Duolingo, Inc. Q1 FY2022 Earnings Call

Good day and welcome to the Duolingo First Quarter 2022 Earnings Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Debbie Belevan, Head of Investor Relations. Please go ahead.

Thank you, operator. And welcome to Duolingo's first quarter 2022 earnings call. Today, after market close, we released a shareholder letter with our Q1 results and commentary, which you can find on our IR website at investors.duolingo.com. Today's call will be led by Luis von Ahn, our Co-Founder and CEO; Matthew Skaruppa, our CFO; and Bob Meese, our Chief Business Officer. We'll begin with some brief remarks before opening the call to Q&A. Just to remind everyone, during this call, we'll make forward-looking statements regarding future events and our financial performance, which are subject to material risks and uncertainties that could cause actual results to differ materially. Some of these risks have been set forth in the risk factors of our periodic reports filed with the SEC. These forward-looking statements are based on assumptions that we believe to be reasonable as of today, and 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'll turn the call over to Luis.

Thank you, Debbie. And welcome, everyone. As usual, I want to kick off the call by reminding you of our mission, which is to develop the best education in the world and make it universally available. We work to achieve this mission by continually innovating and improving our products so that they are fun and effective. Now on to our first quarter results. Since a shareholder letter contains an in-depth discussion of this quarter's performance, Matt and I will provide some brief remarks and then get right into Q&A. Q1 of 2022 was our best quarter yet. We achieved new highs on nearly every metric. In fact, we surpassed our own performance expectations, which led us to raise our full year guidance. We are now projecting full year bookings growth well above 30% and also expect to be profitable for the year on an adjusted EBITDA basis. The reason behind this stellar performance is clear: our product-focused strategy is working. Thousands of A/B tests that we run to make our products better are materializing in the form of stronger word-of-mouth user growth, stronger paying subscriber conversion rates and higher overall retention. Our user growth accelerated from the previous quarter. We converted a record number of new paid subscribers, and we retained more of our previous subscribers. All of this resulted in total bookings growth of 55% this quarter compared to Q1 of last year. And now Matt will discuss our updated outlook for 2022.

Thank you, Luis. As Luis just highlighted, we had a tremendous quarter, and because of that, we are announcing that we are raising our full year guidance. For Q2 2022, we are guiding to $86 million to $89 million in total bookings, $84 million to $87 million in revenue and an adjusted EBITDA of negative $4 million to negative $1 million. For the full year 2022, we are increasing our guidance to $388 million to $397 million in total bookings, $349 million to $358 million in revenue and an adjusted EBITDA of 0 to positive $3 million. Our full year bookings guidance reflects 32% to 35% year-over-year growth, up from the 26% to 30% year-over-year growth we guided to on our last earnings call. In terms of our Q2 guidance, I'd like to point out that this is seasonally our softest quarter in terms of absolute bookings because we don't have our New Year's promotion or other big marketing events as we do in Q1, Q3 and Q4. We plan to continue managing the business with strong cost and capital discipline. For the full year, we expect to be profitable on an adjusted EBITDA basis even while we continue to invest in R&D as we have done historically. We expect that non-GAAP R&D as a percentage of revenue should be roughly flat compared to last year. While we expect to continue to get leverage in non-GAAP sales and marketing through more efficient spending, we will see some deleveraging in non-GAAP G&A, primarily driven by our expanded office footprint and the fact that 2022 is our first full year as a public company. And now I'll turn it back to Luis.

Thank you, Matt. Before going to Q&A, I'd like to take this opportunity to thank our entire team for their dedication to delivering on our mission. I'd like to thank our learners who spread the word of our products to their friends and family, and I'd like to thank you, our shareholders, for your support. We look forward to sharing more with you in the coming quarters. And now we will be happy to take your questions.

Your first question comes from Eric Sheridan from Goldman Sachs. Please go ahead.

Thanks for taking the question. Maybe staying focused on the investment commentary in your opening remarks. Can you remind us some of the key priorities on the product side that you're investing against in 2022 and how we should be thinking about that product roadmap beyond just the next 12 months but over the next couple of years? Thanks so much.

