact, the underlying gross loss ratio was 63%, 9 points better than the prior quarter and nearly 10 percentage points better than the prior year. Our prior period development had a roughly 6% favorable impact in the quarter, and worth noting that the CAT prior period development impact was about 2% unfavorable, while non-CAT was about 8% favorable. Given the notable ups and downs of the quarterly gross loss ratio, it's all the more useful to continue to consider our rolling 4-quarter view of the loss ratio, which we include again in our shareholder letter to get a feel for the longer-term trends. Our trailing 12 months or TTM loss ratio was about 83%, and this is 6 points better year-on-year. From a product perspective, loss ratios improved across the business compared to the prior year with the exception of home, which did not. Gross profit and adjusted gross profit have shown notable improvement over time, driven by continued premium growth coupled with loss ratio and investment income improvements. Q1 gross profit increased by 110% to $35 million versus the prior year, while adjusted gross profit increased by 78% over the same period. Gross profit has grown significantly more than tripling in 2 years, while quarterly adjusted gross profit has more than doubled over that same period. Operating expenses, excluding loss and loss adjustment expense, increased just 2% to $98 million in Q1 compared to the prior year. Other insurance expenses grew 27% in Q1 versus the prior year, a bit more than the growth of earned premium, primarily in support of our increased investment in rate filing capacity. Total sales and marketing expense increased by $2 million or 8%, primarily due to our increased growth spend, which was partially offset by lower personnel-related costs driven by efficiency gains. Total growth spend in the quarter was $19.8 million, up about 14% compared to the prior year. We continue to utilize our Synthetic Agents growth funding program and have financed 80% of our growth spend since the start of the year. As a reminder, you will see 100% of our growth spend flow through the P&L as always, while the impact of the new growth mechanism is visible on the cash flow statement in the balance sheet, and the net financing to date through our Synthetic Agents program is about $28 million as of the end of Q1. Our technology development expense declined 4% to $21 million due primarily to personnel cost efficiencies. Our G&A expense declined 9% compared to the prior year to $30 million, primarily due to lower professional service fees and lower insurance costs. Personnel expense and headcount control continue to be a high priority. Total headcount is down about 11% compared to the prior year at 1,236, while again, our top line in-force premium grew about 22% over the same period. Our net loss was a loss of $47 million in Q1, or a loss of $0.67 per share. This was about 28% better compared to the $66 million loss or $0.95 per share loss we reported in the first quarter of 2023. Our adjusted EBITDA loss was a loss of $34 million in Q1 compared to the $51 million adjusted EBITDA loss in the first quarter of 2023, or about 33% better. Our total cash, cash equivalents, and investments ended the quarter at approximately $927 million, down just 2% since year-end 2023. With these metrics in mind, I'll outline our specific financial expectations for the second quarter and for the full year '24. For the second quarter, we expect in-force premium at June 30 between $839 million and $841 million, gross earned premium between $197 million and $199 million, revenue of between $118 million and $120 million, and an adjusted EBITDA loss of between $49 million and $47 million. We expect stock-based compensation expense of approximately $15 million in the quarter, capital expenditures of approximately $3 million, and a weighted average share count of approximately 70 million shares. For the full year of 2024, we expect in-force premium at December 31 of between $940 million and $944 million, gross earned premium between $818 million and $822 million, revenue of between $511 million and $515 million, and an adjusted EBITDA loss of between $155 million and $151 million. For the full year, we expect stock-based compensation expense of approximately $62 million, capital expenditures of approximately $10 million, and a weighted average share count of approximately 71 million shares. With that, I'd like to hand things back over to Shai to answer a few questions from our retail investors.

