Q1 2023 Duolingo Inc Earnings Call

May 9, 2023

Used to make our products better.

Because of our large user base, we're able to pass to test Max features on small fractions of users and iterate rapidly. This is a great example of how our model works in general and how we'll use generative AI in particular.

As you can tell I'm very excited about all the possibilities I see with AI and duolingo, Max but I should emphasize that we're still in the early stages of rolling Max out we'll continue to update you about the progress, we're making over time and with that I'll turn it over to Matt.

Thanks, Luis to recap our impressive results in the first quarter, we delivered 37% bookings growth year over year, which was about 42% on a constant currency basis.

We had.

Net loss of $2 6 million compared to a net loss of $12 2 million in the year ago quarter.

And we posted our highest quarterly adjusted EBITDA of $15 1 million, which was a 13, 1% adjusted EBITDA margin.

We also had our highest quarterly free cash flow margin of about 25%.

So based on the strong start to the year, we feel very good about our Q2 and full year outlook.

For Q2, 2023, we are issuing guidance of $128 million to $131 million in total bookings $122 million to $125 million in revenue and an adjusted EBITDA margin of 11% to 12%.

And for the full year 2023, we are raising our guidance to 552 to 555 $161 million in total bookings.

$500 million to $509 million in total revenue and we are updating our adjusted EBITDA margin range from 11% to 12%, which reflects an incremental margin of about 32%.

Because of the strong trends we saw in Q1, we are guiding to continued strong topline growth with bookings growing at 30% year over year at the midpoint in revenue growing at 37% at the midpoint.

The combination of strong top line growth and continued discipline on operating expenses and why we feel good about raising our adjusted EBITDA margin guidance at the midpoint.

In Q2, we expect each non-GAAP expense line item to show operating leverage year over year with R&D showing about one point of improvement as a percentage of revenue G&A showing about three points of improvement in F&I I'm showing about one five points of improvement I know that the <unk> line would show about two five points of improvement.

<unk> buffer the roughly $1 $5 million of investment spend that was time shifted from Q1 of this year into Q2.

After the seasonality, we expect for the rest of the year and adjusted EBITDA.

We are guiding to an 11% to 12% adjusted EBITDA margin for Q2 or.

Q3 margin will be lower than Q2 and.

And that's the quarter in which the largest portion of our new hires start and then in Q4 the margin will expand as that quarter is typically our strongest revenue quarter. We don't expect a material step up in costs between Q3 and Q4.

As Luis mentioned, we are excited about duolingo, Max but we are still in the early days of rolling It out we have not yet included any material amount of bookings to revenue in our guidance for this new higher tier.

We will keep you posted on our progress in the coming months.

Finally, we ended the year with approximately $48 3 million fully diluted shares outstanding used in our quarter end close price and as we mentioned on our last call. We expect to end the year with about 2% dilution from equity issued to employees and with that I'll turn it back to Luis.

Thank you Matt.

I just want to take this opportunity to thank our amazing team.

Collective passion and commitment to excellence has helped us deliver another excellent quarter.

And now we would be happy to take your questions as long as they're good.

I'll turn it back to Debbie to manage the queue.

Alright, Thanks, Luis and just for our analyst as a reminder, if you have any questions you can use the Raytheon feature.

So our first question comes from Mark Mahaney of Evercore.

Well I hope this question is good.

We better be back.

We haven't talked to you haven't mentioned yet one of my favorite topics, which is mass so could you just.

Talk about what you're seeing early on in terms of the interest in that.

And then.

And then can you just talk a little bit about the China market too. So that's kind of wax and wane, but I think it's been more waning or not waxing for you becoming stronger so how much of a contributor that's been to you in terms of your EMEA use and if at all you paid shops. Thank you.

Well. Thank you for the questions Mark of course math is also one of my favorite topics.

As you know we launched.

And after the learn math.

Few months ago is doing really well, it's growing entirely organically and it's growing very nicely.

I should mention of course this is still the very early days and it's still also a very small team. So we're we're just basically have a long list of features that we still need to add and we're working on doing that.

