Earnings Call Transcript - DUOL Q2 2022

Operator, Operator

Good afternoon and welcome to Duolingo's Second Quarter 2022 Earnings Webcast. Today after market close, we released our quarterly shareholder letter with our Q2 results and commentary which you can find on our IR website at investors.duolingo.com. With me today are Luis von Ahn, our Co-founder and CEO; Matt Skaruppa, our CFO; and Bob Meese, our Chief Business Officer. They'll begin with some brief remarks before opening the call to Q&A. Please note that this event is being recorded. And just a reminder that we will make forward-looking statements regarding future events and financial performance, which are subject to material risks and uncertainties and have been set forth in the risk factors of our SEC filings. These forward-looking statements are based on assumptions that we believe to be reasonable as of today, and we have no obligation to update these statements as a result of new information or future events. And 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 will turn the call over to Luis.

Luis von Ahn, CEO

Thank you, Debbie, and welcome, everyone. So we went public just over a year ago. And as part of that process, I wrote a letter to lay out my vision for what this company will do. It was a short letter and the whole thing said this. I'm just going to read it. The main thing you need to know is that 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 want to spend their time learning. Duolingo is the platform for building that future, and we are just getting started. Since I wrote that letter, we have made a lot of progress towards that vision. We have increased our user base substantially. When we went public last year, we had about 9 million daily active users. Now we have over 13 million. We had about 38 million monthly active users. Now we have nearly 50 million. We had less than 2 million paying subscribers, and now we have 3.3 million. In the first half of last year, we had about $130 million in bookings. And in the first half of this year, we had nearly $200 million. As these numbers show, we've executed well and achieved or surpassed our targets. But the spirit of my IPO letter was that we are at the beginning of our journey, and I believe in that message now more than ever. We want to build a company that is iconic and durable. We want to build a company that lasts 100 years. So while we pay attention to the near-term macro environment, we always stay focused on the long term and on the future. And with that, I'll turn it over to Matt to talk about our financial outlook.

Matthew Skaruppa, CFO

Thank you, Luis. We delivered strong results in the second quarter, beating expectations. We grew the top line at over 50%, and we were profitable on an adjusted EBITDA basis. It was also our fourth consecutive quarter with accelerating user growth. This gives us the confidence to increase our full year guidance while remaining appropriately prudent given the current uncertainty in the macro environment. So our guidance for Q3 2022 is $94 million to $97 million in total bookings, $93 million to $96 million in revenue, and an adjusted EBITDA of negative $4.5 million to negative $1.5 million. For the full year 2022, we are increasing our guidance to $404 million to $410 million in total bookings, $361 million to $367 million in revenue and an adjusted EBITDA of positive $4 million to $7 million. Our full year bookings guidance reflects 37% to 39% year-over-year growth, up from the 32% to 35% year-over-year growth that we guided to on our last earnings call. I also want to discuss foreign exchange rates and how they impact our guidance. We estimate that on a constant currency basis compared to Q2 of last year, our Q2 2022 bookings would have been just over 4% higher. This is a result of the dollar strengthening nearly 9% over the past year against the basket of currencies that make up our bookings and the fact that just over half of our bookings come from outside the U.S. Our updated guidance takes into account the strengthening of the dollar in the first half of the year and assumes current prevailing foreign exchange rates. Note that every 1% increase in the value of the dollar versus our basket of currencies would have about a $1 million impact on total bookings in the second half of the year. We continue to manage the business with fiscal discipline as we have since our founding. In the second half of 2022, we anticipate that R&D as a percentage of revenue will increase starting in Q3 as it does most years as we bring on new university hires. Sales and marketing will increase slightly as a percent of revenue in Q3. And then in Q4, we'll settle back down to where it has been year-to-date. And we should start seeing some slight leverage in G&A in the back half of the year. Finally, I want to note that we are on track to hit our dilution guidance of 2% to 3% for the year and that we ended the quarter with approximately 47.4 million fully diluted shares outstanding using the average Q2 closing price. And now I'll turn it back to Luis.