Thank you for the question, Eric. So the most important thing to understand is that we're going to be investing the majority of our resources on our language learning app. We think language learning is a massive opportunity. I mean, it's about a $50 billion market, which is mostly shifting online and we are the largest player online. So we're going to be investing mostly in our language learning app. There, we run various metrics, and that's kind of the main focus for the next couple of years. Also, as we said in the shareholder letter, most of the changes that we make are relatively small changes, but we are working on a pretty large change that is going to be live in the next few months, which is a redesign of the home on the app. Hello?

I’m sorry.

Operator, can you hear?

Yes, I can hear. Your next question comes from Justin Patterson from KeyBanc. Please go ahead.

Great, thank you. Perhaps for Luis and Matt can tack on to this, how should we think about the potential impact to users and monetization from Super Duolingo and the new home screen versus past changes to the app like hearts? And then I have one follow-up.

Sorry, Justin, can you hear me okay?

Yeah, I can hear you, although you did cut out a little bit in your response to Eric.

Okay. Hopefully, I mean, I think we're having a little bit of phone trouble, but hopefully if I cut out, you can just ask again. But okay. So we're making some pretty significant changes. I mean, the biggest one was the home screen on the app. There's also Super Duolingo. In terms of Super Duolingo, we don't think that, by itself, is going to have a pretty major impact on metrics. The main reason we're doing the redesign of what our subscription product looks like is that we think it really fits in more with our gamify brand. In terms of the redesign of the home screen of the app, we do think that's going to lead to significant improvements in our metrics, mainly in terms of engagement and teaching effectiveness. So those are two things that we will be closely monitoring. I should say, also, for the redesign of the home screen, we've run thousands of A/B tests. We've undergone significant redesigns roughly every three or four years, so we have experience with this type of redesign. There are a couple of things to mention. The first one is, we will be looking at our metrics closely to ensure that everything improves when we launch it. By the time the redesign launches, we will have a lot of confidence that the metrics will have increased. But one thing I should mention is that people generally do not like change; users do not like change, and this is a pretty major change to the home screen of the app. So even though we know that once we launch it our metrics will be positive, we may see some negative sentiment here and there, but that's something that we're prepared for. Those are two major changes we talked about in the shareholder letter.

Okay, perfect. And then for my follow-up, I just wanted to touch on the social features. It sounds like you're having some success there, even helping users find love. I guess you could probably spin that as a Duolingo love language app down the road. But I'm curious to hear how those social features are benefiting the KPIs, whether it's daily engagement or just better conversion over time, resulting in less churn on the app. Thank you.

Yeah. The social features, the beautiful thing about social features is that they help every single metric truly. What they do is they encourage users to return more often because their friends who are on Duolingo engage with them on Duolingo, so they return more frequently. They also increase the time spent on the app, user retention, and ultimately, as people spend more time on the app, they learn more and subscribe more, resulting in higher revenue. So the social metrics really enhance everything, and this is why we're investing in them.

Great. Thank you.

Thank you. Your next question comes from Mario Lu from Barclays. Please go ahead.

Great. Thanks for taking the question. So the first one is on the strong bookings number this quarter. I believe you came in 9 points above your guidance at the midpoint. So just curious if you could provide more details on what led to the outperformance. You mentioned the New Year's campaign, but anything else to point to that led to this? Thanks.

Thank you for the question, Mario. Our strong performance is largely due to numerous A/B tests we have conducted over the past couple of years, which have compounded over time. The revenue outperformance stems from an increase in users, a higher conversion rate to paying subscribers, and better retention among those subscribers. Essentially, all of our key performance indicators have improved as a result of these compounding effects. While we had a successful New Year's campaign, our performance continued to exceed expectations in the following month as well.

Great. Thanks, Luis. And then just a follow-up on the full year guidance, that's fantastic. I guess how should we think about that raise in the context of the first quarter peak? And then any embedded impact from FX or impacts from Russia that you can call out?

Yeah, thanks. I'm happy to answer that. So obviously, the full year guidance takes into account the results of Q1. The outperformance that Luis mentioned is really broad-based, as we've mentioned, so it's not just any one thing in the business. It's improved user growth, conversion, and retention. The guidance considers all of those factors. Now I just want to mention that the world is obviously an uncertain place, and we're paying close attention to what's going on with the war you mentioned in Ukraine, inflation, interest rates and all those things. And so we've taken a prudent approach to the guidance for the rest of the year, just knowing that there is a lot of uncertainty.

