DUOLINGO, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements, such as those relating to our plans, objectives, expectations, intentions, and beliefs, that involve risks, uncertainties and assumptions. Our actual results could differ materially from these forward-looking statements as a result of many factors, including those discussed in Part I, Item 1A. "Risk Factors," "Special Note Regarding Forward-Looking Statements," and included elsewhere in this Annual Report on Form 10-K. A discussion of our audited financial statements and the notes for the fiscal year endedDecember 31, 2020 and the related notes has been reported previously in our final prospectus, dated as ofJuly 27, 2021 , filed pursuant to Rule 424(b)(4) (File No. 333-257483) with theSEC onJuly 28, 2021 (the "Final Prospectus"), under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations." Our historical results are not necessarily indicative of the results that may be expected for any periods in the future. Amounts reported in millions are rounded based on the amounts in thousands. As a result, the sum of the components reported in millions may not equal the total amount reported in millions due to rounding. In addition, percentages presented are calculated from the underlying numbers in thousands and may not add to their respective totals due to rounding.
Overview
Our flagship app has organically become the world's most popular way to learn languages and the top-grossing Education app in the App Stores, offering courses in over 40 languages to approximately 42
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million monthly active users as ofDecember 31, 2021 . We believe that we have become the preeminent online destination for language learning due to our beautifully designed products, exceptional user engagement, and demonstrated learning efficacy. Initial Public Offering OnJuly 30, 2021 ,Duolingo completed its Initial Public Offering ("IPO") of 5.9 million shares of its Class A common stock at a price to the public of$102.00 per share, 4.5 million of which were sold by the Company and 1.4 million of which were sold by certain selling stockholders, which includes the exercise in full by the underwriters of their option to purchase from the Company an additional 0.8 million shares of the Company's Class A common stock. The gross proceeds to the Company from the IPO were$455.5 million , before deducting underwriting discounts and commissions and offering expenses payable by the Company. The Company did not receive any proceeds from the sale of shares of Class A common stock in the offering by the selling stockholders. Immediately prior to the completion of the IPO, all convertible preferred stock outstanding, totaling approximately 19.1 million shares, was automatically converted into an equivalent number of shares of Class B common stock on a one-to-one basis and their carrying value of$182.6 million was reclassified to additional paid-in capital within stockholders' equity (deficit). Additionally, onJuly 15, 2021 , 6.9 million shares held by our founders were exchanged from Class A common stock into Class B common stock. Our Business Model How We Generate Revenue We use a freemium business model that relies on a premium subscription offering, advertising, and in-app-purchases (IAPs) to produce revenue. We believe the following key attributes of our freemium subscription business model are core to our success.
•Large Market: There is an enormous pool of potential language learners globally that HolonIQ estimates at approximately 2 billion people.
•Free Users: Since none of our learning content is behind a paywall, anyone can download theDuolingo app, use it for as long as they like, and complete any of our courses free of charge. This has allowed us to scale to 42 million MAUs for the quarter endedDecember 31, 2021 . These millions of learners provide two benefits to our business model: •They become advocates forDuolingo and provide word-of-mouth publicity for our product, which enables our growth and has allowed us to make very selective and efficient marketing investments. •Our users complete over 500 million exercises every day, generating large amounts of data that powers our high-volume A/B testing and novel AI techniques. We use this data and the insights that come from it to continually improve both engagement and efficacy.
•Paid Subscriber Conversion: As learners tend to use our product for months or even years before they decide to subscribe, we enjoy economic benefits from attracting new users well into their tenure on the platform. In 2021, subscribers made up 6% of our average MAUs.
Subscription
Our subscription offering is called Duolingo Plus. It offers learners features such as an ad-free experience, along with additional learning and gamification features that enhance their learning experience. One such enhancement is unlimited Hearts, which give learners more flexibility in how they move through course content. 60
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Advertising and Other Revenue
For users who are unable or unwilling to pay a subscription fee, we provide free access to our product and generate advertising revenue from the sale of display and video advertising delivered through advertising impressions. We generally enter into arrangements with the major programmatic advertising networks to monetize our advertising inventory. Our advertising revenue is primarily a function of the number of our free users, hours of engagement of our free users, and our ability to provide innovative advertising placements that are relevant to our users and enhance returns for our advertising partners.
In-app purchases consist of learners purchasing one-time benefits within the app, such as "streak freezes" and "timer boosts."
In addition to monetizing theDuolingo language learning app, we generate revenue from the Duolingo English Test by charging test takers a one-time fee that generally costs$49 . University program acceptance is a driver ofDuolingo English Test revenue. As ofDecember 31, 2021 , over 3,000 higher education programs around the world accept the Duolingo English Test results as proof of English proficiency for international student admissions, including 18 of the top 20 undergraduate programs inthe United States according toUS News and World Report .
Key Operating Metrics and Non-GAAP Financial Measures
We regularly review a number of key operating metrics and non-GAAP financial
measures to evaluate our business, measure our performance, identify trends,
prepare financial projections and make business decisions. The measures set
forth below should be considered in addition to, not as a substitute for or in
isolation from, our financial results prepared in accordance with GAAP. Monthly
active users (MAUs) and daily active users (DAUs), along with paid subscribers,
are operating metrics that help inform management about the underlying growth in
users of our platform, and are a measure of our monetization efforts. To
calculate the year-over-year change in MAUs and DAUs for a given period, we
subtract the average for the same period in the previous year from the average
for the same period in the current year and divide the result by the average for
the same period in the previous year. Other companies, including companies in
our industry, may calculate these measures differently or not at all, which
reduces their usefulness as comparative measures.
