Duolingo, Inc.

Good day and thank you for standing by. Welcome to the Duolingo second quarter 2021 earnings call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone keypad. If you require any further assistance, please press star 0. As a reminder, this conference call is being recorded. I would now like to turn the call over to Debbie Delavan, head of investment Investor Relations, please go ahead.

Welcome, everyone, to Duolingo's first earnings webcast, highlighting our results for the second quarter of 2021. It's great to have you join us today after our successful IPO last month. With me on the call today are Luis Van On, co-founder and chief executive officer, Matt Scarupa, chief financial officer, and Bob Meese, chief business officer. After prepared remarks, we will open up the call to Q&A. I'd like to remind all participants that during this call we will make forward-looking statements regarding future events and financial performance of the company, which are subject to material risks and uncertainties that could cause actual results to differ materially. We caution you to consider the important risk factors contained in our SEC filings. These forward-looking statements are based on assumptions that we believe to be reasonable as of today. We undertake no obligation to update these statements as a result of new information or future events. Additionally, we will present both GAAP and non-GAAP financial measures on today's call. These non-GAAP measures are not intended to be considered in isolation from, a substitute for, or superior to our GAAP results, and we encourage you to consider all measures when analyzing our performance. And with that, I'd now like to turn the call over to Luis.

Thank you, Debbie, and welcome, everyone. Thanks for joining us today. Since this is our first earnings call and many of you are new to our story, I would like to walk through who we are, where we've been, and where we're going from a strategic perspective. Then Matt will cover our results for the quarter, and then we will open up for Q&A. When we started Duolingo, I was in a very fortunate position in my life. I was a professor in computer science at Carnegie Mellon University, and I had just sold two companies to Google. I wanted to work on something that was related to my true passion, which has always been education. But my views on education are very influenced by where I'm from. I grew up in Guatemala, which is not a wealthy country. And a lot of people talk about education as something that can bring equality to different social classes, but I always saw it as the opposite, as something that can bring inequality. Because people who already have a lot of resources can afford to get the best education, whereas people without much money often don't even get basic schooling, especially in poor countries like mine. So, along with my PhD students, Sever and Hacker, we wanted to do something that would give equal access to education to everybody. And so, even before we knew we wanted to teach languages, we actually started with a mission to develop the best education in the world and make it universally available. Now, this mission is very general. So we decided to start by teaching one thing, and we thought about various subjects we could start with, like coding or math, but decided on teaching languages for a number of reasons, the biggest one of which is that it's a huge market. There are close to 2 billion people in the world learning a foreign language. And a big reason for all this demand is that in many countries, really in most of the world, learning English can truly transform your life because it can significantly increase your income potential. And if you look at spend in the language learning market, it's about $60 billion a year. And this is expected to almost double by 2025. One other thing to know about the language learning market is that it's still mostly offline. I think of it as people taking night classes in private institutes to learn English. But this market is shifting online, and by now, as a category leader of online language learning, we expect to capture a lot of that shift. So, in 2012, we launched Duolingo, which was just a free way to learn languages. At first, we launched a website, Duolingo.com, but soon after that, we launched our iPhone app, and then we launched our Android app. And we were very fortunate that after we launched our apps, they quickly became the most downloaded apps in the education category worldwide on both iOS and Android. And by now, we've been downloaded over half a billion times. Now, I should mention, this growth has been overwhelmingly organic through word of mouth, not due to massive marketing campaigns. There are a number of reasons why we became so popular. One is that we were mobile first. So in 2012, most people knew that mobile apps were going to be big, but still, the biggest thing was the web. So every company was spending most of their effort and their money on their website. And apps were usually just a companion product. We decided from the beginning that we would put the majority of our effort on our mobile apps. So we launched a very high-quality app compared to what was out there at the time. And because of this, for example, Apple chose us as the iPhone app of the year in 2013. Another really important reason is that Duolingo was free. At the time, most digital learning products were really expensive, and we were just free, which helped us grow really quickly. Also, right before launching Duolingo, we had this important realization, which is that the hardest thing about learning a language, or really learning anything by yourself, is staying motivated. So we decided to make Duolingo be as fun as possible. Our combination of a very high quality app that is also free and fun made it so that people started telling their friends about Duolingo, and this is what really drove our consistent growth. By now, we have about 40 million monthly active users, and this is still overwhelmingly due to organic word of mouth growth. As you can tell from our MAU graph over time, we have been growing our monthly active users steadily since we launched. Every year, we have had more active users than the previous. Now, if you see that spike around March or April of 2020, that's the impact of COVID. Basically, we had increased demand during that time while the world went into lockdown. As the