Shai Wininger, President and Co-Founder

Thanks, Tim. We'll now turn to our shareholders' questions submitted through the Say platform. First, Henry asked for more insight on the rollout of auto nationwide. Hi Henry, it usually takes a few years to stabilize the performance of a new insurance product after launch. During that period, we test products at lower scale and continuously improve pricing, underwriting, and operational efficiency to get the product to be compatible with our lifetime value targets. Once that happens, we can increase our marketing efforts and grow faster. By the way, despite the fact that the loss ratio isn't yet where we want it to be, it did improve 18 points in 2023, which was the biggest and fastest loss ratio improvement across all of our business lines that year. So while there's still work to be done, a lot has already happened and I expect we will begin rolling out car insurance more broadly early next year. In the next question, Paper Bag wanted to know more about our strategy of balancing growth between the U.S. and Europe. Paper Bag, there are a few reasons why we are optimistic about the European opportunity beyond its sheer size. First, Europe offers attractive and scalable distribution opportunities on the B2B2C side, such as large institutional partnerships, as well as price comparison websites. Secondly, Europe is less catastrophe-prone compared to the U.S., offering diversification benefits or loss exposure, particularly for home insurance. Finally, in Europe, we have much more flexibility over pricing and risk selection relative to the U.S. due to differences in the regulatory environment over there. This, for example, allows us to experiment with pricing models by making multiple changes on a daily basis. In terms of balancing growth across products and geographies, our strategy is simple. We allocate our incremental dollar to the product market and campaign that shows the best lifetime value to customer acquisition cost return. In a sense, our products and geographies compete against each other, so budget allocation frequently and dynamically changes based on seasonality, pricing changes, competitors, new capabilities, and so on. In the next question, Sumit asks whether we are profitable and what our growth target for the next 3 to 5 years is. Sumit, as you probably heard on this call and read in our letter, we are excited by the accelerated timing of us getting to net cash flow positive by the end of this year, 2024, such that by Q1 '25 we expect to be generating positive cash flow on a consistent basis. We expect to reach profitability as measured by adjusted EBITDA the following year. Once we're generating positive cash flow, we will be able to reinvest this additional cash in faster growth. As for your question about our growth targets, we previously indicated our expectation for a multi-year average in-force premium compounded annual growth rate in the mid-20s. While we're not revising this today, we may accelerate our growth rates as new incremental growth opportunities come along. Lastly, Paper Bag asked about the automation index, a metric we used back in 2018 and for some current efficiency metrics. Thanks for the question, Paper Bag. This is something that is near and dear to the Lemonade ethos and to me personally. As I mentioned a few minutes ago, our LAE is outstanding and an excellent benchmark for our efficiency. The percentage of emails handled by generative AI also continues to grow as our generative AI platform now handles 22% of all incoming emails and was recently trained to handle SMS messages as well. One signal that I believe shows our efficiency improvements as a whole is our total operating expenses, which remained virtually flat for 2 consecutive years, while our business has roughly doubled. By the way, the old automation index metric from 2018 has been retired long ago because it couldn't keep up with the growing complexity of our business and failed to properly reflect things like multiple policies per customer, differences in service efforts among products, geographies, and so on. Regardless of this particular metric, our automation levels have increased dramatically since 2018, and I expect to see this continue. Now, I'll turn the call back to the operator for more questions from our friends from the financial community.

Operator, Operator

The first question comes from Yaron Kinar with Jefferies.

Yaron Kinar, Analyst

Tim, you had offered the catastrophe and prior development impacts on a gross basis. Could you offer those on a net basis as well?

Timothy Bixby, CFO

Sure. The distinction between gross and net this quarter was as small as it's ever been, primarily as a result of reserve releases. So the total difference between gross and net was 1% or less than 1%. So the answer is the same for the difference that you're requesting, very minimal.

Yaron Kinar, Analyst

Got it. Okay. And I know you'd mentioned the acceleration of the timeline to free cash flow positive. Can you talk through some of the drivers for the change or the acceleration?

Timothy Bixby, CFO

Yes, we noted that, and net cash flow, this is really the simplest measure of cash investments and equivalents on the balance sheet. Is it going up? Or is it going down? You've seen a couple of periods already where it's actually gone up. In the second half of this past year, in fact, our net cash investments actually increased, and that was a notable change. Now we're in this period where we're heading towards sustainable continued generation of cash instead of use of cash. We're not quite there. This coming quarter, I actually expect it to be flatter or better, and by the end of this year, that should be consistently net positive. The drivers are really just better granularity and understanding of the levers. Our reinsurance agreements tend to move that cash flow out of sync sometimes with the ebbs and flows of the business itself, the growth in customers, and the growth in premium. The greater understanding of the current reinsurance agreement going forward, we're in negotiations for upcoming reinsurance. We expect that to be fundamentally strong and similar. The underlying unit economics of customers each quarter as we go, we're getting a bit more comfortable with that. Some of the tech efficiencies noted, those are sustainable, and we've seen some of those for a number of quarters, but until you get 2 or 3 or 4 quarters under your belt to confirm that there are sustainable improvements. Those are the kinds of things that give us greater confidence now to pinpoint that cash flow positive period.