Luis von Ahn, CEO

Thank you, Matt. Before we take your questions, I'd like to express my gratitude to our talented group of employees who put their collective hearts into our mission every day in order to serve our learners and change their lives through education. I guess I'm also supposed to remind everyone to do their Duolingo lessons today. I got it. I got it. Okay. We're going to do our lessons, okay? Okay. Anyways, I'd also like to remind everyone to watch Duocon on August 26, which is our annual conference for all things Duolingo. And now we would be happy to take your questions. I'll turn it back to Debbie to manage the queue.

Operator, Operator

Thanks, Luis. So your first question comes from Andrew Boone of JMP Securities.

Andrew Boone, Analyst

Hi guys, congrats on the strong results. And thanks for taking my questions. Can we just start with the outperformance in MAU and DAU, I'd love to understand that. And then just stepping back as we think about kind of growth on a go-forward basis and we start to look at 2023 with a little bit finer of point of pencil. Is it fair to think about 20% to 25% for DAU growth and kind of 10% to 15% for MAU growth, which I think was kind of the soft guidance at the point of the IPO?

Luis von Ahn, CEO

Well, thank you, Andrew, for your question. I'm going to talk a little bit about our current outperformance, and then I'm going to let Matt talk about our guidance. So for the outperformance, it's a number of factors, but I think if you ask me, the main factor is just something we've said from the time we IPO-ed, which is we're still in the early days of our journey. We're still in the early days of our DAU growth. We're still in the early days of our revenue growth. And so we're still in a nice part of the curve. Also, I should say one thing, which is that the macro environment is pretty crazy, as you know. So far, we have seen no weakness in our numbers whatsoever, and we expect pretty strong numbers. But things are crazy. And I can't tell you that we're going to be immune forever to whatever is going on in the macro environment. But so far, no weakness in our numbers. I don't know, Matt, if you want to talk about the guidance.

Matthew Skaruppa, CFO

Yes, for sure. Yes. So Andrew, we don't guide to MAU or DAU explicitly. When we went public, we did mention that historically, looking back, MAU grew between 10% and 15% and DAU grew between 20% and 25%. And as you've seen earlier this year, we've outperformed those numbers. But those numbers are pretty long dated times years' data. So I don't think that those numbers are fundamentally changed. We've had nice outperformance here. But again, we're not going to guide formally to it, but if you just look at the long times years of data, those numbers are certainly in the range.

Andrew Boone, Analyst

And then you guys now are live again in China. Can you just speak to the opportunity there and what that could possibly mean for the business over maybe three to five years, right, not near term, but kind of more medium? Thanks so much.

Luis von Ahn, CEO

Thank you for the question about China. As mentioned in our shareholder letter, we are now back live in China. A few months ago, we were removed from the app stores, which meant existing users could still access Duolingo, but new users were unable to download it. We're now back in the app stores and have returned to our previous daily active user and revenue levels. China is a country with significant potential, but it currently represents a small market for us, accounting for about 1% to 2% of our daily and monthly active users and just under 1% of our revenue. It's important to note that while China boasts the largest language learning market in the world, especially for English, it remains challenging for Western companies to succeed there. We see it as an area to invest in, but we are not placing the future of the company on it. I can't predict what the future holds for the Chinese market any better than anyone else.

Operator, Operator

Okay, great. And your next question comes from Eric Sheridan of Goldman Sachs.

Eric Sheridan, Analyst

Thanks so much for taking the question. Great to see everyone. I'm always intrigued when you put the stuff in the letter on the A/B testing. Anything to highlight there where you've seen elements of the A/B testing move out of testing mode and into the app that you're the most excited about either they're driving on the usage side or the monetization side. Just can we get a better sense of some of the bridging from testing into implementation in the business? That would be number one. And number two, any update on math as a product, both on the investment cycle behind it and how you think about launching it more widely as we move out into future quarters? Thanks so much.