lockdown ended, traffic went down a little bit, but it settled higher than before COVID. And from there, we kept growing in the same way we were before COVID. So we are now back to growing at our normal rate. Now, even so, the months of March and April of 2021 were just not as high as the same months in 2020 because the world was in lockdown then. At Duolingo, instead of focusing on marketing, we are obsessed with our product. We are a product and engineering company, and a majority of our employees are working on just making our products better. We use gamification mechanics like a streak that counts how many days in a row you've practiced on Duolingo. We find that it really motivates people. In fact, over 50% of our daily active users have a streak longer than seven days, and around one million learners have an active streak longer than 365, meaning they have used Duolingo daily for at least a year or possibly longer. Again, the insight here is that the hardest thing about learning a language is staying motivated. We really believe that, and this is why we make Duolingo be as fun as possible. We also believe that education is shifting online, and not just online, but to mobile phones. Our approach is to make something that is native to the mobile platform. We know that on mobile, you have to compete for users' attention against social apps and games, so we work really hard to make Duolingo be something people want to do. We want Duolingo to be the learning app for the mobile generation. Looking at Duolingo can be misleading because the app looks so cute and gamified that many people don't realize the amount of sophistication that there is in the background and how much personalization there is in the learning experience. We know every exercise you've done on Duolingo, whether you got it right or wrong, and if you got it wrong, why you got it wrong. And we use that to make a model for each user. So when you start a lesson on Duolingo, we use artificial intelligence to pick exercises that are just right for you. Our learners complete over half a billion exercises per day, and we use all that data to improve how well we teach. And this leads to very effective learning outcomes. In 2020, we did a study to evaluate Duolingo's effectiveness versus traditional university language courses. We ran this study for French and Spanish, and we found that Duolingo learners who complete unit five, or about halfway through this French or Spanish course, are as proficient in reading and writing as a person who has taken four semesters of university classes. And one of the amazing things is that it takes half the time to do that on Duolingo than it does to take the university classes. So on Duolingo, you can do it in half the time, just with an app, and entirely for free. This is something we're very proud of. Now in terms of how we make money, Because of our mission, we decided not to monetize in the usual way that education apps monetize, which is by charging for learning content. We decided to keep all of our courses available for free and to use a freemium model similar to that of Spotify or the dating apps, offering a subscription that gets rid of ads and has some additional features. We make nearly 75% of our revenue from subscriptions. Another thing to understand about the Duolingo story is that we only really started monetizing very recently. And we've grown our revenue very quickly. 2017 was the first year we focused on monetization, and our bookings were around $14 million. And that has more than doubled every year since then. Our bookings in 2020 were $190 million. If you look at how we've been able to grow bookings so fast, there are really two things. One is that our active users are growing, and the other is that we're increasing the fraction of monthly active users who are paying to subscribe. In 2016, That fraction was 0% because we didn't have a subscription yet. Then it has constantly grown. By 2020, it was 4%. And we believe there's still a lot of room to grow that number. We can grow it with optimizations that reduce friction to subscribe and also by adding new features to the subscription that make more people subscribe. Our freemium business model is important to our success because it enables a really significant user scale. The model is driven by two mutually reinforcing flywheels. On the learning flywheel side, the greater the scale of our learner base, the more we can use insights from data analytics to improve both engagement and efficacy. And the more engaging our products are and the more effectively they teach, the more our learners tell their friends about Duolingo and the more we continue to grow our learner base. On the investment flywheel side, our learner scale and word of mouth growth allow us to focus our investments on product innovation and data analytics instead of brand or performance marketing. The more learners use Duolingo and convert into paid subscribers, the more we are able to invest in creating an even more delightful, engaging, and effective learning experience. And this further increases our popularity and user scale. Before I wrap up, I would like to summarize our strategy. First, we will continue to focus on growing our user base around the world with our free, fun app and iconic brand. We will do this by not only continuing to improve the efficacy of our product, but also by teaching higher levels of proficiency. and this will lead to higher monetization as more and more users subscribe to our Plus offering. Our goal is to become the industry standard when describing someone's level of language proficiency. So instead of saying, I'm an intermediate-level Spanish speaker, one will say, I'm a Duolingo 65 in Spanish. That's what we want to do. And finally, we aspire to expand beyond language learning. For example, our recently launched Duolingo ABC, our children's literacy app. Before I turn it over to Matt, I wanted to reiterate what I noted in the shareholder letter, which is included in the S1 prospectus. I plan to dedicate my life to building a future in which, through technology, every person on this planet has access to the best quality of education. And not only that, but a future in which people actually want to spend their time learning. Duolingo is the platform for building that future, and we're just getting started. With that, I'll turn it over to Matt to discuss the Q2 results and guidance.