I don't know if there's anything else to say other than I'm loving using it I'm very soon there is actually going to be more content and.

More advanced content, so we're very happy with that.

China, We're also very happy with our progress in China.

<unk>.

One of our fastest growing countries.

Remind people, though I mean, yes, China is one of our fastest growing countries, we seem to be doing well, but it is still a small market for us.

Robley, 2% to 3% of our revenue give or take.

But it is growing very nicely.

We're very happy with it.

Thank you Luis.

Thank you Mark.

Thanks, Mark Alright next question comes from Justin Patterson of Keybanc.

Great. Thank you very much two if I can first just a big picture one we've seen a lot of companies in gaming and dating hidden asset around monetization and engagement could you talk a bit Luis about just some of the guardrails you have in building product in a way where monetization initiatives don't necessarily impede.

The monetization.

Impede the consumer experience.

I'd be the first question and then since you alluded to it in your prepared remarks would love how you're thinking about it just leveraging AI more over the future whether that's something that investors should think of it as just broadening the set of educational apps that do a lingo can participate so even moving beyond math over time to even just.

Building and deeper more immersive experiences and existing apps and moving up from what might be a casual learning experience to really gaining mastery of the competency. Thank you.

Thank you great questions Justin in terms of the monetization guard layoffs, let me let me just.

Just describe to you how our how we develop product.

The way, we make our product better as we run.

A lot of AB test I mean, we're having hundreds of AB test every quarter and for each AB tests, usually its trying to improve something so its trying to improve either how we monetize or starting to make the app more engaging or trying to teach better et cetera, usually has a goal now in addition to the goal for every every test we run. We also have these guardrail metrics. So for example.

If the Golar for Navy task will be to improve monetization, we may do something where like we make the subscribe button bigger or something like that that stuff. This is a facility example.

The goal of that would be to improve monetization. We also look at what it does to our engagements. So we look at people spending more or less time on the App. We look at whether people are learning more or less for that <unk> et cetera, and we only launch.

Experiments that do not mess up our guardrail metrics. So in this case, if making the subscribe button bigger would make it so that people are spending less time on the App, we would not launch that experiment.

That's what we're doing and it's actually worked out we've been doing this for years and it's worked out really well to be able to grow our monetization without having an impact on our user engagement, which just just to remind you for us internally, we believe user engagement and user growth is the single most important thing.

Because from that all kinds of good things come up I mean, when we are when we when we grow our user even if it start for user we have the chance to convert them into paying subscribers over the next several years because they'll continue coming to duolingo. So this is how we think about that.

In terms of AI.

Sure.

We're extremely excited I'm personally extremely excited about AI since since we launched duolingo. The goal has always been to make something that can teach you as well as a one on one human tutor, but without the one on one human theater, because one of our human tutors are expensive and not very scalable so thats been the goal.

And we've been using AI from the beginning to be able to do that now the main way in which historically we've used AI is we've looked at all the all the exercises that are used to solve.

And at this point, we're getting about $1 billion exercise are sold by our users everyday and we use that to improve how we piece in particular, we use that to try to give users the right exercise at the right time. So we try to make sure that you get exactly the right exercise and we use all the data from from our users with US we've built a very sophisticated model called bird brain that can do that.

Now over the last few months, we've had this amazing thing of generative AI and.

Ever since that that came out of it because we got early access to it.

We started developing features for it and what's amazing about it it's like having a really good writer on staff. It allows us to just have a really good language.

That can come pretty pretty quickly. So that has allowed us to develop new features for example, we developed two new features as part of our new higher tier subscription offer offering called Duolingo Max one of them is called explained my answer which basically explains whenever you have a mistake. It gives you a human language understandable explanation.

Explanation and the other one is called role play where you can basically role player.

Tend to be something like like pretend to be ordering.

Croissant in France, or something and so that gives you a conversational practice. So so far we have.

We've decided to use AI to try to teach closer to a human that's also of course going to allow us to.

Get into other areas. So we are going to invest to be investing in making for example, or other app for our map App for example, better.