Luis von Ahn, CEO

Thank you, Eric, for the questions. Okay. So first of all, in terms of A/B testing, as we mentioned in the letter, we run about 500 A/B tests per quarter. So we're really testing all kinds of things. Some things are pretty minor. Some of the A/B tests are just like one word changed in some button, and some are pretty large features. Two of those that we highlighted in the letter that I'm particularly excited about. One is the Quests tab. So it's a whole tab in the app that is basically going to encourage users to complete actions and generally use the app more. The thing about using the app more is they use it more days in a row, and every day that they use it, they spend more time on it. We know that people who use the app more are also more likely to subscribe. So we really like that. That's one that we're really excited about. Another one that we mentioned in the letter that I'm particularly excited about is this feature called Side Quests, which are in the new home screen of the app. You'll be able to tap on the animated characters, which will give you access to fun little mini-games to practice your language. To play them, you're going to have to pay with gems. The gem economy on Duolingo is something that we're very excited about because it's going to help us with in-app purchases, which we plan on investing in for the next few years. Right now, our revenue from in-app purchases is relatively small, just a couple of percentage points, but we think we can grow that quite a bit, especially in certain geographies where people don't love paying for recurring subscriptions. So that's an update on the A/B testing. And regarding math, thank you for the question. We're very excited about that. When people ask about math or Duolingo ABC, which is our literacy app, I like to remind everyone that for the foreseeable future, certainly this year, next year, and even the year after that, we are primarily a language learning company. Language learning is a massive opportunity. We're still really only scratching the surface. The majority of our investment and revenue will continue to come from language learning for the next, say, 3 to 5 years. Now, with the Math app, I have it on my phone, and I use it every single day. It turns out practicing third and fourth grade math is quite fun, at least for nerds like me. So we have it, and we're on track to release a beta version of the app to the whole world this year. So everything is going according to plan, and I'm particularly excited about it.

Operator, Operator

Okay, great. And your next question comes from Ralph Schackart of William Blair.

Ralph Schackart, Analyst

Great. Thanks for taking the question. And also good to see everybody. Just two if I could. Just in terms of the home screen, you talked about the excitement there to really improve engagement. Maybe just an update on what you're seeing there with the testing. And then just an additional question on regional pricing, how is that effort going?

Luis von Ahn, CEO

Thank you, Ralph. The first question was about the home screen. We are making a significant change to the home screen of Duolingo. Previously, it featured a structure we called the tree, which offered users many options for what to learn next. We are now shifting to a more linear path to guide users on their next learning steps. This change is currently being tested carefully and is live for a small number of our users on iPhones, Androids, and the web across all platforms. The early results are promising and align with our expectations. The old home screen had been in place for about 5 to 6 years and was highly optimized. The new version is completely new and hasn't undergone optimization yet. Our goal was to achieve similar metrics with this unoptimized home screen compared to the previous optimized version. If we can reach that level of performance, it provides a strong foundation for further optimization. So far, we appear to have achieved that parity, which is encouraging. I estimate that we will roll it out to all users by the end of the quarter, and the home screen looks promising. Regarding regional pricing, when we went public, we had a uniform price across all regions, which worked well for the U.S. and part of Western Europe but was not suitable for many other countries. Over the past year, we've adjusted prices in most regions to reflect local economies. This process took time as we focused on long-term bookings, lifetime value, and the impact on recurring subscriptions. Now, pricing is more appropriate for most countries based on their GDP. Prices in the U.S. have remained steady, which is positive, while many developing countries have seen price reductions. We consider this the initial step toward better monetization in these regions. Typically, we generate more revenue in countries like the U.S. or Western Europe compared to Brazil, Peru, or Vietnam. To enhance monetization in those markets, several actions are necessary. The first step was to adjust pricing, which led to an increase in bookings, though not as dramatic as some might expect. It's essential to recognize that having the right price does not guarantee a sudden spike in bookings, and we did not anticipate that. More work is needed in these markets. For instance, consumers in those regions are less familiar with paying for ongoing digital subscriptions. Hence, we need to focus on offering more à la carte in-app purchases and improving payment options that may be lacking. This is just one of the many steps we need to take.

Ralph Schackart, Analyst

Thanks, Luis.

Operator, Operator

And your next question comes from Ryan MacDonald of Needham.

Ryan MacDonald, Analyst

Thanks for taking my question. Luis, I wanted to first start with Duolingo English Test. Obviously, some really strong growth that accelerated on a year-over-year basis. I'm curious what you're seeing there between whether it's just a mix of stronger international enrollments back in the U.S. domestically? Or if this is a result of sort of the increase in the number of universities that you have on the platform?