Got it. Thanks, Matt.

Operator, are you there?

Anybody? I think you can all still hear us. It seems like the operator has essentially disappeared, so we are trying to figure out what to do for now. Sorry about that. This is Luis again. I think we just lost the operator. How about I tell some jokes? I'm kidding.

Excuse me, but one moment. We'll go ahead and proceed with Q&A here. And it looks like we currently still have Mario Lu in the question queue.

Mario, can you hear us?

Yeah, I can hear them. I think I’m good for now. I’ll just jump back in the queue.

Okay. I do apologize, everyone. It looks like we were experiencing technical difficulties. Mr. Lu, we'll then remove you from the queue, sir. Appreciate it. And next, we will take Ralph Schackart of William Blair.

Thanks for taking the question. But Luis, if you have a joke first that you wanted to say, feel free.

I got many but let's proceed.

So just in terms of subscription revenue growth in the shareholder letter, obviously, you talked about new and renewing paid users. Maybe just kind of zeroing in on the renewing paid users. Did you change anything on the testing side or product side? Just curious how you're bringing back previous subscribers. And then I have a follow-up.

Yeah. I mean, we're always running A/B tests to try to continue increasing our number of subscribers. One of the main things that we have been doing to increase renewal rates is increasing the fraction of people that go into the Family Plan. The Family Plan is really good for our retention because if you think about it, if you have a Family Plan and you're using Duolingo and also your significant other is using Duolingo and also your child is using Duolingo, as long as anybody is still using it, you're going to continue paying. So the fraction of people that are on the Family Plan keeps going up. In fact, it has doubled since the beginning of the year, and that's really helped us with renewal rates. But other than that, we just continue making the app more engaging, which gets more people to subscribe and stay subscribed.

Great. Maybe a follow-up. Just as travel continues to return, just curious how is that impacting engagement and user and subscriber growth. Is that a primary use case? Just curious how that's impacting the quarter and the subscriber base.

Travel is one of the various ways people use Duolingo. While it's not the main use case and varies by location, it is a less common use case. We acknowledge its presence, but we don't believe it's significantly affecting our performance. Although people are traveling more, we don't see it having a major impact on our numbers.

Okay. Thanks, Luis.

And next, we have Andrew Boone of JMP Securities.

Hi, thanks for taking my questions. To start, can we have an update on local pricing, just the testing that you were doing around, I think it was four countries? And then secondly, in the letter, you talked about expanding the language learning market. Can you talk about how you are looking to expand the top of the funnel to be more inclusive and bring more users into Duolingo? Thanks so much.

Yeah. Great question. Let me first talk about expanding the language learning market. This is something that we've noticed in many of our markets. In the United States, when we asked our users, approximately 80% of our users were not in the language learning market before Duolingo. They were not learning a language before us. In certain countries, we are really just expanding the market. We believe this occurs due to our iconic brand that a lot of people talk about. Additionally, it's also just really easy to learn with Duolingo, and users tend to share it with each other. The main way we grow is through word of mouth; people say things like, 'Have you tried Duolingo? It's really easy.' That's how we're expanding the market. That covers one question. What was the other question?

Regional pricing.

Yeah, regional pricing question. We continue making progress. We are changing prices in more and more countries. Just for reference, we discussed regional pricing during the IPO. Before the IPO, we had one price in every country. Over the last few months, we have been adjusting prices in many countries. In most cases, this means reducing the price since the previous pricing was optimized for the United States, which is one of the wealthier countries in the world. Most countries are seeing price reductions, and it is having an impact. I want to emphasize that regional pricing is just one of many levers we have. It's having an impact but not a major one; it's a modest effect. The reason is that in the most countries we are changing the price, digital subscriptions are not yet very mature. The regional pricing is a necessary condition to increase our penetration, but not a sufficient one.

Thank you.

The next question we have will come from Mark Mahaney of Evercore ISI.

Okay, thanks. Two questions. First, regarding the record number of MAUs or new users, could you provide a bit of detail on how you attracted them? Were there particular markets, such as India, where you are starting to really break through? More color on where this record number of new users came from, please.