<unk> ABC better we're also going to be using AI to create content faster and cheaper.

So that's the part that it's online, but its life where people are are interacting with AI, but there's also the part that is offline, where we just generate a lot of the content.

Faster and cheaper so in our case, we just think there's just a massive opportunity to make our apps piece better.

More engaging which is really important and also too.

Have lower costs.

Yes, and just to jump in there Justin I think the one additional point I would make that I think is our not so secret weapon is Luis on this you can tell by his answer there. How excited he is I mean, that's really been our dream is to.

This type of technology. So that you can teach in this way I mean, he really wrote us.

Ph D thesis on how humans and computers to work better.

Learn better together so it's just a moment in time, we're pretty lucky that he is leading us through that and Thats great.

Great. Thank you both.

Thanks, Justin and your next question comes from Ralph Shakur of William Blair.

Good afternoon, and thanks for taking the questions.

Just curious on DAU to miles.

<unk>, yet again and saw further reacceleration in the quarter, which is really impressive just curious if there's anything you'd call out there driving that really strong growth. Once again and then second question I know you've been testing pricing in different international markets, just curious what sort of trends you're seeing there and how users are responding to different pricing.

Thank you.

Thank you Ralph in the case of the.

<unk> and <unk>.

Youre right.

We keep getting a product our main product dwelling language learning up keeps getting more and more engaging our <unk> ratio keeps getting better and better we're at 28% now.

And the reason for that is just because we keep running more and more tests that make our product more engaging.

Really it and so the types of things that we do we make our streak feature a more prominent or or just more intuitive we make our social features better so that users get our friends to come back so.

So in general we just have a very high performing growth area for us our growth area. What it does is it gross RDA use and of course, our <unk> ratio is going to get better and better because nobody in this company is looking at meus <unk>. It's nice we report them on everything, but we are trying to grow our <unk> because we believe that getting somebody to come every single day is the right way to learn.

Language learner language by coming once a month.

So that ratio keeps getting getting better and better and I would expect that to continue getting better.

Sure.

Your next question is about it's about regional pricing.

Just to remind everyone.

We IPO at a couple of years ago, we had the same price that we are in the world. We of course knew that that was not.

The most optimal price.

Over over the last couple of years, we have.

Tried prices in every country and at this point.

In most regions in the world in most countries in the world the price makes sense in that it's pretty correlated with GDP.

GDP for that country.

So the prices make sense that has been an increase in the house implied already on increasing our bookings I should say the increase was nice we took care of course, but it wasn't life changing.

Because of what happened with the price wars.

In wealthy countries like the U S or Europe , the prices remain pretty similar sometimes they went up a little bit but they remained pretty similar whereas in poor countries. The prices went down quite significantly and what that did is it got a lot more people too.

To buy but you've got to remember. These are these are poor countries, where digital subscriptions are just not us as mature.

Or.

Sometimes people don't even have payment methods. So so we saw the decrease of prices in the sports for countries as an important step in monetizing them, but we also understand that over a year. So over the next few years.

More things have to happen in order for us to monetize as well as we're monetizing the wealth of countries.

Thanks Luis.

Alright next question comes from Andrew Byrne of JMP Securities.

Okay. Thanks for taking my questions.

One on Max I would assume that Max to tracking attracting a more advanced Lana platform.

Is that true what are you seeing in terms of the type of learners that actually adopted Max and then secondly, just broader question on <unk> more broadly how do you think about this change in the competition for Duolingo are you at all concern there what comes top of mind issues actually that thanks, so much.

Thank you Andrew Okay in terms of Max.

I should say so where.

We were Super happy that we launched Max exactly the Dave that GPT four was announced so we're super happy about but we put that out there.

Very fast now of course, when we put that out there we didn't give it to all our users we gave it to only a small fraction of our users and the reason for that is because that's how we do product development here or dwelling what we start with a small fraction of our users and then particularly for complex features like Max or like our home screen redesign or like the family plan or anything it usually takes us.

Our year to optimize it on small groups of users and then we start giving us more and more users that is just how we do product development that is what's happening with Max.