Luis von Ahn, CEO

Yes. Thank you for asking about the Duolingo English Test. It's a project that is very near and dear to my heart, and it's something that we're very excited about. Just to set the stage, not as many people know about the Duolingo English Test. This is our second largest product. Most people know us for our language learning app. The Duolingo English Test is a standardized English proficiency exam. You go to our website and take a test that tells you how proficient your English is. This test is utilized for a lot of purposes, one of the main uses being university admissions for foreign students. When people want to come to the U.S. to study, for example, at Stanford or Duke, they have to apply and demonstrate that they can speak English. Consequently, they can take the Duolingo English Test to prove their English proficiency. This business is growing very nicely for us, primarily because a lot more institutions are accepting our test. Historically, we started with U.S. universities. By now, about 80% of U.S. universities are accepting our test. We are increasing our efforts in the U.S., and we obviously want to get to 100%, that’s our goal. We’re also increasing our efforts in other big markets for English proficiency exams, such as Canada, the U.K., and Australia. The combination of more institutions accepting our test has led to a higher volume of people taking the test. In the U.S., we have quite a bit of acceptance. For instance, among the 25 top universities in the U.S. in terms of international student enrollment, 100% accept the Duolingo English Test. So if you're applying to the U.S., it's likely that those universities will take it. Additionally, we’re working on spreading the word about this acceptance in countries like India or China, which represent the majority of our test takers, and getting the message out that we are accepted like other tests has helped considerably, and I believe it will continue to do so.

Ryan MacDonald, Analyst

Super helpful color. And then maybe just from a follow-up perspective. On the core language learning app, obviously, it's great to see no macro negative impacts thus far. But as we think about potential recession or tightening of the consumer discretionary budget, do you do much research on where your users are coming from? And I ask the reason is there a potential here of seeing an acceleration in the shift from offline language learning to online, given that it's $30 to $60 an hour for a language tutor in person versus obviously, that's nearly the price of an annual subscription. Just curious your thoughts there? Thanks.

Luis von Ahn, CEO

Yes, that's a really good hypothesis, one that I wish were true. I don't know if it's going to be true or not because we just haven't really hit the recession, at least not fully. But I believe that the market is going to continue to shift online. Just to remind you, the language learning market is about $60 billion a year. The vast majority of it is still offline. Over the years, we've seen a gradual shift online, and we believe that will continue. It’s a good question about whether the recession will aid that shift, especially since offline language learning is considerably more expensive. The honest answer is I don't know if that will happen, but it stands to reason that it could.

Ryan MacDonald, Analyst

Thanks for the color. Congrats again.

Luis von Ahn, CEO

Thank you.

Operator, Operator

And your next question comes from Justin Patterson of KeyBanc.

Justin Patterson, Analyst

Great, thank you very much. Perhaps as a variance of Eric's question, it looks like there's been a lot more iteration on more products, consumer user-facing features recently. I'd love to hear about just how the pace of innovation has improved as that DAU and MAU base has resulted in more A/B tests. And then secondly, you mentioned Duocon, Luis, anything you're particularly excited about coming up? Thank you.

Luis von Ahn, CEO

Okay. So first, in terms of the pace of innovation. So two things affect our pace of innovation. One is the number of users that we have to experiment with. As they increase, we can run more experiments at a time. That helps. The other thing that helps, of course, is the number of people working on the product. So the number of engineers, product managers, and designers that we have also help us run more experiments. That’s basically what's happening. We are hiring more and more people. We are hiring prudently. You're not going to see us doing layoffs or anything like that. We're hiring carefully as we have for the whole time. But that’s basically what increases the pace of innovation. You are right that we are running more A/B tests. It’s pretty much the case that every quarter, we run more A/B tests than the previous quarter because we have more people working on them. As for Duocon, you should just tune in. There’s a lot of really cool stuff coming up.

Justin Patterson, Analyst

You missed a great opportunity for Duo to just lock in behind you again.

Luis von Ahn, CEO

Duo has a very hard job. He has to be everywhere at once, reminding everybody to do their lessons. So I don't know where he is.

Operator, Operator

And the next question comes from Aaron Kessler of Raymond James.

Aaron Kessler, Analyst

Great, thank you. One, you shared some nice marketing leverage in the quarter. Can you just talk about that? Should we expect a little bit maybe deleverage in the back half on the marketing side and maybe with kind of ad rates apparently coming down a bit. Just wondering if that's helping you on the marketing efficiency side? On the other hand, are you seeing any negative implications on your advertising revenues from kind of lower performance-based advertising that we've seen this quarter? Thank you.

