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Good day, and thank you for standing by. Welcome to the Duolingo Second Quarter 2021 Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded.
I would now like to turn the call over to Debbie Belevan, Head of 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 von Ahn, Co-Founder and Chief Executive Officer; Matt Skaruppa, 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 2 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 student, Severin 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 off-line. 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 0.5 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 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 were really learning anything by yourself and 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 user 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. After 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 month 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 7 days, and around 1 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 in Duolingo, we use artificial intelligence to pick exercises that are just right for you. Our learners complete over 0.5 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 the study for French and Spanish, and we found that Duolingo learners who complete Unit 5, or about halfway through this French or Spanish course, are as proficient in reading and writing as a person who has taken 4 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 have 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 2 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 traction 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 our really significant user scale. The model is driven by 2 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 converting to paid subscribers, the more we are able to invest in creating an even more delightful and 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 products 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 S-1 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 2 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 for Duolingo English Test takers. 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 our 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 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 a 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 and difficult to compare to Q2 2021. While we don't know exactly how much our 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 million 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 saw a slight decline this year as the world reopened, as 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 30 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 improvement, such as new premium features, product optimizations that drive subscriber conversion and retention improvements.
In Q2 '21, 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 are 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 ARPDAU.
Our gross margin was 72.6%, which is an increase as compared with a 70.5% gross margin we had last year. This increase is driven primarily by a higher subscription gross margin due to our mix shift towards annual subscription plan and from increased advertising margins driven by the improvement in 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 onetime 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 '21 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 million to $66 million of bookings or 35% to 41% year-over-year growth, $58.5 million to $61.5 million of revenue or 29% to 36% year-over-year growth, and an adjusted EBITDA loss of negative $12 million to negative $8 million. For full year 2021, we are guiding to $267 million to $273 million of bookings or 40% to 44% year-over-year growth, $236 million to $242 million of revenue or 46% to 50% year-over-year growth, and an adjusted EBITDA loss of negative $14 million 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.
[Operator Instructions] Your first question comes from the line of Justin Patterson with KeyBanc.
Great. Could you perhaps elaborate on regional pricing tests?
And then Luis, next week, we have Duocon. Any teasers ahead of the event?
Thanks for the question. So we have -- okay. So we’ve been – as we said in the road show, we’ve been testing in different regions so far. We have succeeded in changing the price in a few countries, in Brazil, 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 should watch and see. I mean we’re going to be announcing a lot of really cool stuff, 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 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.
[Operator Instructions] Your next question comes from the line of Jian Li with Evercore ISI.
So I just wanted to -- a couple of questions. One is just the DAU-to-MAU ratio continues to kind of go up pretty nicely. Can you talk about what are the kind of the initiatives of the product development that drives this consistent growth?
Sure. I mean in terms of our product development, we majorly work on 3 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. The first 2 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 adds. Obviously, the year-over-year comp is tougher. But just like moving forward, would you say that -- would you expect kind of the net adds cadence to be on a higher level, like closer to the 2020 level? Or do you expect that to kind of go back to kind of the 2019 level growth?
Yes. Thanks, Jian. 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, as Luis has mentioned, our MAU growth is, we believe, likely going back to the pre-COVID 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 – that the pre-COVID growth rates will apply going forward.
[Operator Instructions] And we have no further questions at this time. I will now turn the call over back to Luis for closing remarks.
Yes. Thank you. And I’d 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.