So at this point, we can't really give for example metrics from Max or anything like that because we just we just don't know where this will end up.

But what I can say is.

There is a lot of demand for this higher tier which is good we're happy with that.

There is also demand for the actual features and now to your question about whether this is attracting more advanced learners. The honest answer is we don't know.

It is.

If people are buying it it's hard to know whether they are more advanced learners or not but they are very interested they may they may be more committed are wealthier.

Probably the things that I would say rather than more advanced.

But it's just hard to know what it's doing.

I should also say because.

When we were preparing.

That would kill me if I did not say that you should not include Max in your models, because we ourselves are not including Max and our model. It is too early to tell.

So thats the thing with Max.

With the language models and competition. This is just not something were particularly worried about.

Theres enough moats for US for example, large.

Which model side. This is a great thing that.

Allowing the trained on the whole worldwide web.

And they have this very generic information and so whenever you ask it to write something is basically what the worldwide web would say, it's kind of like on like the average of what the worldwide web would say.

What they don't happen, they're not trained with for example data about how people learn a language.

Or they are not trained with all the data we have we have a lot of data and so we the way we use these large language models just kind of on top of how we do our AI for our own stuff. So.

We have this huge data mode of all the people that are learning a language with us and it is.

I don't know 10 to 20 times larger than any of our competitors.

So that's one thing we also have the distribution to.

Even if we just apply the large language models without any tweaks, which we're not doing we're actually tweaking them, but even if we did that without any tweaks, we still have much larger distribution than anybody else. So.

That's a big thing we also of course have other most like.

The fact that our product is so engaging and on our brands and also all our are engaging characters like like.

Like all being passive aggressive and stuff like that so this is just not something that we're particularly worried about in terms of competition.

Hopefully that answers the question.

Okay. Next question comes from Ryan Macdonald of Needham.

Thanks for taking my questions. Congrats on awesome quarter at least maybe just piggybacking off of that topic as you think about sort of Maxim.

You should know that as you sort of maturing scaling it out and I think one of the benefits of Hawaii chat GBT gain so much adopt.

Adoption. So quickly is not only with a powerful but it was also.

And <unk> got to experiment without it with that so as you think about rolling out the features more broadly with Mac.

Balance sort of functionality with pricing given obviously a max.

Sort of fairly steep increase relative to the core doing super duolingo.

Yes, that's an excellent question and that's something that over over time, we're going to see what features belong somewhere or bought big features along where at this point. We're happy that we have we had the standard free tier we have always had.

Super dwelling or Reno for the last five years, we've had kind of the paid tier we knew that adding an extra higher tier was going to be good for the business. So.

<unk> was a good kind of excuse a good recent to add a higher tier for the business and we have that and so now we have these three tiers and over the next literally years, it's going to take US a year, we're going to be figuring out where to put each feature.

And we're going to do what we think is best for our business.

It is important dimension.

Of course, we care about revenue on everything but the single most important for us as a free user growth.

Because that leads to good stuff everywhere. So yes, if we see that certain things make more sense in the free tier will put them. There now the one thing that I'll mention which is important dimension.

Providing particularly live access to large language models is not super cheap.

For example, in our case, we use open AI, we have to pay them for GPT four et cetera. So for now we keep them. We keep these features in the highest tier so that we can actually pay for that cost over time, though we expect that the cost of clearing large language models is going to go down quite significantly and that may allow us to do certain other things.

Example, for the free tier so it's just something that is going to evolve over time.

And it's a little early to tell where these features are going to are going to end up.

And kind of.

On an ongoing basis makes sense I appreciate the color that was Mike. Good question not my lame in sort of that one I apologize if I missed this but what really struck me on the metrics.

The nice jump quarter over quarter and paid subs.

If I missed I apologize, but was there anything that you are in terms of specific region.

Sure.

Specific feature that you would attribute that large jump that you saw sort of fourth quarter to first quarter on the paid subs side.

Well, there's a number of things so our paid subscriptions just have been.

