Duolingo, Inc. (DUOL) FY 2022 MD&A

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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. The following 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. 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 over 60 million monthly active users for the three months ended December 31, 2022. 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

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On July 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. Additionally, on July 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 the Duolingo 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 more than 60 million MAUs for the three months ended December 31, 2022. These millions of learners provide two benefits to our business model:

◦They become advocates for Duolingo 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 900 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. As of December 31, 2022, subscribers made up 7.8% of our average MAUs over the last twelve months as compared to 6.2% of our average MAUs during the year ended December 31, 2021.

Subscription

Our subscription offering is called Super Duolingo. 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.

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

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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 the Duolingo 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 of Duolingo English Test revenue. As of December 31, 2022, over 3,800 higher education programs around the world accept the Duolingo English Test results as proof of English proficiency for international student admissions, including the top 25 undergraduate programs ranked by international enrollment, as well as top schools such as Yale, Stanford, MIT, Duke and Columbia.

The Company also recognizes revenue from Dos Lenguas LLC, “Duo’s Taquería,” a restaurant that opened during 2022, in the space adjacent to our headquarters in Pittsburgh.

Basis of Presentation

Items within Management's Discussion and Analysis of Financial Condition and Results of Operations include a discussion of changes between the years ended December 31, 2022 and 2021. For a discussion of changes from the year ended December 31, 2021 to the year ended December 31, 2020, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operation in Part II, Item 7. of our Annual report on Form 10-K for the year ended December 31, 2021 (filed with the SEC on March 3, 2022).

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.

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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. The measurement period for MAUs is the three months ended December 31, 2022 and the same period in the prior year where applicable, and the analysis of results is based on those periods. MAUs are a measure of the size of our global active user community on Duolingo.

We had approximately 60.7 million and 42.4 million MAUs for the three months ended December 31, 2022 and 2021, respectively, representing an increase of 43% from the prior year period. We grew MAUs through product initiatives designed to make the app more social and engaging, through marketing and through improving our courses, all of which we believe 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. The measurement period for DAUs is the three months ended December 31, 2022 and the same period in the prior year where applicable, and the analysis of results is based on those periods. DAUs are a measure of the consistent engagement of our global user community on Duolingo.

We had approximately 16.3 million and 10.1 million DAUs for the three months ended December 31, 2022 and 2021, respectively, representing an increase of 62% from the prior year period. The DAU / MAU ratio, which we believe is an indicator of user engagement, increased to 26.9% from 23.8% a year ago. We grew DAUs through many of the same product initiatives as we grew MAUs, such as making the product more fun and engaging.

Paid Subscribers. Paid subscribers are defined as users who pay for access to Super Duolingo, 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.

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As of December 31, 2022 and 2021, we had approximately 4.2 million and 2.5 million paid subscribers, respectively, representing an increase of 67% from the prior year period. We grew paid subscribers through product improvements that led to higher subscriber conversion and steady subscriber retention.

Subscription Bookings and Total Bookings. Subscription bookings represent the amounts we receive from a purchase of a subscription to Super Duolingo. Total bookings represent the amounts we receive from a purchase of a subscription to Super Duolingo, a purchase of a Duolingo English Test, an in-app 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 ended December 31, 2022 and 2021, we generated $331.8 million and $224.5 million of subscription bookings, respectively, representing an increase of 48% from the prior year period. We grew subscription bookings by selling more first-time and renewal subscriptions. Subscription bookings grow when we convert a greater proportion of users to first-time subscribers, and increase renewal rates.

For the years ended December 31, 2022 and 2021, we generated $428.6 million and $294.2 million of total bookings, respectively, representing an increase of 46% from the prior year period. We grew total bookings through the growth in subscription bookings noted above, in addition to growth in advertising, the Duolingo English Test, and other bookings, primarily related to in-app purchases.

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 financial measures differently or not at all, which reduces their usefulness as comparative measures.

The Company also uses non-GAAP constant currency revenues and non-GAAP percentage change in constant currency revenues, which exclude the impact of fluctuations in foreign currency exchange rates, for financial and operational decision-making and as a means to evaluate period-to-period comparisons. The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons and we believe this information is useful to investors to facilitate comparisons and better identify trends in our business. The impact of changes in foreign currency may vary significantly from period to period, and such changes generally are outside of the control of our management. We calculate constant currency revenues by using current period foreign currency revenues and translating them to constant currency using prior year comparable period exchange rates. Constant currency revenue percentage change is calculated by determining the change in current period revenues over prior year comparable period revenues where current period foreign currency revenues are translated using prior year comparable period exchange rates.

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Adjusted EBITDA. Adjusted EBITDA is defined as net loss excluding interest (income) expense, net, income tax provision, depreciation and amortization, stock-based compensation expenses related to equity awards, IPO and public company costs, transaction costs related to an acquisition, 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 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.