Three Months Ended December 31, Year Ended December 31,
(Operating metrics are in millions) 2021 2020 2021 2020
Operating Metrics
Monthly active users (MAUs) 42.4 37.0 40.5 36.7
Daily active users (DAUs) 10.1 8.4 9.6 8.2
Paid subscribers (at period end) 2.5 1.6 2.5 1.6
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Year Ended December 31,
2021 2020
Operating Metrics
Subscription bookings $ 224,520 $ 144,379
Total bookings $ 294,247 $ 190,181
Non-GAAP Financial Measures
Net loss (GAAP) $ (60,135) $ (15,776)
Adjusted EBITDA $ (1,066) $ 3,630
Net cash provided by operating activities (GAAP) $ 9,170 $ 17,708
Free cash flow $ 12,746 $ 13,976
Operating Metrics
Monthly active users (MAUs). MAUs are defined as unique Duolingo users who
engage with our mobile language learning application or the language learning
section of our website each month. MAUs are reported for a measurement period by
taking the average of the MAUs for each calendar month in that measurement
period. MAUs are a measure of the size of our global active user community on
Duolingo .
We had approximately 42.4 million and 37.0 million MAUs for the three months
ended December 31, 2021 and 2020, respectively, representing an increase of 15%.
We grew MAUs through product initiatives that made the app more social and
engaging and through brand marketing, both of which helped us attract new users,
retain existing users, and reengage the millions of former users who return to
our language learning app.
Daily active users (DAUs). DAUs are defined as unique Duolingo users who engage
with our mobile language learning application or the language learning section
of our website each calendar day. DAUs are reported for a measurement period by
taking the average of the DAUs for each day in that measurement period. DAUs are
a measure of the consistent engagement of our global user community on Duolingo .
We had approximately 10.1 million and 8.4 million DAUs for the three months
ended December 31, 2021 and 2020, respectively, representing an increase of 20%.
The DAU / MAU ratio, which we believe is an indicator of user engagement,
increased to 23.8% from 22.8% a year ago. We grew DAUs through many of the same
initiatives as we grew MAUs, like making the product more fun and engaging, as
well as through our marketing efforts.
Paid Subscribers. Paid subscribers are defined as users who pay for access to
Duolingo Plus, including subscribers who pay for a family plan, and had an
active subscription as of the end of the measurement period. Each unique user
account is treated as a single paid subscriber regardless of whether such user
purchases multiple subscriptions, and the count of paid subscribers does not
include users who are currently on a free trial or who are non-paying members of
a family plan.
As of December 31, 2021 and 2020, we had approximately 2.5 million and 1.6
million paid subscribers, respectively, representing an increase of 56%. We grew
paid subscribers through product improvements that increased the size of our
free user base, led to higher conversion of free users to paid subscribers, and
by better retaining subscribers.
Subscription Bookings and Total Bookings. Subscription bookings represent the
amounts we receive from purchases of a subscription to Duolingo Plus. Total
bookings represent the amounts we receive from purchases of a subscription to
Duolingo Plus, a registration for a Duolingo English Test, an in-app
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purchase for a virtual good and from advertising networks for advertisements served to our users. We believe bookings provide an indication of trends in our operating results, including cash flows, that are not necessarily reflected in our revenues because we recognize subscription revenues ratably over the lifetime of a subscription, which is generally from one to twelve months. For the years endedDecember 31, 2021 and 2020, we generated$224.5 million and$144.4 million of subscription bookings, respectively, representing an increase of 56%. We grew subscription bookings by selling more first-time and renewal subscriptions as well as subscriptions to subscribers who previously had a subscription and return. As we grow our user base, convert a greater proportion of users to first-time subscribers, increase renewal rates, and increase the proportion of re-subscribers, we increase subscription bookings. For the years endedDecember 31, 2021 and 2020, we generated$294.2 million and$190.2 million total bookings, respectively, representing an increase of 55%. We grew total bookings through the growth in subscription bookings noted above, in addition to growth in Advertising, Duolingo English Test, and other bookings.
Non-GAAP Financial Measures
We use certain non-GAAP financial measures to supplement our Consolidated
Financial Statements, which are presented in accordance with GAAP. These
non-GAAP financial measures include Adjusted EBITDA and free cash flow. We use
these non-GAAP financial measures for financial and operational decision-making
and as a means to evaluate period-to-period comparisons. By excluding certain
items that may not be indicative of our recurring core operating results, we
believe that Adjusted EBITDA and free cash flow provide meaningful supplemental
information regarding our performance. Accordingly, we believe these non-GAAP
financial measures are useful to investors and others because they allow for
additional information with respect to financial measures used by management in
its financial and operational decision-making and they may be used by our
institutional investors and the analyst community to help them analyze the
health of our business. However, there are a number of limitations related to
the use of non-GAAP financial measures, and these non-GAAP measures should be
considered in addition to, not as a substitute for or in isolation from, our
financial results prepared in accordance with GAAP. Other companies, including
companies in our industry, may calculate these non-GAAP financials measures
differently or not at all, which reduces their usefulness as comparative
measures.