Matthew Skaruppa, CFO

Yes, I'm happy to take that. So part of the advertising leverage this quarter was driven by just a shift in spend. We were going to spend it this quarter, we're going to spend it next quarter. That'll shake out to be between around $1 million to $2 million. So there's some of that. But in the back half of the year, we would expect to see some deleveraging in Q3 because of what I just said about the shift. But then in Q4 it should be right back to kind of where it was this quarter-ish. So nothing crazy going on in the sales and marketing line. The second part of your question is true. We did see average revenue per DAU go down on the marketing side of the business, similar to what others have seen. The good news for us is that if that went down in the order of 10%, because DAUs went up so much, the net effect is that advertising dollars still grew relatively nicely for the quarter. So we're still monitoring that. It does seem to be something that could persist throughout the rest of the year, average revenue per DAU going down. But like I said, with user growth, we can offset that.

Luis von Ahn, CEO

Average revenue per DAU on advertising.

Matthew Skaruppa, CFO

Yes, exactly.

Aaron Kessler, Analyst

Great, thank you.

Operator, Operator

And your next question comes from Mario Lu of Barclays.

Mario Lu, Analyst

Great, thanks for taking the questions. So the first one is on the bookings fee in the second quarter. I believe you beat your guide by 11% at the midpoint. So just wondering if you could provide some color on what were the main drivers for the outperformance. Any user acquisition channels you can call out there?

Matthew Skaruppa, CFO

Yes, so the beat on the guide was driven partly by the fact that when we issued that guide, we were early on in the quarter, and there was a lot of macro uncertainty, so we were being appropriately prudent. There was also outperformance even over internal expectations on certain metrics like user growth, conversion, and retention. Those are really the core components that led to the bookings beat. And then when we look to guidance going forward, we're taking that outperformance into account for the rest of the year. However, we're still layering on a prudent outlook because of the uncertainty Luis mentioned.

Mario Lu, Analyst

Got it, thank you. And then just a follow-up on the Side Quests and Quests. Those both look very exciting. I guess just at a high level, you said Side Quests is to increase revenue, Quests is to increase engagement. But I guess in terms of being a language app, can you remind us what incentive users have to spin more gems or is that still being tested?

Luis von Ahn, CEO

In terms of spending more gems, it's just the whole gamification of Duolingo. People really get into it. It’s a pretty complex ecosystem. So one of the user journeys would be something like this. A user is using Duolingo, they get really into the leaderboards, which consist of 30 random people. If you're in the top 10, you increase to the next league, etc. They get really competitive and are trying to get more and more points per minute. Side Quests provide a good number of points, so people try them and enjoy it. That drives them to spend gems. It creates a tight gamification loop.

Mario Lu, Analyst

Great. Well, just don't make it too pay-to-win, like some games.

Luis von Ahn, CEO

Don't worry. We spend a lot of effort on that. We want to make sure that everything we do is beneficial for learning in the end too. We put a lot of effort into making sure that the Side Quests achieve that balance.

Operator, Operator

All right. And the next question comes from Arvind Ramnani at Piper Sandler.

Arvind Ramnani, Analyst

Thank you, everyone. I have a few questions. This is the first time you are addressing the potential effects of the macro environment. I'm not sure if you have experienced a similar macro cycle before, as you may have been a different or private company at that time. If we do see an impact on the business from the macro perspective, do you believe it will primarily affect the mid-teen top of the funnel growth or the conversion? Where do you expect the initial impact to be?

Luis von Ahn, CEO

Arvind, great question. I don't know. It’s very hard to determine. So far, we have seen no weakness in our numbers. I think free users will likely continue growing, while people may be less inclined to subscribe if they’re facing tough economic situations. One hypothesis, however, is that as we have a freemium model and our free product is so good, the people that are having trouble paying may just resort to using the product for free, which doesn’t bother us because that’s good for user growth. We have users everywhere in the world; in poorer countries, very few pay and they just use Duolingo for free. Ultimately, it’s hard to predict what’s going to happen. But so far, no weakness in our numbers.