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(1)In addition to stock-based compensation expense of $73.8 million and $40.8 million for the years ended December 31, 2022 and 2021, respectively, this includes costs incurred related to taxes paid on equity transactions as follows:

(2)IPO and public company costs include costs associated with IPO readiness incurred in 2021 and costs associated with the establishment of our public company structure and processes, including consultant costs, a one-time fee associated with the set-up of our initial proxy statement, and fees paid to consultants and Deloitte for work in connection with remediation of the material weakness disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. These costs are included in our Consolidated Statements of Operations and Comprehensive Loss as follows:

(3)Represents costs incurred related to an acquisition including due diligence, valuation and integration costs, which is included within General and administrative within our Consolidated Statements of Operations and Comprehensive Loss.

(4)Represent costs incurred related to the earn-out payment on the acquisition, which is included within General and administrative within our Consolidated Statements of Operations and Comprehensive Loss.

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(5)Includes costs related to our tender offer initiated in February 2021 including fees incurred, as follows:

(6)Represents one-time cash awards to Duolingo contributors under our non-employee volunteer program included within Sales and marketing expenses within our Consolidated Statements of Operations and Comprehensive Loss.

For the year ended December 31, 2022 and 2021, we generated Adjusted EBITDA of $15.5 million and an Adjusted EBITDA loss of $1.1 million, respectively. Adjusted EBITDA increased in both periods due to a combination of our growth in revenue, improved gross margin, and reduction in operating expenses as a percentage of revenue as compared to the prior year periods.

Free Cash Flow: Free cash flow represents net cash provided by operating activities, reduced by capitalized software development costs and purchases of property and equipment, and increased by IPO and public company costs, transaction costs related to an acquisition, 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 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. Free cash flow has certain limitations in that it does not represent our residual cash flow for discretionary expenditures and our non-discretionary commitments. 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:

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(1)IPO and public company costs include costs associated with IPO readiness incurred in 2021 and costs associated with the establishment of our public company structure and processes, including consultant costs, a one-time fee associated with the set-up of our initial proxy statement, and fees paid to consultants and Deloitte for work in connection with remediation of the material weakness disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

(2)Represents costs incurred related to an acquisition including due diligence, valuation and integration costs, which is included within General and administrative within our Consolidated Statements of Operations and Comprehensive Loss.

(3)Represent costs incurred related to the earn-out payment on the acquisition, which is included within General and administrative within our Consolidated Statements of Operations and Comprehensive Loss.

(4)Includes taxes paid on equity transactions.

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(5)Represents one-time cash awards to Duolingo contributors under our non-employee volunteer program included within Sales and marketing expenses within our Consolidated Statements of Operations and Comprehensive Loss.

For the year ended December 31, 2022 and 2021, we generated $46.2 million and $12.7 million of free cash flow, respectively. The increase in free cash flow in both periods was mainly attributable to the increase in net cash provided by operating activities.

Constant Currency: The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons. We use non-GAAP constant currency revenues and non-GAAP percentage change in constant currency revenues for financial and operational decision-making and as a means to evaluate period-to-period comparisons.

Total revenues were $369,495 for the year ended December 31, 2022, an increase of 47% over the year ended December 31, 2021 on a reported basis, and 51% on a constant currency basis. Subscription revenues totaled $273,507 for the year ended December 31, 2022, an increase of 51% over the year ended December 31, 2021 on a reported basis, and 55% on a constant currency basis.

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 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 make New 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 December 31, 2022 and 2021

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 of December 31, 2022 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 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.

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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 employee-related compensation, including stock-based compensation, of engineers, designers, and product managers, in addition to 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 and product improvements 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 promote Duolingo. 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, public company costs to comply with the rules and regulations of the SEC and the Listing Rules of the Nasdaq Global Select Market, and other general overhead costs that support our operations. 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.

Interest Income

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Interest income consists of income earned on our money market funds included in cash and cash equivalents and on our marketable securities.

Other (Expense) Income, Net

Other (expense) income, net consists primarily of foreign currency exchange losses and gains losses.

Provision for Income Taxes

The provision for income taxes represents the income tax expense associated with our operations based on the tax laws of the jurisdictions in which we operate. These foreign jurisdictions have different statutory tax rates than the United States. Our effective tax rates will vary depending on the relative proportion of foreign to domestic income, changes in the valuation of our deferred tax assets and liabilities, and changes in tax laws.

The following table sets forth our Consolidated Statements of Operations and Comprehensive Loss data, including year-over-year change, for the periods indicated:

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(1)Includes stock-based compensation expenses as follows:

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(2)Includes amortization of capitalized software and depreciation of property and equipment as follows:

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(a) Amortization of capitalized software is recorded to Cost of revenue and Sales and marketing for revenue and non-revenue generating capitalized software, respectively.