Yeah, hi, Mark. The first thing to say is that we're growing in every single region. We are growing a little faster in specific areas. Asia, especially India, is one of our fastest-growing territories, but we are also growing significantly in the United States. You asked how they came in. The vast majority of users come in through word of mouth, which has been our historical growth method—organic growth. We have conducted a few marketing campaigns that have been efficient; particularly in Asian countries, we found that paid influencers work well. We have not spent a huge amount of money on that, but it has proven effective. Additionally, our use of social media, especially TikTok for English-speaking countries like the U.S. and the UK, has helped spread the word. However, organic growth remains the predominant source of our new users.

Okay. And to date, you've been a language learning app and a really interesting one. Your goal is much broader than language learning, especially when you talk about education. So please discuss the timeline for when we can expect to see products like Duolingo Math come out. What else could we see and when could we see it? Thank you.

That's a great question. Our ambitions are quite large. We want to address all of education. The language learning market is enormous, and there's still much runway for us. For the foreseeable future, the majority of our growth and revenue will indeed be from language learning. We are working on other apps. We launched Duolingo ABC, which is for literacy, and we are planning to have a public beta of our Math app later this year. However, do not expect any meaningful revenue contribution from the Math app or other educational products this year or next year. If there is any, it will be minimal. The main reason is our language learning product is experiencing significant growth, and it may take time for the other products to catch up and become meaningful.

Okay, that makes sense. Thank you very much, Luis.

Thank you, Mark.

I apologize for the technical delay earlier. The next question comes from Arvind Ramnani of Piper.

Hi, and thanks for taking my question. I wanted to ask about some other digital learning firms. Many are facing various headwinds, yet it looks like you haven't received any memo about a post-pandemic slowdown. In fact, you're seeing good growth. What is unique about your model where you aren't seeing a slowdown? Should we expect a slowdown in the next two to three quarters?

We have no reason to believe there's going to be a slowdown. In fact, our user growth numbers are accelerating for now. A few points: We are not a COVID story like many education companies. Our growth rates returned to organic levels after a brief spike during the early lockdowns in 2020. Also, we are mainly a product-driven company. Many education firms focus heavily on marketing. We spend most of our resources on creating an excellent product that promotes word of mouth. The outcomes show that the compounding of our thousands of A/B tests is continually improving the product. Additionally, language learning is a significant market; we’re just beginning to tap into its potential with both user growth and monetization. You should continue to see growth.

Perfect. And from a product perspective, are there timelines you can share regarding ancillary learning products like Math? Or is it more that Math won't be introduced in the near future?

I’m showing multiple speakers.

Sorry, can you hear me?

We can hear you. I do apologize.

So with Math, we will release a public beta version of the Math app later this year. However, let me emphasize once more that you should not expect any meaningful revenue contribution from the Math app or other products. The growth in our language learning will remain the primary source of revenue over the next few years.

Terrific. Thank you very much.

Thank you.

And next, we have a question from Nat Schindler of Bank of America.

Yeah. Hi, guys. I just wanted to follow up on that Math comment. I can understand that you're not looking to monetize very quickly. But more importantly, what are your thoughts? Most of your subscribers have not been children; they have been adult users historically for Duolingo. People engage with language learning their whole lives. I don't see a lot of individuals, and I’m an engineer and a geek, who sit and do math learning later in life. So is there a real market for adults paying for math learning?

That's a great question. The first point to make is that these are new products, and we'll develop them. We're enthusiastic about math because we believe it's essential for everyone to learn. Most users will likely be children, though we think there is some market potential for adults focused on brain training. However, the vast majority of users will be children. One reason we are excited about our Family Plan is we expect to bundle multiple learning products, and we anticipate that the Family Plan’s popularity will support our expansion.

Great. Thank you.

At this time, we are showing no further questions. I will then plan to conclude today's Q&A. At this time, I'd like to hand the conference back over to the management team for any closing remarks. Sir?

Just thank you. Thank you very much, everybody, for the great questions. We look forward to speaking again next quarter, and sorry about the operator dropping off. They probably went and got addicted to Duolingo.

Everyone, I do thank you for your patience. And we thank you, sir, for your time today and to the rest of the management team. The conference call has now concluded. Again, we thank you. Take care and have a wonderful day.