Adjusted EBITDA. Adjusted EBITDA is defined as net loss excluding interest
(income) expense, net, income tax provision, depreciation and amortization,
Initial Public Offering ("IPO") and public company readiness costs, stock-based
compensation expenses related to equity awards, tender offer-related costs and
other expenses. Adjusted EBITDA is used by management to evaluate the financial
performance of our business and we present Adjusted EBITDA because we believe it
is helpful in highlighting trends in our operating results and that it is
frequently used by analysts, investors and other interested parties to
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evaluate companies in our industry. The following table presents a reconciliation of our net loss, the most directly comparable financial measure presented in accordance with GAAP, to Adjusted EBITDA.
Year Ended December
31,
(In thousands) 2021 2020
Net loss $ (60,135) $ (15,776)
Interest (income) expense, net (19) (231)
Provision for income taxes 177 68
Depreciation and amortization 2,726 2,256
IPO and public company readiness costs (1) 3,909 282
Stock-based compensation expenses related to equity awards (2) 42,457 17,031
Tender offer-related costs (3) 5,599 -
Other expenses (4) 4,220 -
Adjusted EBITDA $ (1,066) $ 3,630
________________
(1)IPO and public company readiness costs include costs associated with IPO
readiness and establishment of our public company structure and processes,
including consultant costs. These costs are included within our Consolidated
Financial Statements included elsewhere in this Annual Report on Form 10-K as
follows:
Year Ended December 31,
(In thousands) 2021 2020
Research and development $ 46 $ -
Sales and marketing 459 -
General and administrative 3,404 282
Total $ 3,909 $ 282
(2)In addition to stock-compensation expense of $40,804 and $17,031 for the
years ended December 31, 2021 and 2020, respectively, this includes costs
incurred related to taxes paid during 2021 on equity transactions of $1,653 , of
which $631 was included within Research and development, $53 was included within
Sales and marketing and $969 was included within General and administrative in
our Consolidated Statement of Operations and Comprehensive Loss.
(3)Includes costs related to our tender offer initiated in
Research and Sales and General and
(In thousands) Cost of revenues development marketing administrative Total
Tender offer $ 10 $ 3,302 $ 173 $ 1,790 $ 5,275
Fees and taxes paid on
tender offer $ - $ - $ - $ 324 $ 324
Total $ 10 $ 3,302 $ 173 $ 2,114 $ 5,599
(4)Represents one-time cash awards to Duolingo contributors under our
non-employee volunteer program included within Sales and marketing expenses
within our Consolidated Statement of Operations and Comprehensive Loss. See Note
2 included in our Consolidated Financial Statements elsewhere in this Annual
Report on Form 10-K.
Adjusted EBITDA increases as we grow revenue, improve gross margin, and reduce
operating expenses as a percentage of revenue, or through a combination of those
drivers. For the year ended December 31, 2021 , we incurred a loss of $1.1
million and for the year ended December 31, 2020 we generated income of $3.6
million of Adjusted EBITDA, respectively. The decrease in Adjusted EBITDA
occurred because operating expenses, adjusted for costs incurred related to IPO
and public company readiness and other costs which did not occur in the prior
year, grew at a higher rate than revenues and gross profit.
Free Cash Flow: Free cash flow represents net cash provided by operating
activities, reduced by purchases of property and equipment, capitalized software
development costs, and increased by IPO and public company readiness costs,
taxes paid related to stock-based compensation equity awards and other costs, as
we believe they are not indicative of future liquidity. We believe that free
cash flow is a measure of liquidity that provides useful information to our
management, investors and others in
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understanding and evaluating the strength of our liquidity and future ability to
generate cash that can be used for strategic opportunities or investing in our
business. The following table presents a reconciliation of net cash provided by
operating activities, the most directly comparable financial measure calculated
in accordance with GAAP, to free cash flow:
Year Ended December
31,
(In thousands) 2021 2020
Net cash provided by operating activities $ 9,170 $ 17,708
Less: Capitalized software development costs (2,620) (638)
Less: Purchases of property and equipment (3,586) (3,376)
Plus: IPO and public company readiness costs (1) 3,909 282
Plus: Taxes paid related to stock-based compensation equity
awards (2) 1,653 -
Plus: Other (3) 4,220 -
Free cash flow $ 12,746 $ 13,976
________________
(1)IPO and public company readiness costs include costs associated with IPO readiness and establishment of our public company structure and processes, including consultant costs.
(2)Includes costs incurred related to taxes paid on equity transactions.
(3)Represents payment of one-time cash awards toDuolingo contributors under our non-employee volunteer program included within Sales and marketing expenses within our Consolidated Statement of Operations and Comprehensive Loss. See Note 2 to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K. For the years endedDecember 31, 2021 and 2020, we generated$12.7 million and$14.0 million of free cash flow, respectively. The decrease in free cash flow was mainly attributable to the decrease in net cash provided by operating activities in addition to higher capitalized software development costs and capital expenditures.