Consistently growing ever since we launched our subscription that's just basically they just keep growing and growing and growing and.

And there is no single reason for that I mean, we just get better and better at converting our users.

Sure.

We do that by a number of things I mean, one of them is just making the subscription more interesting by adding more features to it or improving the features for it but also by merchandising we get a lot better at knowing when to advertise to subscription what to say to you to get you to subscribe.

So all of that just we run enough EBITDA that gets us more and more subscriptions.

I think thats. The main answer that standard thing that keeps happening every quarter. So there was a jump.

Jump in I would say every quarter.

Since we've been public.

Since we've been public we've seen a nice trend up in conversion basically every quarter. So I think this recent quarter I was just kind of continued strength in our conversion trends.

Based on what you said.

Alright, Thanks again, congrats on a great quarter.

Thank you Ryan.

Okay. Next question comes from Mario <unk> with Barclays.

Sure.

Great. Thanks for taking the question. The first one is languishing royalty Asia.

Okay.

So that's.

A lot of people have asked us for it.

But.

We're concentrated right now on our main business I think is the answer.

But it is.

Internally I would say if we had a bulk have the employees would vote to make it a real show more than that.

Got it nicely as well.

Yes.

It's data format shape that you guys accelerated each first quarter I guess any main drivers for this.

I know you guys talked about compounding right is.

As a social media they tick tock witnessed.

<unk> anything to call out.

How should we think about it.

For <unk> this year.

Yes.

The main reason are growing is because our product is getting better.

We can track that we know that and it's the compounding effect of just it become stickier and stickier Thats. The main reason now there are other reasons or for example, you mentioned marketing.

We keep getting more and more efficient and better marketing, we haven't really found our marketing team has really found its stride in terms of what are the things that.

The levers that work and don't for example, we have found that.

Organic social media is really good for US Tictoc is an example, but it's not just stick dock I mean, we do really well and Twitter, we do really well in Instagram. So we just found that we have a brand that is very good for social media and its organic is not paid stuff. So that works really well we have found that influenced this work and this is paid paid influences worked really well in certain countries, particularly.

Early in Asia, and Latin America that influences worked really well and we have also found that some small amount of performance marketing in <unk>.

Usually and cheaper markets works also really well for us.

So these are the things that.

We have found work well.

And combined all of this is just keep accelerating ideas in terms of what to expect for Q2, I'll, let Matt speak to that but I think.

The one thing that I'll say is it's very nice that our users.

The growth of our users has been accelerating for I don't know how many quarters in a row by now.

Obviously this can't go on forever. That's the one thing that I'll say I don't think we can have 300 quarters of accelerating user growth at some point, we run out of people that was that was going to be my point is we feel really good about the seven quarters. Since we've been public it can't go on forever and we can still have really strong user growth, even if it doesn't accelerate.

It's not a requirement that things accelerate we want them to stay strong and we like the trends.

So far this year.

Great. Thank you and then just one more on gross margins.

Look at Cogs.

I assume that a portion of his app store fees.

Did you see a ruling from the apples.

K square.

Hey al.

Sure.

Direct to consumer if you will.

What is Julian.

Strategy is potentially going to direct to consumer.

Expanding gross margin.

Yes.

Yes, so I mean historically we've.

It's pretty clear that we view the app stores with good partners Luis mentioned part of our advantage.

Earlier this thing are incredibly widespread distribution and thats in part because of the App stores.

Our margins on our subscription products have gone up because.

More and more users are staying on our platform for longer than a year and that reduces our app store fees and that's our primary way too.

Increased subscription gross margins overtime as far as the other.

Taking.

Different tax.

That's not really been something we've experimented with and have passed but it has not really been a focus and I don't expect it to be a.

A focus for us in the near term.

Got it thank you.

Yes.

And next question comes from Arvind <unk> of Piper Sandler.

Thanks Debbie.

All of my questions have been taken and again when I think of your question.

So I wanted to ask about the data and the English test I know, it's kind of a big part of the story.

And I think it drives a decent amount of optionality.

If some of the Domino's and oil in place.