Yaron Kinar, Analyst

That makes sense. And if I could sneak one more in before I requeue. The growth spend seemed to be a little light relative to the full-year target. I'm assuming that's just a matter of ramping up that spend as you expect to accelerate growth over the course of the year? Or is it that you are expecting to revise that target down?

Timothy Bixby, CFO

Yes, you're exactly right. It's the former. The year-on-year comparison is a little out of sync with the year-on-year quarter comparison. Q1 a year ago was relatively high in terms of growth spend versus the full year '23. We've got the opposite effect this year. We're ramping up. If we looked at January, February, March, we would see a consistent ramp-up. So the full-year target is unchanged. As we head into Q2 and forward, you will see an acceleration versus the prior year.

Operator, Operator

The next question is from Tommy McJoynt with Stifel.

Thomas McJoynt-Griffith, Analyst

I know it's only a point or two when I look at the difference between the gross and the net loss ratio. But this was the first time that the net loss ratio was lower than the gross loss ratio. Can you talk through how that mechanically happened?

Daniel Schreiber, CEO

Yes. There are typically 2 main drivers of a difference between gross and net loss ratio. One is unallocated loss adjustment expense, which is a part of our expense structure that is not subject to the reinsurance agreements. As that number ebbs and flows, it can drive a greater or lesser difference between gross and net. The second main driver is we do have reinsurance coverages where we pay premiums but have very little claims. This quarter, specifically, that unallocated loss adjustment expense number was notably low because of reserve adjustments. When you get a swing in those two numbers, it can really bring the net and the gross close together. I don't expect it to be the new normal, but we can see quarters where it's relatively similar.

Thomas McJoynt-Griffith, Analyst

Got it. Makes sense. And then separately, do you have an update on your latest thoughts on what kind of a normalized CAT load for the year should be? And has that changed at all with your focus on really leaning into growth on the renters and pet side and maybe less so on the home and auto side, just kind of how that has impacted your expected CAT load?

Timothy Bixby, CFO

So at a high level, I would say, no fundamental change in isolation. The Q1 number was a little bit higher in percentage terms, 16% impact on the quarter. But important to note that in that 16%, there were no named storms. It was a broad distribution of technically CAT events, but not enormous CAT events. So lots of storms clearing the CAT definition threshold that has been unchanged for many years. So the combination of events in Q1 does not fundamentally change our assumptions. It tends to be isolated to our home product, which is again typical. But I would say business as usual, and the underlying trends continue to be the same. I would highlight that the trailing 12 months number is a good metric because it takes out a bit of the variance of seasonality and CAT impact across products.

Operator, Operator

The next question is from Jason Helfstein with Oppenheimer.

Jason Helfstein, Analyst

Two questions. One, on AI, the whole world has woken up to the benefits of using AI and LLMs. Can you elaborate on how you think the newer technology, the newer LLMs, will help you with onboarding, underwriting, adjudicating claims, and when we might see some of those benefits?

Daniel Schreiber, CEO

Jason, you're quite right, of course, AI is all the rage right now, but it's been in our tagline since the founding of the company, so this isn't something new. The foundational work that we've been doing in terms of risk assessment, risk selection, risk pricing, is about using the vast amounts of data that we're able to collect as part of our onboarding process. Being a purely digital provider of insurance gives us orders of magnitude more signals than traditional companies get. We can match those signals to claims afterwards. Previously, systems recorded claims poorly, making it hard to reconcile the data and leading to poor quality data. We're able to address these challenges because everything is built digitally. One point we tried to make is that a few years ago, when we spoke about these themes, it was a hypothesis that perhaps cohered, but was unproven. Now, you see it clearly in the numbers—22% top line growth and an 11% decrease in headcount. That's dramatic, and I think, pretty much impossible without that level of automation and LLMs doing what previously humans had to do. Over the last 2 years, the size of our book has doubled, our gross profit has tripled, and our operating expenses haven't changed. Those metrics reflect effective use of technology. In terms of auto, we'd like to see inflationary pressures abate, but we're still bullish despite those challenges. We want to see some of our rate filings approved but feel confident based on our systems' ability to manage and adapt to inflationary pressures.