Impact of COVID-19
To date, the COVID-19 pandemic has not had a significant, negative impact on our operations or financial performance. We believe that COVID-19 increased our operating metrics and financial metrics for a period of time in 2020 due, in part, to stay at home and other social distancing measures, most notably in the second quarter. The pandemic also increased adoption of the Duolingo English Test. Because this increase was driven in part by increased acceptance of the test, and because we believe that the vast majority of universities are unlikely to stop accepting the test when the pandemic ends, we do not expect theDuolingo English Test to revert to pre-pandemic levels. The extent of the impact of the COVID-19 pandemic on our operational and financial performance, however, depends on certain developments, including ongoing social distancing measures, and future prevention and mitigation measures, as well as the potential for some of these measures to be reinstituted in the event of repeat waves of the virus. Any such developments may have adverse impacts on global economic conditions and consumer confidence and spending, and could materially adversely affect demand, or subscribers' ability to pay, for our products and services. For additional information, see "Risk Factors-General Risk Factors-Our business and results of operations may be materially adversely affected by the recent COVID-19 outbreak or other similar outbreaks." Seasonality
We experience some seasonality in both user growth and monetization on our platform. Historically, the number of users on our platform and the number of subscribers we have increase in January and then
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moderate throughout the first quarter and second quarter back to our secular growth trend. In the third quarter, historically, we've seen the number of users on our platform increase as our product is used by students that return to school in certain geographies. Finally, in the latter part of December, as the new year approaches, we see an increase in usage as people makeNew Years resolutions, including resolutions to learn new things like languages. Monetization, through an increase in subscribers, also increases at the end of December and into January when we run a promotion tied to the New Year holiday.
Results of Operations
Comparison for the Years Ended
Revenue
We generate revenues primarily from the sale of subscriptions. The term-length of our subscription agreements are primarily monthly or annual. We began to roll out a family plan during the second half of 2021 and as ofDecember 31, 2021 offer it exclusively as an annual subscription. We have historically had a six-month subscription plan but during the fourth quarter of 2020, we began to phase it out. We also generate revenue from advertising, the in-app sale of virtual goods, and our English assessment test, the Duolingo English Test.
Cost of Revenues
Cost of revenues predominantly consists of third-party payment processing fees charged by various distribution channels, and also includes hosting fees. To a much lesser extent, cost of revenues includes costs for contractors, wages and stock-based compensation for certain employees in the capacity of customer support, amortization of revenue generating capitalized software, and depreciation of certain property and equipment. We intend to continue to invest additional resources in our infrastructure and our customer support and success organization to expand the capabilities of our platform and ensure that our users are realizing the full benefit of our products. The level, timing, and relative investment in these areas could affect our cost of revenues in the future.
Gross Profit and Gross Margin
Gross profit represents revenues less cost of revenues. Gross margin is gross profit expressed as a percentage of revenues. Our gross profit may fluctuate from period to period as our revenues fluctuate, and also as a result of the timing and amount of investments we make in items related to cost of revenues.
Operating Expenses
Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, and stock-based compensation expense. Operating expenses also include overhead costs for facilities, including depreciation expense. Research and Development. We invest heavily in research and development in order to drive user engagement and customer satisfaction on our platform, which we believe helps to drive organic growth of new users. This, in turn, drives additional growth in, and better lifetime value of, our paid subscribers, as well as increased advertising revenue from impressions from our free users. Expenses are primarily made up of costs incurred for the development of new and improved products and features in our applications. Such expenses include compensation of engineers, designers, product managers, including stock-based
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compensation, materials, travel and direct costs associated with the design and required testing of our platform. We expect engineers, designers, and product managers to represent a significant portion of our employees for the foreseeable future. We regularly test product improvements with our users. Many of these tests start by making small changes in the product that affect small numbers of users. As the tests evolve, they can require increasing investment and can impact more users. This process of constant testing is how we implement many of our new products and improvements to our platform and, in total, require large investments and involve substantial time and risks to develop and launch. Some of these products may not be well received or may take a long time for users to adopt. As a result, the benefits of our research and development investments may be difficult to forecast. We expect to continue to spend a significant portion of our revenues on research and development in the future. Sales and Marketing. Sales and marketing expenses are expensed as incurred and consists primarily of brand advertising, marketing, digital and social media spend, field marketing, travel, trade show sponsorships and events, conferences and employee-related compensation, including stock-based compensation for personnel engaged in sales and marketing functions, and amortization of non-revenue generating capitalized software used to promoteDuolingo . We expect our sales and marketing expenses will decline as a percentage of revenues over the long-term. General and Administrative. General and administrative expenses primarily consist of employee-related compensation, including stock-based compensation, for management and administrative functions, including our finance and accounting, legal, and people teams. General and administrative expenses also include certain professional services fees, general corporate and director and officer insurance, our facilities costs, and other general overhead costs that support our operations. We expect to incur additional general and administrative expenses as a result of operating as a public company, including expenses to comply with the rules and regulations of theSEC and the Listing Rules of the Nasdaq Global Select Market, as well as higher expenses for corporate insurance, director and officer insurance, investor relations, and professional services. We expect that our general and administrative expenses will increase in absolute dollars as our business grows. However, we expect that our general and administrative expenses will remain steady or decrease as a percentage of our revenues as our revenues grow faster than these expenses over the long-term.