The following table sets forth the components of our Consolidated Statements of Operations and Comprehensive Loss for each of the periods presented as a percentage of revenue.

Revenues

Revenues increased $118.7 million, or 47%, to $369.5 million during the year ended December 31, 2022, from revenues of $250.8 million during the year ended December 31, 2021. The main drivers of the increase for both periods were:

•Subscription revenue increased $92.8 million during the year ended December 31, 2022, primarily due to an increase in the average number of paid subscribers during the periods presented;

•Advertising revenue increased $6.2 million during the year ended December 31, 2022. These increases were driven by the increase in DAUs, which resulted in increased advertisements served, but partially offset by advertising pricing declines during the periods presented;

•Duolingo English Test revenue increased by $8.1 million during the year ended December 31, 2022 due to an increase in the number of international students taking the Duolingo English Test, driven in part by marketing efforts; and

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•Other revenue increased $11.6 million during the year ended December 31, 2022, primarily due to increase in DAUs and average in-app purchase revenue per user.

The following table provides the changes in revenues by product type:

Cost of Revenues and Gross Margin. Total gross margin increased to 73.1% during the year ended December 31, 2022 from 72.4% during the year ended December 31, 2021, respectively. This increase in both periods is mainly due to increased subscription margins from both improved retention and reduction in fees charged by the Google Play store. Offsetting this increase was a decline in Advertising margins, which was primarily due to decreases in average advertising revenue per DAU.

The following table provides the change in cost of revenues, along with related gross margins:

Operating Expenses

Research and Development. Research and development expense increased $46.6 million, or 45%, to $150.4 million during the year ended December 31, 2022 from $103.8 million during the year ended December 31, 2021. The increase was mainly due to:

•Increased employee costs from headcount growth of $40.3 million during the year ended December 31, 2022. This increase was partially offset by costs incurred in the year ended December 31, 2021 which did not occur again in the current year related to:

•$3.3 million of costs incurred in the prior year related to the tender offer, and

•$1.3 million in stock-based compensation expense from restricted stock units (RSUs),

•Increased web services and technology costs of $4.0 million,

•Increased contractor costs of $3.7 million,

•Increased travel and meal costs of $2.5 million due to the easing of restrictions related to COVID-19, and

•Increased other costs of $0.7 million incurred as our headcount grows and we expand our facilities footprint.

Research and development continues to be our largest operating expense as we invest in it in order to drive user engagement with and customer satisfaction in our platform. This engagement and satisfaction, we believe, helps to drive organic growth in MAUs and DAUs, growth in, and better retention of, paid subscribers, as well as increased advertising opportunities with free users.

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Sales and Marketing. Sales and marketing expense increased $7.8 million, or 13%, to $67.0 million during the year ended December 31, 2022 from $59.2 million during the year ended December 31, 2021. This increase was mainly due to increase in employee costs of $6.0 million due to the growth in headcount in addition to increased direct marketing and other expenses of $6.4 million. These increases were partially offset by $4.2 million of costs incurred during the prior year related to the awards paid as part of phasing out our volunteer contributor program, $0.2 million related to RSUs expense mentioned above, and $0.2 million related to tender offer costs, neither of which occurred in the current year.

Direct marketing spend and other expenses as a percentage of revenue decreased for both periods presented as a result of applying learnings from past years, which enabled us to spend marketing expenses more efficiently.

General and Administrative. General and administrative expense increased $39.3 million, or 50%, to $117.8 million during the year ended December 31, 2022 from $78.6 million during the year ended December 31, 2021. The main drivers of this increase were related to the following:

•Increased stock-based compensation expense related to equity awards of $14.5 million, of which $14.5 million related to the founder awards which were granted upon the IPO and $6.1 million related to increased headcount. These increases were partially offset by costs incurred upon the IPO of $6.1 million related to increased stock-based compensation expense for the acceleration of founder stock options and RSUs, which did not occur again in the current year.

•Increased net employee related costs of $7.8 million, due to an increase of $9.6 million from increased headcount, partially offset by $1.8 million in one-time costs related to the tender offer which occurred in the year ended December 31, 2021 and did not occur again in the current year,

•Increased travel and meals expenses due to the easing of restrictions related to COVID-19 of $5.3 million,

•Increased rent related costs incurred to expand to our facilities footprint of $4.0 million,

•Increased insurance costs associated with being a public company of $2.0 million, and

•Other net increases of $5.7 million, due to increased headcount, professional fees, contractor expense, transaction costs and sales and VAT taxes.

Interest Income

Interest income increased $7.2 million during the year ended December 31, 2022 due to an increase in interest rates earned on our money market funds.

Other (Expense) Income, Net

Other (expense) income, net decreased $0.7 million, during the year ended December 31, 2022, mainly the impact from changes in foreign currency rates.