Where does that stand in terms of broader acceptance from universities or I think you said the British in the Canadian government.

The dominoes that and get it get it rolling.

Yes. Thank you for the Great question I mean, the dueling English test is something that we're all very excited about Amit personally I'm very excited about the dueling languished just as you said it provides quite a bit of Optionality. It's also.

It's quite complementary to the drilling of a language learning app because if we are able to really win that that would help us.

One the score that people used to talk about the language is what we really would love to get to it to a point where as opposed to people, saying when they're asked how much French D&O as opposed to people, saying Oh I took four years of French in high school, we want people to say Oh, I'm, a dual <unk> 65.

That's of course, that's going to take a while but thats kind of where we want to get too and they're doing well English test. This is one of the ways in which that with that type of square will get a lot of legitimacy.

We're very excited by it.

It's growing so its growing nicely now of course I should mention that it's important to say, it's just about 10% of our revenue.

The growth of the drilling going with that is not going to be a smooth as the growth of our language learning App, which is just the kind of is very predictable very smooth growth because of the dwelling. When you Express has just this externalities like for example government accepting at universities.

So the growth is going to be just less smooth, but where we're very happy with the progress. We've made a lot of progress with among U S institutions, we're making a good progress with Canada.

Australia, and the UK and we keep growing the number of accepting institutions. There now you mentioned governments, yes, we are working on acceptance by the UK government and Canadian and Australian government of course, the U K being the bigger one.

That's just going to take some time.

They have a call for proposals for tests, which hasn't even gone out we don't know when that's going to go out and they've been talking about it for the last year. So at some point it'll go out is completely outside of our control and so that will.

That's the thing about dealing with governments.

Yes.

Perfect and then.

In terms of.

Matt if you can.

End of.

I don't have.

Any kind of metrics set of use hedge anything you're.

We'll then to kind of.

Sure in terms of kind of.

Progress you made on that.

Yes, we're not sharing exact.

Metrics, yet, but we are very happy with the growth is what I can tell you I mean, it's growing very nicely you can probably look at.

Theres ways to track metrics external and you can see that it's growing very nicely.

Perfect.

That sounds great.

Thank you.

Thanks Evan.

Next question comes from Nat Schindler with DNA.

Okay. Thank you guys I think on last year, but.

Louise ear.

Our computer scientists and a language learning expert youre perfect person to ask this question because it really.

<unk> been asked this a lot recently been told this is going to happen I really want to know.

I'm trying to figure out.

How is the search box going to teach me wrench.

You mean, how is the search box like like chat CPT code of tissue front, yes, its a really amazing I keep getting its whole again and again that chat GTP its going to teach me languages and I'm truly.

Little hard hard pressed to figure out how that would work do you have any ideas.

Well I'll tell you this.

I am sure there is some savant out there who can probably learn French by just clearing something like Chuck GBT. Similarly for hundreds of years <unk> been able to learn French by reading books books have been out there you can actually in fact, some people a small number of people can actually learn a language by reading a bunch of.

Books.

But your average person does not have enough motivation or enough aptitude to be able to really learn a language by reading books. Similarly, I don't think that they can just sit there with just a search box and we like.

Hi, and then it just usually your average student just does not even know what to ask on <unk>.

Also the other big problem is keeping yourself motivated.

We've always thought and this is something that I think sets.

Sets us apart from most educational companies, we've always thought the hardest thing about learning something is staying motivated.

And the reason we believe that is because the technology to learn anything has been therefore like thousands of yes. It's called books you could actually learn almost anything you want to learn quantum mechanics that you actually can go and read a book just turns out the vast majority of people choose not to because it's really boring.

The hardest thing about learning anything staying motivated and so that's the thing that and that's what really sets us apart with duolingo that we really are.

Are going to use things like GPT for but we're going to combine it with things to keep your more motivated and also guide you through it I mean, if you have no guide.

It's very hard I mean, this is like asking you to just learn math by yourself you can.

But it's the vast majority people just won't do it.

I think right answer thank you.

Q1 2023 Duolingo Inc Earnings Call

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