Arvind Ramnani, Analyst

Perfect. And then from a pricing perspective, like if you go back two years when you were private, you had kind of one pricing model, and now you have multiple. You're starting to introduce more pricing models. I think the family plan is kind of probably the newest pricing model. How should we think about your pricing models? Are you being a little bit more creative on pricing? Should we expect some of that over the next six months?

Luis von Ahn, CEO

So the first thing to say about pricing is that we're always experimenting. We'll continue experimenting with pricing in different geographies and packages. We’re trying to compare the relative price of the family plan versus the individual plan versus the annual. We are always experimenting. If we see something that wins, you’ll see us change it, but it’s hard to say what will happen in six months. I don’t think you’ll see any fundamentally different packages. The current packages we have are monthly, yearly, and the annual plan, which can be paid monthly or yearly. It’s tough to predict the next six months, but you might see different prices as we continue experimenting.

Arvind Ramnani, Analyst

Great. And just last question. Certainly, you've mentioned 450 to 500 A/B tests. Of those, which do you think has the biggest potential to impact your revenue or margins?

Luis von Ahn, CEO

Out of all the 500 tests we're running, which do you think the single one has the most potential? I don't know. The two I'm most excited about are the ones I put in our shareholder letter. I'm most excited about those two, Side Quests and the Quests tab. But sometimes I'm good at predicting what's going to be really big, and sometimes I am pretty bad at it. Those are the ones I noted in the letter.

Arvind Ramnani, Analyst

All right, perfect. Looking forward to seeing you at Duocon.

Luis von Ahn, CEO

It is going to be good.

Operator, Operator

All right. The next question comes from Mark Mahaney at Evercore.

Mark Mahaney, Analyst

I have two questions. First, where do you see subscriber penetration rates going as a percentage of monthly active users? I remember during the IPO a couple of years ago, there was speculation that you might reach double-digits based on trends in some dating apps. Looking at the chart in your shareholder letter, the growth trajectory looks promising, possibly even exceeding your expectations. What are your updated thoughts on long-term penetration rates? Secondly, I want to ask about two markets, China and India. I know India has been discussed already, but I see significant risk-reward dynamics there. You've mentioned that entering new countries isn’t necessarily capital-intensive, and you've experienced viral growth in several regions. The potential for monthly active users and subscribers in China seems immense given your offerings, despite the regulatory challenges. Can you provide some insights on that? Also, any updates on India would be helpful, considering it has been one of your stronger markets, although there may have been some regulatory hurdles. So those are my three questions. Thank you.

Luis von Ahn, CEO

Great, okay. Penetration. You’re right; our penetration of paying subscribers to MAUs has definitely outperformed what I expected since we IPO-ed. We've been seeing a one percentage point growth per year, like 3% to 4%, 4% to 5%. The last couple of years, it's increased to about two percentage points annually. I believe this is good, and the idea is that it can reach mid-teens, but it’s hard to say. I want to clarify; we don’t primarily operate on that metric of percentage of paying subscribers versus MAUs. Internally, we focus on long-term bookings. If we lower the price significantly, that metric could rise significantly without improving revenue. Pricing experimentation, such as regional pricing, has accelerated that but it’s not a focus metric. Now, regarding India, we haven't faced any regulatory issues there. India has been one of our top markets in terms of user growth. For revenue, we haven’t monetized as effectively yet. We've had some issues with acceptance of our freemium model. Many users found it difficult to understand offers to subscribe, leading them to leave. However, we are working to turn our revenue back on in India, and we see a lot of potential there. For China, we have a Beijing office where the team had been growing quickly. China represents our fastest growth market prior to being taken down from app stores. We view it as a fabulous opportunity but are conscious, given the volatility with other Western companies. We will continue to invest strategically rather than dramatically because we have a way to organically grow without having to overspend. Overall, we're excited about China and India but remain cautious.

Matthew Skaruppa, CFO

Thanks, Mark.

Operator, Operator

Great, and it looks like there are no other questions. So I'll just turn it back to Luis.

Luis von Ahn, CEO

Well, I think that's it. Thank you so much. Thank you for all the questions. And just once again, please watch Duocon on August 26. And remember to do your lessons; otherwise, Duo is going to come back here and kidnap my family.