Provision for Income Taxes

Provision for income taxes increased $0.8 million, during the year ended December 31, 2022, primarily attributable to estimated foreign tax expense as well as the impact, for US federal income tax purposes, of the capitalization of research and development expenses in accordance with Internal Revenue Code ("IRC") Section 174.

Liquidity and Capital Resources

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Since inception, we have financed operations primarily through revenues and the net proceeds we have received from the issuance of equity.

As of December 31, 2022, we had $608.2 million in cash and cash equivalents. Our cash and cash equivalents primarily consist of bank deposits and money market funds. Our marketable securities consist of 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. 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 of December 31, 2022, we had deferred revenues of $157.6 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:

Operating Activities

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 ended December 31, 2022 increased $44.5 million, or 485%, to $53.7 million. This increase was mainly due to the decrease of net loss adjusted by stock-based compensation expense, in addition to an increase in deferred revenue.

Investing Activities

Cash used in investing activities increased $8.0 million, or 128%, to $14.2 million for the year ended December 31, 2022, from $6.2 million for the year ended December 31, 2021. The increase was due to increased costs from capital expenditures to purchase property and equipment to support office space and site operations, capitalization of software development and the acquisition of Gunner Made LLC.

Financing Activities

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Cash provided by financing activities for the year ended December 31, 2022 was $14.8 million, which was from proceeds from exercises of stock options. Cash provided by financing activities for the year ended December 31, 2021 was $430.5 million and was driven by the net proceeds from the IPO of $431.1 million less costs of $4.9 million, and proceeds from exercises of stock options of $12.5 million. These increases were partially offset by cash paid in the prior year for the tender offer of $8.2 million, which did not reoccur.

Contractual Obligations

The following table summarizes our contractual obligations and commitments as of December 31, 2022:

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(1)Consists of future non-cancelable minimum rental payments under operating lease obligations, excluding short-term leases.

(2)Other commitments consist of hosting costs, with a committed spend of $12.5 million remaining from a two year contract entered in the prior 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.

Critical Accounting Policies and Estimates

The preparation of our Consolidated 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 the 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.

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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 purchase Super Duolingo 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 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 neither been proctored nor expired.

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

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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 the SEC 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-coupon US 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.

Restricted Stock Units (RSUs)

We began to grant RSUs in November 2020. The fair value of RSUs is estimated based on the fair value of our common stock on the date of grant. For awards granted prior to the IPO, each RSU award vested 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 was satisfied upon the occurrence of the IPO on July 30, 2021, and $2,035 of stock-based compensation expense was recognized related to those awards. For awards granted subsequent to the IPO, each RSU vests based upon the satisfaction of length of service. We measure and recognize compensation expense for all stock-based awards based on the estimated fair value of the award.

Performance-based RSUs

In June 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

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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 in July 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 the American 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;

•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.

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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 of December 31, 2022, we maintained a valuation allowance of approximately $108,504 against our domestic net deferred tax assets primarily related to net operating loss carryforwards, research and development credit carryforwards and research and development expense capitalization.

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.

Internal Use Capitalized Software

We capitalize certain costs related to the development of our platform and other software applications for internal use. In accordance with authoritative guidance, we begin to capitalize our costs to develop software when preliminary development efforts are successfully completed, management has authorized and committed project funding, and it is probable that the project will be completed and the software will be used as intended. We stop capitalizing these costs when the software is substantially complete and ready for its intended use, including the completion of all significant testing. These costs are amortized on a straight-line basis over the estimated useful life of the related asset, generally estimated to be three years. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditure will result in additional functionality and expense costs incurred for maintenance and minor upgrades and enhancements. Costs incurred prior to meeting these criteria together with costs incurred for training and maintenance are expensed as incurred and recorded within research and development expenses in our consolidated statements of operations.

We exercise judgment in determining the point at which various projects may be capitalized, in assessing the ongoing value of the capitalized costs and in determining the estimated useful lives over which the costs are amortized. To the extent that we change the manner in which we develop and test new features and functionalities related to our platform, assess the ongoing value of capitalized assets or determine the estimated useful lives over which the costs are amortized, the amount of internal-use software development costs we capitalize and amortize could change in future periods.

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 II, Item 8 of this Annual Report on Form 10-K for a discussion of Recent Accounting Pronouncements.

Emerging Growth Company Status

Upon completion of the IPO, the Company qualified as an Emerging Growth Company ("EGC"), as defined in the Jumpstart Our Business Startups Act, and previously elected to take advantage of the extended transition period for the adoption of new or revised accounting standards available to EGCs. Effective December 31, 2022, the Company lost EGC status as a result of becoming a “large accelerated

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filer." As a result, we are no longer able to take advantage of the reduced disclosure requirements applicable to an EGC.