Other Income, Net of Other Expenses
Other income, net of other expenses consists primarily of foreign currency exchange gains and losses in addition to interest expense, partially offset by income earned on our money market funds included in cash and cash equivalents and on our marketable securities.
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The following table sets forth our Consolidated Statement of Operations and
Comprehensive Loss data, including year-over-year change, for the periods
indicated:
Year Ended December 31,
(in thousands) 2021 2020 % Change
Revenues $ 250,772 $ 161,696 55 %
Cost of revenues (1) (2) 69,186 45,987 50
Gross profit 181,586 115,709 57
Operating expenses:
Research and development (1) 103,833 53,024 96
Sales and marketing (1) (2) 59,170 34,983 69
General and administrative (1) 78,590 43,713 80
Total operating expenses 241,593 131,720 83
Operating loss (60,007) (16,011) 275
Other income, net of other expenses 49 303 (84)
Loss before provision for income taxes (59,958) (15,708) 282
Provision for income taxes 177 68 160
Net loss and comprehensive loss $
(60,135)
________________
(1)Includes stock-based compensation expenses as follows:
Year Ended December 31,
(In thousands) 2021 2020
Cost of revenues $ 8 $ 6
Research and development 9,298 2,773
Sales and marketing 881 348
General and administrative 30,617 13,904
Total $ 40,804 $ 17,031 (2)Includes amortization of capitalized software as follows:
Year Ended December 31,
(In thousands) 2021 2020
Cost of revenues (a) $ - $ 86
Sales and marketing (a) 693 546
Total $ 693 $ 632
________________(a)Amortization of capitalized software is recorded to cost of revenues and selling and marketing for revenue and non-revenue generating capitalized software, respectively.
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The following table sets forth the components of our Consolidated Statement of
Operations and Comprehensive Loss for each of the periods presented as a
percentage of revenue.
Year Ended December 31,
2021 2020
Revenues 100 % 100 %
Cost of revenues 28 28
Gross profit 72 72
Operating expenses:
Research and development 41 33
Sales and marketing 24 22
General and administrative 31 27
Total operating expenses 96 82
Operating loss (24) (10)
Other income, net of other expenses - -
Loss before provision for income taxes (24) (10)
Provision for income taxes - -
Net loss and comprehensive loss (24) % (10) %
Revenues. Revenues increased$89.1 million , or 55%, to$250.8 million during the year endedDecember 31, 2021 , from revenues of$161.7 million during the year endedDecember 31, 2020 . The main driver was an increase in subscription revenue of$63.2 million , primarily due to an increase in the average number of paid subscribers during the year endedDecember 31, 2021 as compared to the year endedDecember 31, 2020 . In addition, advertising revenues increased$11.5 million . The increase was predominantly driven by the increase in average revenue per DAU for our ads and also by the increase in DAUs, which resulted in increased advertisements served, during the year endedDecember 31, 2021 as compared to the year endedDecember 31, 2020 . Duolingo English Test revenue increased by$9.5 million due to the growth in the number of tests taken, which was in turn driven by an increase in the number of institutions that accept our test and our marketing efforts. Finally, other revenue increased$4.9 million , due to growth of in-app purchases.
The following table provides the changes in revenues by product type:
Year Ended December 31,
(in thousands) 2021 2020 Change % Change
Subscription $ 180,698 $ 117,501 $ 63,197 54 %
Advertising 38,501 27,043 11,458 42 %
Duolingo English Test 24,658 15,155 9,503 63 %
Other 6,915 1,997 4,918 246 %
Total revenues $ 250,772 $ 161,696 $ 89,076 55 %
Cost of Revenues and Gross Margin. Total gross margin increased to 72.4% during
the year ended December 31, 2021 , from 71.6% during the year ended December 31,
2020 . This increase is mainly due to increased subscription margins driven by
reduced payment processing fees for subscription revenue due to improved
retention, and increased advertising margins driven by an increase in average
revenues per DAU for ads served to free users, which was partially offset by a
decrease in Duolingo English Test margins driven by increased proctoring costs.