Operator, Operator

The next question is from Katie Sakys with Autonomous Research.

Katie Sakys, Analyst

Can you give us more insight into this quarter's ex-CAT loss ratio improvement? What products drove that and how sustainable do you think some of those changes might be going forward?

Daniel Schreiber, CEO

Sure. The distinction between CAT and non-CAT can be a bit arbitrary. In this quarter, we had many storms, resulting in a higher CAT load and a lower underlying measure. Across all products, except home, we saw year-on-year improvement. I would focus on the big picture: consistent improvement in all products. We've finally seen rate approvals start to move at a more healthy pace in larger markets. We have moderated growth in products where the loss ratio was somewhat elevated, and now we have the ability to switch our strategy as we see improvements. Our long-term view remains strong.

Katie Sakys, Analyst

Are there any geographies where you're getting more than enough pricing and feel like you could lean into growth there?

Daniel Schreiber, CEO

Yes, we feel like we've passed a key point. There are many rate approvals still pending, but they are more widespread and somewhat smaller. Inflation continues at a moderated pace, but we're ready to handle it. Certain territories where our growth went to close to zero are now showing sizable rate approvals, and we're optimistic about moving forward.

Operator, Operator

The next question is from Andrew Kligerman with TD Securities.

Andrew Kligerman, Analyst

Can you share what drives the retention ratio of 88%? What differentiates Lemonade to keep customers from switching to competitors?

Daniel Schreiber, CEO

Yes, the annual dollar retention continues to strengthen. Several factors contribute to this. One is the customer satisfaction we enjoy, measured by NPS. The industry doesn't do well by that measure, but we tend to be in the 70s or 80s across all touchpoints, including claims experience. The interaction with our AIs and the instant nature of that relationship leads to high retention. Additionally, we can upsell customers who initially come to us for renters insurance. As they grow their needs, they tend to stay with us and purchase additional insurance products. We expect this aspect to grow significantly as our business evolves.

Andrew Kligerman, Analyst

Do you feel Lemonade has enough of a head start in AI compared to competitors so that they won't catch up?

Daniel Schreiber, CEO

Yes, we believe we have a structural advantage given our technology-focused foundation. Incumbents face challenges due to legacy systems. They may catch up, but they are encumbered by outdated infrastructure. We've designed our models with future technology in mind and have continually adapted it to leverage new advances efficiently.

Operator, Operator

The next question is from Matt Smith with Halter Ferguson Financial.

Matt Smith, Analyst

Can you provide insight into the marginal dollar potential for spend and if there is any impact on your GAAP metrics?

Timothy Bixby, CFO

No. Our growth spend and growth efficiency are all systems go. We're ramping up as planned since January. Over the last year, we've seen efficiency improvements, and our LTV to CAC ratio remains well above 3, which is very encouraging. We're financed efficiently through our Synthetic Agents program.

Matt Smith, Analyst

The premium per customer increase was higher than expected. Any trends driving that?

Timothy Bixby, CFO

The increase in premium per customer is primarily driven by rate increases. While previously we also saw product mix changes, the bulk is now from rate increases as we see continued improvement in retention and multi-line customers. We have significant room to grow in the future.

Operator, Operator

The next question is from Bob Huang with Morgan Stanley.

Jian Huang, Analyst

You beat the quarter by a significant margin, but your full-year guidance increase seems low. Are there any earnings pull-forwards affecting your rationale?

Timothy Bixby, CFO

Great question. There is a nuance here. We saw a positive impact in Q1 from reserve adjustments, which is not sustainable going forward. That had an outsized benefit to the Q1 revenue, which we do not assume will replicate. This accounts for most of the guidance discrepancy. We remain cautiously optimistic.

Operator, Operator

The next question is from Tommy McJoynt from Stifel.

Thomas McJoynt-Griffith, Analyst

What threshold do you use for defining what's in the catastrophe bucket?

Timothy Bixby, CFO

We use a standard measure of $25 million to define catastrophe events, and we’ve used this threshold for a long time.

Operator, Operator

Thank you. We have no further questions, so I will hand back over to the management team to conclude.

Timothy Bixby, CFO

Thanks so much. That wraps up our comments, and thanks for joining. We look forward to seeing you again next quarter.

Operator, Operator

Thank you. This concludes today's call. Thank you for joining. You may now disconnect your lines.