Thank you, Luis. And thank you all for joining us on our first earnings call. We are pleased to report a strong second quarter. Before I jump into the numbers, I want to quickly talk about our growth framework. We focus on two areas of growth. First, we have our core language learning product, which includes subscriptions, ads, and in-app purchases. And second, we have our new initiatives, which include the Duolingo English Test, also known as the DET, and other new products that we may seek to monetize in the future. For our language learning product, we plan to continue to grow by expanding the number of active learners on our platform, by driving higher conversion of our free users to paid subscribers, and by increasing the lifetime value of our subscribers. We plan to continue to invest in R&D to improve our language learning app to drive these growth vectors. For our new initiatives, we plan to continue growing by expanding adoption of the DET among institutions and consumers, and by offering more value-added features to the Duolingo English test taker. We will also grow by creating new products on our platform, which we have already started to do through Duolingo ABC, our early literacy app. With that, let's take a look at our Q2 operating and financial metrics and their comparative performance against the same quarter last year. Subscription bookings increased 34% year over year to reach $48.9 million in the second quarter. Total bookings increased to 30% year-over-year to reach $64.5 million, and revenue increased 47% year-over-year to reach $58.8 million. As to our users and subscriber metrics, MAU decreased year-over-year to $37.9 million, and DAU increased slightly to $9.1 million. Paid subscribers increased 46% as compared to Q2 2020. Our non-GAAP financial metrics include adjusted EBITDA and free cash flow. Adjusted EBITDA increased year over year to $3.7 million, and free cash flow declined from $7.9 million in Q2 of last year to $2.1 million in Q2 of this year. This was driven by working capital changes as the increases in bookings this year was less than Q2 of last year, given the extraordinary nature of Q2 2020. And to expand upon Q2 2020, our comparable quarter from a year ago, I want to discuss the impact of COVID-19. In Q2 2020, we experienced an unseasonal uplift driven by COVID-19. In the typical year, we expect Q2 to be in line with Q1 in terms of bookings and other measures. They can be flat, slightly down, or slightly up, but not materially different quarter over quarter. This historical seasonality makes Q2 2020 stand out as difficult to compare to Q2 2021. While we don't know exactly how much of Q2 2020 performance was COVID related, If you were to normalize Q2 2020 to be more in line with Q1 2020, you would see a higher year-over-year growth rate in Q2 2021 bookings, revenue, and other metrics. With that context, let's drive further into our operating metrics, starting with a review of our active learners. In Q2 2021, we had 37.9 MAUs, a 3% decline from last year, and we had 9.1 million DAUs, a 2% increase from last year. our DAU to MAU ratio increased from 23% to 24%. During Q2 2020, we saw an all-time high in MAU, and so a slight decline this year as the world reopened was expected. We believe we will continue to grow nicely year over year as we get past this comparable period, and that we'll be doing so from a higher baseline level of users as Luis walked you through on a previous page. As of June 30th of this year, we had 1.9 million subscribers, or 46% more than the same period last year. Our subscriber penetration increased from 4% to 5%. These increases were driven by continued investment in product improvements, such as new premium features, product optimizations that drive subscriber conversion, and retention improvements. In Q2 2021, we generated $64.5 million of bookings, a 30% increase year-over-year, driven by strong growth in subscription bookings which grew at 34% year over year. As we have discussed, a core growth driver for us is shifting our subscriber mix towards subscribers on our annual plan. We do this because they have approximately 2x the lifetime value of our monthly subscribers. For Q2, we ended the quarter with more than 75% of subscribers on the annual plan, up from about 64% last year, and we were pleased with this trend. We generated $58.8 million in revenue, a 47% increase year over year. Ad revenue grew 33% year-over-year and made up 15% of total revenue. Ad revenue growth was driven by strong average revenue per daily active user, or ARPDO. Our gross margin was 72.6%, which is an increase as compared with the 70.5% gross margin we had last year. This increase is driven primarily by a higher subscription gross margin due to our mixed shift towards annual subscription plans and from increased advertising margins driven by the improvement and ARPDAU that I just mentioned. Our non-GAAP operating expenses in Q2 2021 were $39.3 million, or 67% of revenue, an increase of over 65% of revenue in Q2 2020, driven primarily by our continued investment in R&D. As a reminder, non-GAAP operating expenses represent GAAP expenses adjusted for depreciation, amortization, stock-based compensation, and one-time expenses. we provided a reconciliation between non-GAAP and GAAP metrics in the appendix. Our adjusted EBITDA in Q2 2021 was $3.7 million, an increase from the $2.3 million last year. This was driven by our revenue growth and our increased gross profit, offset by an increase in operating expenses, including our continued investment in R&D. Our free cash flow in Q2 2021 was $2.1 million, a decline from the $7.9 million in the comparable period last year. This resulted primarily from the working capital changes I mentioned previously. I'll now turn to our forward-looking guidance. For Q3 2021, we are guiding to $63 to $66 million of bookings, or 35 to 41% year-over-year growth, $58.5 to $61.5 million of revenue, or 29 to 36% year-over-year growth, and an adjusted EBITDA loss of negative 12 to negative $8 million. For full year 2021, we are guiding to 267 to 273 million of bookings, or 40 to 44% year-over-year growth, 236 to 242 million of revenue, or 46 to 50% year-over-year growth, and an adjusted EBITDA loss of negative 14 to negative $8 million. With that, thank you again for joining us today. And at this point, we would like to open it up for questions.