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The following table provides the change in cost of revenues, along with related
gross margins:
Year Ended December 31,
2021 2020
(in thousands) Costs Gross Margin Costs Gross MarginTotal cost of revenues$ 69,186 72.4 %$ 45,987 71.6 % Operating Expenses Research and Development. Research and development expense increased$50.8 million , or 96%, to$103.8 million during the year endedDecember 31, 2021 from$53.0 million during the year endedDecember 31, 2020 . The increase is mainly attributable to our growth in headcount leading to an increase in employee costs of$41.4 million , of which$3.3 million was related to the tender offer,$1.3 million of it related to RSU expense recorded upon the IPO, in addition to$4.2 million of it related to contractor costs. Research and development continues to be our largest operating expense as we invest heavily in it in order to drive user engagement with and customer satisfaction in our platform, which we believe helps to drive organic growth in MAUs and DAUs; this in turn drives additional growth in, and better retention of, paid subscribers, as well as increased advertising opportunities with free users. Sales and Marketing. Sales and marketing expense increased$24.2 million , or 69%, to$59.2 million during the year endedDecember 31, 2021 from$35.0 million during the year endedDecember 31, 2020 . While we incurred$4.2 million of costs related to one-time cash awards we granted toDuolingo contributors under our non-employee volunteer program, which we refer to as contributor awards, and$3.8 million of additional expenses related to employee costs, of which$0.2 million was related to the tender offer and$0.2 million of it related to RSU expense recorded upon the IPO, the majority of the increase was driven by spending on performance marketing where we found opportunities to grow quality DAUs at low cost and from brand marketing in priority markets such asJapan ,India andSoutheast Asia . See Note 2 to our Consolidated Financial Statements included elsewhere in this this Annual Report on Form 10-K for further discussion of the contributor awards. General and Administrative. General and administrative expense increased$34.9 million , or 80%, to$78.6 million during the year endedDecember 31, 2021 from$43.7 million during the year endedDecember 31, 2020 . The main drivers of this increase were related to the following: •Increased stock-based compensation costs of$22.5 million which were recognized upon the IPO, offset by a decline of$10.2 million related to theNovember 2020 secondary transaction which did not occur in 2021. Stock-based compensation costs recognized upon the IPO relate to the following:
•$5.6 million of costs related to the acceleration of founder stock options,
•$0.5 million of costs related to RSUs granted in prior periods, where the performance based vesting condition was satisfied upon the IPO, and
•$16.4 million of costs related to the performance-based RSUs issued to our founders which will continue through the life of the plan,
•Increased employee related costs of$8.0 million due to the growth in headcount in addition to$1.8 million of stock-based compensation costs related to the tender offer,
•Professional fees of
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•Increased costs incurred to expand to our facilities footprint of
•Increased insurance costs associated with being a public company of
•Other increases of
Other Income, Net of Expenses
Other income, net of other expenses decreased
Liquidity and Capital Resources
Since inception, we have financed operations primarily through revenues and the net proceeds we have received from the issuance of equity and debt securities. Prior to going public, we raised a total of$183.3 million in capital financing, less issuance costs of$0.7 million . Additionally, we received aggregate net proceeds of$431.1 million from the IPO onJuly 30, 2021 , after deducting underwriting discounts and fees of$24.5 million . The Company paid an additional$4.9 million related to offering costs. As ofDecember 31, 2021 , we had$553.9 million in cash and cash equivalents. Our cash and cash equivalents primarily consist of bank deposits and money market funds. Our marketable securities consist US government treasury and agency securities. We believe that our existing cash and cash equivalents, and cash flow from operations will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our subscription growth rate and renewal activity, the timing of cash received from our payment processing platforms, the expansion of our sales and marketing activities, the introduction of new products and the enhancements to existing products, and the current uncertainty in the global markets resulting from the ongoing COVID-19 pandemic on our operations. We may be required to seek additional equity. If we are unable to raise additional capital or generate cash flows necessary to expand our operations and invest in continued innovation, we may not be able to compete successfully, which would harm our business, operations and financial condition. A substantial source of our cash from operations comes from deferred revenue, which is included in the liabilities section of our Consolidated Balance Sheet. Deferred revenues consists of the unearned portion of customer billings, which is recognized as revenue in accordance with our revenue recognition policy. As ofDecember 31, 2021 , we had deferred revenues of$98.3 million , which is recorded as a current liability and expected to be recognized as revenue in the next 12 months, provided all other revenue recognition criteria have been met.
The following table summarizes our cash flows for the periods presented:
Year Ended December 31 ,
(in thousands) 2021 2020
Net cash provided by operating activities$ 9,170 $
17,708
Net cash used for investing activities (6,206)
(4,014)
Net cash provided by financing activities 430,468
46,953
Net increase in cash and cash equivalents$ 433,432 $ 60,647 Operating Activities 71
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Cash flows from operating activities can fluctuate significantly from period to period due to timing of payments and cash collections. Our largest source of operating cash is cash collection from sales of subscriptions to our users. Our primary uses of cash from operating activities are for personnel expenses, marketing expenses, hosting expenses and overhead expenses. Cash provided by operating activities for the year endedDecember 31, 2021 decreased$8.5 million , or 48%, to$9.2 million . This decrease was due mainly to an increase in net loss for the periods presented, partially offset by increases from changes in working capital.
Investing Activities
Cash used in investing activities increased$2.2 million , or 55%, to$6.2 million for the year endedDecember 31, 2021 , from investing activities for the year endedDecember 31, 2020 of$4.0 million . The increase is due to increased costs from capitalization of software development and capital expenditures to purchase property and equipment to support office space and site operations.
Financing Activities
Cash provided by financing activities for the year endedDecember 31, 2021 was$430.5 million , and was mainly driven by the net proceeds from the IPO of$431.1 million , less offering expenses of$4.9 million , and proceeds from exercises of stock options of$12.5 million . These increases were partially offset by payments made as a result of the tender offer of$8.2 million . Cash provided by financing activities for the year endedDecember 31, 2020 was$47.0 million and primarily relates to the issuance of convertible preferred stock, net of issuance costs, of$44.9 million , in addition to proceeds from exercises of stock options of$2.0 million .
Contractual Obligations
The following table summarizes our contractual obligations and commitments as ofDecember 31, 2021 : Payments Due by Period Less than 1 More than 5 Total Year 1-3 Years 3-5 Years years Operating lease commitments (1)$ 44,391 $ 5,153 $ 11,196 $ 6,279 $ 21,763 Other commitments (2) 23,000 10,500 12,500 - - Total contractual obligations$ 67,391 $ 15,653 $ 23,696 $ 6,279 $ 21,763 ________________ (1)Consists of future non-cancelable minimum rental payments under operating lease obligations, excluding short-term leases. Refer to Note 6 to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for additional information. (2)Other commitments consist of hosting costs. We are committed to spend$25.0 million over two years, with a minimum spend of$10.5 million in the first year and$12.5 million in the second year.
Off-Balance Sheet Obligations
We did not have during the periods presented, and we do not currently have any off-balance sheet financing arrangements or any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities, that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
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Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions about future events that affect amounts reported in our Consolidated Financial Statements and related notes, as well as the related disclosure of contingent assets and liabilities at the date of the financial statements. Management evaluates its accounting policies, estimates and judgments on an ongoing basis. Management bases its estimates and judgments on historical experience, current trends and various other factors that are believed to be relevant at the time Consolidated Financial Statements are prepared. Actual results may differ from these estimates under different assumptions and conditions. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected. Management evaluated the development and selection of its critical accounting policies and estimates and believes that the following involve a higher degree of judgment, complexity or uncertainty and are most significant to reporting our results of operations and financial position, and are therefore discussed as critical. The following critical accounting policies reflect the significant estimates and judgments used in the preparation of our Consolidated Financial Statements. Revenue Recognition Nature of Revenue We account for revenue contracts with customers by applying the five step model in Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers. Our predominant sources of revenue are time-based subscriptions, in-app advertising placement by third parties and the Duolingo English Test. Revenue is recognized upon transfer of control of promised goods or services to customers in an amount that reflects the consideration expected to be received in exchange for those goods or services. Revenue is recognized net of any taxes collected from customers, which are subsequently remitted to governmental authorities. Revenue from time-based subscriptions includes a stand-ready obligation to provide hosting services that are consumed by the customer over the subscription period. Users can purchaseDuolingo monthly or they can purchase a six-month or year-long subscription and pay for the subscription at the time of purchase. Under the year-long subscription, users can purchase a single plan or a family plan. The family plan includes up to six users to be on one subscription. Such payments are initially recorded to deferred revenue. The user has the ability to download limited content offline. However, as there is a significant level of integration and interdependency with the online functionality, we consider the service to be a single performance obligation for the online and offline content. We enter into arrangements with advertising networks to monetize the in-app advertising inventory. Revenue from in-app advertising placement is recognized at a point in time when the advertisement is placed and is based upon the amount received. Duolingo English Test revenue is generally recognized once the tests have gone through the proctoring process and a certification decision has been made. This process usually takes less than 48 hours after the test has been completed and uploaded. Customers have 21 days from the date of purchase to take the exam or their purchase will expire and revenue will be recognized. The vast majority of customers complete their exams prior to expiration. Sometimes organizations may purchase tests in bulk via coupons with a one year expiration date. We defer revenue from all tests that have not been proctored nor expired.
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Our users have the option to purchase consumable in-app virtual goods. We recognize revenue over the period in which the user consumes the virtual good, which is generally within a month.
Principal Agent Considerations-We make our application available to be downloaded through third-party digital distribution service providers. Users who purchase subscriptions also pay through the respective app stores. We evaluate the purchases via third-party payment processors to determine whether its revenues should be reported gross or net of fees retained by the payment processor. We are the principal in the transaction with the end user as a result of controlling, hosting, and integrating the delivery of the virtual items to the end user. We record revenue gross as a principal and record fees paid to third-party payment processors as Cost of revenues.
Significant Judgment Around Revenue Arrangements with Multiple Deliverables
Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Our time-based subscriptions allow users the ability to download limited content offline. Significant judgment is required to determine whether this offline content should be considered distinct and accounted for separately, or not distinct and accounted for together with the online functionality provided and recognized over time. As there is a significant level of integration and interdependency with the online functionality, which is not the case with the offline functionality, we believe we have a single performance obligation for the online functionality and offline content.
Equity Based Compensation
We follow ASC 718, Compensation-Stock Compensation, to account for our equity based compensation.
Stock-based Compensation ASC 718 requires all stock-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. We generally grant our option awards in a combination of service-based and performance-based. We measure the fair value of our options on the date of grant using the Black-Scholes pricing model which requires the use of several estimates, including the volatility of our share price, the expected life of the option, risk free interest rates and expected dividend yield. The use of different assumptions in the Black-Scholes pricing model would result in different amounts of equity based compensation expense. Furthermore, if different assumptions are used in future periods, our equity based compensation expense could be materially impacted in the future. Prior to the completion of our IPO, we were not a publicly traded company and had only limited historical information on the price of our common stock as well as employees' option exercise behavior. As a result, we could not rely on historical experience alone to develop assumptions for our share price volatility. As such, our share price volatility was estimated with reference to a peer group of companies. Subsequent to the completion of our IPO, we transitioned to utilize the closing price of our publicly-traded stock to determine our volatility. We determined the expected life of our options using the simplified method described in theSEC Staff Accounting Bulletin Topic 14, Share-Based Payment, which defines the expected life as the average of the contractual term and the vesting period. The risk-free interest rate is based on the yield curve of a zero-couponUS Treasury bond on the date the option award was granted with a maturity equal to the expected term of the option award. We have not and do not expect to pay dividends on our common shares. See Note 9, "Stock Based Compensation," to our Consolidated Financial Statements appearing elsewhere in Annual Report on Form 10-K, for further information on equity based compensation. 74
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Restricted Stock Units (RSUs)
We began to grant RSUs inNovember 2020 . The fair value of RSUs is estimated based on the fair value of our common stock on the date of grant. Each RSU award vests based upon the satisfaction, during the term of the RSUs, of two requirements: length of service and a liquidity event defined as a change in control or a qualified IPO. The service-based vesting condition for the majority of these awards is satisfied over four years. The liquidity-based vesting condition is satisfied upon the occurrence of a qualifying liquidity event. We measure and recognize compensation expense for all stock-based awards based on the estimated fair value of the award. Prior toJuly 30, 2021 , no stock-based compensation expense had been recognized for RSUs because the liquidity-based vesting condition had not been probable of being satisfied. Upon the IPO, the liquidity-based vesting condition was met and$2,035 of stock-based compensation expense was recognized related to these awards.