As a reminder, if you have a question at this time, please press the star, then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, press pound key. Please limit your question to one question and one follow-up. Your first question comes from the line of Justin Patterson with KeyBank. Your line is now open.

Great. Thank you very much. Could you perhaps elaborate on regional pricing tests? And then, Luis, next week we have Duocon. Any teasers ahead of the event? Thank you.

Thanks for the question. So we have, okay, so we've been, as we said in the roadshow, we've been testing in different regions. So far, we have succeeded in changing the price in a few countries, in Brazil and in Japan and in Germany, and then the prices remain the same in the U.K. as well, and the prices remain the same in every other country. We're going to continue doing that over the next few quarters. You're going to see us do that. And in terms of Duocon, you know, you should watch and see. I mean, we're going to be announcing a lot of really cool stuff. You know, certainly going to be talking about family plan. We're certainly going to be talking about the new ways of teaching non-Roman scripts. So, you know, Asian languages, for example, we're going to be talking about that. And a lot more. You should watch it. It's going to be cool. Great. Thank you.

As a reminder, if you have a question at this time, please press a star, then the number one key on your touchtone telethon. Your next question comes from the line of Jianli with Evercore ISI. Your line is now open.

Hey, thank you guys. So I just wanted to, a couple questions. One is just, you know, the DAU to MAU ratio continues to kind of go up pretty nicely. Can you talk about what are the kind of the initiatives or the product development that drives this consistent growth?

Sure. I mean, in terms of our product development, we majorly work on three things. We work on improving engagement, so getting people to use the app more and more often. We work on teaching better, and we also work on monetizing better. That mainly means getting more people to subscribe. You know, the first two are the things that really lead to a higher DAU to MAU ratio. Basically, we've added more gamification to the app, and also it teaches better, so basically people use it more often.

Great. And also just a follow-up kind of just on the paid subs, net ads. Obviously, you know, the year-over-year comp is tougher. But just by moving forward, would you say that, would you expect kind of the net ads cadence to be on a higher level, you know, like closer to the 2020 level? Or do you expect that to kind of go back to kind of the 2019 level growth?

Yeah, thanks, Jan. That's a great question. So if you look at the 2020 number, we essentially added around 700,000 net subscribers. And from our projections and what we see in the business, you know, as Luis has mentioned, our MAU growth is, we believe, likely going back to the pre-COVID period. rate of growth, and we continue to take all the efforts that Luis has talked about in terms of driving increased conversion and then maintaining retention. And so we think that the cadence of the pre-COVID growth rates will apply going forward.

Thanks, guys. I'll go back to the queue.

Thanks. Once again, if you would like to ask a question, please press the star, then the number one key on your touchtone telephone. Once again, if you would like to ask a question, please press the star one on your telephone keypad. And we have no further questions at this time. I will now turn the call over back to Luis for closing remarks.

Yeah, thank you. And I just really like to thank you all for attending and for all the great questions. And we look forward to talking with you regularly in the future. I also want to take this time to thank all our wonderful employees for the great work they do every day. It's really all because of them that we're showing these really strong results. So thank you. And thank you for attending.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.