Performance-based RSUs
InJune 2021 , we granted an aggregate of 1.8 million performance-based RSUs ("Founder Awards") to our founders. The Founder Awards vest upon the satisfaction of both a service-based condition and a performance-based condition and generally are settled one year after vesting. The service-based condition is satisfied as to 25% of the Founder Awards on each anniversary of the completion of the IPO, subject to the continuous service of the founders through the applicable date. The performance-based condition will be satisfied with respect to each of ten equal tranches only upon the achievement of the specified stock-price hurdles for each such tranche over a period of ten years from the date of grant. The fair value of the Founder Awards is determined using a model based on multiple stock-price paths developed through the use of a Monte Carlo simulation that incorporates into the valuation the possibility that the stock-price hurdles may not be satisfied. The associated stock-based compensation is recorded over the derived service period, using the accelerated attribution method. If the stock-price hurdles are met sooner than the requisite service period, the stock-based compensation expense will be adjusted to prospectively recognize the remaining expense over the remaining derived service period. Provided that the founders continue to provide services to us, stock-based compensation expense is recognized over the derived service period, regardless of whether the stock-price hurdles are achieved.
Common Stock Valuations
Subsequent to our IPO inJuly 2021 , the fair value of common stock is determined based upon the closing price of our Class A common stock immediately prior to the grant date. Prior to our IPO, determining the fair value of our common stock requires complex and subjective judgment and estimates. There is inherent uncertainty in making these judgments and estimates. The absence of an active market for our common stock required our board of directors to estimate the fair value of the common stock for purpose of setting the exercise price of the options and estimating the fair value of the common stock at the time options were granted based on factors such as valuations of comparable companies, the status of our development and sales efforts, revenue growth, and additional objective and subjective factors relating to our business. We performed its analysis in accordance with applicable elements of the practice aid issued by theAmerican Institute of Certified Public Accountants' ("AICPA") Practice Guide, Valuation of Privately Held Company Equity Securities Issued as Compensation; with this guidance, our board of directors exercised reasonable judgment and considered numerous and subjective factors to determine the best estimate of fair value of our common stock, including the following:
Company Specific Factors
•Actual and forecasted operating and financial performance based on management's estimate;
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•The development and maintenance of client relationships;
•Client and industry recognition;
•The hiring and retention of key personnel;
•The historical lack of a public market for our common stock;
General Economic Factors
•Industry trends and competitive environment;
•Trends in client and the at-large public spending, including client and public confidence;
•Overall economic indicators;
•The general economic outlook; and
•The common stock valuations have historically leveraged the historical appraisals we have received to value our common stock, utilizing an income approach.
Income Taxes
Deferred tax assets and liabilities are recognized principally for the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts, using currently enacted tax rates. The measurement of a deferred tax asset is reduced, if necessary, by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. Significant judgment is required in evaluating the need for and magnitude of appropriate valuation allowances. The realization of our deferred tax assets is dependent on generating future taxable income and the reversal of existing temporary differences. Changes in tax laws and assumptions with respect to future taxable income could result in adjustment to these allowances. As ofDecember 31, 2021 , we maintained a valuation allowance of approximately$76,293 against net deferred tax assets related to both domestic and foreign net operating loss carryforwards, and state research and development credit carryovers as its future utilization remained uncertain. In addition, we recognize a tax benefit for uncertain tax positions only if we believe it is more likely than not that the position will be upheld on audit based solely on the technical merits of the tax position. We evaluate uncertain tax positions after the consideration of all available information.
Recent Accounting Pronouncements
See Note 2, Basis of Presentation and Summary of Significant Accounting Policies in the notes to our Consolidated Financial Statements included in Part I, Item I of this Annual Report on Form 10-K for a discussion of Recent Accounting Pronouncements.
Emerging Growth Company Status
We are an "emerging growth company" as defined under the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards would otherwise apply to private companies. While we have not historically delayed the adoption of new or revised accounting standards until such time as those standards would apply to private companies, we have elected to take advantage of this extended transition period and, as a result, our operating results and financial statements in the future may not be comparable to the operating results and financial statements of companies who have adopted the new or revised accounting standards.
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